2020年FRM二级教材book3：Credit Risk Measurement and Management（信用风险计量和管理）

@GARP

2020

®

EXAMPARTII

CreditRiskMeasurement

andManagement

Pearson

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Gratefulacknowledgmentismadetothefollowingsourcesforpermissiontoreprintmaterialcopyrightedorcontrolled

bythem:

"TheCreditDecision"and"TheCreditAnalyst,"byJonathanGolinandPhilippeDelhaise,reprintedfromTheBankCredit

&

AnalysisHandbook,2ndedition(2013),bypermissionofJohnWileySons,Inc.

"RatingsAssignmentMethodologies,"byGiacomoDeLaurentis,RenatoMaino,LucaMolteni,reprintedfromDeveloping,

&

&

"CreditRisksandDerivatives,"byReneM.Stulz,reprintedfromRiskManagementDerivatives(2007),bypermissionof

CengageLearning.

"SpreadRiskandDefaultIntensityModels,""PortfolioCreditRisk,"and"StructuredCreditRisk,"byAllanMalz,reprinted

&

fromFinancialRiskManagement:Models,History,andInstitutions(2011),bypermissionofJohnWileySons,Inc.

"CounterpartyRisk,""Netting,Close-outandRelatedAspects,""Collateral,""CreditExposureandFunding,""CounterpartyRisk

Intermediation,""CreditandDebitValueAdjustments,""Wrong-WayRisk,"byJonGregory,reprintedfromThexVAChallenge:

CreditRisk,Funding,Collateral,andCapital,3rdedition(2015),bypermissionofJohnWiley&Sons,Inc.

"TheEvolutionofStressTestingCounterpartyExposures,"byDavidLynch,reprintedfromStressTesting:Approaches,

Methods,andApplications,editedbyAkhtarSiddiqueandlftekharHasan(2013),bypermissionofIncisiveMedia/RiskBooks.

"CreditScoringandRetailCreditRiskManagement"and"TheCreditTransferMarketsandTheirImplications,"byMichel

Crouhy,DanGalai,andRobertMark,reprintedfromTheEssentialsofRiskManagement,2ndedition(2014),bypermission

ofMcGraw-HillCompanies.

"AnIntroductiontoSecuritisation,"byMooradChaudhry,reprintedfromStructuredCreditProducts:CreditDerivativesand

SyntheticSecuritisation,2ndedition(2010),bypermissionofJohnWiley&Sons,Inc.

"UnderstandingtheSecuritizationofSubprimeMortgageCredit,"byAdamB.AshcraftandTilSchuermann,reprintedfrom

FoundationsandTrends®inFinance:Vol.2,No.3(2008),bypermissionofNowPublishers,Inc.

"CapitalStructureinBanks,"byGerhardSchroek,RiskManagementandValueCreationinFinancialInstitutions(2002),

bypermissionofJohnWiley&Sons,Inc.

LearningObjectivesprovidedbytheGlobalAssociationofRiskProfessionals.

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ISBN10:0135966051

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CreditAnalysisversusCreditRisk

Modeling

Chapter1TheCreditDecision1

15

1.4CategoriesofCreditAnalysis15

IndividualCreditAnalysis

EvaluatingtheFinancialCondition

ofNonfinancialCompanies

17

1.1DefinitionofCredit

CreditworthyorNot

CreditRisk

2

2

3

3

4

5

17

17

EvaluatingFinancialCompanies

CreditAnalysis

ComponentsofCreditRisk

CreditRiskMitigation

Collateral-AssetsThatFunction

toSecureaLoan

Guarantees

1.5AQuantitativeMeasurement

ofCreditRisk

19

19

20

20

20

20

20

20

21

ProbabilityofDefault

LossGivenDefault

ExposureatDefault

ExpectedLoss

5

6

6

SignificanceofCreditRiskMitigants

TheTimeHorizon

8

8

8

9

9

ApplicationoftheConcept

MajorBankFailureIsRelativelyRare

BankInsolvencyIsNotBankFailure

WhyBotherPerformingaCredit

Evaluation?

