...interesting journey, from the ancient origins of credit to the birth of ratings agencies, all the way through modern-day deficiencies in understanding probability of default. C redit is much older than writing. Hammurabi’s Code, which codified legal thinking from 4,000 years ago in Mesopotamia, didn’t outline the basic rules of borrowing and didn’t address concepts such as interest, collateral and default. These concepts appear to have been too well known to have required explanation. However, the Code did emphasize that failure to pay a debt is a crime that should be treated identically to theft and fraud. The Code also set some limits to penalties. For example, a defaulter could be seized by his creditors and sold into slavery, but his wife and children could only be sold for a three-year term. Similarly, the Bible records enslavement for debt without disapproval; for example, the story of Eli’sha and the widow’s oil concerns the threatened enslavement of two children because their father died without paying his debts. But the Bible also goes further than Hammurabi in limiting the collection rights of creditors — purely as a matter of mercy. The modern bankruptcy concepts of protection from creditors and extinguishment of debt are entirely absent from both Hammurabi and the Bible. For most of history, credit default was a crime. At various places and times, it was punishable by death, mutilation, torture, imprisonment or enslavement — punishments that...
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...and the uses to be made of internal ratings. RATINGS MIGRATION SYSTEM An Internal Ratings Migration Study by Michel Araten, Michael Jacobs Jr., Peeyush Varshney, and Claude R. Pellegrino-- This article discusses issues in evaluating banks’ internal ratings of borrowers. Ratings migration analysis entails the actuarial estimation of transition probabilities for obligor credit risk ratings, with emphasis on estimation of empirical default probabilities. Measurement of changes in borrower credit quality over time is important as obligor risk ratings are a key component of a bank’s credit capital methodology. These analyses permit banks to more accurately assess and price credit risk, as well as improve their assessment of loss reserves and portfolio capital requirements. Measurement of rating accuracy includes the notions of ordinal as well as cardinal accuracy. Ordinal accuracy tests the effectiveness of the ratings system in distinguishing credit risk on a relative basis. One can gauge ordinal accuracy by comparing agency ratings or default...
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...MORTGAGE PORTFOLIO ANALYZER: A QUASI-STRUCTURAL MODEL OF MORTGAGE PORTFOLIO LOSSES TECHNICAL DOCUMENT 1 Mar 4, 2011 Roger M. Stein Ashish Das Yufeng Ding Shirish Chinchalkar ABSTRACT This document outlines the underlying research, model characteristics, data, and validation results for Mortgage Portfolio Analyzer, which is an analytic tool to assess credit risk measures, capital levels and stress scenarios for portfolios of residential mortgages. Mortgage Portfolio Analyzer comprises loan-level econometric models for default, prepayment, and severity. These models are integrated through common dependence on local macro-economic factors, which can be either simulated at national, state, and Metropolitan Statistical Area (MSA) levels or input in the form of stress scenarios. This integration produces correlation in behaviors of loans across the portfolio. The simulation incorporates a multi-step Monte Carlo approach and generates monthly P&I cash flows and losses which enables the model to be used for ALM applications or to be combined with an external cash flow waterfall tool and used for simulation of RMBS transactions. Scenario and stress testing is also done in a multiperiod framework. Furthermore, the model accommodates both loan-level and portfolio-level mortgage insurance. The resulting tool can be used for analyzing the credit risk in both portfolios of whole loans and RMBS transactions. © 2011 Moody’s Research Labs. All rights reserved. Many past and present members...
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...Credit Risk Management Ken Brown Peter Moles CR-A2-engb 1/2012 (1044) This course text is part of the learning content for this Edinburgh Business School course. In addition to this printed course text, you should also have access to the course website in this subject, which will provide you with more learning content, the Profiler software and past examination questions and answers. The content of this course text is updated from time to time, and all changes are reflected in the version of the text that appears on the accompanying website at http://coursewebsites.ebsglobal.net/. Most updates are minor, and examination questions will avoid any new or significantly altered material for two years following publication of the relevant material on the website. You can check the version of the course text via the version release number to be found on the front page of the text, and compare this to the version number of the latest PDF version of the text on the website. If you are studying this course as part of a tutored programme, you should contact your Centre for further information on any changes. Full terms and conditions that apply to students on any of the Edinburgh Business School courses are available on the website www.ebsglobal.net, and should have been notified to you either by Edinburgh Business School or by the centre or regional partner through whom you purchased your course. If this is not the case, please contact Edinburgh Business School at the address below:...
