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possibility that borrower will not meet the scheduled repayments and default on their loan
credit risk management
identification, quantification, monitoring and controlling credit risk at transaction and portfolio level
ie, loan amount or market value of securities due
Percentage of total exposure that is lost
occurs when an institution is unable to make interest payments or pay off the amount owed on a debt instruments at maturity
Loss= Exposure x Default x Severity
Expected Loss = PD*EAD*LGD
More important measure of risk. Represents volatility of actual losses.
the degree to which individual borrowers default behaviors are related
credit loss reserve
amount set aside for Expected Loss...a reserve is separate on balance sheet.
covers risk of large unexpected losses. Important for equity holders and debt holders...reflected in their Moody's or S&P credit and debt ratings, respectively
non-normal, highly skewed distribution.
Leptokurtic (say that 3 times fast!)
represents number of multiples of UL required to make a capital cushion...that equates with implied credit rating. Ex. Double A rated firm must carry enough EC economic capital for solvency
Off balance sheet credit risk
Options - credit risk for buyer is value of the option
banking supervision -