Banking

Lecture 8 Credit risk

Magda Peen Institute of Economic Studies, Faculty of Social Science, Charles University in Prague, Czech Republic November 21, 2012

Contents
1. Credit risk definition
2. Basic debt instruments 3. Macro assessment of credit risk, esp. CR

4. Credit registers 5. Assessment of credit risk, country risk 6. Micro assessment of credit risk - loan granting process
7. Loan pricing
Slide 2

Credit risk - definition

Credit risk
risk to the bank of losses resulting from the failure of a counterparty to meet its obligations in accordance with the terms of a contract under which the bank has become a creditor of the counterparty (CNB), Credit risk represents 5070% of all banking risks.

Slide 3

Credit risk
Total Assets Assets sensitive to credit risk (granted loans, investments in bonds, equity etc.) Assets non-sensitive to credit risk (tangible and intangible assets, cash deposited at the central bank etc.) Equity Total Liabilities Liabilities

Loans - Non-standard contracts difficult to transfer to third parties

Securities (Tradable securities) - Standard contract easy to transfer to third parties
Slide 4

Credit risk measurement

Credit rating Credit scoring PD (probability of default) NPL (non-performing loans) LGD Models (combining all of this)

Credit risk
Corporate defaults 1970-2008

Source: Moodys Slide 6

Credit risk
Annual Speculative-Grade Default Rates, 1920-2008

Source: Moodys

Slide 7

Credit risk
Average Annual Upgrade-to-Downgrade Ratios, 1970-2008

Source: Moodys

Slide 8

Contents
1. Credit risk definition
2. Basic debt instruments 3. Macro assessment of credit risk, esp. CR

4. Credit registers 5. Assessment of credit risk, country risk 6. Micro assessment of credit risk - loan granting process
7. Loan pricing
Slide 9

Credit risk Basic debt instruments

A simple loan
Fixed-payment loan contract Coupon bond Discount bond (or zero-coupon bond)

Slide 10

Credit risk Basic credit/debt types

Corporate financing (corporate loans, securities) Retail financing (retail loans, loans to households = individuals + trades) Consumer credits Mortgages Etc. Government and public financing Loans to financial institutions

Project financing and other structured financing (of corporate or public projects)
Etc.

Slide 11

Contents
1. Credit risk definition
2. Basic debt instruments 3. Macro assessment of credit risk, esp. CR

4. Credit registers 5. Assessment of credit risk, country risk 6. Micro assessment of credit risk - loan granting process
7. Loan pricing
Slide 12

Credit risk Loan portfolio structure, CR

Source: Financial market supervision report, 2011

Slide 13

Credit risk
Deteriorating bank ratings

Source: FITCH

Slide 14

Contents
1. Credit risk definition
2. Basic debt instruments 3. Macro assessment of credit risk, esp. CR

4. Credit registers 5. Assessment of credit risk, country risk 6. Micro assessment of credit risk - loan granting process
7. Loan pricing
Slide 15

Loan granting process

General level
Credit strategy (approved by Board of Directors) Organizational issues (departments involved in credit process) Internal norms Credit limits Credit risk management Controlling and audit

Slide 16