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1、Credit Risk ManagementEnhancing Your Bottom LineEbrahim ShabudinEbrahim ShabudinManaging Director Managing Director Deloitte&Touche LLPDeloitte&Touche LLPThe AFP 23rd Annual Conference New OrleansNovember 3-6,2002Credit BackgroundThorough identification and accurate Thorough identification and accur
2、ate measurement of credit risk,supported by strong measurement of credit risk,supported by strong risk management can help improve the bottom risk management can help improve the bottom lineline.An uncertain and volatile economic.An uncertain and volatile economic environment significantly impacts t
3、his abilityenvironment significantly impacts this ability.The desire to grow and turn in outstanding.The desire to grow and turn in outstanding results has a tendency to put pressure on the results has a tendency to put pressure on the checks and balances within businesseschecks and balances within
4、businessesValue PropositionCredit plays a critical role in“selling”products and servicesCredit plays a critical role in“selling”products and services Expands revenue opportunities with creditworthy,incremental Expands revenue opportunities with creditworthy,incremental customerscustomers Utilizes in
5、novative structures to support business relationshipsUtilizes innovative structures to support business relationshipsEffective credit risk management limits credit losses and provides Effective credit risk management limits credit losses and provides stable cash flows and earningsstable cash flows a
6、nd earnings Marketplace rewards companies exhibiting earnings and cash flow Marketplace rewards companies exhibiting earnings and cash flow stability with higher P/E multiplesstability with higher P/E multiples Marketplace penalizes credit induced volatility and“surprises”Marketplace penalizes credi
7、t induced volatility and“surprises”Raises questions about quality of managementRaises questions about quality of managementCorporate Credit RiskCompanies are exposed to significant levels Companies are exposed to significant levels of credit risk emanating from different sourcesof credit risk emanat
8、ing from different sourcesAccounts Receivables Accounts Receivables Other Notes ReceivablesOther Notes ReceivablesBuyer and Franchise FinancingBuyer and Franchise FinancingWith Recourse FinancingWith Recourse Financing Project FinanceProject Finance Structured TransactionsStructured Transactions Lea
9、ses with RecourseLeases with RecourseDerivatives Exposures Derivatives Exposures FX,Interest Rate Risk,Commodities etc.FX,Interest Rate Risk,Commodities etc.Collateral RiskCollateral Risk Parent or Third Party Guarantees Parent or Third Party Guarantees Commercial and Standby Letters of CreditCommer
10、cial and Standby Letters of Credit Note also that Critical Suppliers to the company Note also that Critical Suppliers to the company may pose specific credit riskmay pose specific credit riskDSO Impact an exampleActualActualCompany ACompany APeer AveragePeer AverageQ3 A/RQ3 A/R$295,396,000$295,396,0
11、00Q3 SalesQ3 Sales$261,201,000$261,201,000 DSOs=DSOs=124*124*51.351.3HypotheticalHypotheticalD D CashCashDSOsDSOs51.351.3Q3 SalesQ3 Sales$261,201,000$261,201,000 Q3 A/R=Q3 A/R=$122,002,230$122,002,230+$173,393,770+$173,393,770*Equals 295.4M/261.2M x 90(or number of days in sales period)Equals 295.4M
12、/261.2M x 90(or number of days in sales period)Credit as a FacilitatorCredit risk management is important Credit is a facilitator of business growth and Credit is a facilitator of business growth and performanceperformance High business margins tend to attract lower quality High business margins ten
13、d to attract lower quality clients and therefore higher risk profile to manageclients and therefore higher risk profile to manage Clients(buyers)may be concentrated in selected Clients(buyers)may be concentrated in selected industries and provide limited portfolio diversification industries and prov
14、ide limited portfolio diversification opportunityopportunity Poor credit risk management resulting in negative Poor credit risk management resulting in negative impact to bottom-line is heavily penalized by marketsimpact to bottom-line is heavily penalized by marketsCredit Strategy&Risk ToleranceuSp
15、ecific Quantifiable ObjectivesuManagement Review MethodologyuCredit Strategy Statement and Risk ToleranceuCoordination with Business PlanThe business strategies and objectives drive the establishment of creditpolicies and procedures.Measurement and reporting as well as the use of current technologie
16、s enhance credit decision-making and improve risk management.The entire process is continually re-evaluated and improved.Credit Risk Areas to ConsiderCredit PolicyCredit PolicyCredit Approval Credit Approval AuthorityAuthorityLimit SettingLimit SettingPricing Terms Pricing Terms and Conditionsand Co
17、nditionsDocumentation:Documentation:Contracts and Contracts and CovenantsCovenantsCollateral and Collateral and SecuritySecurityCollections,Collections,Delinquencies Delinquencies and Workoutsand WorkoutsExposure Exposure ManagementManagement AggregationAggregation ControlControlPeriodic Account Per
