When there is a counter-party failure in performing the repayment obligation on due date, it gives rise to low quality assets which in turn lead to Credit Risk. Like the interest rate risk and liquidity risk, credit risk is also an inherent feature of any from that is into the business of lending funds either to individuals or to a corporate (ICMR), Credit Management, 2004).
There has to be experience to scrutinize all the credit information and interpret the same. However good the analyses may have been, the bank will be in no position to distinguish a good borrower from a bad borrower, who has no intention of repaying the loan. Despite all the caution, bad loans do creep into the banks accounts. Thus, evaluation and pricing decisions should be followed up with periodic review of the account and the credit rating of the borrower. Any fall in the rating will increase the credit risk. Credit risks persist from the time the loan is granted throughout its life period and continuous review during this period will help in the early detection of the problem loans.
The above information is for monitoring the credit risk exposure at a micro level. If a broader outlook of the credit risk exposure and its position is to be determined, then a macro level approach has to be adopted. This is made possible through the use of the Capital Adequacy Ration (CAR). The capital adequacy of a bank, which is the ratio of its capital to its risk weighted assets (RWAs), provides information about the extent to which the possible losses can be absorbed by the capital. Normally, the ultimate defense against credit risk that a bank possesses will be its equity capital or net worth. If from an earnings position, it turns out into an operating losses position, it would be the equity capital account that absorbs such losses, thereby giving management time to reach to the situation. Therefore, it can be said that the higher the CAR the better it is for the financial institution.
The main aim of the credit policy of a bank will be to screen out the best proposals for acceptance. The Capital Adequacy rate provides a benchmark for monitoring the risk level considering the total assets of the company.
Commercial banks provide capital market related services, depository services, advises on portfolio management or investment counseling, etc. Many banks have now started offering investment services to the retail customer, which is essentially advice and execution of mutual fund investments and redemptions.
CAPITAL MARKET PRODUCTS
Advice on debt and equity is restricted primarily to new issues, with secondary market investments being discouraged. There are no charges for this service; in fact, customers are paid incentives/commissions for investing through them. The bank essentially gets its income from the mutual fund/broker directly and also cross-sells other banking products. Arbitrage, stock lending are products, which are beyond traditional asset management but still many banks are offering them to retain their customers ((ICMR), Commercial Banking, 2003).
Portfolio Management Services offered by banks can be differentiated into discretionary and non-discretionary services. Discretionary portfolio management allows the portfolio manager to take investment decisions on behalf of his/her clients within the broad parameters of asset allocation. Non-discretionary services of the type provided by banks essentially mean that the client has to authorize, every transaction done on his/her behalf. The non-discretionary services offered by a banker can be listed as follows:
Advisory services - Flexible, unbiased ...
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(Credit Risk Essay Example | Topics and Well Written Essays - 3000 Words)
“Credit Risk Essay Example | Topics and Well Written Essays - 3000 Words”, n.d. https://studentshare.net/business/290380-credit-risk.
Exactly one year later, its stock price had fallen by 94% to $3.75. At the onset, United States federal officials and additional regulators attempted to access the capital markets to alleviate the liquidity crisis. Afterward, the Federal Reserve Bank’s Board of Governors declared a bailout plan to rescue AIG from a looming collapse because it feared that AIG’s collapse would be a threat to the overall state of the economy.
The concept of credit risk can be simply described as an investor’s risk of loss due to a borrower’s failure to make payments as promised. Such an event of loss is termed as default. According to the Basle Committee, the international banking supervisory body, inadequate credit risk management continues to be the most threatening issue in the modern banking industry.
It is similar to a linear regression model but is suited to models where the dependent variable is dichotomous. Logistic regression coefficients can be used to estimate odds ratios for each of the independent variables in the model.” In order to run binary logistic regression model to find out the dependence of various variables on Credit Risk, the following steps are taken: 1.
Today, bankers are increasingly becoming conscious about recent developments in their respective markets and have resorted into various method of managing credit risk. Risk management appears to have improved in most regions as a result of the introduction of new approaches to the allocation of credit as well as better measurement and pricing of the various risks (BIS Paper No 33, 2005).
All these dynamics will be critically analysed in the subsequent sections of the essay. (Investment Bank Watch, 2008)
For effective credit risk management, banks ought to consider a wide range of issues. Experts within the region's banking industry agree that in order for this to be done, and then there should be sound business processes and robust technology.
However the modern banking industry is vastly different from the olden days of banking. Present day banks are commercial profit making 'organizations'. They are faced with the challenge of meeting the ever changing demands of the '3 Cs'. The 3Cs (Customer, Change & Competition) play a very crucial role in the long term stability of a bank.
The two different branches of banking namely commercial banking and investment banking have different purposes and though both involve credit risk which is fundamental in their operations, the methods of assessing and managing them differ. Investment banking deals with raising of funds in the capital market by issuing and selling securities.
Nickel et al. (2001) is the only paper which tests the predictive ability of portfolio models on an out-of-sample basis.
The major reason for the scarcity of research is the lack of data suitable for back testing (cf. Jackson and Perraudin, 2000). In this paper, I therefore use Monte Carlo simulations to quantify the accuracy of credit risk models.
Normally, a sound lending procedure includes not only identifying and segregating the high-risk applicants from those who are prospective applicants but also the process of modifying the offered loan conditions such as loan
Residual income is what remains after required return on equity is deducted from the net income. The residual earnings model attempts to adjust the estimates of a firm’s future earnings, to account for the equity cost and place a more accurate
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