DefaultasaBenchmark

PricingofBankDebt

Creditors'RightsandtheLegalSystem

21

22

22

22

23

23

1.3EvaluatingtheCapacity

toRepay:ScienceorArt?

14

TheLimitationsofQuantitativeMethods14

HistoricalCharacterofFinancialData14

FinancialReportingIsNotFinancialReality14

QuantitativeandQualitativeElements15

AllocationofBankCapital

EventsShortofDefault

BanksAreDifferent

•••

111

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Chapter2TheCreditAnalyst25

38

39

39

40

40

2.1TheUniverseofCreditAnalysts26

JobDescription1:CreditAnalyst

ConsumerCredit

26

26

26

26

27

27

27

27

27

QualitativeElements

JobDescription2:CreditAnalyst

CreditModeling

InterminglingoftheQualitativeand

Quantitative

41

42

42

43

43

43

45

JobDescription3:CreditAnalyst

CorporateCredit

MacroandMicroAnalysis

AnIterativeProcess

PeerAnalysis

JobDescription4:CreditAnalyst

CounterpartyCredit

ResourcesandTrade-Offs

LimitedResources

PrimaryResearch

ClassificationbyFunctionalObjective

RiskManagementversusInvestment

Selection

28

28

2.4RequisiteDatafortheBank

CreditAnalysis

PrimaryResearchversusSecondary

Research

46

46

46

ASpecialCase:TheStructuredFinance

CreditAnalyst

TheAnnualReport

29

30

30

31

32

TheAuditor'sReportorStatement

ByTypeofEntityAnalyzed

ContentandMeaningoftheAuditor's

Opinion

CorporateCreditAnalysts

QualifiedOpinions

ChangeinAuditors

WhoIstheAuditor?

BankandFinancialInstitutionAnalysts

Sovereign/MunicipalCreditAnalysts

TheRelationshipbetweenSovereign

RiskandBankCreditRisk

32

33

TheFinancialStatements:Annual

andInterim

49

49

ClassificationbyEmployer

TimelinessofFinancialReporting

Banks,NBFls,andInstitutionalInvestors33

RatingAgencies

33

34

2.5SpreadingtheFinancials

50

GovernmentAgencies

MakingFinancialStatementsComparable50

OrganizationoftheCreditRiskFunction

withinBanks

DIYorExternalProvider

50

51

34

OneApproachtoSpreading

2.2RoleoftheBankCreditAnalyst:

ScopeandResponsibilities

2.6AdditionalResources

51

34

TheBankWebsite

51

TheCounterpartyCreditAnalyst

34

News,theInternet,andSecurities

PricingData

TheRationaleforCounterpartyCredit

Analysis

54

54

34

35

36

37

37

37

ProspectusesandRegulatoryFilings

CreditAnalystversusCreditOfficer

ProductKnowledge

SecondaryAnalysis:ReportsbyRating

Agencies,Regulators,andInvestment

Banks

TheFixed-IncomeAnalyst

54

ApproachestoFixed-IncomeAnalysis

ImpactoftheRatingAgencies

2.7CAMELinaNutshell

54

iv•Contents

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CashFlowSimulations

ASyntheticVisionofQuantitative-Based

StatisticalModels

101

103

57

4.4HeuristicandNumerical

Approaches

104

104

106

DefinitionofCreditRisk

StepstoDeriveEconomicCapital

forCreditRisk

58

ExpertSystems

NeuralNetworks

ComparisonofHeuristicandNumerical

Approaches

58

58

61

62

63

ExpectedLosses(EL)

108

UnexpectedLosses(UL-Standalone)

UnexpectedLossContribution(ULC)

