Many a banker thinks that being certified as Standardized mode, he or she is allowed to continue to practice banking the same way as has always been done. What bankers fail to realize is that one of the more important tenants of the Basel accords is for them to become proactive in their management of credit risk, and not reactive to credit problems. Being Standardized or IRB is a technical distinction. The ability of a banker to become proactive is a must across all disciplines in banking, particularly credit risk.
OK so what do we mean by Proactive? In our article on “How we make Credit Decisions” we discussed some possible reasons of why bankers keep repeating the same mistakes (http://www.credit-risk-store.com/make-credit-risk-decisions/). Essentially the majority of bankers are reactive to credit issues, they wait until the problem arises then they take measures to sort it out. By producing credit applications of 25 pages, they are led to believe that the study is comprehensive enough and early warning signs are covered in full. In fact in one conversation with a banker, I was told that he was in full control given the annual credit review, frequent calls to the client, and acquisition of excess reports and MIS. We touched on this subject in our article “How do you manage Credit Risk at your bank?” in which bankers fall into the trap of thinking they have the magic solution to affective credit risk management (http://www.credit-risk-store.com/how-manage-credit-risk-bank/).
In short, being proactive means the following:
- Identify credit issues with the obligor early, long before they surface in a material sense;
- Align your exposure to the obligor accordingly, reducing it with increasing credit risk;
- Keep an eye on these issues during the monitoring phase of the account; and
- Take action when they start to deteriorate.
Linking exposures to risk profile of the obligor will preserve the Portfolio Risk Rating (PRR). Your bank’s share of wallet of the obligor’s needs should reduce with increasing credit risk, so that come the day the obligor has problems fulfilling its obligations to banks, your exposure is either too small or you are out of the relationship altogether.In order to achieve the above, you need to measure risk. Risk in our definition is any factor that may have an adverse impact on the obligor that limits it from generating sufficient cash to meet its commitments to banks. Central to this definition, cash flow assessment and calculation is essential. In addition, the obligor’s business model needs to be assessed for weaknesses in cash flow generation; those that have impacted negatively on its ability to meet obligations to banks, and those that are likely to do so through sensitivity analysis. Check our Financial Analysis packages for details http://www.credit-risk-store.com/online-courses/financial-analysis/. In addition, one has to measure obligor needs and then apply the share of wallet on these needs. These needs are both short and long term. On the latter in particular, central to structuring facilities is the assessment of the obligor’s future cash generating ability, the tenor of the exposure relative to the underlying credit risk, and the cushion needed to cover volatility in cash flows. For more details please refer to our Facility Structuring package http://www.credit-risk-store.com/online-courses/financial-analysis/. Enjoy going through these articles. If you feel you need to know more about how to analyze, visit our Credit Risk Store on http://www.credit-risk-store.com/online-courses/
© 2014 6 Sigma Group
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