Credit risk emerged as a significant risk management issue during the 1990s. In increasingly competitive markets, banks and securities houses began taking on greater credit risk from this period onwards. While the concept of ‘credit risk’ is as old as banking itself, it seems that only recently the nature and extent of it has increased dramatically. For example, consider the following developments:
- credit spreads tightened during the late 1990s and again during 2002–2007, to the point where blue-chip companies such as General Electric, British Telecom and Shell were being offered syndicated loans for as little as 10–12 basis points (bps) over LIBOR. To maintain margin, or the increased return on capital, banks increased lending to lower rated corporates, thereby increasing their credit risk both overall and as a share of overall risk;
- investors were finding fewer opportunities in interest rate and currency markets, and therefore moved towards yield enhancement through extending and trading credit across lower rated and emerging market assets;
- the rapid expansion of high yield and emerging market sectors, again lower rated assets, increased the magnitude of credit risk for investors and the banks that held and traded such assets.
The growth in credit risk exposure would naturally be expected to lead to more sophisticated risk management techniques than those employed hitherto. It was accompanied, however, by a rise in the level of corporate defaults and ...