Advanced Credit Risk Analysis and Management

16

Credit Risk and The Basel Accords

The Basel Accords place a heavy emphasis on credit risk. In fact Basel I, rolled out in the late 1980s, focused purely on credit risk. Subsequent Basel Accords began to include market risk, liquidity risk, leverage risk and concentration risk, amongst others. However, credit risk still occupies a place of paramount importance in the Basel Accords because credit risk is the most important of all risks faced by banks/FIs.

The major cause of serious banking problems and bad debt issues can be directly attributable to ineffective credit standards, weak risk management infrastructure, or a lack of flexibility to react quickly to changes in economic or other external circumstances that lead to a deterioration of credit assets. The 2008 Credit Crisis is a stark reminder – inadequate credit risk management can have far reaching impacts of systemic proportions. The mismanagement (or lack of awareness) of both obligor and portfolio credit risks is identified as one of the major reasons for the collapse of banks and financial institutions in this crisis.

16.1 BASEL ACCORDS

After the failure of two high profile international banks1 in 1974 – Herstatt Bank in Germany and Franklin National Bank in the US – the central banks of major economies in the world recognized the need for broad supervision of banking globally. Thus the Basel Committee was formed in 1974 to formulate broad supervisory standards and guidelines of best practice in banking supervision. ...