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Unit 5: Credit Risk Management
was exposed to market risk, primarily due to trading activities centered in the Corporate Notes
and Institutional Clients business of UBS Warburg. Credit risk represented the loss, which
UBS would suffer if a client or counterparty failed to meet its contractual obligations. It
was inherent not only in traditional banking products but also in foreign exchange and
derivatives contracts, such as swaps and options. UBS aimed at ensuring sufficient liquidity
to meet its liabilities when due, without compromising its ability to respond quickly to
strategic opportunities.
Source: http://www.icmrindia.org
Self Assessment
Fill in the blanks:
1. …………………are usually defined by the adverse impact on profitability of several distinct
sources of uncertainty.
2. Trading ………………………risk arises as a result of illiquidity of securities in the trading
portfolio of the bank.
5.2 Credit Risk
Simon Hills (2004) of the British Bankers Association defines credit risk “is the risk to a bank’s
earnings or capital base arising from a borrower’s failure to meet the terms of any contractual or
other agreement it has with the bank. Credit risk arises from all activities where success depends
on counterparty, issuer or borrower performance”.
It can be understood from the above that credit risk arises from a whole lot of banking Credit
Risk Management activities apart from traditional lending activity such as trading in different
markets, investment of funds, provision of portfolio management services, providing different
type of guarantees and opening of letters of credit in favour of customers etc.
Example: Even though guarantee is viewed as a non-fund based product, the moment a
guarantee is given, the bank is exposed to the possibility of the non-funded commitment turning
into a funded position when the guarantee is invoked by the entity in whose favour the guarantee
was issued by the bank.
This means that credit risk runs across different functions performed by a bank and has to be
viewed as such. The nature, nomenclature and the quantum of credit risk may vary depending
on a number of factors. The internal organization of credit risk management should recognize
this for effective credit risk management.
Credit risk can be segmented into two major segments viz. intrinsic and portfolio (or
concentration) credit risks. The focus of the intrinsic risk is measurement of risk at individual
loan level. This is carried out at lending unit level. Portfolio credit risk arises as a result of
concentration of the portfolio to a particular sector, geographic area, industry, type of facility,
type of borrowers, similar rating, etc. Concentration risk is managed at the bank level as it is
more relevant at that level.
Credit Risk is the potential that a bank borrower/counter party fails to meet the obligations on
agreed terms. There is always scope for the borrower to default from his commitments for one
or the other reason resulting in crystallisation of credit risk to the bank.
These losses could take the form outright default or alternatively, losses from changes in portfolio
value arising from actual or perceived deterioration in credit quality that is short of default.
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