The Principles of Banking, 2nd Edition

CHAPTER 19Credit Risk Assessment and Reporting Principles

Abstract

Credit risk is a key bank risk exposure type, and alongside liquidity risk the definition of a bank's business model. It is the possibility of loss to the bank's capital base arising from a borrower's failure to repay a loan or otherwise meet its loan contractual obligations. The bank will operate processes to determine the extent of the credit risk of a borrower as part of its loan approval process, and then on an ongoing basis during the life of the loan. The loan book management process will include reporting on extent of credit risk and also implementing loan provision and loan recovery processes as and when necessary.

For this second edition we have stripped out credit risk from the earlier book’s chapter on all risks and presented a standalone chapter on this topic. It should be read in conjunction with Chapter 10. For a large majority of the world’s banks, by far the largest driver of their regulatory capital requirement is credit risk. To be a banker is to understand, and apply, principles of credit risk management.

DRIVERS OF CREDIT RISK

We would argue that a proper understanding of credit is not possible without a deep familiarity with the market that one is operating in. That is, to know one's risk is to know one's market. Banks have attempted to measure the extent of their credit risk, and hence the amount of capital needed to cover this risk, through the use of credit risk models. It is worthwhile ...