Credit Risk Management

Foreword

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

Foreword

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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

quality.

■ Annexes: We provide annexes on information such as the SSAP and FRS

reporting standards currently in use in the UK.

■ Glossary

■ 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

management.

Andrew Fight

www.andrewfight.com

Foreword

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