EconomicCapitalforCreditRisk

4.5InvolvingQualitative

Information

109

ProblemswiththeQuantification

ofCreditRisk

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65

Chapter5CreditRisks

andCredit

Derivatives

Chapter4RatingAssignment

113

Methodologies67

5.1CreditRisksasOptions

114

4.1Introduction

68

115

4.2Experts-BasedApproaches

StructuredExperts-BasedSystems

Agencies'Ratings

69

69

70

116

117

118

FromBorrowerRatingstoProbabilities

ofDefault

Experts-BasedInternalRatingsUsed

byBanks

73

119

121

76

VaRandCreditRisks

4.3Statistical-BasedModels

Statistical-BasedClassification

StructuralApproaches

77

77

78

80

5.2BeyondtheMertonModel

121

5.3CreditRiskModels

CreditRisk+

122

124

125

126

ReducedFormApproaches

StatisticalMethods:LinearDiscriminant

Analysis

CreditMetricsTM

TheKMVModel

82

StatisticalMethods:LogisticRegression89

FromPartialRatingsModulestothe

SomeDifficultieswithCreditPortfolio

Models

127

127

129

IntegratedModel

91

5.4CreditDerivatives

UnsupervisedTechniquesforVariance

ReductionandVariables'Association

92

5.5CreditRisksofDerivatives

Contents•v

Chapter6SpreadRiskand

DefaultIntensity

Models

ConditionalDefaultDistributions

AssetandDefaultCorrelation

152

154

131

CreditVaRUsingtheSingle-FactorModel155

132

SpreadMark-to-Market

133

Chapter8Structured

6.2DefaultCurveAnalytics

TheHazardRate

134

135

135

135

136

CreditRisk

159

8.1StructuredCreditBasics

160

CapitalStructureandCreditLosses

inaSecuritization

Waterfall

162

163

164

6.3Risk-NeutralEstimates

ofDefaultProbabilities

136

IssuanceProcess

136

138

139

140

8.2CreditScenarioAnalysis

ofaSecuritization

165

166

169

TrackingtheInterimCashFlows

TrackingtheFinal-YearCashFlows

8.3MeasuringStructuredCredit

RiskviaSimulation

145

145

145

171

TheSimulationProcedureandtheRole

ofCorrelation

171

173

175

177

179

MeansoftheDistributions

DistributionofLossesandCreditVaR

DefaultSensitivitiesoftheTranches

SummaryofTrancheRisks

Chapter7Portfolio

CreditRisk

147

8.4StandardTranchesandImplied

CreditCorrelation

180

CreditIndexDefaultSwapsandStandard

Tranches

ImpliedCorrelation

7.1DefaultCorrelation

148

180

181

DefiningDefaultCorrelation

TheOrderofMagnitudeofDefault

Correlation

148

SummaryofDefaultCorrelationConcepts182

150

8.5IssuerandInvestorMotivations

7.2CreditPortfolioRisk

Measurement

forStructuredCredit

IncentivesofIssuers

182

183

183

150

GranularityandPortfolioCredit

Value-at-Risk

150

IncentivesofInvestors

vi•Contents

201

201

201

201

202

9.1Background

186

9.1.1CounterpartyRiskversusLendingRisk186

9.1.2SettlementandPre-SettlementRisk186

9.1.3MitigatingCounterpartyRisk

9.1.4ExposureandProductType

9.1.5Setups

187

188

189

203

204

10.2.7TheImpactofNetting

10.3MultilateralNettingand

TradeCompression

9.2Components

190

205

205

206

206

207

207

9.2.1Mark-to-MarketandReplacementCost190

10.3.1Overview

9.2.2CreditExposure

191

10.3.2MultilateralNetting

10.3.3BilateralCompressionServices

10.3.4TheNeedforStandardisation

10.3.5Examples

9.2.3DefaultProbability,Credit

MigrationandCreditSpreads

191

9.2.4RecoveryandLossGivenDefault192

9.3ControlandQuantification

9.3.1CreditLimits

192

192

193

194

194

195

196

10.4TerminationFeatures

andResets

209

209

9.3.2CreditValueAdjustment

9.3.3CVAandCreditLimits

9.3.4WhatDoesCVARepresent?

