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Credit Risk Management plays a vital role in the banking operations. The management of credit risk is of diverse nature and the techniques are different and varied.
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Trends in Credit Risk Management:Can Systemic Banking Crises Be Avoided?
Ernest D. Napier, Managing DirectorFinancial Services Ratings
Standard & Poor’s, New York
Oslo, NorwaySeptember 12, 2002
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Agenda
I. Revisiting the Past: What Went Wrong Last Time Around?
II. Exploring New Advances and Techniques in Credit Risk Management
III. Navigating the Potential Roadblocks
IV. What Lies Ahead: Can Banks Learn From Their Mistakes?
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4
Nordic Financial Institutions Ratings 1996
vs 2002
0123456789
10
AA
A
AA
+
AA
-
A+ A A-
BB
B+
BB
B
No
L/T
rat
ing
Num
ber
of r
atin
gs
19962002
5
Global Banking Crises
Source: International Financial Statistics
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A Deadly Chain Reaction
The Asset The Asset Quality CycleQuality Cycle
ProfitabilityProfitability
LiquidityLiquidity
CapitalizationCapitalization
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Nordic BanksRisk Management Scorecard
Parameter Pre-Crisis Post-Crisis Change
Loan Growth Rapid Moderate
Customer Exposures Extremely Large Large
Industry Exposures Large Large
Underwriting Process Weak Satisfactory
Provisioning Policies Adequate Adequate
Risk Awareness Low High
Financial Flexibility Moderate Good
Regulatory Environment Inadequate Adequate
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The New Frontier: Greater Volatility
•Interest Rates
•Exchange Rates
•Borrower Credit Quality
Shareholder Expectations
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PORTFOLIO MANAGEMENT
CREDIT MODELS
DERIVATIVES
ASSET SECURITIZATIONS
LOAN SALES
DYNAMIC PROVISIONING
CREDIT INSURANCE
Bankers Toolbox
New Developments in Credit Risk Management
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The Role of Models
Automate Mechanical Tasks Provide Base Line for Comparison Speed Surveillance Simulate Complex What If Scenarios Decision Making Tools
– Analyze Complex Multidimensional Interactions
– Optimization over Several Variables
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Various Types of Modeling
Rating Estimate ModelsProbability of Default ModelsRecovery ModelsCorrelation ModelsPortfolio Loss Models
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System Functionality
Trading
Portfolio Accounting
Portfolio Analytics
Market Risk Management
Credit Risk Management
Performance Attribution
Performance Measurement
Alg
orit
hmic
s
As k
a ri
Bar
ra
Bl a
c kR
ock*
dbR
iskO
ffic
e
Glo
beO
p
Mea
suri
ck
Ris
kMet
rics
Sun
Gar
d
Wil
shir
e
No Yes Limited Planned * Fixed Income Only
SourceSource: Risk Magazine
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Modeling Capability Probability density versus RGD and
collateral
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Modeling CapabilityProbability Density Versus RGD and
Default Rate
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Modeling Capabilty Point Probabilities Versus Debt Cushion
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Model Risk Prevails
Models Assume Steady State Markets, Not Systemic Shocks
Sensitive to Look back Period Chosen and Other Assumption
Even Stress Scenarios Are Only As Good As Those Who Design Them
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‘Unexpected’ Financial Shocks
1987 1990 1992 1994 1995 1997 1998 1999 2000 2001
1987 StockMarket Crash
1990 NikkeiCrash
1990 HighYield Tumbles
1992 EuropeanCurrency Crisis
1994 US InterestRate Hike
1994—1995Mexican Peso Crisis
1995 LatinAmerican Crisis
1997 Asian Crisis
1998 Russian Crisis
1998 LTCM
1999 Brazil Crisis
2000Tech
Meltdown
2001 Tech Meltdown
911 TerroristAttacks
Source: Risks Magazine
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Default Rates For Static Pools 1981-2000
CCC B BB BBB A AA AAA
1 year Average Rate 21.94 8.3 .94 .22 .05 .00 .00
3 Year Average Rate 34.37 21.00 4.62 0.74 0.17 0.00 0.03
Cumulative
Minimum (3 yr) 6.67 8.24 1.22 0.00 0.00 0.00 0.00
Maximum (3yr) 58.33 24.38 14.18 2.99 1.15 0.86 0.45
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Who Absorbs the Credit Losses?
Expected Loss Distribution
Average expected losses Covered by risk premium
Covered by most subordinated tranche, equity, or reserve account
Covered by next most subordinated tranche
Covered by investment grade tranches
Typical Asset Securitization Transaction
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Global Banks: Ratings Distribution
0%
10%
20%
30%
40%
50%
60%
70%
AAA AA A BBB BB & B CCC
Ratings
19901995
2000
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Average Ratings of Major International Banks
1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000
AAA
AA+
AA
AA-
A+
A
A-
BBB+
BBB
Australia
US
UK
France
Nordic
Japan
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Credit Trends: This Time Around?
Moderate increase in total leverage via the banking sector
More pronounced increase in household sector leverage
Continued disintermediation (growth of the corporate bond market)
Improved credit assessment in banking
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All banks tend to relax their lending standards during periods of economic prosperity.
Good credit judgment will often be ignored due to competitive pressures.
Banks cannot escape the impact of the market conditions and regulatory environments in which they operate.
Key Points
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Contact Information
• Ernest D. Napier, Managing Director• Telephone (1) 212 438-7397 • Fax (1) 212 438-7375• [email protected]
