Factores inhibidores de la productividad del trabajo

3.3.1 Credit Risk Management: Importance and Regulatory Requirement

The management of credit risk has become a key objective for all financial

institutions across the world. The goal of credit risk management is to maximise a bank’s risk-adjusted rate of return by maintaining credit risk exposure within

acceptable parameters (Basel Committee on Banking Supervision, 1999). Risk is also one of the key capital performance indicators proposed in various regulatory regimes. For example, Basel Capital Accord II suggests that overall capital adequacy after 2005 should be measured as: regulatory total capital = credit risk capital requirement

53 + market risk capital requirement + operational risk capital requirement. Banks need to manage the credit risk inherent in the entire portfolio as well as the risk in

individual credits or transactions. Banks should also consider the relationships between credit risk and other risks. It has been widely recognised that the effective management of credit risk is a critical component of a comprehensive approach to risk management and essential to the long-term success of any financial institutions

(Nijskens and Wagner, 2011; Cebenoyan and Strahan, 2004; Basel Committee, 1999; Credit Suisse, 1997).

Most major banking problems have been either explicitly or indirectly caused by weaknesses in credit risk management (Basel Committee on Banking Supervision, 1999). Therefore, managing credit risk is a major issue faced by all financial

institutions and the new regulatory guidelines proposed by various regulatory bodies recommend a more systematic approach to credit risk management using both quantitative and qualitative methods. Chavez-Demoulin, Embrechts, and Neslehova (2006) note that due to the new regulatory guidelines known as Basel II for banking and Solvency II for insurance, the financial industry is looking for qualitative approaches to and quantitative models for operational risk including credit risk.

A number of studies have examined the impact and effectiveness of the New Basel Capital Accord (Basel II) on risk management in general and credit risk management in particular of financial institutions. For instance, Wahlström (2009) believes that the New Basel Capital Accord, Basel II, promotes standards for measurement of financial and operational risk in the banking industry. However, its approach to such risk measurement has been severely criticised in the literature, inevitably raising doubts concerning the effectiveness of Basel II. Using data from 25 semi-structured

interviews with banking staff in four Swedish banks, Wahlström (2009) suggests that Basel II is well established in practice, but there are significant concerns that such measurement of risk may adversely affect banks’ activities. Whilst Basel II is generally supported by banking staff who work directly with risk measurement, its usefulness is questioned by banking staff in operations. According to the author, this difference between these two groups may be explained in relation to variations in their respective frames of reference. Both groups are inclined to take account of

54 information that meshes well with their existing frames of reference and are thus more inclined to value changes that the Accord with their own viewpoints. Indeed, the capital adequacy framework Basel II aims to promote the adoption of stronger risk management practices by the banking industry. The implementation makes validation of credit risk models more important. Lenders therefore need a validation

methodology to convince their supervisors that their credit scoring models are performing well. Medema, Koning and Lensink, (2009) propose and implement a simple validation methodology that can be used by banks to validate their credit risk modelling exercise in the context of a commercial bank in the Netherlands.

3.3.2 Credit Risk Management: Approaches

Over the past century, various approaches to measure and manage credit risk have been developed.Some of the popular approaches in which financial firms manage their credit risk include credit portfolio models, internal ratings, exposure limit, and stress testing. For example, stress testing is often used by financial institutions to manage their credit risks. Stress testing is done to overcome some of the drawbacks of risk models that are overly dependent on historical data, and to test the specific risk parameters which define the model. Based on the limited inputs, these models can sometimes cause an underestimation of risk. Stress testing typically allows testing based on a combination of different scenarios including shocks and conceived scenarios, and is often applied to firm-wide portfolios to capture the complete risk along different lines of business. Stress testing is now a regulatory requirement in certain countries since it helps ensure that companies maintain adequate capital levels.