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...or herself undertakes a primary liability to make good another’s loss, which loss may or may not result from the act of another (third) person”. “An expressed or implied contract to compensate an individual for loss or damage; for example, an insurance policy”. “A contract by which one party promises to save other from loss caused to him by the conduct of the promisor or by the conduct of any other person is called a contract of indemnity”. Essentials of contract of indemnity An indemnity is a personal security undertaking given by a third party, but under an indemnity the surety’s obligation is independent of debtor/creditor relationship. It is therefore a primary liability, not dependent on the debtor’s default. Indemnity is not given by repayment after payment. Indemnity requires that the party to be indemnified shall never be called upon to pay. In a contract of indemnity not only is there no requirement for a default by a third party as a condition of liability but there may not even be a third party involved for either the creation or exercise of the right. Indemnity holder Indemnifier Guarantee When getting a bank loan, a person is often asked to provide a guarantee. Guarantee an indemnity are often used to reinforce each other. “A contract of guarantee is an undertaking by which a person accepts what is sometimes called a secondary liability to answer for the debt or default of another person who is primarily liable to a third. The contract...
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...Credit risk measures A simple loan Appendices Deposits 3% - 20% Shareholders’ equity Copyright © 2016 CapitaLogic Limited Term loans, credit cards, mortgages, corporate bonds < 1% 3 Bank Dividend + equity price appreciation Copyright © 2016 CapitaLogic Limited 4 Funding source Credit Credit Loan Private lending placement Bond The idea that a borrower uses other people’s monies in pursuit of his financial needs Spend today but pay tomorrow DEBT A loan transferable among lenders Interest Equity To compensate a lender for supplying temporary funding to a borrower Media focus in developed countries and China Time value of money Default of the borrower Service charge 5 Copyright © 2016 CapitaLogic Limited Time value of money My money in one year CNY 100,000 + CNY 12,000 Copyright © 2016 CapitaLogic Limited 6 Default A borrower fails to pay to the lender the interest and/or principal in full on schedule Debt collection efforts will then be initiated by the lender to recover the whole or part of the principal plus interest...
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...MANAGEMENT Risk Management In Banks R.S. Raghavan < E X E C U T I V E ◆Risk is inherent in any walk of life in general and in financial sectors in particular. Till recently, due to regulated environment, banks could not afford to take risks. But of late, banks are exposed to same competition and hence are compeled to encounter various types of financial and non-financial risks. Risks and uncertainties form an integral part of banking which by nature entails taking risks. There are three main categories of risks; Credit Risk, Market Risk & Operational Risk. Author has discussed U M M A R Y > in detail. Main features of these risks as well as some other categories of risks such as Regulatory Risk and Environmental Risk. Various tools and techniques to manage Credit Risk, Market Risk and Operational Risk and its various component, are also discussed in detail. Another has also mentioned relevant points of Basel’s New Capital Accord’ and role of capital adequacy, Risk Aggregation & Capital Allocation and Risk Based Supervision (RBS), in managing risks in banking sector. effectively controlled and rightly managed. Each transaction that the bank undertakes changes the risk profile of the bank. The extent of calculations that need to be performed to understand the impact of each such risk on the transactions of the bank makes it nearly impossible to continuously update the risk calculations. Hence, providing...
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...DEFINITION OF RISK: 1. Risk in finance is defined in terms of the variability of actual returns on an investment, around an expected return, even when those returns represent positive outcomes. 2. The decisions on how much risk to take and what type of risks to take are critical to the success of the business. 3. The essence of good management is making the right choices when it comes to dealing with different risks. 4. In banking, the risk is the possibility that a borrower or counterparty will fail to meet its obligations in accordance with the agreed terms, both in terms of time and quantity. 5. Risk does not come alone – the default of one firm may cripple affiliated firms such as suppliers, customers and banks. RISK MANAGEMENT: 1. Risk Management is a planned method of dealing with the potential loss or damage. It is an ongoing process of risk appraisal through various methods and tools. 2. Risk Management involves not only to protect oneself against some risks but also to decide which risks are to be exploited and how to exploit them. 3. Risk Management covers credit decision making, performance assessment, pricing, capital computation, provisioning etc. 4. Risk Management covers the following: a. It assesses what could go wrong b. It determines which risks are important to be dealt with c. It implements strategies to deal with those risks. 5. Risk Management is not – d. A guarantee to avoid all...