9.3.5HedgingCounterpartyRisk

9.3.6TheCVADesk

10.4.1WalkawayFeatures

10.4.2TerminationEvents

10.4.3ResetAgreements

21O

211

10.5Summary

211

9.4BeyondCVA

196

9.4.1Overview

9.4.2EconomicCostsofAnOTCDerivative196

196

Chapter11Collateral

213

9.4.3xVATerms

197

9.5Summary

198

11.1Introduction

214

214

215

11.1.1RationaleforCollateral

11.1.2AnalogywithMortgages

11.1.3VariationMarginandInitialMargin215

11.2CollateralTerms

215

199

11.2.1TheCreditSupportAnnex(CSA)215

11.2.2TypesofCSA

11.2.3Threshold

11.2.4InitialMargin

216

217

218

10.1Introduction

200

10.1.1Overview

10.1.2TheNeedforNettingand

Close-Out

200

11.2.5MinimumTransferAmount

andRounding

11.2.6Haircuts

218

218

220

200

10.1.3PaymentandClose-OutNetting200

11.2.7LinkagetoCreditQuality

Contents•vii

11.2.8CreditSupportAmount

11.2.9ImpactofCollateralonExposure221

220

11.8ConvertingCounterparty

RiskintoFundingLiquidityRisk238

11.3MechanicsofCollateral

222

11.9Summary

238

11.3.1CollateralCallFrequency

222

11.3.2ValuationAgents,Disputesand

Reconciliations

11.3.3TitleTransferandSecurityInterest223

Chapter12CreditExposure

222

andFunding239

11.3.4Coupons,Dividendsand

Remuneration

223

11.4CollateralandFunding

11.4.1Overview

224

224

224

224

225

12.1CreditExposure

240

240

240

241

12.1.1Definition

12.1.2BilateralExposure

12.1.3TheClose-OutAmount

11.4.2Substitution

11.4.3Rehypothecation

11.4.4Segregation

12.1.4ExposureasaShortOptionPosition241

11.4.5VariationandInitialMargin

RehypothecationandSegregation

11.4.6StandardCSA

12.1.5FutureExposure

242

242

226

226

12.1.6ComparisontoValue-at-Risk

12.2MetricsforExposure

12.2.1ExpectedFutureValue

12.2.2PotentialFutureExposure

12.2.3ExpectedExposure

243

243

243

244

11.5CollateralUsage

227

227

227

228

11.5.1ExtentofCollateralisation

11.5.2CoverageofCollateralisation

11.5.3CollateralType

12.2.4EEandPFEforaNormal

Distribution

12.2.5MaximumPFE

12.2.6ExpectedPositiveExposure

12.2.7NegativeExposure

12.2.8EffectiveExpectedPositive

Exposure(EEPE)

244

244

245

245

11.6TheRisksofCollateral

229

11.6.1CollateralImpactOutsideOTC

DerivativesMarkets

11.6.2MarketRiskandtheMarginPeriod

ofRisk

11.6.3OperationalRisk

11.6.4LegalRisk

11.6.5LiquidityRisk

229

230

231

232

232

232

245

12.3FactorsDrivingExposure

12.3.1LoansandBonds

246

246

246

246

248

249

250

11.6.6FundingLiquidityRisk

12.3.2FutureUncertainty

12.3.3PeriodicCashflows

12.3.4CombinationofProfiles

12.3.5Optionality

11.7RegulatoryCollateral

Requirements

233

233

234

234

236

11.7.1Background

12.3.6CreditDerivatives

11.7.2CoveredEntities

11.7.3GeneralRequirements

11.7.4Haircuts

11.7.5SegregationandRehypothecation236

11.7.6InitialMarginCalculations

12.4TheImpactofNetting

andCollateralonExposure

252

252

253

12.4.1TheImpactofNettingonFuture

Exposure

12.4.2NettingandtheImpactof

Correlation

237

11.7.7StandardisedInitialMargin

Method(SIMM)

