Title Details

PART I INTRODUCTION

1 Credit Basics 3

1.1 Meaning of Credit 4

1.2 Role of Credit 6

1.3 Credit Market 6

1.4 Credit – Advantages and Disadvantages 7

1.5 Suppliers of Credit 11

1.6 Credit Risk Study 12

Appendix: Credit Creation 13

Questions/Exercises 14

2 Essentials of Credit Risk Analysis 15

2.1 Meaning of Credit Risk 15

2.2 Causes of Credit Risk 16

2.3 Credit Risk and Return 17

2.4 Credit Risk Analysis 17

2.5 Historical Progress of Credit Risk Analysis 19

2.6 Need for Credit Risk Analysis 19

2.7 Challenges of Credit Risk Analysis 22

2.8 Elements of Credit Risk Analysis 24

Questions/Exercises 25

3 Credit Risk Management 27

3.1 Strategic Position of Credit Risk Management 27

3.2 Credit Risk Management Context 28

3.3 Credit Risk Management Objectives 28

3.4 Credit Risk Management Structure 29

3.5 Credit Risk Culture 29

3.6 Credit Risk Appetite 30

3.7 Credit Risk Management in Non-Financial Firms 31

3.8 Credit Risk Management in Financial Intermediaries 31

Questions/Exercises 34

PART II FIRM (OR) OBLIGOR CREDIT RISK

4 Fundamental Firm/Obligor-Level Risks 37

4.1 Firm (or) Obligor Risk Classification 37

4.2 Risk Matrix 39

4.3 Different Risk Levels 39

Questions/Exercises 42

5 External Risks 43

5.1 Business Cycle 43

5.2 Economic Conditions 46

5.3 Inflation and Deflation 50

5.4 Balance of Payments and Exchange Rates 51

5.5 Political 52

5.6 Fiscal Policy 53

5.7 Monetary Policy 53

5.8 Demographic Factors 54

5.9 Regulatory Framework 55

5.10 Technology 55

5.11 Environment Issues 55

5.12 International Developments 56

5.13 Others 56

5.14 Monitoring External Risks 57

Questions/Exercises 58

6 Industry Risks 61

6.1 Understanding Obligor’s Industry or Market 61

6.2 Types of Industry Risks 63

6.3 Industry Life Cycle 64

6.4 Permanence of Industry 65

6.5 Government Support 65

6.6 Industry and Factors of Production 66

6.7 Industry and Business Cycles 66

6.8 Industry Profitability 67

6.9 Competitor/Peer Group Analysis 71

Questions/Exercises 77

7 Entity-Level Risks 79

7.1 Understanding the Activity 80

7.2 Risk Context and Management 81

7.3 Internal Risk Identification Steps 82

7.4 SWOT Analysis 83

7.5 Business Strategy Analysis 84

7.6 Pitfalls in Strategy 89

7.7 Management Analysis 90

7.8 Other Internal Risks 94

Questions/Exercises 97

8 Financial Risks 99

8.1 Importance of Financial Statements 99

8.2 Quality and Quantity of Financial Statements 101

8.3 Role of Historical Financial Statements 102

8.4 Financial Analysis 103

8.5 Analytical Tools 105

8.6 Solvency Ratios 115

8.7 Operational Ratios 123

8.8 Encapsulated Ratios 134

Questions/Exercises 143

9 Integrated View of Firm-Level Risks 147

9.1 Relevance of an Integrated View 147

9.2 Judgement 147

9.3 Identifying Significant Credit Risks 148

9.4 Risk Mitigants 150

9.5 Types of Mitigants 150

9.6 Principles to be Borne in Mind While Selecting Mitigants 153

9.7 Monitoring of Credit Risk 154

Appendix: Credit Risks and Possible Mitigants 155

Questions/Exercises 158

10 Credit Rating and Probability of Default 161

10.1 Credit Risk Grading 161

10.2 Probability of Default 163

10.3 External vs. Internal Rating 166

10.4 PD in Credit Structural Models 169

Questions/Exercises 172

PART III CREDIT RISKS – PROJECT AND WORKING CAPITAL

11 Credit Risks in Project Finance 177

11.1 Distinctive Features of Project Finance 177

11.2 Types of Project Finance 178

11.3 Reasons for Project Finance 179

11.4 Parties Involved in Project Finance 180

11.5 Phases of Project and Risks 182

11.6 Project Credit Risks 183

11.7 Financial Study 187

11.8 Project Credit Risk Mitigants 192

Questions/Exercises 202

12 Credit Risks inWorking Capital 207

12.1 Definition of Working Capital 207

12.2 Assessing Working Capital through the Balance Sheet 208

12.3 Working Capital Ratios 210

12.4 Working Capital Cycle 212

12.5 Working Capital vs. Fixed Capital 216

