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CREDIT RISK MANAGEMENT

CREDIT RISK MANAGEMENT. THE COMMODITISATION OF CREDIT RISK TRENDS IN CREDIT RISK MANAGEMENT. KEY PROPOSITION. THE ADVENT OF ACTIVE AND LIQUID CREDIT TRADING WILL REQUIRE COMPLETE RE-ENGINEERING OF THE CREDIT FUNCTION & PROCESS ALTER THE NATURE OF BANKING FUNDAMENTALLY. AGENDA.

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CREDIT RISK MANAGEMENT

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  1. CREDIT RISK MANAGEMENT THE COMMODITISATION OF CREDIT RISK TRENDS IN CREDIT RISK MANAGEMENT

  2. KEY PROPOSITION • THE ADVENT OF ACTIVE AND LIQUID CREDIT TRADING WILL REQUIRE • COMPLETE RE-ENGINEERING OF THE CREDIT FUNCTION & PROCESS • ALTER THE NATURE OF BANKING FUNDAMENTALLY

  3. AGENDA • KEY DRIVERS OF CHANGE • CREDIT RISK MANAGEMENT PARADIGMS • CLASSICAL • MODERN • CREDIT RISK MANAGEMENT ARCHITECTURE • IMPLICATIONS FOR FINANCIAL SERVICES

  4. KEY DRIVERS OF CHANGE • KEY FEATURE OF CREDIT RISK • CENTRAL TO ALL FINANCIAL TRANSACTIONS • TRADITIONAL VIEW OF CREDIT • ILLIQUID • CURRENT VIEW OF CREDIT • LIQUID & TRADEABLE • SHIFT FROM STATIC MANAGEMENT OF CREDIT TO DYNAMIC MANAGEMENT OF CREDIT RISK

  5. KEY DRIVERS OF CHANGE • SHAREHOLDER VALUE ISSUES • RETURN ON CREDIT CAPITAL • OPTIMISATION OF RETURN ON CREDIT CAPITAL • CHANGES IN FINANCIAL SERVICES • VALUE CHAIN IN FINANCIAL SERVICES • TREND TO UNBUNDLING THE MICROSTRUCTURE

  6. PRODUCT/ KNOWLEDGE MANAGEMENT CAPITAL MANAGEMENT RISK MANAGEMENT TECHNOLOGY MANAGEMENT RISK ORIGINATION/ DISTRIBUTION PRODUCT MANUFACTURE PROCESSING/ ADMINISTRATION PRODUCT FOCUS CLIENT FOCUS

  7. KEY DRIVERS OF CHANGE CREDIT RISK MANAGEMENT PERFORMANCE CONTROL FAILURES QUANTIFICATION OF CREDIT RISK INTERACTION OF MARKET AND CREDIT RISK CREDIT RISK PRICING INABILITY TO PRICE CREDITR ISK “CORRECTLY” INCONSISTENCY OF PRICING

  8. KEY DRIVERS OF CHANGE COSTS OF CREDIT RISK MANAGEMENT INFRASTRUCTURE LIQUEFACTION OF CREDIT RISK SYNDICATION & ASSET SALES SECURITISATION CREDIT DERIVATIVES & CREDIT LINKED NOTES

  9. DEVELOPMENTS IN CREDIT ENHANCEMENT TECHNIQUES BI-LATERAL MULTILATERAL ADVANCES IN CREDIT/ DEFAULT RISK THEORY INFRASTRUCTURE DEVELOPMENTS SYSTEMS CAPABILITIES KEY DRIVERS OF CHANGE

  10. KEY DRIVERS OF CHANGE CHANGE IN REGULATORY FRAMEWORK SHIFT TO CAPITAL BASED REGULATION REGULATORY ARBITRAGE (POSSIBILITY) OF MODEL BASED CREDIT RISK CAPITAL

  11. KEY DRIVERS OF CHANGE KEY NEAR TERM FACTORS CREDIT CAPITAL MANAGEMENT CREDIT PRICING CREDIT RISK MANAGEMENT REGULATORY DEVELOPMENTS SHIFTS IN BANKING STRATEGY

