StudentShare solutions
Triangle menu

Credit Risk Models in Financial Institutions - Essay Example

Not dowloaded yet

Extract of sample
Credit Risk Models in Financial Institutions

The most critical factor that affects the 3Cs of a bank is 'Credit Risk'.
Banking is a domain where 'risk-free' activity is an unknown concept. Particularly in the field of credit appraisal, risk is associated with every decision made by the portfolio analyst. Although it is not possible to wipe out risk altogether, it can be reduced to a manageable level. Stated simply, 'zero-risk' situation is impossible to be achieved in banking.
There have been considerable discussions regarding the role of the portfolio analysts and credit officers in banks. It has been noted that in several cases, officers are forced to 'take' a decision rather than 'making' a decision due to the lack of freedom to analyze and make a decision based on the merits of the case. There are two ways of reaching to a decision; subjective and objective. A subjective decision is based on the impression the bank has about the counterparty. Although this method has a substantial role to play in the decision making process, an objective analysis instils a certain degree of integrity, security and refinement. Credit Risk Management is an activity of paramount importance for any bank. Effective risk management increases the stakeholder value by providing for 'value creation', 'value preservation' and 'capital optimization'. Credit Risk Modelling is the first step towards implementing a robust risk mitigation environment. Credit risk models are intended to aid banks in quantifying, aggregating and managing risk across geographical and product lines (BIS, 1999).
The pith of the report will cover various aspects of credit risk modelling such as 'techniques to measure risk', 'building an assessment model' and the various prevalent credit risk models being used world wide. In the process the report also throws light on subjects such as banking risks and credit risk parameters.

What is Credit Risk

Risk taking is a synonymous with credit appraisal. Risk taking is not an activity that takes place by chance; rather it is a deliberate action in the process of financial decision making. Risk is a factor, which, if it takes effect, produces undesirable outcomes for the bank. Bhargava (Bhargava, 2000) presents an insightful pie chart describing the main financial risks that are prevalent in the banking industry.



Figure: Pie Chart showing the proportion of Financial Risks (Bhargava, 2000)

It can be clearly seen that Credit Risks occupy a major portion of the pie and a bane for most bankers across the world.
Risk Management Group of the Basel Committee on Banking Supervision defines credit risk as "potential that a borrower or counterparty of a financial institution will fail to meet the obligations in accordance with the agreed terms" (bcbs54, 2000). In other words, the probability that the receiver of the loan will not pay back in full, within the specified time frame, the complete repayment amount {including any interest and service charge} is called credit risk. Lack of appropriate lending discipline and inadequate system of control generally results in setbacks to banks. Several major banks such as Enron have collapsed due to poor transaction management, incomplete credit information and ...Show more

Summary

Credit provided by financial institutions is an important driver of a nation's economy. The process of granting credit is not new. Before the banking industry cropped up, individuals or families did the traditional banking business of providing credit to those who needed it…
Author : ivyheller
Credit Risk Models in Financial Institutions essay example
Read Text Preview
Save Your Time for More Important Things
Let us write or edit the essay on your topic
"Credit Risk Models in Financial Institutions"
with a personal 20% discount.
Grab the best paper

Related Essays

Finance and Accounting Essay: Credit and Market Risk
Criticisms have been against Basel II and its inability to set required standards for banking sectors globally (Lall, 2009). The long drafting process that has been adopted by Basel II has failed in managing risks and has such an inability has led to financial crisis with increased risks (Cornford, 2010).
14 pages (3500 words) Essay
Essay on Financial Institutions Management
And with the passage of time, these financial institutions have not only increased vertically but also horizontally as well. in these days, not only banks but also credit unions and building societies also provide their services similar to one offered by the banks.
12 pages (3000 words) Essay
Market Risk and Credit Risk: Risk management strategy, policies & procedures
Activities performed by the Commercial Banks in Singapore include: 1) Taking of deposits 2) Giving out loans 3) Cheque services 4) Financial advisory services (if allowed by the central bank of Singapore - Monetary Authority of Singapore) 5) Insurance Broking 6) Capital Market Services 7) Full Banking (a type of commercial bank) can deal with the local financial institutions on a commercial basis 8) Retirement schemes and pension fund investment schemes (Monetary Athority of Singapore) a.2.
11 pages (2750 words) Essay
Credit risk management of CDSs, case from AIG
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.
18 pages (4500 words) Essay
Banking and the management of financial institutions

The author states that financial institutions are very essential in accelerating developments. For developments to be achieved, people have to invest and for people to invest they must save. People therefore can only safe if there are places to save and can invest if there are financial institutions to lend them money to invest. 

6 pages (1500 words) Essay
Financial Markets and Institutions
Financial market securities include bonds, stocks, commodities, agricultural goods and precious metals. The derivatives market is financial market for derivative instruments such as options contracts and futures contracts. The characteristic feature of derivative instrument is that the value of derivative is derived from the underlying.
5 pages (1250 words) Essay
Financial Markets and Institutions
Among the different product traded are equities, fixed income securities, derivatives and foreign exchange. This paper will focus on the foreign exchange market in the U.S. and the types of foreign exchange transactions. It will also focus on the factors affecting the interest rates, ease or difficulty of forecasting the interest rate changes, role of Federal Reserve towards the U.S.
5 pages (1250 words) Essay
Financial Risk Management
The investors need to have diversified portfolio for reducing the performance risk. In a similar manner, it is essential for the financial institutions to implement effective risk management procedures and techniques for mitigating the financial risks. It is very important to reduce the credit risks and interest rate risks which can have negative impact on the performance of the financial institutions.
10 pages (2500 words) Essay
Financial Institutions Lending
The number of different ratios that a credit analyst should take into account when analyzing the company is enormous, however, there are a few ratios that can provide a good insight into company's liquidity, profitability... A ratio that indicates what proportion of debt a company has relative to its assets.
4 pages (1000 words) Essay
Financial Markets and Institutions
This paper will define what financial markets and institutions are and their implication in an economy particularly in a largely consolidating world market. Financial markets "consist of agents, brokers, institutions, and intermediaries transacting purchases and sales of securities." The individuals and institutions operating in the financial markets are linked by contracts and communications networks that form an externally visible financial structure, laws, and friendships.
10 pages (2500 words) Essay
Get a custom paper written
by a pro under your requirements!
Win a special DISCOUNT!
Put in your e-mail and click the button with your lucky finger
Your email
YOUR PRIZE:
Apply my DISCOUNT
Comments (0)
Rate this paper:
Thank you! Your comment has been sent and will be posted after moderation