The Moorad Choudhry Anthology, + Website

CHAPTER 6Banks and Credit Risk

“Unfortunately Vic came off rather badly [in the squadron], as he suffered from two career‐limiting character faults: firstly he was outspokenly honest and always said what he really thought, and secondly he was invariably right.”

—Michael Napier, Tornado Over the Tigris: Recollections of a Fast Jet Pilot, Pen & Sword Books, 2015

For a very large majority of the world's banks, by far the biggest driver of their regulatory capital requirement is credit risk. Specifically this is the exposure arising from lending money to borrowers who are not risk‐free and present default risk to the lender. The author once undertook a short consulting engagement at a regional bank in southern Austria for which credit risk represented 91% of the bank's total regulatory capital requirement! The remainder was made up of miniscule amounts for non‐traded market risk, liquidity risk, and operational risk. This is possibly somewhat extreme an example but serves to illustrate the point.

Given the significance of credit risk on the balance sheet, it is clear that it is a subject that needs to be understood. It is as important to a bank's good health as liquidity risk is. Therefore this chapter deals with the topic in some depth, and we consider the concept of the credit risk management framework in a banking operation.

UNDERSTANDING AND MANAGING CREDIT RISK: PART 1

Credit is the core business of a bank and is also its key to profitability and primary risk. As credit ...