Chapter 11: 4, 7, 8, 10, 11, 12, 14, 15, 18, 20, 21, 22, 23, 24, 26, 27

Chapter Eleven
Credit Risk: Individual Loan Risk

Chapter Outline

Introduction

Credit Quality Problems

Types of Loans

• Commercial and Industrial Loans • Real Estate Loans • Individual (Consumer) Loans • Other Loans

Calculating the Return on a Loan

• The Contractually Promised Return on a Loan • The Expected Return on a Loan

Retail versus Wholesale Credit Decisions

• Retail • Wholesale

Measurement of Credit Risk

Default Risk Models • Qualitative Models • Quantitative Models

Summary

Appendix 11A: Credit Analysis (www.mhhe.com/saunders7e)

Appendix 11B: Black-Scholes Option Pricing Model (www.mhhe.com/saunders7e)
Solutions for End-of-Chapter Questions and Problems

1. Why is credit risk analysis an important component of FI risk management? What recent activities by FIs have made the task of credit risk assessment more difficult for both FI managers and regulators?

Credit risk management is important for FI managers because it determines several features of a loan: interest rate, maturity, collateral and other covenants. Riskier projects require more analysis before loans are approved. If credit risk analysis is inadequate, default rates could be higher and push a bank into insolvency, especially if the markets are competitive and the margins are low.

Credit risk management has become more complicated over time because of the increase in off-balance-sheet activities that create implicit contracts and obligations between prospective lenders and buyers. Credit risks of some off-balance-sheet products such as loan commitments, options, and interest rate swaps, are difficult to assess because the contingent payoffs are not deterministic, making the pricing of these products complicated.