Foundations of Financial Risk: An Overview of Financial Risk and Risk-based Financial Regulation, 2nd Edition

CHAPTER 5 Credit Risk Management

Chapter 5 takes a deeper look at how banks manage credit risk, starting with portfolio risks and credit exposure. Credit portfolio modeling is complex, and while some banks do build their own models, most use com­mercially available models; Section 5.3 provides a brief description of such tools. Credit monitoring was described in Chapter 4 in Section 4.6 on the credit process, but it features here again along with early warning signals, given their important role in the management of the portfolio credit risk pro­file. Section 5.8 explains remedial management and provides a framework of next steps in the event of distressed loans. The final section discusses the Basel III Accord's guidelines to measure and manage credit risk.

Chapter Outline

• 5.1 Portfolio Management
• 5.2 Techniques to Reduce Portfolio Risk
• 5.3 Portfolio Credit Risk Models
• 5.4 Credit Monitoring
• 5.5 Credit Rating Agencies
• 5.6 Alternative Credit Risk Assessment Tools
• 5.7 Early Warning Signals
• 5.8 Remedial Management
• 5.9 Managing Default
• 5.10 Practical Implications of the Default Process
• 5.11 Credit Risk and the Basel Accords

Key Learning Points

• Portfolio management involves determining the contents and the struc­ture of the portfolio, monitoring its performance, making any changes, and deciding which assets to acquire and which assets to divest.
• Key portfolio risks are concentration risk, correlation risk, and conta­gion risk.
• Banks use various techniques to reduce the overall ...