Credit risk

Credit risk, credit risk or default risk is a term used in banking term, by which general the risk is understood that a borrower's loans granted to it can not repay in full conformity with the contract or not or will. General credit risk for banks is the most important type of risk. Outside of the credit system is synonymous spoken by the debtor risk.

• 3.1 Determination of credit risks
• 3.2 Control
• 3.3 Monitoring

System

In the delineation of individual sub-concepts to the general concept of credit risk is to separate between the banking operations and banking regulatory perspective because both make other accruals in their sometimes very different approach.

Bank operational perspective

The specific banking risk term is not used consistently due to the interdependencies and overlaps within individual types of risk in the literature. Büschgen want to know the term of the credit risk on the credit risk, ie the insolvency -related event of a default, concentrated. For him the credit risk in a broader sense includes only the pre-settlement risk as in the area of ​​contracts. The narrowing of credit risk on credit and collateral risks in the lending business is widespread. Therefore, a prevailing view is only in basic questions of individual risk terms, but their mutual boundary is already controversial.

The specific banking concept of credit risk is broader than that of the bank regulatory perspective and describes potential losses arising from a deterioration in the creditworthiness of the borrower, or even by its inability to pay. In this broad definition, also the issuer, investment and the collateral risk become caught. The most is in the bank practice, the term extent of credit risk at Sal Oppenheim. For here be understood as a counterparty default risk in addition to the traditional credit risk, the counterparty risks from trading transactions and the issuer risk and country risk.

Issuer Risk

Issuer risk is the risk of credit deterioration or default of an issuer or of a Reference Entity. It is caused by the purchase of securities for its own portfolio of credit institutions, securities issuance and placement transactions ( in the phase of syndication and underwriting ) and credit derivatives with an issuer - Underlying ( the credit default swap for the so-called Protection Seller ). Affected are in addition to the classical bonds, promissory notes and certificates and reverse convertibles and convertibles each with their bond component.

Investment Risk

The investment risk is similar to the credit risk because it consists of the risk that the commitments entered into by a credit institution holdings to potential losses provisioned ( due to dividend failure, partial write-offs, capital losses or reduction of hidden reserves ) from equity from profit transfer agreements ( transfer of losses ) or liability risks ( can lead eg letters ). The investment risk covers both strategic investments ( in banking-related area) as well as on operational investments ( non-banking ).

Collateral risk

The collateral risk consists of the risk that the collateral received as collateral for a loan collateral during the loan term partially or completely lose value and therefore are not sufficient to cover the loans or even may not contribute. To reduce this risk, collateral percentage deductions ( haircuts ) are made of the value of collateral received credit guarantees by using collateral values ​​and lending limits by which the amount of possible lending is limited. Legal risks are not part of the collateral risk, but belong to the operational risks of the general operations of the Bank.

Deferrals to other risks

Not belong to the credit risk in the narrower sense banking operations, the country and transfer risks stop, the counterparty risk and settlement risk. Thereafter, the country and transfer risk stop is not attributed to the credit risks. The types of risk, country and transfer risk stop, counterparty and settlement risk are organizationally very different monitors in banks and controlled than the credit risk in the narrower sense. In particular, these types of risk term content and scope are used widely in the literature. With crucial for the definition and the classification of these risks is part of the organization in controlling and monitoring in banks.

Country and transfer risk stop

Main article: Country risk

Under the country and transfer risk stop all threats are subsumed which affect the failure or the moratorium of a state in which a borrower has its legal seat. It can be used cross-border payments as a result of the unwillingness ( political risk) and / or the inability to pay ( economic risk) of a state arise and therefore forms a separate, not be influenced by creditors and borrowers, parent sphere of risk. If another state (or possibly its subdivisions ) but even the debtor ( in its own currency ), the country and transfer risk stop is identical to the Credit Risk or Issuer Risk concept.