Most financial institutions have their own internal credit models that they use for risk management. Credit portfolio models differentiate credit risk based on different parameters such as industry, geography, credit grade, etc. A numerical simulation is run to generate a large number of scenarios, simulating various states of the economy and the resulting impact of each on the credit portfolio value. With this analysis, portfolio managers can make decisions on what should be the ideal composition of the portfolio, based on their risk appetite and performance targets. Crouhy, Galai and Mark (2000) provide a comparative analysis of current credit risk models and they particularly review the current proposed industry sponsored Credit Value-at-Risk

55 methodologies. In the analysis, the authors made several comments on recent

methods. Firstly, the credit migration approach, as proposed by JP Morgan with Credit Metrics, is based on the probability of moving from one credit quality to another, including default, within a given time horizon. Secondly, the option pricing, or structural approach, as initiated by KMV and which is based on the asset value model originally proposed by Merton (1974). In this model the default process is

endogenous and relates to the capital structure of the firm. Default occurs when the value of the firm’s assets falls below some critical levels. Third, the actuarial

approach proposed by Credit Suisse Financial Products (CSFP) with CreditRisk+ only focuses on default. Defaults for individual bonds or loans are assumed to follow an exogenous Poisson process. Finally, McKinsey & Company (1997) propose

CreditPortfolioView which is a discrete time multi-period model where default probabilities are conditional on the macro-variables like unemployment, the level of interest rates, the growth rate in the economy, which to a large extent drive the credit cycle in the economy.

The effective management of credit risk is a critical component of risk management and indispensable for the long-term success of any financial institution. The goal of credit risk management is to maximise the bank’s risk-adjusted rate of return by maintaining credit risk exposure within the acceptable limits (Cui, 2008). In addition to measuring and controlling it, firms also need to try mitigating their credit risk. A variety of approaches can be adopted by a financial institution to mitigate its credit risk. They include, among others,

 Risk-based pricing: This is a tool which firms use to calculate the interest rates on loans given based on the probability of default, or the risk on the loan.

 Covenants: Firms incorporate very strict covenants in their deal contracts. Such covenants generally require the debtor to meet certain conditions such as maintaining a required capital level, or prohibit him from carrying out certain actions.

 Credit insurance: Credit insurance covers any losses that may result from unpaid receivables. It also covers bankruptcies as well as late payments.

 Credit derivatives: These derivative instruments provide protection against the credit risk of the underlying asset of the derivative.

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 Collaterals: The counterparty bearing the credit risk in a deal asks the opposite counterparty for collateral, which the party at risk holds till the deal is completed

 Engaging in credit guarantee scheme (CGS): Credit risk mitigation can either take the form of funded or unfunded protection. Guarantees are one form of unfunded credit risk mitigation. Because the protection is unfunded it relies exclusively on the creditworthiness of the guarantor. Consequently, the most creditworthy guarantees are likely to be those provided by government. Hway-Boon, Muzafar, Alias and Azali. (2003) carry out a research about credit guarantee agency in developing countries and find that banks are reluctant to lend to SMEs due to the high credit risk involved. Their study evaluates the efficiency of a CGS, which provides help to SMEs to secure loans from financial institutions, for example, in Malaysia via non-parametric analysis. They conclude that CGS is found to be operating at a relatively low level of overall technical efficiency which is constituted slightly more by pure technical inefficiency than scale inefficiency. This result is corresponding to the studies conducted by other researchers taking place in both Taiwan and Japan (Uesugi, Sakai and Yamashiro, 2006). In other countries various mechanisms have been adopted by financial institutions to assist SMEs financing and manage credit risks. For instance, the financial institutions in Japan have adopted a lending method based on the partnership model that

promises security and reduces the risk of blocking of funds (Fukuda, 2012). Korea has one of the largest credit guarantee companies in the world (Beck, Demirguc- Kunt and Martinez-Peria, 2011) with nine other provincial guarantee corporations with a central re-guarantee organisation. Malaysia has a unique institution that combines the roles of a credit institution, a venture capital company, a credit rating agency and a guarantee company (Beck et al., 2011).