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...IDENTITY CARD NO. : 3505543 NAME : GEORGE S. OGUTU CONTACT : P. O. BOX 11873-00400, NAIROBI. CELL PHONE : 0722 736 054 OCCUPATION : CIVIL SERVANT EMPLOYER : GOVERNMENT OF KENYA, MINISTRY OF ROADS DISTRICT : SIAYA LOCATION : USONGA SUB-LOCATION : USONGA VILLAGE : NYANDORERA RESIDENCE : RONGAI STATES: I am the above mentioned male adult Kenyan of the above given address, aged 52years. I am employed by the Government of Kenya, Ministry of Roads as a Technologist based in Nairobi’s Industrial Area. I am the owner and Policy Holder of Motor Vehicle Registration Number KAA 572R Nissan Sunny Saloon. I had insured the said Vehicle with M/S Gate-way Insurance Company ** policy Number 010/070/1/140134/2008/11. The cover which was on display as on 1st September, 2012 was valued from 14th November, 2009 to expire on 13th November, 2012. I wish to state as follows:- I do recall that on the 1st day of September, 2012, I gave my vehicle to Keziah Ogutu who is my young sister. She was to use the vehicle to go to her office. At about 8.00 am, she called me and informed me that she had been involved in an accident along Mombasa Road at Bellevue while driving to her office. She further told me that a Pedestrian ran on the road when she collided with the vehicle. She told me that the Pedestrian sustained injuries. I then rushed to the scene and found the Police at the scene. The victim had already been removed from the scene and taken to hospital by an ambulance. After Police...
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...Introduction: The Gatwick Gold Corporation business credit proposal brought Wellfleet Bank with an opportunity to obtain a highly profitable deal and conduct a new and long-term relationship with the third-largest gold producer in the world, and a number of “broader issues” at same time. Corresponding to the attitude the Chief Risk Officer Cromwell holds for risk, ensuring the risk infrastructure is growing with business opportunities at same speed. Identifying and measuring all risks involved in any deals becomes a crucial and high priority mission in such risky environment. Question 1: First, it is important and necessary to identify all the kind of risk Wellfleet Bank faces in this strategy. Syndicated and leveraged loans have played important roles in Wellfleet Banks’ corporate bank business since 2004. Facility for Gatwick Gold Corporation, with a large amount of debt already, a 1-year bridging loan of $1billion is considered as a leveraged loan. Gatwick Gold Corporation had committed a $50 million facility before. A sudden increase in this limit by $1 billion surprised relationship manager Jaidev Kapoor, who had 10-year working experience in Wellfleet. In addition, a syndicated loan agreement is the kind of loan in which a borrower requires a large or sophisticated facility or multiple types of facility by the channel through funding from a group of lenders. It facilitates the loan process by combining several separate bilateral loans, each with different terms and...
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...grows, they need to make sure that their risk infrastructure keeps apace with the business opportunities. A consequence for their growth strategy, the bank is facing several risks, such as legal/regulatory risk, credit risk, business risk and operational risk. The legal/regulatory risk is presented by changing international regulatory rules, the bank is required to set aside and manage capital reserves in response to these new regulatory rules. The global economy is becoming more competitive and Wellfleet bank is growing against a risky environment. Companies may default and that present credit risk to the bank. Wellfleet has more strict risk control than its competitors, and pay more attention to the risk modeling rather than the holistic view of the company requesting the facility or industries it operates in. The business risk followed by key lending decisions that the bank makes may result in an opportunity loss for revenue from current/potential customers. The power of the risk management function caused lots of tension in the corporate banking unit. The bank has a growing demand at the same time keeping an effective balance between risk and business...
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...In this week’s lecture, we looked at the credit risk management. Credit risk is defined as the potential for loss due to a counterparty failing to meet its financial obligations in accordance with agreed terms. The sources of credit risk for the bank are summarized as direct lending, traditional off-balance sheet business, investment and capital market operations, etc. For the commercial banks the major risk is the credit risk which accounted by 50%-60% of total risk, far more compared to market risk and operational risk. Thus the credit risk management is quite important. The managed way is measured on the nature of counterparty (retail credit, corporate credit and business banking credit) they are measured differently from each other. EG:The retail business has lots of transactions but relatively small amounts related to individuals, which adopt a proprietary scoring model. It is considered the factors as appropriate weights, historical data on defaulted and good loans, information provided by the credit applicant etc. Then, the SMEs credit model used to predict the probability of default of bankruptcy. The Z-score is derived from 5 financial ratios using 8 inputs from the financial statements; a low Z-score, the higher risks of bankruptcy. Third, for the large companies, the credit rating is provided involve detailed analysis. The rating agency demonstrates the S&P’s investment grade ratings as AAA,AA,A; BBB,BB.B…from strongest capacity to meet financial obligation...