237

viii•Contents

12.4.3NettingandRelativeMTM

254

Chapter14Creditand

DebtValue

12.4.4ImpactofCollateralonExposure254

12.5Funding,Rehypothecation

andSegregation

Adjustments273

12.5.1FundingCostsandBenefits

257

12.5.2DifferencesbetweenFundingand

14.1Overview

274

274

CreditExposure

257

257

14.2CreditValueAdjustment

12.5.3ImpactofSegregation

andRehypothecation

12.5.4ImpactofCollateralonCredit

andFundingExposure

14.2.1WhyCVAIsNotStraightforward274

14.2.2HistoryofCVA

14.2.3CVAFormula

274

275

275

276

276

277

258

260

12.5.5Examples

14.2.4CVAExample

12.6Summary

260

14.2.5CVAasaSpread

14.2.6ExposureandDiscounting

14.2.7Risk-Neutrality

14.2.8CVASemi-AnalyticalMethods277

Chapter13CounterpartyRisk

Intermediation26114.3ImpactofCredit

Assumptions

277

277

278

14.3.1CreditSpreadImpact

14.3.2RecoveryImpact

13.1Introduction

262

263

14.4CVAAllocationandPricing279

13.2SPVS,DPCS,CDPCSand

Monolines

14.4.1NettingandIncrementalCVA

14.4.2IncrementalCVAExample

14.4.3MarginalCVA

14.4.4CVAasaSpread

14.4.5NumericalIssues

279

279

280

281

281

13.2.1DefaultRemotenessand

"TooBigtoFail"

