2. KEY PROPOSITION
• THE ADVENT OF ACTIVE AND LIQUID CREDIT
TRADING WILL REQUIRE
– COMPLETE RE-ENGINEERING OF THE CREDIT
FUNCTION & PROCESS
– ALTER THE NATURE OF BANKING
FUNDAMENTALLY
3. AGENDA
• KEY DRIVERS OF CHANGE
• CREDIT RISK MANAGEMENT PARADIGMS
– CLASSICAL
– MODERN
• CREDIT RISK MANAGEMENT ARCHITECTURE
• IMPLICATIONS FOR FINANCIAL SERVICES
4. KEY DRIVERS OF CHANGE
• KEY FEATURE OF CREDIT RISK
– CENTRAL TO ALL FINANCIAL TRANSACTIONS
• TRADITIONAL VIEW OF CREDIT
– ILLIQUID
• CURRENT VIEW OF CREDIT
– LIQUID & TRADEABLE
• SHIFT FROM STATIC MANAGEMENT OF CREDIT
TO DYNAMIC MANAGEMENT OF CREDIT RISK
5. KEY DRIVERS OF CHANGE
• SHAREHOLDER VALUE ISSUES
– RETURN ON CREDIT CAPITAL
– OPTIMISATION OF RETURN ON CREDIT
CAPITAL
• CHANGES IN FINANCIAL SERVICES
– VALUE CHAIN IN FINANCIAL SERVICES
– TREND TO UNBUNDLING THE
MICROSTRUCTURE
9. KEY DRIVERS OF CHANGE
• DEVELOPMENTS IN CREDIT ENHANCEMENT
TECHNIQUES
– BI-LATERAL
– MULTILATERAL
• ADVANCES IN CREDIT/ DEFAULT RISK THEORY
• INFRASTRUCTURE DEVELOPMENTS
– SYSTEMS CAPABILITIES
10. KEY DRIVERS OF CHANGE
• CHANGE IN REGULATORY FRAMEWORK
– SHIFT TO CAPITAL BASED REGULATION
– REGULATORY ARBITRAGE
– (POSSIBILITY) OF MODEL BASED CREDIT RISK
CAPITAL
11. KEY DRIVERS OF CHANGE
• KEY NEAR TERM FACTORS
– CREDIT CAPITAL MANAGEMENT
– CREDIT PRICING
– CREDIT RISK MANAGEMENT
– REGULATORY DEVELOPMENTS
– SHIFTS IN BANKING STRATEGY
12. CREDIT RISK PARADIGMS
• TYPES
– CLASSICAL
– MODERN
• KEY ISSUE
– APPLICABILITY TO DIFFERENT MARKET
SEGMENTS
18. IMPLICATIONS OF CLASSICAL PARADIGM
•
•
•
•
•
•
•
CREDIT RISK ASSUMPTION
CREDIT PRICING
CREDIT CAPITAL MANAGEMENT
CREDIT RISK FOCUS
CHANGES IN CREDIT QUALITY
PERFORMANCE ATTRIBUTION OF ORIGINATORS
PERFORMANCE OF CREDIT FUNCTION
19. MODERN PARADIGM
• CONCEPT
– CREDIT RISK AS A SEPARATE TRADEABLE
ASSET CLASS
– RISK MANAGED DYNAMICALLY THROUGH
HEDGING AND TRADING TOOLS
• SCHEMATIC
23. IMPLICATIONS OF MODERN PARADIGM
•
•
•
•
•
•
•
CREDIT RISK ASSUMPTION
CREDIT PRICING
CREDIT CAPITAL MANAGEMENT
CREDIT RISK FOCUS
CHANGES IN CREDIT QUALITY
PERFORMANCE ATTRIBUTION OF ORIGINATORS
PERFORMANCE OF CREDIT FUNCTION
24. IMPLICATIONS OF MODERN PARADIGM
• CLIENT MANAGEMENT
– CORE VERSUS NON CORE CLIENTS
– HOME VERSUS FOREIGN MARKETS
25. CREDIT RISK MANAGEMENT ARCHITECTURE
• CONCEPT
– RISK MANAGEMENT SYSTEMS COMPONENTS
– INFORMATION SYSTEMS
• SCHEMATICS
26. CREDIT RISK MANAGEMENT ARCHITECTURE
CREDIT ANALYSIS
CREDIT PORTFOLIO MODELLING/
CREDIT PRICING
CREDIT TRADING
CREDIT CAPITAL MANAGEMENT
ECONOMIC CAPITAL
REGULATORY CAPITAL
CREDIT ENHANCEMENT
CREDIT ADMINISTRATION
CREDIT SYSTEMS/
IT INFRASTRUCTURE