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...the Degree of Bachelor of Commerce (Banking and finance option) of Chuka University CHUKA UNIVERSITY AUGUST, 2013. DECLARATION AND APPROVAL This research proposal is my own original work and has not been presented for a degree in any other university, either in part or a whole. Amulyoto, F. U. Signature……………………………… Date…………………………………… APPROVAL This research has been submitted for examination with the approval of the following university supervisor: MR. NGENO K. W. A. Department of Business Administration Chuka University Signature………………………… Date……………………………… ACKNOWLEDGEMENT The writing of this proposal was made possible through support and encouragement from various persons. I sincerely thank my creator, the Almighty God who has given me grace to carry out my research study. I would also like to thank my supervisor Mr. Ngeno. Through his guidance and correction I was able to come up with this proposal. The gratitude is profound. Special thanks to everyone else who’s input in this work cannot go unmentioned. DEDICATION This research is dedicated to my mother, Mrs. Judith Amulyoto. TABLE OF CONTENTS DECLARATION AND APPROVAL ii ACKNOWLEDGEMENT iii DEDICATION iiv TABLE OF CONTENTS v LIST OF TABLES vii LIST OF FIGURES viii LIST OF ABBREVIATIONS AND ACRONYMS iix ABSTRACT …………………………………………………………………………………...… x CHAPTER ONE 1 1.1Background of the study 1 1.2 Statement of the...
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...Understanding the Risk of Synthetic CDOs Michael S. Gibson∗ Revised, July 2004 ∗ Trading Risk Analysis Section, Division of Research and Statistics, Federal Reserve Board. I thank John Ammer, Jim O’Brien, Pat Parkinson, Pat White, Frank Zhang and many other colleagues for helpful comments and Michael Gordy for suggesting the idea behind section 7. This paper represents the views of the author and should not be interpreted as reflecting the views of the Board of Governors of the Federal Reserve System or other members of its staff. I can be reached via email at michael.s.gibson@frb.gov. Postal address: Mail Stop 91, 20th and C Streets NW, Washington, DC 20551. Phone: 1-202-452-2495. Fax: 1-202-452-3819. Understanding the Risk of Synthetic CDOs Abstract: Synthetic collateralized debt obligations, or synthetic CDOs, are popular vehicles for trading the credit risk of a portfolio of assets. Following a brief summary of the development of the synthetic CDO market, I draw on recent innovations in modeling to present a pricing model for CDO tranches that does not require Monte Carlo simulation. I use the model to analyze the risk characteristics of the tranches of synthetic CDOs. The analysis shows that although the more junior CDO tranches – equity and mezzanine tranches – typically contain a small fraction of the notional amount of the CDO’s reference portfolio, they bear a majority of the credit risk. One implication is that credit risk disclosures relying...
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...A MODEL FOR RISK BASED PRICING FOR INFRASTRUCTURE FINANCING BY BANKS By Prof Ajay Pathak* Infrastructure development is the new buzzword for India Inc.Policy makers are putting emphasis on development of roads, ports, airports, and urban infrastructure to facilitate growth. The government is opening up private investment in the infrastructure through Special Purpose Vehicles (SPV). With the changing regulations, however, infrastructure finance so far has been untouched by the commercial banks. but this is the new avenue to gear up their fund based activities. With increased exposure in infrastructure, banks need to be cautious about the credit risks inherent in the projects with long gestation periods. It was found that infrastructure development has a high correlation with the macroeconomic factors like GDP growth rate of the country. Such macroeconomic trends actually influence income generation and timely recovery of the credit extended. So for greater risk sensitivity a model pricing mechanism has been developed to address the macroeconomic changes in the economy for better risk management. It is an obvious fact that risk is inherent in every action. In extending credit to other parties one of the main risks of the Bank is Credit Risk. The possibility of losses associated with diminution in the credit quality of borrowers/counter parties is called credit risk. In a simpler way, credit risk may be defined...
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