Rm 10
- 1. Risk Management University of Economics, Kraków, 2012 Tomasz Aleksandrowicz
- 2. credit risk management credit risk definition credit bureau and rating agencies credit risk management
- 3. credit risk
- 4. Rating • evaluation or assessment of something • quality rating • quantity rating • combined rating 4
- 5. credit rating • estimation of credit worthiness • ability of debt repayment by potential borrower • credit rating assigned to: – private individual – security (e.g. bond, derivative) – security issuer (e.g. corporation, government, municipalities, SPV, NGO) • provided by credit bureau / rating agency 5
- 7. credit bureau 7
- 8. credit bureau • credit bureau / consumer credit reporting agency (UK) • target private individuals • evaluation made on overall credit history and current assets and liabilities • data collected from credit institutions (banks, credit unions, corporations) • users of rating pays for rating 8
- 9. criteria for private credit score • debt • usage of credit lines (i.e. credit cards) • ability to pay a loan • saving patterns • spending patterns • interest • other (equality issues) 9
- 10. FICO credit score formula
- 11. 11
- 12. corporate and sovereign rating
- 13. Rating agency • assigns credit ratings for issuers of certain types of debt obligations • target non-individuals: enterprises, organisations and governments • evaluation made on company data (annual/quarterly reports) • analysis of company statement using financial analysis tools and methods • short term and long term debt rating • debt issuer pays for rating 13
- 14. rating agencies 14
- 15. Long-term credit ratings (I)(S&P) investment grade • AAA: the best quality borrowers, reliable and stable (many of them governments) • AA: quality borrowers, a bit higher risk than AAA. Includes: – AA+: equivalent to Moody's and Fitch Aa1 – AA: equivalent to Aa2 – AA-: equivalent to Aa3 • A: economic situation can affect finance – A+: equivalent to A1 – A: equivalent to A2 • BBB: medium class borrowers, which are satisfactory at the moment 15
- 16. Long-term credit ratings (II)(S&P) non-investment grade • BB: more prone to changes in the economy • B: financial situation varies noticeably • CCC: currently vulnerable and dependent on favorable economic conditions to meet its commitments • CC: highly vulnerable, very speculative bonds • C: highly vulnerable, perhaps in bankruptcy or in arrears but still continuing to pay out on obligations • CI: past due on interest 16
- 17. Long-term credit ratings (III)(S&P) non-investment grade • R: under regulatory supervision due to its financial situation • SD: has selectively defaulted on some obligations • D: has defaulted on obligations and S&P believes that it will generally default on most or all obligations • NR: not rated 17
- 18. Short term credit ratings (I)(S&P) • A-1: obligor's capacity to meet its financial commitment on the obligation is strong • A-2: is susceptible to adverse economic conditions however the obligor's capacity to meet its financial commitment on the obligation is satisfactory • A-3: adverse economic conditions are likely to weaken the obligor's capacity to meet its financial commitment on the obligation 18
- 19. Short term credit ratings (II)(S&P) • B: has significant speculative characteristics. The obligor currently has the capacity to meet its financial obligation but faces major ongoing uncertainties that could impact its financial commitment on the obligation • C: currently vulnerable to nonpayment and is dependent upon favorable business, financial and economic conditions for the obligor to meet its financial commitment on the obligation • D: is in payment default. Obligation not made on due date and grace period may not have expired. The rating is also used upon the filing of a bankruptcy petition. 19
- 20. Rating classes comparation 20
- 21. rating agencies criticism • not downgraded companies promptly enough • too familiar a relationship with rated company management • errors of judgment in rating structured products • oligopoly allegations 21
- 23. standardized (default) approach • risk depends on exposure type • banks are using ratings from external Credit Rating Agencies • ratings used for quantification of required capital for credit risk • in many countries it is the only method used by regulators 23
- 24. standardized approach - risk weights 24
- 25. Key elements of IRB methods • EC (economic capital) = EL (expected loss) + UL (unexpected loss) • PD (probability of default) • EAD (exposure-at-default) • LGD (and other parameters) 25
- 26. expected and unexpected loss (I) 26
- 27. expected and unexpected loss (II) • EL (expected loss) = PD x EAD x LGD • When default occurs, the actual loss is the combination of – exposure at default – loss given default • UL (expected loss) – complex calculations 27
- 28. PD • default –an event when counterparty is stopped its debt payment • usually after 90 days • state for the counterparty—is in default or not • depends on counterparty characteristics • could be simplistic or modular • could be based on banks’s own data or data bought from outside vendor 28
- 29. EAD • credit exposure • economic value of the claim on the counterparty at the time of default • depends on type of exposure (i.e. credit, derivative) 29
- 30. LGD • represents the fractional loss due to default • LGD = 1 – recovery rate • strictly empirical issue • recovery rate depends mainly on: – exposure characteristics – seniority/status of the debt – economy cycle • importance of collateral / collateral seniority 30
- 31. foundation internal ratings-based approach (F-IRB) • banks are using internal rating system • rating system is self-developed (based on bank’s data) • bank’s own model to calculate PD (probability of default) • regulators calculated LGD (and other parameters) • risk-weighted assets (RWA) is calculated • regulatory capital is fixed percentage of risk-weighted assets 31
- 32. advanced internal ratings-based approach (A-IRB) • banks are using internal rating system • rating system is self-developed (based on bank’s data) • bank’s own model to calculate – PD (probability of default) – EAD (exposure-at-deafult) – LGD (loss-given-default) • risk-weighted assets (RWA) is calculated • regulatory capital is fixed percentage of risk-weighted assets 32
- 33. credit risk models • no universal solution • best known models – CreditMetrics (JP Mogran) – CreditRisk+ (Credit Suisse) – KMV (Moody’s KMV) – CreditPf.View (McKinsey) • many banks has its own models/variations 33