13.2.2SpecialPurposeVehicles

13.2.3DerivativeProductCompanies264

263

263

13.2.4MonolinesandCDPCs

265

14.5CVAwithCollateral

282

13.3CentralCounterparties

13.3.1TheClearingMandate

13.3.2OTCClearing

266

266

267

268

268

14.5.1ImpactofMarginPeriodofRisk282

14.5.2ThresholdsandInitialMargins283

14.6DebtValueAdjustment

284

14.6.1Overview

284

14.6.2AccountingStandardsandDVA284

14.6.3DVAandPricing

14.6.4BilateralCVAFormula

285

285

270

14.6.5Close-outandDefaultCorrelation286

270

271

14.6.6Example

14.6.7DVAandOwn-Debt

14.6.8DVAinDerivatives

286

287

288

272

13.4Summary

27214.7Summary

289

Contents•ix

16.3StressTestingCurrent

Exposure

308

16.4StressTestingtheLoan

Equivalent

309

312

15.1Overview

292

16.5StressTestingCVA

15.2OverviewofWrong-WayRisk292

15.2.1SimpleExample

15.2.2ClassicExampleandEmpirical

Evidence

15.2.3GeneralandSpecificWWR

15.2.4WWRChallenges

292

16.6CommonPitfallsinStress

TestingCCR

313

313

292

293

293

Conclusion

15.3QuantificationofWrong-Way

Risk

Chapter17CreditScoringand

RetailCreditRisk

294

294

294

295

15.3.1Wrong-WayRiskandCVA

15.3.2SimpleExample

15.3.3Wrong-WayCollateral

Management315

15.4Wrong-WayRiskModelling

Approaches

17.1TheNatureofRetailCredit

Risk

296

296

296

297

298

299

316

15.4.1HazardRateApproaches

15.4.2StructuralApproaches

15.4.3ParametricApproach

15.4.4JumpApproaches

CreditScoring:Cost,Consistency,

andBetterCreditDecisions

319

320

321

15.4.5CreditDerivatives

17.3FromCutoffScorestoDefault

RatesandLossRates

15.4.6Wrong-WayRiskandCollateral300

15.4.7CentralClearingand

Wrong-WayRisk

301

17.4MeasuringandMonitoring

thePerformanceofaScorecard322

15.5Summary

303

17.5FromDefaultRiskto

CustomerValue

323

324

Chapter16TheEvolution

ofStressTesting

17.6TheBaselRegulatory

Approach

17.7SecuritizationandMarket

Reforms

Exposures

305

325

326

17.8Risk-BasedPricing

16.1TheEvolutionofCounterparty

CreditRiskManagement

17.9TacticalandStrategic

RetailCustomerConsiderations326

306

16.2ImplicationsforStressTesting307

Conclusion327

x•Contents

Conclusion

354

355

Chapter18TheCreditTransfer

MarketsandTheir

APPENDIX18.1:WhytheRating

ofCDOsbyRatingAgenciesWas

Misleading

18.1WhatWentWrongwiththe

SecuritizationofSubprime

Mortgages?

Chapter19AnIntroduction

332

334

336

toSecuritisation357

18.2WhyCreditRiskTransfer

isRevolutionary...IfCorrectly

Implemented

19.1TheConceptof

Securitisation

358

18.3HowExactlyisallthis

ChangingtheBankCredit

Function?

19.2ReasonsforUndertaking

Securitisation

359

360

360

360

Funding

BalanceSheetCapitalManagement

RiskManagement

BenefitsofSecuritisationtoInvestors361

CreditDerivatives

340

19.3TheProcessof

Securitisation

361

361

362

362

362

363

18.7TypesofCreditDerivatives341

CreditDefaultSwaps

First-to-DefaultCDS

342

343

344

345

346

TotalReturnSwaps

19.4IllustratingtheProcess

ofSecuritisation

DueDiligence

18.8CreditRiskSecuritization

346

364

364

364

364

365

365

365

BasicsofSecuritization

SecuritizationofCorporateLoans

andHigh-YieldBonds

TheSpecialCaseofSubprimeCDOs

Re-Remics

SyntheticCDOs

348

348

350

350

351

351

352

MarketingApproach

DealStructure

FinancialGuarantors

FinancialModelling

CreditRating

Single-TrancheCDOs

CreditDerivativesonCreditIndices

19.5ABSStructures:APrimer

onPerformanceMetricsand

TestMeasures

18.9SecuritizationforFunding

PurposesOnly

CoveredBonds

353

353

354

354

366

366

366

369

GrowthofABS/MBS

CollateralTypes

SummaryofPerformanceMetrics

Pfandbriefe

FundingCLOs

Contents•xi

19.6SecuritisationPost-Credit

Crunch

FrictionsbetweentheInvestorandthe

CreditRatingAgencies:ModelError

387

387

370

FiveFrictionsthatCausedthe

SubprimeCrisis

StructuringConsiderations

370

ClosingandAccounting

Considerations:CaseStudy

ofECB-LedABSTransaction

20.5AnOverviewofSubprime

MortgageCredit

388

OtherConsiderations

20.6WhoistheSubprime

Mortgagor?

19.7Securitisation:Impactofthe

2007-2008FinancialCrisis

ImpactoftheCreditCrunch

389

374

WhatisaSubprimeLoan?

391

374

397

399

Conclusion

References

376

376

HowareSubprimeLoansValued?

20.7OverviewofSubprimeMBS400

Subordination

401

402

402

403

403

404

Chapter20Understanding

theSecuritization

ExcessSpread

ShiftingInterest

PerformanceTriggers

InterestRateSwap

RemittanceReports

ofSubprime

MortgageCredit377

20.8AnOverviewofSubprime

MBSRatings

406

20.1Abstract

378

WhatisaCreditRating?

406

20.2ExecutiveSummary

20.3Introduction

378

380

HowDoesOneBecomeaRating

Agency?

407

WhenisaCreditRatingWrong?

HowCouldWeTell?

