SC3-Chapter 20 - Managing Credit Risk on the Balance Sheet 1

SC3-Chapter 20 - Managing Credit Risk on the Balance Sheet...

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Click to edit Master subtitle style 11 Managing Credit Risk on the Balance Sheet SC3-Chapter 20 Saunders and Cornett Financial Markets and Institutions: An Introduction to the Risk Management Approach, 3rd Edition
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22 Chapter Objectives o There are four primary objectives in this chapter n introduce four distinct forms of lending n take an overview of loan pricing o emphasis on the importance of the risk premium n take an overview of the various methods of credit analysis n take an overview of credit or FICO scores
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33 Credit Risk Management o Banks are in the business of acquiring (purchasing) funds and investing the funds in risky financial claims o Banks must be able to n measure n mitigate and price n reserve (RLLL) – for expected losses n monitor (review) – for changes in credit quality n allocate capital (retained earnings) – for unexpected losses for the risk associated with all of the financial claims they invest in.
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44 Importance of Credit Risk Management o Most large and small bank failures can be traced back to loan losses n losses must be written of against earnings and capital o banks maintain relatively little capital o In the US, significant credit risk problems have led to falling profits and bank failures at various times n 1980s: residential and farm mortgages n 1990s: commercial real estate and loans to LDCs, rising default rates on credit cards, high default rates on loans to Russian business ventures n early 2000s: increase in personal bankruptcy filings n 2006: rising default rates on residential and commercial mortgage loans n 2007-2008: Subprime mortgage crisis and credit crunch
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55 Part 1: Credit Analysis-Types of Lending o The approach to credit analysis differs among the four major types of lending n real estate lending n consumer and small business lending n mid-market lending n large commercial lending o In all four, the 5 Cs of credit should form the core of the bank’s credit analysis
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66 Five Cs of Credit Analysis n Character: specific purpose of the loan and the seriousness of the intent to repay n Capacity: legal authority to sign a binding contract and
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SC3-Chapter 20 - Managing Credit Risk on the Balance Sheet...

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