12.6 Working Capital Behaviour 216

12.7 Working Capital, Profitability and Cash Flows 223

12.8 Working Capital Risks 225

12.9 Impact of Working Capital Risks 229

12.10 Working Capital Risk Mitigants 230

12.11 Working Capital Financing 232

Questions/Exercises 236

PART IV CREDIT PORTFOLIO RISKS

13 Credit Portfolio Fundamentals 241

13.1 Credit Portfolio vs. Equity Portfolio 241

13.2 Criticality of Portfolio Credit Risks 242

13.3 Benefits of Credit Portfolio Study 242

13.4 Portfolio Analysis 247

13.5 Credit Portfolio Risk vs. Return 249

Appendix: Organizational Conflict in Credit Risk Management 249

Questions/Exercises 251

14 Major Portfolio Risks 253

14.1 Systematic Risk 253

14.2 Diversifiable Risk 255

14.3 Concentration 258

14.4 Credit Portfolio Beta 263

Questions/Exercises 263

15 Firm Risks to Portfolio Risks and Capital Adequacy 265

15.1 Obligor PD and Portfolio PD 265

15.2 Migration Risk 266

15.3 Default Risk 269

15.4 Loss Given Default (LGD) 270

15.5 Expected Loss (EL) 271

15.6 Provisioning 272

15.7 Credit Loss Distribution 274

15.8 Economic Capital 276

Questions/Exercises 282

16 Credit Risk and The Basel Accords 285

16.1 Basel Accords 285

16.2 Basel I (1988) – First Basel Accord 286

16.3 Basel Accord II (2006) 288

16.4 Basel III 296

Appendix 300

Questions/Exercises 302

PART V PORTFOLIO RISK MITIGANTS

17 Credit Risk Diversification 305

17.1 Traditional Diversification 305

17.2 Modern Diversification of Credit Portfolio 309

17.3 Correlations in Credit Risk Models 315

Questions/Exercises 315

18 Trading of Credit Assets 317

18.1 Syndicated Loans/Credit Assets 317

18.2 Securitization 318

18.3 Distressed Debt 321

18.4 Factoring 322

18.5 Distressed Receivables 322

Questions/Exercises 322

19 Credit Derivatives 323

19.1 Meaning of a Credit Derivative 323

19.2 Credit Default Swap (CDS) 324

19.3 Total Return Swap 330

19.4 Credit Option (CO) 332

19.5 Credit Spread Options (CSO) 333

19.6 Credit Derivative Linked Structures 333

19.7 Future of Credit Derivatives 334

19.8 Credit Derivatives and Over-the-Counter (OTC) Markets 334

Questions/Exercises 334

PART VI CREDIT RISK PRICING

20 Pricing Basics 337

20.1 Credit Pricing Factors 337

20.2 Pricing Structure 342

20.3 Credit Risk Pricing Model 344

20.4 Prime Lending Rate 345

Questions/Exercises 348

21 Pricing Methods 349

21.1 RORAC (Return on Risk-Adjusted Capital) Based Pricing 349

21.2 Market Determined 351

21.3 Economic Profit Based Pricing 351

21.4 Cost Plus 353

21.5 Structured Pricing 353

21.6 Grid Pricing 354

21.7 Net Present Value (NPV) Pricing 354

21.8 RANPV (Risk-Adjusted NPV) Pricing 355

Questions/Exercises 355

PART VII THE LAST LINE OF DEFENCE – SECURITY

22 Security Basics 359

22.1 Need for Security 359

22.2 Merits and Demerits of a Security 360

22.3 Attributes of a Good Security 362

22.4 Security and Pricing 362

22.5 Impact of Systematic Risks on Security 364

22.6 Facility Grades 364

Questions/Exercises 366

23 Collaterals and Covenants 367

23.1 Tangible Security 367

23.2 Intangible Security 369

23.3 Methods of Taking Security 371

23.4 Realizing Security 372

23.5 Covenants – A Trigger to Seek Additional Security 373

Questions/Exercises 377

PART VIII CREDIT CRISIS

24 Road to Credit Crisis 381

24.1 Credit and Growth 381

24.2 Role of Banks 382

24.3 Formation of Credit Bubbles 385

24.4 Types of Credit Bubble 386

24.5 Credit Bubble Explosion 387

Questions/Exercises 390

25 2008 Credit Crisis 393

25.1 Credit Asset – Prime vs. Sub-Prime 393

25.2 Securitization 394

25.3 US Housing Bubble 396

25.4 Role of OTC Derivatives 398

25.5 Role of Rating Agencies 400

25.6 Why Did the Bubble Burst? 401

25.7 Consequences 402

25.8 Impact of the Lehman Collapse 403

25.9 Housing Crisis to Credit Crisis to Economic Crisis 404

25.10 Common Factors 1929 vs. 2009 406

25.11 Lessons of the 2008 Credit Crisis 407

Questions/Exercises 410

Bibliography 411

Index 415