408

408

TheSubprimeCreditRatingProcess

TheSevenKeyFrictions

381

ConceptualDifferencesbetween

CorporateandABSCreditRatings

FrictionsbetweentheMortgagor

andOriginator:PredatoryLending

411

381

HowThrough-the-CycleRating

CouldAmplifytheHousingCycle

FrictionsbetweentheOriginator

andtheArranger:PredatoryLending

andBorrowing

411

413

417

419

CashFlowAnalyticsforExcessSpread

PerformanceMonitoring

383

384

384

385

386

FrictionsbetweentheArranger

andThirdParties:AdverseSelection

HomeEquityABSRatingPerformance

FrictionsbetweentheServicerandthe

Mortgagor:MoralHazard

20.9TheRelianceofInvestors

onCreditRatings:ACaseStudy422

FrictionsbetweentheServicer

andThirdParties:MoralHazard

OverviewoftheFund

423

424

Fixed-IncomeAssetManagement

FrictionsbetweentheAssetManager

andInvestor:Principal-Agent

Conclusions

426

xii•Contents

References

426APPENDIXC

431

SomeEstimatesofPDbyRating

431

APPENDIXA

428

PredatoryLending

TheCenterforResponsibleLendingHas

IdentifiedSevenSignsofaPredatoryLoan428

428Bibliography

433

437

Index

APPENDIXB

429

429

429

430

430

PredatoryBorrowing

FraudforHousing

FraudforProfit

TheRoleoftheRatingAgencies

•••

Contents•XIII

®

Chairman

EverettD.ReeseChairofBankingandMonetaryEconomics,

TheOhioStateUniversity

Members

Dr.AttilioMeucci,CFA

PresidentandCEO,GlobalAssociationofRiskProfessionals

Founder,ARPM

Beck,SMD

Dr.VictorNg,CFA,MD

ChiefRiskOfficer,TIAAFinancialSolutions

ChiefRiskArchitect,MarketRiskManagementandAnalysis,

GoldmanSachs

OperationalRiskManagement,Citigroup

Dr.MatthewPritsker

SeniorFinancialEconomistandPolicyAdvisorISupervision,

Regulation,andCredit,FederalReserveBankofBoston

JulianChen,FRM,SVP

FRMProgramManager,GlobalAssociationofRiskProfessionals

Dr.Samantha

FRM,SVP

Dr.ChristopherDonohue,MD

GARPBenchmarkingInitiative,GlobalAssociationofRisk

Professionals

BalanceSheetAnalytics&Modeling,PNCBank

Dr.TilSchuermann

Partner,OliverWyman

DonaldEdgar,FRM,MD

Risk&QuantitativeAnalysis,BlackRock

NickStrange,FCA

Director,SupervisoryRiskSpecialists,PrudentialRegulation

Authority,BankofEngland

HerveGeny

GroupHeadofInternalAudit,LondonStockExchangeGroup

Dr.Sverrir�orvaldsson,FRM

KeithIsaac,FRM,VP

SeniorQuant,SEB

CapitalMarketsRiskManagement,TDBankGroup

WilliamMay,SVP

GlobalHeadofCertificationsandEducationalPrograms,Global

AssociationofRiskProfessionals

xiv•FRM®Committee

••

itec1s1on

LearningObjectives

Aftercompletingthisreadingyoushouldbeableto:

•Definecreditriskandexplainhowitarisesusing

examples.

•Comparethecreditanalysisofconsumers,corporations,

financialinstitutions,andsovereigns.

•Explainthecomponentsofcreditriskevaluation.

•Describequantitativemeasurementsandfactorsofcredit

risk,includingprobabilityofdefault,lossgivendefault,

exposureatdefault,expectedloss,andtimehorizon.

•Describe,compareandcontrastvariouscreditrisk

mitigantsandtheirroleincreditanalysis.

•Comparebankfailureandbankinsolvency.

•Compareandcontrastquantitativeandqualitative

techniquesofcreditriskevaluation.

ExcerptisChapter1ofTheBankCreditAnalysisHandbook,SecondEdition,byJonathanGo/inandPhilippeDelhaise.

