Credit Portfolio Risks

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Credit Portfolio Risks


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What is Portfolio Credit

Risk? Credit exposure to a group of similar

borrowers is called portfolio credit risk

While firm-level credit risk analysis focuseson micro-credit risk or borrower level, creditportfolio risk analysis focuses on the macro-credit risks or studies the credit risk

behaviour of a group of borrowers / creditassets


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Why Portfolio Credit

Analysis Credit portfolio cannot be managed

efficiently unless portfolio credit risks areknown

Awareness of portfolio is a must to identify,monitor, and control risk concentrations andcorrelations on an ongoing basis

To monitor the credit quality of the loan

portfolio All banks with sizeable credit portfolio desire

to have optimum diversification


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Benefits of Portfolio

Credit Risk Study Proper management of portfolio credit risk can

reduce the portfolio risk below the total or averageof firm credit risks

Facilitates active credit portfolio management Enables maturity matching Optimises liquidity Helps Sales and Marketing Gives insights into sectoral/ industrial risk

exposures To calculate the risk based capital requirement Helps in devising portfolio management strategies


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Basel Accords and Credit

Portfolio Basel accords adopt a portfolio

approach in determining credit risks

and fixing capital needsAt portfolio level, controls are imposed

in the form of risk weights


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Credit portfolio Risk

Variables

Credit Portfolio Risk

Systematic Risk Non- Systematic Risk

Asset Class

Collateral RiskCurrency Risk

Maturity RiskQuality Risk

Location RiskIndustry Risk

Exposure RiskExternal Risks


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Systematic Risks

Systematic Risk is common to the economy orcountry as a whole,

Cannot be eliminated by combining the assets in a

large and well diversified portfolio Hence, known as non- diversifiable risk

Examples are economic shocks and foreignexchange crises

In depth awareness of systematic risks helps thebank to design appropriate policies to protect andenhance the quality of the portfolio, ensuringadequate returns


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Diversifiable Risks

1.Asset Class:

Credit assets are derived from many types

of customers

small, medium and large. Each type of customers shows distinct

features

If the credit portfolio consists mainly of oneasset class, portfolio risk tends to berelatively higher


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Diversifiable Risks

2. Exposure Risk:

The amount exposed to s credit risk is

termed as exposure risk

Even when the firm credit risk isacceptable, concentration of exposures

in a few customers can spell doom


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Diversifiable Risks

3. Industry Risks:

An ideal portfolio ought to be balanced, with

a differing mix of obligors originating fromdifferent industries, and of various sizes andtypes

Modern methods determine scientifically thetype and extent of diversification required inthe portfolio.


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Diversifiable Risks

4. Region / Location/ CountryRisks

Portfolio scattered over a wide areaoffers comfort from the portfolio riskspoint of view

If the external credit exposure has asignificant role, it is better to disperseamong several countries


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Diversifiable Risks

5. Quality Risks

Ideally, it is better to fill the credit portfolio withAAA category credit assets.

Usually, banks have a target quality of portfolio inmind- say 92% to 95% of the total portfolio oughtto be higher than BBB (medium credit risk) anddevise strategies to attain this

Both default and migration probabilities of aparticular industry sector or a group of customersor different risk grades should be studied tounderstand the quality risk of the portfolio


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Diversifiable Risks

6. Maturity Risks:

The average maturity of the portfolio

should be effectively managed in orderto avoid liquidity problems

Maturity depends on the nature of the

business Constant watch on the asset-liability

situation is necessary


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Diversifiable Risks

7. Currency Risks

When obligations to be met from the

realisation of credit assets are denotedin different currencies, currency riskimpacts

Diversification and hedging areconsidered effective solutions tocurrency risks


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Diversifiable Risks

8. Collateral Risk

If the banks accept only one kind of security, asharp fall in the value of the security impacts the

portfolio risk Market correlation among the collateral securities

the concentration risks of the collateral portfolioand

The capacity of the market to absorb the sale of thecollateral in times of counter party default,

Necessitates diversification of collaterals


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Firm Risks and Portfolio

Risks Portfolio Risks and firm credit risks are interlinked,

Because a portfolio does not exist unless there areseveral credit assets

Portfolio credit risk is the agglomeration of severalindividual firm risks

The major milestones on the road to credit loss aremigration, default, loss given default an ultimate

write offs A study of the above helps the bank in assessing

the firm and portfolio credit risks


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Impact of Portfolio Credit

Risks In the case of a reasonably spread portfolio, not all

firm credits will default at the same time

By intelligent diversification, the portfolio risks can

be lowered below the sum of the individual creditrisks

Study of migration risks, default risk and credit lossat portfolio level is often linked to the stages of thebusiness cycle

Portfolio managers try to rein in migration risks byshuffling portfolio, seeking altered collaterals andby using other portfolio management measures


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Portfolio Credit risk

Mitigants Traditionally, all unsystematic risks can be diversified The three principal types of diversification are:1.Counter- party limit : The central bank usually stipulates

maximum credit to a specific party. For example, it may be

stipulated that a single credit exposure to any counter- partyshould not exceed 10% of the TNW of the creditor

2.Region wise restriction: Usually large and multinational banksadopt this

3.Industry Limit: Industries are categorised according risks andexposures to each industry is regulated according to this

Credit Derivatives have been heralded as path-breakingproducts that enable financial institutions to manage creditrisks


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Thank You

Credit Portfolio Risks

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