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BANK CREDIT DEPARTMENT
Simona Cioffi
ASSESSING CREDIT RISK OF COUNTRIES
AND FINANCIAL INSTITUTIONS
Brescia, May 27th 2014
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Bank Credit Department
Summary
Introduction to Bank Credit Department
Risk from Pillar I: Credit risk
Standardised Approach
Country analysis
Bank analysis
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Bank Credit Department
credit analysis of countries;
credit analysis of domestic and international financial institutions using
standardised approach;
providing trade finance solution (L/Cs with postfinancing/deferred payment;
bank guarantees; stand by L/Cs; ECA backed transaction; credit insurance)
for all UBI Group’s legal entities in order to promote international trade;
Suggesting a price range for all trade finance business (confirmed L/Cs; L/Cs
with postfinancing/deferred payment; bank guarantees; stand-by L/Cs; ECA
backed transaction);
issuing of foreign guarantees;
relationship with ECA’s (Export Credit Agencies) such as SACE and EBRD,
IFC, etc.
Bank Credit Department – Mission -
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Bank Credit Department
LOANS
LETTERS OF CREDIT
SYNDICATED LOANS
FINANCIAL GUARANTEES
DERIVATIVES TRADE
MONEY MARKET OPERATIONS
FOREX EXCHANGE
Credit risk - transactions involved
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Bank Credit Department
• CREDIT RISK POLICY (POLICY RISCHI CREDITIZI)
• COUNTRY AND COUNTERPARTY CREDIT RISK REGULATION (REGOLAMENTO RISCHIO CONTROPARTI ISTITUZIONALI E PAESE)
• CREDIT FACILITIES TO CAP MAXIMUM EXPOSURE TO REACH
Credit risk - rules
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Bank Credit Department
PILLAR I RISKS as follows:
CREDIT RISK the risk of incurring losses resulting from the default of a
counterparty. This also comprises counterparty risk in the definition; it is the
risk that a counterparty defaults before the transaction itself is settled;
MARKET RISK risk of changes in the market value of financial instruments
held, due to unexpected changes in market conditions and/or in the credit
rating of the issuer
OPERATIONAL RISK the risk of incurring losses resulting from the inefficiency
or procedures failure, human error, business disruption, system failure and
so on
Credit risk - definition
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Bank Credit Department
is the risk of loss arising from the inability or failure of an obligor (borrower or counterparty) to meet its obligations.
CREDIT RISK
Risk arising from the creditworthiness of trading partners
COUNTERPARTY RISK
Credit risk – UBI characteristic risk
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Bank Credit Department
There are three broad approaches to credit risk (1) (Basel II) :
1. Standardised approach;
2. Bank’s internal rating systems (IRB);
3. Advanced bank’s internal rating systems (A-IRB)
(1) (the standardized approach to credit risk, Basel Committee on banking supervision (january 2001)
UBI GROUP APPLIES: BORROWER
STANDARDISED
APPROACH SOVEREIGN INSTITUTIONAL
BANK’S INTERNAL RATING
SYSTEM
ADVANCED INTERNAL
RATING SYSTEM
CORPORATE (2012.06.16
provision n.423940)
RETAIL
(2013.07.19 provision
n.689988)
Credit risk - analyses
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Bank Credit Department
• Long-term Issuer Default Rating
• The ability to meet financial commitments in the long-term, independently of the maturity of individual obligations. This rating is an indicator of the probability that an issuer will default.
• AAA: best rating – D: default
FITCH
• Long-term debt and deposit rating
• The ability to repay long-term debt (maturing in or after one year) in local currency.
• (Aaa: best rating – C: default)
Moody’s
• Long-term Counterparty Credit Rating
• The issuer credit rating reflects the agency’s opinion of the intrinsic creditworthiness of the bank combined with an assessment of the potential for future support that the bank might receive in the event of default .
