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Unit 5: Credit Risk Management

the loss of amount outstanding at the time of default as reduced by the recoverable amount. The Notes
loss in case of default is D* X * (I-R) where D is Default percentage, X is the Exposure Value and
R is the recovery rate.
Credit Risk is measured through Probability of Default (POD) and Loss Given Default (LGD).
Bank should estimate the probability of default associated with borrowers in each of the rating
grades. How much the bank would lose once such event occurs is what is known as Loss Given
Default. This loss is also dependent upon bank’s exposure to the borrower at the time of default
commonly known as Exposure at Default (EaD). The extent of provisioning required could be
estimated from the expected Loss Given Default (which is the product of Probability of Default,
Loss Given Default & Exposure & Default). That is ELGD is equal to POD × LGD × EaD.
Credit Metrics mechanism advocates that the amount of portfolio value should be viewed not
just in terms of likelihood of default, but also in terms of credit quality over time of which
default is just a specific case.
Credit Metrics can be worked out at corporate level, at least on an annual basis to measure risk-
migration and resultant deterioration in credit portfolio.
The ideal credit risk management system should throw a single number as to how much a bank
stands to lose on credit portfolio and therefore how much capital they ought to hold.

Case Study Credit Risk Management at ABN AMRO

olland’s leading bank, ABN AMRO operates more than 800 offices at home and
another 2,600 in 75 other countries. In the US, ABN AMRO owns Chicago-based
HLaSalle Bank and Standard Federal Bank, one of Michigan’s largest banks. ABN
AMRO’s comprehensive risk management framework aims at combining centralized
policy setting with broad oversight, supported by risk execution and monitoring in the
Group’s network. ABN AMRO’s goal is to identify and analyze risks at an early stage; to
set and monitor prudent limits; and to learn and evolve continuously to help it face a
volatile and rapidly-changing risk environment. ABN also had a large presence in Brazil
(through its ownership of Banco Real and Paraiban) and Malaysia (where it had operated
for more than 100 years). The bank was expanding its presence in the Philippines, India,
Singapore, Taiwan, and Thailand. The case discusses in detail how ABN manages credit
risk.

ABN had three major business segments: private clients & asset management, consumer
and commercial clients, and wholesale clients, but its strategic focus was on the
mid-market segment. Each of ABN’s Strategic Business Units (SBUs) was responsible for
managing a distinct client segment or product segment, while also sharing expertise and
operational excellence across the Group. ABN’s comprehensive risk management
framework aimed at combining centralized policy setting with broad oversight, supported
by risk execution and monitoring in the Group’s network.
The Managing Board established the strategic risk philosophy and policies for ABN under
the oversight of the Supervisory Board. Responsibility for the overall implementation of
risk policy lay with the CFO, who was a member of the Managing Board. ABN had
established an Asset and Liability Committee (ALCO) structure mirroring the bank’s
organization. Under this structure there was a Group ALCO at Group level and an ALCO
in its client-facing business units, each responsible for managing the Asset and Liability
Management (ALM) process in its own particular area of interest.
Contd...

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