Counterparty risk

With counterparty risk (English counterparty risk ) is the risk of default by a professional market party ( counterparty and the term is used in this context as a counter-concept to customer ) refers. This addition to traditional credit risk - for example, money market deposits - in particular, the failure risks arising from derivative positions or in the settlement of financial transactions.

During the term of a derivative transaction, the so-called replacement risk is available ( pre -settlement risk). This is the risk that a counterparty fails while a college with him derivative transaction cost has a positive value. The surviving business partner loses the economic advantage, and needs to make a possible replacement transactions ( re- roofing ) to less favorable conditions for him.

To reduce the settlement risk, arrange professional market players derivative transactions usually under general agreements which netting agreements (English netting agreements) provide. If a partner fails, receivables from all concluded under the framework contract transactions are offset, so that the replacement risk exists only in the amount of the remaining balance. In addition, (English Credit Support Annexes ) is also the mutual posting of collateral agreed to reduce the risk further, in part via so-called credit support annexes.

The importance of counterparty risk in derivatives became clear during the financial market crisis in 2007 when near-collapse of American International Group. AIG had occurred on a large scale, as guarantor in credit default swaps.

The meet current cash and derivative transactions leads to the resolution or settlement risks so-called. Their character differs depending on how the transaction is made. To reduce risk, transactions are partially passed through a clearing house, which acts as a stakeholder for both parties, respective business only train to train handles (also with English. "Delivery versus Payment " ) only if both parties necessary for the running of the business assets to made available ( purchased ) have (so-called "matching "). So take a clearinghouse for securities, the asset transfers at a securities purchase only present if the buyers have the purchase price and the seller purchased the securities with the Clearing Agent. Settlement risk is then reduced to a short-term replacement risk: If one counterparty, the other counterparty must also not afford. His risk is reduced that he needs to complete a replacement business and has changed to his disadvantage during the settlement period of the course.

This residual risk can be virtually eliminated if, for a central counterparty clearing occurs. The business partner then do not directly to each other. Rather, the central counterparty between them which meets regardless of any event of their default occurs. This possibility of risk reduction is about the system of Continuous Linked Settlement.

Will not train to train settled, one speaks of a " Franco- Valuta " - or "Free -of -payment " business. Both opponents cause the fulfillment of their obligation independently. If one of the counterparties from, it may be that the other has already done, but he receives no consideration (settlement risk ). In case of carriage - value transactions, settlement risk is thus essentially equal to the amount to be paid, so it has a much larger amount of damage than with a train - to - train - processing. In forex trading, one also talks of Herstatt risk.

Settlement risk in derivative transactions and settlement risks are accompanying effects from the banking business. In contrast to, for example, the traditional lending risks from the corporate business they are not discussed specifically for revenue generation. Rather, they are similar to operational risk is an inevitable consequence of the operation of certain business activities.

Regulatory Perspective

Dealing with credit risks for banks in Germany by the German Banking Act and derived regulations and circulars (particularly the Solvency Regulation (or the Principle I), the GroMiKV and MaRisk ) prudentially regulated.

In particular, the Solvency ( Solvency ) thorough review of credit risks and classifies them as part of the higher credit risks. According to § 4 paragraph 2, sentence 2 of the Solvency Regulation on credit risk is part of the risk that a counterparty is not the absence of timely provides to the bank or is triggered at the Institute due to non- performance of a third party, a performance obligation. This broad definition includes both the credit risk on cash loans as well as from the assumed contingent liability of an institution ( bank guarantees ). Item also includes the financial risks of the institutions are subsumed from their investments, such as 2 sentence clarifies Solvency 2 in § 4 para.

Counterparty risk is a bank- regulatory preamble, which in addition to the credit risk also includes country and transfer risk and counterparty risk. The summarized under default risk risk components of credit risk, country and transfer risk and counterparty risk are terms from the bank management that has, or not taken, the banking supervision law only partially.