• (AAA: best rating – D: default
Standard and
Poor’s
External Credit Assessment Institutions
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Bank Credit Department
…
FITCH LONG TERM
ISSUER DEFAULT RATING
MOODY’S LONG TERM
DEPOSIT RATING
STANDARD AND POOR’S LONG TERM COUNTERPARTY CREDIT
RATING
RISK COUNTRIES
LOW RISK BBB- <SOVEREIGN
RATING< A
MEDIUM RISK BB- <SOVEREIGN
RATING< BB+
HIGH RISK UNRATED
<SOVEREIGN RATING< BB-
NO RISK COUNTRIES
= OECD belonging
Countries - categories
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Bank Credit Department
SOVEREIGN RISK
COUNTRY RISK
COUNTRY RISK
covers the downside
of a country’s
Business environment
including legal
environment, levels of
corruption, and
socioeconomic
variables such as
income disparity
SOVEREIGN RISK
COUNTRY RISK
SOVEREIGN
RISK
capture the risk
of a country
defaulting on its
debt obligations
Sovereign risk - country risk
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Bank Credit Department
general legislation;
business legal environment;
corruption;
political stability;
good government;
regulation;
size and potential of domestic market;
education, literacy rates and technological sophistication
Country risk – key factors
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Bank Credit Department
CORRUPTION PERCEPTION INDEX – CPI – cpi.transparency.org
GLOBAL COMPETITIVENESS INDEX - GCI -
www.weforum.org/reports/global-competitivenes
DOING BUSINESS RANKINGS www.doingbusiness.org
UNITED NATION HUMAN DEVELOPMENT INDEX - HDI - hdr.undp.org
WORLD BANK POLITICAL RISK INDICATOR
Country risk – major indices widely available
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Bank Credit Department
SOVEREING RISK
COUNTRY RISK
Country limits are set in order to constrain the risks potentially arising from country-specific or region specific event.
Country risk - exposure
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Bank Credit Department
INVESTMENT GRADE COUNTERPARTY / NON INVESTMENT GRADE COUNTERPARTY
FITCH LONG TERM ISSUER
DEFAULT RATING
MOODY’S LONG
DEPOSIT RATING
STANDARD AND POOR’S
COUNTERPARTY CREDIT
RATING
LONG TERM FOREIGN
CURRENCY ISSUER
DEFAULT RATING
High Investment grade in no
risk countries (AAA to A-)
Investment grade in no
risk countries (BBB+ to
BBB-)
Non investment grade in no
risk countries (BBB- to unrated)
Investment grade in risk
countries (BBB to BBB-
)
Non Investment
grade in risk countries (BBB+ to
BBB-)
Non Investment
grade in risk countries
(BB+ to B-)
Case by case assessment
Counterparty risk - categories
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Bank Credit Department
Counterparty risk – financial counterparties
BANKS AND BANKING GROUPS –
Institution licensed as a receiver of deposits and a lender of loans
SECURITIES FIRMS AND GROUPS HEADED BY A SECURITIES FIRM
ASSET MANAGEMENT COMPANIES AND SICAVS
FINANCIAL INTERMEDIARIES REFERRED TO IN ARTICLE 107 OF THE CONSOLIDATED LAW ON BANKING
ELECTRONIC MONEY INSTITUTIONS - EMIS
PAYMENT INSTITUTIONS
FINANCIAL CONGLOMERATES
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Bank Credit Department
Counterparty risk – bank balance sheet – income statement
100 100
less LOAN LOSSES RESERVE 50
INTEREST
BEARING
LIABILITIES
SECURITIES BORROWING
OTHER
ASSET
EARNING
ASSETS
350
CUSTOMER DEPOSITS TOTAL GROSS LOANS CUSTOMERS500
BANK ASSETS BANK LIABILITIES
100 EQUITY
400
350
150
CASH DUE TO BANKS
L
IQ
UID
IT
Y
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Bank Credit Department
• First part of the two-tier risk based capital standard commonly used by regulatory agencies to assess a financial institution's capital adequacy.
• TIER 1 CAPITAL / TOTAL RISK-WEIGHTED ASSETS
TIER 1 RATIO
•a loan is non performing when payment of interest and principal are PAST DUE by 90 days or more
•NON PERFORMING LOANS / TOTAL LOANS
NPL ratio
•A decrease basically means banks were provisioning less for their bad debt.
• IMPAIRMENT ON LOANS / OUTSTANDING OR GROSS NON-PERFORMING LOANS
NPL coverage
ratio
• Indicates the percentage of a bank's loans funded through deposits
•Maximum 80% to 90% (the higher the ratio the more the institution is relying on borrowed funds)
•LOANS (GROSS) / TOTAL DEPOSITS
LOAN/DEPOSIT
RATIO
•Indicates how well management employed the earning asset base
•Net Interest Income (annualized) / Average Interest Earning Assets
NET INTEREST MARGIN
•it gives you the revenues split, how much revenues comes from the net interest income and how much derived from fees and trading gain
NET INTEREST INCOME
TO REVENUES
•Efficiency improves as the ratio decreases TOTAL NON-INTEREST EXPENSES / TOTAL NET INCOME
COST/INCOME RATIO
•it measures the proportion of a bank's total loans that have been lost due to NPL
•NET CHANGES IN IMPAIRMENT FOR CREDIT RISKS / AVERAGE OUTSTANDING LOAN PORTFOLIO
COST OF RISK
Counterparty risk – ratios analyses
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Bank Credit Department