CREDIT RISK MANAGEMENT THE COMMODITISATION OF CREDIT RISK TRENDS IN CREDIT RISK MANAGEMENT

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

AGENDA KEY DRIVERS OF CHANGE CREDIT RISK MANAGEMENT PARADIGMS –CLASSICAL –MODERN CREDIT RISK MANAGEMENT ARCHITECTURE IMPLICATIONS FOR FINANCIAL SERVICES

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

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

PRODUCT MANUFACTURE ORIGINATION/ DISTRIBUTION RISK PROCESSING/ ADMINISTRATION CAPITAL MANAGEMENT PRODUCT/ KNOWLEDGE MANAGEMENT TECHNOLOGY MANAGEMENT PRODUCT FOCUSCLIENT FOCUS RISK MANAGEMENT

KEY DRIVERS OF CHANGE CREDIT RISK MANAGEMENT PERFORMANCE –CONTROL FAILURES –QUANTIFICATION OF CREDIT RISK –INTERACTION OF MARKET AND CREDIT RISK CREDIT RISK PRICING –INABILITY TO PRICE CREDITR ISK CORRECTLY –INCONSISTENCY OF PRICING

KEY DRIVERS OF CHANGE COSTS OF CREDIT RISK MANAGEMENT INFRASTRUCTURE LIQUEFACTION OF CREDIT RISK –SYNDICATION & ASSET SALES –SECURITISATION –CREDIT DERIVATIVES & CREDIT LINKED NOTES

DEVELOPMENTS IN CREDIT ENHANCEMENT TECHNIQUES –BI-LATERAL –MULTILATERAL ADVANCES IN CREDIT/ DEFAULT RISK THEORY INFRASTRUCTURE DEVELOPMENTS –SYSTEMS CAPABILITIES KEY DRIVERS OF CHANGE

CHANGE IN REGULATORY FRAMEWORK –SHIFT TO CAPITAL BASED REGULATION –REGULATORY ARBITRAGE –(POSSIBILITY) OF MODEL BASED CREDIT RISK CAPITAL

KEY DRIVERS OF CHANGE KEY NEAR TERM FACTORS –CREDIT CAPITAL MANAGEMENT –CREDIT PRICING –CREDIT RISK MANAGEMENT –REGULATORY DEVELOPMENTS –SHIFTS IN BANKING STRATEGY

CREDIT RISK PARADIGMS TYPES –CLASSICAL –MODERN KEY ISSUE –APPLICABILITY TO DIFFERENT MARKET SEGMENTS

CREDIT RISK BY MARKET SEGMENT SEGMENTS –RETAIL –MID-MARKET –WHOLESALE/ CORPORATES DIMENSIONS –RISK –PRICING –CREDIT METHODOLOGY –LIQUIDITY AND TRADEABILITY

SIZE OF INDIVIDUAL EXPOSURE HIGH LOW NUMBER OF COUNTERPARTIES SMALL LARGE RETAIL MID-MARKET WHOLESALE

CLASSICAL PARADIGM CONCEPT –ASSESS RISK AND MATCH WITH CAPITAL –RISK MANAGEMENT TECHNIQUES DIVERSIFICATION COLLATERAL SCHEMATIC

CREDIT REQUEST CREDIT LIMIT CREDIT FUNCTION ORIGINATIONCLIENT TRANSACTION CREDIT ASSESSMENT MONITORING CREDIT LIMIT & CREDIT ADMINISTRATION TRANSACTION ORIGINATION PREPARATION OF CREDIT REQUEST PRICING/ STRUCTURING ADMINISTRATION CREDIT RISK MANAGEMENT CAPITAL PROVISIONING RISK SYNDICATION

CLASSICAL PARADIGM KEY ELEMENTS CREDIT ANALYSIS AND ASSESSMENT PROCESS

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

MODERN PARADIGM CONCEPT –CREDIT RISK AS A SEPARATE TRADEABLE ASSET CLASS –RISK MANAGED DYNAMICALLY THROUGH HEDGING AND TRADING TOOLS SCHEMATIC