1

restsupontwofundamentalprinciples;namely,thecreditor's

CREDIT.Trustgivenorreceived;expectationoffuturepay­

confidencethat:

mentforpropertytransferred,oroffulfillmentorpromises

1.Theborroweris,andwillbe,willingtorepaythefunds

given;mercantilereputationentitlingonetobetrusted;­

advanced

appliedtoindividuals,corporations,communities,or

2.Theborrowerhas,andwillhave,thecapacitytorepaythose

nations;as,tobuygoodsoncredit.

funds

-Webster'sUnabridgedDictionary,1913Edition

Thefirstpremisegenerallyreliesuponthecreditor'sknowledge

Abanklivesoncredit.Tillitistrusteditisnothing;and

oftheborrower(ortheborrower'sreputation),whilethesecond

whenitceasestobetrusted,itreturnstonothing.

istypicallybaseduponthecreditor'sunderstandingofthebor­

-WalterBagehot1

rower'sfinancialcondition,orasimilaranalysisperformedbya

trustedparty.4

Peopleshouldbemoreconcernedwiththereturnoftheir

principalthanthereturnontheirprincipal.

1.1DEFINITIONOFCREDIT

-JimRogers2

Consequently,abroad,ifnotall-encompassing,definitionofcredit

istherealisticbelieforexpectation,uponwhichalenderiswilling

toact,thatfundsadvancedwillberepaidinfullinaccordancewith

theagreementmadebetweenthepartylendingthefundsandthe

ThewordcreditderivesfromtheancientLatincredere,

3

whichmeans"toentrust"or"tobelieve."Throughthe

interveningcenturies,themeaningofthetermremainsclose

totheoriginal;lenders,orcreditors,extendfunds-or

"credit"-baseduponthebeliefthattheborrowercanbe

entrustedtorepaythesumadvanced,togetherwithinterest,

accordingtothetermsagreed.Thisconvictionnecessarily

5

borrowingthefunds.Correspondingly,creditriskisthepos­

sibilitythatevents,astheyunfold,willcontravenethisbelief.

or

Not

Putanotherway,asensibleindividualwithmoneytospare

(i.e.,savingsorcapital)willnotprovidecreditonacommercial

6

basis-thatis,willnotmakealoan-unlessshebelievesthat

1

WalterBagehot,LombardStreet:ADescriptionoftheMoneyMar­

theborrowerhasboththerequisitewillingnessandcapacityto

repaythefundsadvanced.Assuggested,foracreditortoform

suchabeliefrationally,shemustbesatisfiedthatthefollowing

twoquestionscanbeansweredintheaffirmative:

1.Willtheprospectiveborrowerbewilling,solongasthe

2

obligationexists,torepayit?

Variousattributions;seeforexampleGlobal-I;500ofthe

MostWitty,AcerbicandEruditeThingsEverSaidAboutMoney(Har­

rimanHouse,2002).AuthorofAdventureCapitalistandInvestment

Biker,JimRogersisbestknownasoneoftheworld'sforemostinves­

tors.Asco-founderoftheQuantumfundwithGeorgeSorosin1970,

Rogers'sextraordinarysuccessasaninvestorenabledhimtoretireat

theageof37.Heremainsinthepubliceye,however,throughhisbooks

andcommentaryinthefinancialmedia.

2.Willtheprospectiveborrowerbeabletorepaytheobliga­

tionwhenrequiredunderitsterms?

4

Thisisassuming,ofcourse,thatthefinancialconditionoftheborrowerhas

beenhonestlyandopenlyrepresentedtothecreditorthroughtheborrow­

er'sfinancialstatements.Therelevanceoftheassumptionremainsimportant,

asthediscussionsconcerningfinancialqualitylaterinthebookillustrate.

3

See,forexample,"credit....Etymology:MiddleFrench,fromOld

Italiancredito,fromLatincreditum,somethingentrustedtoanother,

loan,fromneuterofcreditus,pastparticipleofcredere,tobelieve,

entrust."Merriam-WebsterOnlineDictionary,.Web­

ster'sRevisedUna