18、iodic Account ReviewsReviews Payments/AgingPayments/Aging Credit ConditionCredit ConditionCompliance with Compliance with Covenants,TermsCovenants,TermsTechnology/ReportsTechnology/Reports Transactions/Transactions/BookingsBookings Risk-adjusted Risk-adjusted ReturnReturnn nSales Sales ChannelsChann
19、elsn nRisk StrategyRisk Strategyn nUnderwriting Underwriting StandardsStandardsn nCredit Credit ApplicationApplicationn nAnalysisAnalysisuuBusiness/Business/IndustryIndustryuuFinancialFinancialuuCreditCreditn nCredit Scoring Credit Scoring and Ratingsand RatingsOrigination/AssessmentAdministrationMo
20、nitoring/ControlRiskManagementn nPortfolio Portfolio ManagementManagementn nConcentrationConcentrationn nDiversificationDiversificationn nAllowance for Allowance for Bad DebtsBad Debtsn nRisk Risk MitigationMitigationn nObjectivesObjectivesn nType of Type of ExposureExposuren nInstruments or Instrum
21、ents or MethodsMethodsValue CreationBusiness Performance MeasuresPerformance-based management utilizes metrics that measure actual performance against predetermined thresholds.The thresholds are established taking into account the organizations strategy,operatingenvironment and process controls.The
22、measures drive value creation and should support problem identification and correction.nBusiness StrategySystemsOperationsFinancePerformance ManagementCredit AnalysisCredit DecisionsCollectionsCREDIT POLICYRISK MANAGEMENTCredit Risk Managements Inter-related ActivitiesComplianceOriginationReportingC
23、redit Policies&Procedures Analysis&RiskManagementGovernance,Controland ImplementationMeasurementMethodologiesTechnology&Data IntegrityCredit Strategy&Risk ToleranceA complete and coherent risk management A complete and coherent risk management framework contains the following elementsframework conta
24、ins the following elementsCredit Risk ManagementCredit Risk ManagementA New ParadigmA new business paradigm had evolved:causing A new business paradigm had evolved:causing a lack of reliance on good fundamental analysisa lack of reliance on good fundamental analysisThe idea that stock market values
25、would The idea that stock market values would continue to go up indefinitelycontinue to go up indefinitelyIncreasingly competitive,complex and volatile Increasingly competitive,complex and volatile market placemarket placeHigher than expected actual debt burdensHigher than expected actual debt burde
26、nsExtensive reliance on unrealistic future cash Extensive reliance on unrealistic future cash flowsflowsFailures in corporate governanceFailures in corporate governanceQuestionable personal and corporate ethicsQuestionable personal and corporate ethicsImplications for Corporate GovernanceCurrent org
27、anization structures to be revisitedCurrent organization structures to be revisitedClarity around roles and responsibilitiesClarity around roles and responsibilitiesNeed for honesty,integrity and independence Need for honesty,integrity and independence(self-regulation)(self-regulation)Technical expe
28、rtise of people and strong Technical expertise of people and strong management processesmanagement processesImproved disclosure requirementsImproved disclosure requirementsImportance and implementation of sanctionsImportance and implementation of sanctionsIncreased legislation and compliance Increas
29、ed legislation and compliance requirementsrequirements Vision:Vision:Managing Risk/ReturnManaging Risk/ReturnPricing decisions,Performance measurement,business and customer segmentation,compensation,etc.A business model view of Credit Risk Infrastructure componentsCredit Risk Management Strategic Vi
30、sionDevelopment Stages Foundation StageFoundation Stage includes application of risk identification includes application of risk identification methodologies,risk scoring or rating systems and strong methodologies,risk scoring or rating systems and strong underwriting standardsunderwriting standards
31、 Basic StageBasic Stage tends to include managing on a transactional basis by tends to include managing on a transactional basis by evaluating specific attributes such as structuring,collateral and evaluating specific attributes such as structuring,collateral and pricingpricing Advanced StageAdvance
32、d Stage represents managing on a portfolio basis represents managing on a portfolio basis including aspects such as concentrations,correlations and including aspects such as concentrations,correlations and diversificationdiversification The Sophisticated StageThe Sophisticated Stage includes applica
33、tion of highly developed includes application of highly developed measurement techniques for transactions and portfolios,supported measurement techniques for transactions and portfolios,supported by decision-making relating to segments or businesses against by decision-making relating to segments or
