Major Portfolio Risks

The critical nature of portfolio credit risks is widely recognized. The portfolio approach to credit risk is one of the central themes of Basel Accords, which began in 1988. (Please see Chapter 16 for the Basel Accords.) During 2008, many US banks who stuffed their credit portfolio with sub-prime or sub-prime linked assets, watched helplessly as their credit portfolios failed.

Many financial institutions and banks in the Western world acquired entities as part of their expansion strategies; however this resulted in increased portfolio risk, which later proved disastrous. For example, during 2006, Wachovia Bank acquired Golden West Financial Corporation of Oakland, California for approximately $25 billion. One of the reasons for acquisition was to take advantage of exposure to the California retail banking presence. However, it added about $120 billion of residential mortgages to Wachovia's credit portfolio. Almost the entire Golden West mortgage portfolio consisted of Adjustable Rate Mortgages (ARM). ARMs suffered heavily during the sub-prime crisis and added to the woes of Wachovia Bank.

Similarly, the acquisition of Halifax Bank of Scotland (HBOS) during late 2008 brought a variety of credit portfolio level troubles to Lloyds TSB Bank (LTSB), a well-run conservative UK based bank. Subsequently, as the losses from HBOS accumulated, the merged entity had to rely on UK treasury support, resulting in 41% ownership by the UK government.

Understanding of portfolio ...

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