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Chapter 8: Credit Risk from the Regulator’s Perspective - Coggle Diagram
Chapter 8: Credit Risk from the Regulator’s Perspective
Introduction
The sectors that were not specified for lending assistance would have been to credit rationing.
Lending institutions might have been subject to concentration risk.
Given the directive of the regulator, bank might have approved marginal lending applications in the directed sectors.
Capital Adequacy
financial institutions normally fail as a result of poor credit decisions.
Depositors need to be protected against poor decisions by management
financial institutions are required to put a side capital for each credit risk exposure
Large Credit Exposures
An 'exposure' under prudential regulations generally means a potential for loss under a finance facility that has been provided.
credit risk exposure increase when spread through only a small number of lending counterparties.
A large exposure is defined as an exposure to an individual or group counterparties that exceeds 10 percent of the consolidated capital base.
The capital base is that specified in the capital adequacy guidelines and includes both Tier 1 and Tier 2 capital.
Securization
Absolves the financial institutions from any legal recourse from the sale of loans.
Results in the financial institution not holding capital against the loan.
Clean Sale Supply of Assets
There should be no beneficial interest in the sold assets and absolutely no obligation to the financial institution.
There should be no recourse (including costs) to the lending institution.
The amount paid for the loans should be fixed and should be received by the time the assets are transferred from the lending institution.
Any assets that are provided to the special purpose vehicle as a substitute or provided at below book value are not considered as relieving credit risk.
Credit Derivatives
ability to dramatically alter the credit profile of the statement of financial position of a financial institutions.
The effectiveness of credit derivatives becomes an issue of how well the instruments reduce the requirement of capital adequacy.
A credit derivatives is deemed to afford protection if the physical settlement has a deliverable obligation.
In terms of maturity, a financial institution is deemed to have full protection if the maturity of derivatives equals the maturity of the underlying asset.
Developments in Regulations
Basel III, due to the shortage of capital and liquidity.
Basel III required banks to maintain proper leverage ratios and keep certain level of reserve capital on hand.
Credit Ratings
Short term
Long term
The process start with a meeting with the company under consideration to help the company know what to expect and what will be required of the rating process.
The corporate credit risk factors are divided into two categories:
Business Risk
Key rating factors for that industry, such as profitability factors and risk vulnerability.
Diversification factors for business that have exposures to different industries.
Size, and geographic and market dominance
Financial Risk
Management Evaluation
Management of the business will be assessed for their ability to plan and implement their business plan.
An opinion is formed of management's appetite for risk, and the inclusion of past business seccesses would be considered.
There is also a focus on the structure of the organisation and any undue reliance on one person.