This book on credit risk management aims to provide the reader with
an introduction of the role and mechanics of credit analysis within the
lending function of a commercial bank.
In recent years, many banks have, for sake of economy, pared down the
credit analyst function and rely increasingly on using outside sources of
information such as broker’s reports and credit rating agency reports to
rationalize their credit decisions.
It nevertheless remains important for bankers to learn about and under-
stand the framework of credit analysis within the framework of credit
risk management. Aside from the arguments of due diligence, which
means that every bank ultimately is responsible for the safekeeping of
depositors’ funds and accordingly effecting its own credit analysis, is the
issue of comprehension. That is to say, for those banks deciding not to
invest in the analytical function and rely on outside sources of analysis,
it nevertheless remains important for the reader to not only understand
the analyst’s arguments but how those arguments have been reached at
in the first place.
This book aims to provide the reader with a structural road map of the
analytical process and tie it in to the formation of an effective credit risk
management policy within the organization.
This book is therefore organized in a classic sequence, that of an analyst
undertaking a financial analysis of an entity and taking it through the
credit chain for approval and subsequent monitoring and management.
The book is presented in eight main chapters:
■ Introduction to corporate credit: This first chapter aims to introduce
the novice to setting the groundwork in the credit analysis, approval,
and management process, and mainly focuses on non-financial cri-
teria. It basically situates the role of credit management in the role of
bank credit policy and orients the student to the information gather-
ing and sifting process necessary to enable the formulation of pertin-
ent and intelligent credit proposals enabling informed credit decisions
to be made.
■ Business risks: This second chapter treats the matter of non-financial
risks (vs. financial risks) and describes the importance of the ‘new
investment criteria’ of the ‘dot com’ economy, as well as traditional
elements of non-financial risks such as the nature of the obligor (limited
vs. unlimited liability), management, industry, market, and products.
Models such as SWOT, PEST, and Porter’s Five Forces which are used to
assess competitor positions, business strategy and plans, as well as legal
and documentation risks. The role of auditors is also treated.
■ Financial risks: Financial statement analysis (financial statements,
annual reports and accounts, balance sheets, profit and loss state-
ments). This chapter takes a more quantitative approach in focusing
on the financial analysis of a borrower. A full discourse on the com-
position, meaning, and analysis of financial statements and company
accounts is featured. This comprises the obtaining, processing, and
analysis of company annual reports and accounts and some allusion
to financial ratio analysis is made. An orientation on PC based spread-
sheet methods and processing of a company’s financial ratios in the
light of peer group and industry sector averages will be treated. This
ratio analysis is useful in taking a photo at a given moment in time
and assessing a borrower’s relative positioning in his industry sector
and economic environment.
■ Transaction risks – term loan agreements and covenants: Loan docu-
mentation, financial ratio covenants, and security arrangements are
necessary tools in managing credit risk. This chapter will explore how
to enhance security from a legal perspective as well as a financial
aspect (e.g. by incorporating appropriate financial covenants into the
loan agreement based on the materials covered in the previous two
chapters: ratios and cash flow forecasting).
■ Setting CRM in place via risk rating systems: All of the information in
the preceding sections must not only be analysed but developed into
a coherent set of guidelines if the bank is to proactively manage its
portfolio exposure via any meaningful credit policy. Credit risk man-
agement therefore is not only about the information gathering and
analytical process, it is using that information to set in place effective
policy guidelines that are the bank’s constant tool to ensure portfolio
■ Annexes: We provide annexes on information such as the SSAP and FRS
reporting standards currently in use in the UK.
■ Suggested readings
We trust that this book goes some way in enabling the practitioner to
review already known information and consider new concepts and tech-
nologies within a framework that can be of use in effective credit risk
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