Lecture 6-1 Loan Portfolio Risk

Lecture 6-1 Loan Portfolio Risk - McGraw-Hill/Irwin Lecture...

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Unformatted text preview: McGraw-Hill/Irwin Lecture 6 Credit Risk II Instructor: Lixiong Guo Date: August 24, 2011 Overview of Chapter 12 § Measuring credit risk in a loan portfolio context. – Diversification benefit. – Concentration risk. – The risk-return of the overall loan portfolio affects an FI’s overall credit risk exposure. § The use of loan portfolio models in setting credit exposure limit to industrial sectors. § Regulatory approaches to monitoring credit risk. – FDIC Improvement Act 1991: Bank regulators should incorporate credit concentration risk into their evaluation of bank insolvency risk. 6-2 Simple Models of Loan Concentration § Migration analysis – Track credit rating changes within sector or pool of loans. – Rating transition matrix reflects history of ratings changes. – FIs curtail lending or charge higher credit risk premium to sectors that have experienced unexpected larger rating drops than historic benchmarks. 6-3 Loan Migration Matrix 6-4 Risk grade: end of year | 1 2 3 D Risk grade: 1| .85 .10.04 .01 beginning 2| .12.83 .03 .02 of year 3| .03 .13.80 .04 The loan migration matrix (transition matrix) reflects historic experience of a pool of loans in terms of credit rating migration. Simple Models of loan concentration § Concentration limits – Setting limits on loans to individual borrowers or sectors – Concentration limit = maximum loss as a percent of capital ‚ loss rate – Lower loss rate => higher concentration limit – FIs typically set geographic concentration limits or combination of industry and geographic limit. 6-5 Diversification & Modern Portfolio Theory § Applying portfolio theory to loans – Using loans to construct the efficient frontier – Select the portfolio of loans that maximize the return on the loan portfolio for any given level of risk § The idea is to fully exploit the diversification potential of the pool of assets and thus diversify away a considerable amount of unsystematic credit risk....
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This note was uploaded on 10/23/2011 for the course FINS 3630 taught by Professor Yip during the Three '09 term at University of New South Wales.

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Lecture 6-1 Loan Portfolio Risk - McGraw-Hill/Irwin Lecture...

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