27. •CREDIT EXPOSURE - STATIC & DYNAMIC (PFCE MODEL)
•DEFAULT PROBABILITY/ RATINGS MIGRATION
•RECOVERY RATES
•DEFAULT CORRELATIONS
RATING MODELS
•INTERNAL
•EXTERNAL
CREDIT
ANALYSIS
RISK DATA
CREDIT
MODELS
•PORTFOLIO
MODELS
•PRICING
MODELS
TRANSACTION
DATA
OBLIGOR/
COUNTERPARTY
DATA
•ECONOMIC
CAPITAL
•REGULATORY
CAPITAL
CREDIT
CAPITAL
MANAGEMENT
CREDIT
DATA
•COLLATERAL
CREDIT
ENHANCEMENT
LIMIT
ADMINISTRATION
•PROVISIONING
REPORTING
•SETTLEMENT LIMITS
•RISK LIMITS
•NETTING
•CLEARING
HOUSE
28. IMPLICATIONS FOR FINANCIAL SERVICES
• TYPES
– MICRO(OPERATIONAL)
• REDEFINITION OF CREDIT PROCESS WITHIN
ORGANISATIONS
– MACRO(STRATEGIC)
• REDEFINITION OF BUSINESS FOCUS
30. STRATEGIC CHANGES
• THEME
– SHIFT FOCUS OF BANKS FROM HOLDER OF
RISK TO ORIGINATORS AND DISTRIBUTORS OF
RISK
• MODELS OF BANKING PRACTICE
31. MODEL 1 - CLASSICAL BANKING MODEL
LOAN TRANSACTION
BORROWER
DEPOSIT TRANSACTION
BANK
BANK ORIGINATES, FUNDS, ADMINISTERS
AND RETAINS CREDIT RISK OF BORROWER
DEPOSITOR
32. MODEL 2 - INVESTMENT BANKING/ SECURITIES MODEL
ISSUE OF SECURITIES
DISTRIBUTION OF SECURITIES
BORROWER
BANK
UNDERWRITING OF PLACEMENT OF SECURITIES
AND SYNDICATION OF UNDERWRITING RISK
OTHER BANKS
BANK ORIGINATES TRANSACTION AND MAY ADMINISTER IT AS
PAYMENT AGENT. FUNDING AND CREDIT RISK OF BORROWER IS
TRANSFERRED TO INVESTOR. PRIMARY RISK IS UNDERWRITING
WHICH IS SYNDICATED TO REDUCE RISK LEVEL,
INVESTOR
33. MODEL 3 - SECURITISATION MODEL
SALE OF LOAN BACKED
SECURITIES
LOAN TRANSACTION
BORROWER
BANK
SECURITISATION
VEHICLE
INVESTOR
SALE OF LOAN TO
SECURITISATION VEHICLE
BANK ORIGINATES AND ADMINISTERS THE LOAN. BANK SELLS LOAN TO
SECURITISATION VEHICLE WHICH ISSUES LOAN ASSET BACKED SECURTIES. FUNDING
AND CREDIT RISK OF BORROWER IS BORNE BY INVESTOR. BANK RISK IS CONFINED
TO CREDIT RISK PRE-SALE TO SECURITISATION VEHICLE AND ANY UNDERWRITING
RISK ON THE PLACEMENT OF THE LOAN ASSET BACKED SECURITIES
34. MODEL 4 - ECONOMIC RISK TRANSFER MODEL
LOAN TRANSACTION
BORROWER
CREDIT DEFAULT SWAP OR
CREDIT LINKED NOTE
BANK
BANK ORIGINATES, FUNDS AND ADMINISTERS THE LOAN. CREDIT RISK OF
BORROWER IS TRANSFERRED TO INVESTORS OR OTHER BANKS. BANK
CREDIT RISK IS PRE ECONOMIC HEDGE ONLY. WHERE A CREDIT LINKED
NOTE IS ISSUED THE INVESTOR/ OTHER BANK ALSO PROVIDES FUNDING.
INVESTOR/
OTHER BANK
35. KEY CHALLENGES
•
•
•
•
•
CREDIT RISK MODELLING PROBLEMS
DEVELOPMENT OF CREDIT TRADING
CREDIT ENHANCEMENT PROBLEMS
CHANGES IN CREDIT INFRASTRUCTURE
CHANGE MANAGEMENT
36. CONCLUSIONS
• THE ADVENT OF ACTIVE AND LIQUID CREDIT
TRADING WILL REQUIRE
– COMPLETE RE-ENGINEERING OF THE CREDIT
FUNCTION & PROCESS
– ALTER THE NATURE OF BANKING
FUNDAMENTALLY