ORIGINATION CREDIT FUNCTION CREDIT PORTFOLIO CREDIT TRADING CAPITAL MARKET CREDIT CAPITAL CLIENT TRANSACTION CREDIT REQUEST CREDIT LIMIT & CREDIT CHARGE TRANSACTION ORIGINATION STRUCTURING/ PRICING ADMINISTRATION SYNDICATION/ ASSET SALES SECURITISATION CREDIT DERIVATIVES CREDIT ASSESSMENT CREDIT PORTFOLIO ANALYSIS CREDIT CAPITAL MANAGEMENT CREDIT PORTFOLIO MANAGEMENT & POSITIONING

TRANSACTION RETURN TRANSACTION CREDIT RISK ORIGINATOR INTERNAL CREDIT DEFAULT SWAP CREDIT RISK CREDIT RISK CHARGE CREDIT PORTFOLIO CREDIT CAPITAL CREDIT HEDGES CREDIT RISK TRADED & HEDGED CREDIT RISK ASSUMED & MANAGED

MODERN PARADIGM KEY ELEMENTS CREDIT ANALYSIS AND ASSESSMENT PROCESS

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

IMPLICATIONS OF MODERN PARADIGM CLIENT MANAGEMENT –CORE VERSUS NON CORE CLIENTS –HOME VERSUS FOREIGN MARKETS

CREDIT RISK MANAGEMENT ARCHITECTURE CONCEPT –RISK MANAGEMENT SYSTEMS COMPONENTS –INFORMATION SYSTEMS SCHEMATICS

CREDIT DATA TRANSACTION DATA CREDIT ANALYSIS RISK DATA CREDIT MODELS CREDIT ENHANCEMENT REPORTING CREDIT CAPITAL MANAGEMENT LIMIT ADMINISTRATION OBLIGOR/ COUNTERPARTY DATA RATING MODELS INTERNAL EXTERNAL CREDIT EXPOSURE - STATIC & DYNAMIC (PFCE MODEL) DEFAULT PROBABILITY/ RATINGS MIGRATION RECOVERY RATES DEFAULT CORRELATIONS PORTFOLIO MODELS PRICING MODELS COLLATERAL NETTING CLEARING HOUSE ECONOMIC CAPITAL REGULATORY CAPITAL PROVISIONING SETTLEMENT LIMITS RISK LIMITS

IMPLICATIONS FOR FINANCIAL SERVICES TYPES –MICRO(OPERATIONAL) REDEFINITION OF CREDIT PROCESS WITHIN ORGANISATIONS –MACRO(STRATEGIC) REDEFINITION OF BUSINESS FOCUS

OPERATIONAL CHANGES RE-ENGINEERING THE CREDIT PROCESS ALTERATION OF CREDIT RISK ARCHITECTURE/ INFRASTRUCTURE

STRATEGIC CHANGES THEME –SHIFT FOCUS OF BANKS FROM HOLDER OF RISK TO ORIGINATORS AND DISTRIBUTORS OF RISK MODELS OF BANKING PRACTICE

BORROWERBANK DEPOSITOR MODEL 1 - CLASSICAL BANKING MODEL LOAN TRANSACTIONDEPOSIT TRANSACTION BANK ORIGINATES, FUNDS, ADMINISTERS AND RETAINS CREDIT RISK OF BORROWER

BORROWERBANK INVESTOR MODEL 2 - INVESTMENT BANKING/ SECURITIES MODEL ISSUE OF SECURITIESDISTRIBUTION OF SECURITIES 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, OTHER BANKS UNDERWRITING OF PLACEMENT OF SECURITIES AND SYNDICATION OF UNDERWRITING RISK

BORROWERBANKINVESTOR MODEL 3 - SECURITISATION MODEL LOAN TRANSACTION SALE OF LOAN BACKED SECURITIES 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 SECURITISATION VEHICLE SALE OF LOAN TO SECURITISATION VEHICLE

BORROWERBANK INVESTOR/ OTHER BANK MODEL 4 - ECONOMIC RISK TRANSFER MODEL LOAN TRANSACTIONCREDIT DEFAULT SWAP OR CREDIT LINKED NOTE 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.

KEY CHALLENGES CREDIT RISK MODELLING PROBLEMS DEVELOPMENT OF CREDIT TRADING CREDIT ENHANCEMENT PROBLEMS CHANGES IN CREDIT INFRASTRUCTURE CHANGE MANAGEMENT

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