Financial Risk Management: A Practitioner's Guide to Managing Market and Credit Risk, 2nd Edition

CHAPTER 13

Credit Risk

The field of credit risk management has undergone major transformations over the past two decades. Traditional commercial bank lenders, whose focus used to be almost exclusively on the analysis of individual borrowers with a small dose of limits to avoid excessive concentration in a region or industry, have increasingly viewed overall portfolio management as a major part of their function. This has opened the door to rapid growth in the use of quantitative risk management techniques. At the same time, the introduction of an array of vehicles for transferring credit risk between creditors—the increased use of loan sales, loan syndication, and short sales of bonds, along with the introduction of many varieties of credit derivatives, asset-backed securities, and collateralized debt obligations (CDOs)—has served as a tool for portfolio management.

Over the same time period, many new players have become active participants in credit risk markets. While there have always been nonbank investors in corporate bonds, such as insurance companies, pension funds, and mutual funds, the variety of new instruments available for investors in credit risk—asset swaps, total return swaps, credit default swaps (CDSs), CDOs—has both introduced new investors, such as hedge funds, and increased the participation of existing investors.

In looking at the principles guiding credit risk management, one sees a genuine dichotomy between the views of traditional commercial bank lenders ...