  12. CREDIT RISK PARADIGMS TYPES CLASSICAL MODERN KEY ISSUE APPLICABILITY TO DIFFERENT MARKET SEGMENTS

  13. CREDIT RISK BY MARKET SEGMENT SEGMENTS RETAIL MID-MARKET WHOLESALE/ CORPORATES DIMENSIONS RISK PRICING CREDIT METHODOLOGY LIQUIDITY AND TRADEABILITY

  14. LARGE RETAIL MID-MARKET NUMBER OF COUNTERPARTIES WHOLESALE SMALL HIGH LOW SIZE OF INDIVIDUAL EXPOSURE

  15. CLASSICAL PARADIGM CONCEPT ASSESS RISK AND MATCH WITH CAPITAL RISK MANAGEMENT TECHNIQUES DIVERSIFICATION COLLATERAL SCHEMATIC

  16. CAPITAL • PROVISIONING • RISK SYNDICATION CREDIT RISK MANAGEMENT CREDIT REQUEST TRANSACTION CREDIT FUNCTION ORIGINATION CLIENT CREDIT LIMIT • TRANSACTION ORIGINATION • PREPARATION OF CREDIT REQUEST • PRICING/ STRUCTURING • ADMINISTRATION • CREDIT ASSESSMENT • MONITORING CREDIT LIMIT & CREDIT ADMINISTRATION

  17. CLASSICAL PARADIGM KEY ELEMENTS CREDIT ANALYSIS AND ASSESSMENT PROCESS

  18. IMPLICATIONS OF CLASSICAL PARADIGM CREDIT RISK ASSUMPTION CREDIT PRICING CREDIT CAPITAL MANAGEMENT CREDIT RISK FOCUS CHANGES IN CREDIT QUALITY PERFORMANCE ATTRIBUTION OF ORIGINATORS PERFORMANCE OF CREDIT FUNCTION

  19. MODERN PARADIGM CONCEPT CREDIT RISK AS A SEPARATE TRADEABLE ASSET CLASS RISK MANAGED DYNAMICALLY THROUGH HEDGING AND TRADING TOOLS SCHEMATIC

  20. TRANSACTION • TRANSACTION ORIGINATION • STRUCTURING/ PRICING • ADMINISTRATION ORIGINATION CLIENT CREDIT REQUEST CREDIT LIMIT & CREDIT CHARGE CREDIT FUNCTION • CREDIT ASSESSMENT • CREDIT PORTFOLIO ANALYSIS • CREDIT CAPITAL MANAGEMENT • SYNDICATION/ ASSET SALES • SECURITISATION • CREDIT DERIVATIVES CREDIT TRADING CREDIT PORTFOLIO CREDIT PORTFOLIO MANAGEMENT & POSITIONING CREDIT CAPITAL CAPITAL MARKET

  21. CREDIT RISK ASSUMED & MANAGED CREDIT CAPITAL TRANSACTION CREDIT RISK INTERNAL CREDIT DEFAULT SWAP CREDIT RISK CREDIT PORTFOLIO TRANSACTION ORIGINATOR RETURN CREDIT RISK CHARGE CREDIT HEDGES CREDIT RISK TRADED & HEDGED

  22. MODERN PARADIGM KEY ELEMENTS CREDIT ANALYSIS AND ASSESSMENT PROCESS

  23. IMPLICATIONS OF MODERN PARADIGM CREDIT RISK ASSUMPTION CREDIT PRICING CREDIT CAPITAL MANAGEMENT CREDIT RISK FOCUS CHANGES IN CREDIT QUALITY PERFORMANCE ATTRIBUTION OF ORIGINATORS PERFORMANCE OF CREDIT FUNCTION

  24. IMPLICATIONS OF MODERN PARADIGM CLIENT MANAGEMENT CORE VERSUS NON CORE CLIENTS HOME VERSUS FOREIGN MARKETS

  25. CREDIT RISK MANAGEMENT ARCHITECTURE CONCEPT RISK MANAGEMENT SYSTEMS COMPONENTS INFORMATION SYSTEMS SCHEMATICS

  26. CREDIT EXPOSURE - STATIC & DYNAMIC (PFCE MODEL) • DEFAULT PROBABILITY/ RATINGS MIGRATION • RECOVERY RATES • DEFAULT CORRELATIONS • PORTFOLIO MODELS • PRICING MODELS • RATING MODELS • INTERNAL • EXTERNAL CREDIT ANALYSIS CREDIT MODELS RISK DATA TRANSACTION DATA CREDIT DATA • COLLATERAL • NETTING • CLEARING HOUSE OBLIGOR/ COUNTERPARTY DATA CREDIT ENHANCEMENT • ECONOMIC CAPITAL • REGULATORY CAPITAL • PROVISIONING CREDIT CAPITAL MANAGEMENT LIMIT ADMINISTRATION REPORTING • SETTLEMENT LIMITS • RISK LIMITS

