Lecture 6- Credit Risk(2) (2).pptx - Credit Risk(Source...

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Credit Risk(Source : Yeah (2019)Sunway University Business SchoolTel: +603 7491 8622Fax: +603 5635 8633H/P: +6012 3787866Email: [email protected]Website:
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2Risk Versus UncertaintyUncertaintyRiskDefinitionThe lack of complete certaintyThe existence of more than one possibilityThe ‘true’ outcome/state/result/ value is not knownA state of uncertainty where some of the possibilities involve a loss, injury, catastrophe, or other undesirable outcome (i.e. something bad could happen)MeasurementA set of probabilities assigned to a set of possibilitiesA set of possibilities with quantified probabilities and quantified losses.ExampleWe think there is a 60% chance it will rain tomorrow, and a 40% chance it won’t.”“It is our belief that there is a 40% chance the proposed oil well will be dry with a loss of RM50 million in exploratory drilling costs.”
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Credit riskWhat is credit risk? Why is it important?What are the types and drivers of credit risk?Credit risk modelling
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Definition of credit risk4Credit risk is the risk that a borrower defaults and does not honour its obligation to service debt.potential that a borrower will fail to meet his obligations in accordance with agreed termsDefault occurs when borrower (or counterparty) is unable to pay or cannot pay on time.
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Reasons for default5Borrower (Obligor/Debtor) is in a financially stressed situation and may be facing a bankruptcy procedure.Borrower refuses to comply with its debt service obligation, e.g., in the case of a fraud or a legal dispute.Technical defaults result from a misunderstanding because of the flaw in
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3 aspects of RISK61)Expected loss: Budgeted level which is used as a planning assumption.2)Unexpected loss = normal volatility: level of loss which is the worst case over a specified period (eg. 10 or 20 years)3)Catastrophic loss: Level of loss threatening the viability of the
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Credit risk components7Credit risk is typically represented by: 1)Default risk: probability that a default event occurs or probability of default (PD)2)Loss risk: actual loss depends on the loss given default (LGD)3)Exposure risk (EAD): exposure at default4)Maturity (M)
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Types and Drivers of credit risk8Type of riskDriverRiskiness of borrowerProbability of default (PD)Riskiness of transactionLoss given default (LGD)Likely amount of exposureExposure at default (EAD)Time dimension riskMaturityDiversification/ concentration riskCorrelations
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Assessing losses associated with credit risk9
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Covering losses associated with credit risk10
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Mathematical expression of expected loss11
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Probability of default (PD)12
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Exposure at default (EAD)13
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Loss given default (LGD)14
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Modelling probability of default15
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Logistic regression modelling16Consumer credit risk model
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Credit scoring using logistic regression17Background infoFactorsLiquiditySolvencyBehaviourExpert judgement, univariate analysis and regressionWeightCoefficientPDRating classTransformationDepends on desired rating
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