Under settlement risk, the law understands ( § 4 para 2, sentence 4 of the Solvency Regulation ), both parties did not meet after a performance timing transactions on which changes in the value of traded financial instruments may result. As a so-called intermediate risk Solvency describes the settlement risk in § 14 paragraph 1, in which the offsetting transaction of the other contracting party responsible for payment has not yet been fulfilled, but the institute itself has already been done according to the contract. The difference between resolution and intermediate risk, therefore, is whether both parties have not (yet) done, although they were obliged to perform ( settlement risk) or whether only one partner of his obligation is not fulfilled ( intermediate risk). In addition, the delivery risk is limited by law to the trading book, while extending the settlement risk on the banking book of an institution.

Country Risk

Finally, under the default risk is also the country and transfer risk subsumed stop without this term appears in the Act. For this is § 9 paragraph 1 sentence 3 of the Solvency Regulation succinctly that from a store also allows multiple counterparty credit risk exposures arise. This also meant that a loan to a borrower with legal domicile abroad initially represents a credit risk, but also the country and transfer risks stop can prevent the loan repayment in whole or in part beyond. This is both isolated (either the borrower is insolvent, although no country risks or vice versa ) and cumulative ( borrower is insolvent and there is a stop transfer ) is conceivable.

Several counterparty credit risk exposures also arise in convertibles, as the BaFin makes clear in response to a request. Then convertible bonds exist with conversion rights of the creditor ( " Convertibles " ) from a balance sheet counterparty risk positions in accordance with § 10 of the Solvency Regulation in terms of its bond component and a derivative counterparty credit risk exposure in accordance with § 11 of the Solvency Regulation in relation to the option component.

Collateral risk

A major difference between the banking operations and bank regulatory system is the collateral risk. Among the risk is understood that the collateral received as collateral for a loan collateral may expire during the loan term in value partially or completely, and therefore no longer be sufficient in order to cover the credit claim. This collateral risk is prudentially treated as credit risk mitigation technique that is not part of the default risk. Any legal risks that the collateral for legal reasons could not be recycled are also regulatory assigned not part of the collateral risk, but to the operational risks pursuant to § 269 paragraph 1 sentence 2 of the Solvency Regulation. If realized, the collateral risk, include the costs not covered by income from disposals of securities lending Parts for credit risk. If an institution for legal reasons prevented the realization of collateral, so the losses are therefrom attributable to operational risks.

Key figures for credit risk

The credit risk of individual credit exposures is often characterized with three key figures that in the new Basel Capital Accord ( see also minimum capital requirements for credit risk ) play a central role. These are:

• The failure probability, ie the probability that the debtor defaults ( PD abbreviation of English "probability of default").
• The expected amount of the claim at default ( EAD abbreviation of English "exposure at default", in principle I referred to as a credit equivalent amount ): The EAD includes current receivables as well as expected future claims by the borrower. It is in lines of credit and overdraft facilities of special importance, since experience teaches that credit lines with failure busy often higher than normal or even exaggerated.
• The loss given default ( LGD abbreviation of English " Loss Given Default"): The LGD indicates what fraction of the exposure amount is expected to be lost in case of failure. Key factors that affect the LGD, the nature and degree of the collateral and the ranking position of receivables. The tendency of the LGD is at a high level of collateralisation and great value of the collateral is lower in subordinated claims against it higher.

The expected loss ( EL abbreviation of English "expected loss" ), also referred to as standard risk costs, can from the above three ratios are determined as follows:

The EL is strictly speaking not a risk measure because it reflects the expected value of the future loss from loan defaults and thus no information about the uncertainty regarding the future loss (unexpected loss, UL abbreviated by English "unexpected loss" ) includes. A measure of the uncertainty is the value at risk.

Credit Risk Management

When measuring, control and monitoring of credit risk the bank's operational and regulatory perspective are largely merged. In particular, the Solvency Regulation and the MaRisk indicate specifically before the needs, tools and targets to allow uniform management of credit risk by the credit institutions. Objective of credit risk management is the ability to meet the required regulatory risk-bearing capacity of a credit institution. The risk-bearing capacity of a credit institution is largely determined by its ability to balance assets or earnings losses due to risk admissions without inventory risk and without serious negative impact on its business opportunities ( growth impairment).