  27. IMPLICATIONS FOR FINANCIAL SERVICES • TYPES • MICRO(OPERATIONAL) • REDEFINITION OF CREDIT PROCESS WITHIN ORGANISATIONS • MACRO(STRATEGIC) • REDEFINITION OF BUSINESS FOCUS

  28. OPERATIONAL CHANGES • RE-ENGINEERING THE CREDIT PROCESS • ALTERATION OF CREDIT RISK ARCHITECTURE/ INFRASTRUCTURE

  29. STRATEGIC CHANGES • THEME • SHIFT FOCUS OF BANKS FROM HOLDER OF RISK TO ORIGINATORS AND DISTRIBUTORS OF RISK • MODELS OF BANKING PRACTICE

  30. MODEL 1 - CLASSICAL BANKING MODEL LOAN TRANSACTION DEPOSIT TRANSACTION DEPOSITOR BORROWER BANK BANK ORIGINATES, FUNDS, ADMINISTERS AND RETAINS CREDIT RISK OF BORROWER

  31. MODEL 2 - INVESTMENT BANKING/ SECURITIES MODEL ISSUE OF SECURITIES DISTRIBUTION OF SECURITIES INVESTOR BORROWER BANK UNDERWRITING OF PLACEMENT OF SECURITIES AND SYNDICATION OF UNDERWRITING RISK OTHER BANKS BANK ORIGINATES TRANSACTION AND MAY ADMINISTER IT AS PAYMENT AGENT. FUNDING AND CREDIT RISK OF BORROWER IS TRANSFERRED TO INVESTOR. PRIMARY RISK IS UNDERWRITING WHICH IS SYNDICATED TO REDUCE RISK LEVEL,

  32. MODEL 3 - SECURITISATION MODEL SALE OF LOAN BACKED SECURITIES LOAN TRANSACTION SECURITISATION VEHICLE BORROWER BANK INVESTOR SALE OF LOAN TO SECURITISATION VEHICLE BANK ORIGINATES AND ADMINISTERS THE LOAN. BANK SELLS LOAN TO SECURITISATION VEHICLE WHICH ISSUES LOAN ASSET BACKED SECURTIES. FUNDING AND CREDIT RISK OF BORROWER IS BORNE BY INVESTOR. BANK RISK IS CONFINED TO CREDIT RISK PRE-SALE TO SECURITISATION VEHICLE AND ANY UNDERWRITING RISK ON THE PLACEMENT OF THE LOAN ASSET BACKED SECURITIES

  33. MODEL 4 - ECONOMIC RISK TRANSFER MODEL LOAN TRANSACTION CREDIT DEFAULT SWAP OR CREDIT LINKED NOTE INVESTOR/ OTHER BANK BORROWER BANK BANK ORIGINATES, FUNDS AND ADMINISTERS THE LOAN. CREDIT RISK OF BORROWER IS TRANSFERRED TO INVESTORS OR OTHER BANKS. BANK CREDIT RISK IS PRE ECONOMIC HEDGE ONLY. WHERE A CREDIT LINKED NOTE IS ISSUED THE INVESTOR/ OTHER BANK ALSO PROVIDES FUNDING.

  34. KEY CHALLENGES • CREDIT RISK MODELLING PROBLEMS • DEVELOPMENT OF CREDIT TRADING • CREDIT ENHANCEMENT PROBLEMS • CHANGES IN CREDIT INFRASTRUCTURE • CHANGE MANAGEMENT

  35. CONCLUSIONS • THE ADVENT OF ACTIVE AND LIQUID CREDIT TRADING WILL REQUIRE • COMPLETE RE-ENGINEERING OF THE CREDIT FUNCTION & PROCESS • ALTER THE NATURE OF BANKING FUNDAMENTALLY

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