34、 businesses against established hurdle rates.established hurdle rates.Credit Risk ClarifiedCredit risk is defined as the risk of loss or potential Credit risk is defined as the risk of loss or potential loss resulting from:loss resulting from:Default in contractual obligations by a customerDefault i
35、n contractual obligations by a customer Migration in condition and ratingMigration in condition and rating Deterioration in performance Deterioration in performance Credit risk includes both an expected(predictable)Credit risk includes both an expected(predictable)and unexpected(volatile)loss compon
36、ent.and unexpected(volatile)loss component.Businesses have to contend with Expected and Unexpected LossesExpected LossesExpected Losses AnticipatedAnticipated Cost of doing businessCost of doing business Charged to provisionsCharged to provisions Captured in pricingCaptured in pricing Relatively eas
37、ier to Relatively easier to measuremeasureAssessing expected loss Assessing expected loss includes determining includes determining exposure,default probability exposure,default probability and severityand severityUnexpected LossesUnexpected Losses Unanticipated but Unanticipated but inevitableinevi
38、table Must be planned forMust be planned for Covered by reservesCovered by reserves Allocated to businessesAllocated to businesses Difficult to measureDifficult to measureAssessing unexpected loss Assessing unexpected loss requires making qualitative requires making qualitative judgments around pote
39、ntial judgments around potential volatility of average lossesvolatility of average lossesCredit Risk Management ExplainedAlthough credit risk may be difficult to measure it is Although credit risk may be difficult to measure it is important to estimate and manageimportant to estimate and manage What
40、 does Credit Risk Management mean?What does Credit Risk Management mean?It represents an institutions ability to properly identify It represents an institutions ability to properly identify and evaluate the potential risk of default in payment of and evaluate the potential risk of default in payment
41、 of obligations of customersobligations of customers It incorporates the firms ability to effectively manage It incorporates the firms ability to effectively manage and control this exposure in a way that is consistent and control this exposure in a way that is consistent with the institutions busin
42、ess strategy,risk appetite with the institutions business strategy,risk appetite and credit cultureand credit cultureImportant Building BlocksEffective Credit Risk Management requiresEffective Credit Risk Management requires Clear origination and underwriting standards Clear origination and underwri
43、ting standards A strong corporate and credit cultureA strong corporate and credit culture Highly developed risk measurement techniques Highly developed risk measurement techniques Ability to recognize and cover expected and unexpected Ability to recognize and cover expected and unexpected lossesloss
44、es Pricing commensurate with risks undertakenPricing commensurate with risks undertaken Methodologies to assess net profit contributions by Methodologies to assess net profit contributions by customers and appropriate business segmentscustomers and appropriate business segments Proper allocation of
45、capital and management resourcesProper allocation of capital and management resourcesIn order to:In order to:Improve overall corporate performance,measured by a Improve overall corporate performance,measured by a higher EPS or P/E ratio(or market value)higher EPS or P/E ratio(or market value)Credit
46、Policy and ProcessCredit Policy should be clear and conciseCredit Underwriting Standards must be developed and included in policyCredit Processes should be reasonable and allow quick response to clientsHealthy balance between sales and credit approval should exist and be respectedRisk MonitoringExpo
47、sure must be complete and currentRegular reporting and updating of clients payment performance Minimum annual reviews of clients should be performedFinancial conditions should be regularly assessedRequired action must be initiated and follow up must take placeContract Terms and DocumentationContract
48、 negotiations must take place at the Contract negotiations must take place at the right level in the organizationright level in the organizationAppropriate approvals must be obtainedAppropriate approvals must be obtainedInternal or external legal departments must Internal or external legal departmen
49、ts must document completelydocument completelyTerms and conditions should be understood and Terms and conditions should be understood and compliance mechanism put in placecompliance mechanism put in placeExceptions must be reported and managed Exceptions must be reported and managed urgently to reso
50、lutionurgently to resolutionRisk Rating System EffectivenessCredit Scoring is generally used to“risk rate”homogeneous portfoliosCredit Scoring is generally used to“risk rate”homogeneous portfolios Highest applicability is in consumer and retail portfoliosHighest applicability is in consumer and reta