In this sense, credit risk management under any arrangements for the collection, aggregation and management of risks associated with credit transactions can be understood. The mapping of the effects of risk entries, the resulting losses, the charges obtained for the assumption of risk and the valuation gains and losses are then in the financial statements ( accounts).

Determination of credit risk

The credit risk of an institution is first identified by adequate use of appropriate selection procedures from the entire data set and then quantified by combining the individual risk contributions, so that it can form the basis for determining the risk-bearing capacity as part of the overall risk. Credit risk is measured with the help of performance in credit ratings: the worse the rating, the higher is the probability of failure. In a risk-based pricing borrower must pay premiums with bad credit rating credit spreads as a risk premium. Does not take place risk- based pricing, it may be a negative for the relevant bank or insurance " adverse selection ". Adverse selection means: Poor borrowers remain good borrowers switch to a more favorable for them bank.

In the next step, the individual, by the various institutions considered to be suitable sub-forms of credit risks are aggregated to a total size. The purpose of this regular determination is the identification of risk concentrations or negative change due to deteriorating credit ratings.

Control

Risk management includes all planned or taken measures to deal with the identified and analyzed risk. One of the most important - implicit - requirements of the Solvency is the uniform reference " borrower" to which the control process is to focus. Explicit provisions in detail and are then, however, the rating procedures and processes that require a classification of borrowers in certain risk categories. These risk categories are then provided with stepped default probabilities. Based on the calculated failure probabilities can then be the overall credit risks split into different rating levels, with the aim institutions under the control also aims at reducing the proportion of bad risks evaluated in the overall portfolio.

Monitoring

The monitoring of credit risks in a further step with a comprehensive range of quantitative tools and metrics. Some tools are common to several types of risk, but others must be tailored to the characteristics of specific risk categories.

• Limit Control:

Each debtor and each risk group is assigned to a risk - oriented credit limit ( maximum amount of credit ), the amount and duration of which depends on the individual 's credit rating. In this way, there are credit limits for individual borrowers and borrower groups ( borrower unit ), industries, other groups of borrowers with uniform positive correlation and country limits. These limits can be refined by sub-limits.

• Economic capital ( economic capital ):

Is a measurement used to determine the amount of equity required that able absorb very severe unexpected losses on the loan portfolio must be. With "extreme" a confidence level of 99.5 % is referred to the economic capital calculated. This means that the occurring within one year of unexpected losses with a probability of 99.5% or more are covered by equity.

The expected loss measures on the basis of historical loss data into the hypothetical loss that is expected to occur within one year of credit risk. In order to determine the expected loss for credit risk credit rating, loan maturities and collateral are taken into account to measure the riskiness of the loan portfolio. Therefore, this indicator is to measure the credit risk. The calculation results can also be used to determine the allowance for loan losses in the financial statements.

• Stress tests:

The measurement and evaluation of the credit risk can be extended stress testing. Hereby the influence of hypothetical changes in the economic conditions on the whole or part of the loan portfolio can be simulated. This will also be the resultant changes in terms of the changes in the rating of the loan portfolio and thus on the core capital ratio of a bank visible. With the help of stress tests and potential hazards or concentrations to be uncovered.

Impact on lending

The capital and reserves required risk-bearing capacity of banks is aimed at the protection of depositors and their deposits. Risk-bearing capacity in this sense means the maximum capacity of the equity of a bank through resulting losses from the risks taken.

The existing preserve this risk-bearing bank regulatory instruments, on which ultimately the risk management of individual banks oriented, but pro-cyclical. In cyclical recessionary phases or individual economic crises of their borrowers the credit institutions tend to reduce their loans and select cautious in new loans were granted because they have inferior rating due own funds and have to worry about by rising credit risks higher loan losses. In these cases, the core capital ratio of institutions decreases already by rating downgrades in their borrowers, without that there has been new loan arrangements. Thus, they may reinforce the economic downturn; conversely, this also applies to upturns.