AE18-ACT8:Managing Credit Risk in Money Market

 The major benefit of integrated

and quantitative credit risk
CREDIT RISK
management is the reduction of
 Credit risk is the possibility of a loss revenue losses. Monitoring credit
resulting from a borrower's failure risk, allows the executive
to repay a loan or meet contractual management team to understand
obligations. which potential clients may come at
 Credit risk is a particular concern too high a risk and above your pre-
when a large proportion of credit identified risk tolerance.
sales are concentrated with a small  Credit risk can be use as a strategic
number of customers since the opportunity. Through effective
failure of one of those customers credit risk management, Businesses
could seriously affect the seller's can significantly improve overall
cash flows. performance and secure competitive
 Credit risk also describes the risk advantages.
that a bond issuer may fail to
make payment when requested or
that an insurance company will be 8 STEPS OF MANAGING CREDIT
unable to pay a claim. RISK1ST KNOW YOUR
 When it comes to measuring credit COSTUMER
risk, banks should focus on the
 Five C’s: credit history, capacity to  1st Know your Customer
repay, capital, associated collateral, - Knowing your customer is the
and the loan’s conditions. It is foundation of the credit process.
effective methods for measuring
credit risk can reduce potential losses  2nd Analyze Nonfinancial Risk
and help banks make better loans. - The concept of risk management
can apply to a single loan or
Credit Risk = Default Probability customer relationship (micro) or
x Exposure x Loss Rate to an entire loan portfolio
(macro).

WHY DO WE NEED CREDIT RISK  3rd Understand the Numbers

MANAGEMENT? - Focus on the financial capacity of
the company as evidenced by the
 It is the practice of mitigating losses information provided.
by understanding the adequacy of - Examine the accuracy of the
a bank's capital and loan loss information.
reserves at any given time. - Examine the quality and
 The goal of credit risk management sustainability of financial
in banks is to maintain credit risk performance
exposure within proper and
acceptable parameters.
 AE18-ACT8:Managing Credit Risk in Money Market

CREDIT RATING
 4th Structure the Deal ❖ Credit Rating is an estimate of the ability
- Understanding profitability and of a person or organization to fulfill their
cash flow, liquidity, and leverage
financial commitments, based on previous
are key to structuring the facility.
dealings.
-
❖ A Credit Rating or score is assigned to
 5th Price the Deal any entity that wants to borrow money- an
- Complex factors determine the
final rate individual, a corporation, a state or
- Your financial institution’s provincial authority, or a sovereign
finance and lending divisions, in government.
conjunction with the ALCO, will
❖ A Credit Rating is a measurement of
set loan pricing and service fee
business entity’s ability to repay a
strategies.
financial

 6th Present the Deal obligation based on income and past

- Communicating your findings in repayment histories.
a cogent and professional manner
❖ A Credit Rating refers to a quantified
is a critical step in getting your
assessment of a borrower’s creditworthiness
proposal approved.
in
 7th Close the Deal general terms or with respect to a particular
- Closing the deal takes place after debt or financial obligation.
the analysis structuring, and pricing
had been completed. ❖ Credit Ratings determine whether a
borrower is approved for credit as well as
 8th Monitor the Relationship the
- Monitoring can be accomplished interest rate at which it will be repaid.
in two ways:

01. Have a loan covenant checklist 3 MAJOR RATING COMPANIES

that routinely tracks your customer’s
adherence to covenants. ❖S&P
02. Require that an officer of the
-S & P creates ratings by getting information
company regularly (e.g., quarterly)
from published reports, such as annual
certify as to the company’s
reports,
compliance with all of its
outstanding agreements. press releases, and news articles.
 AE18-ACT8:Managing Credit Risk in Money Market

-Assigning letter grades to companies and ● CIS submit positive and negative credit
countries and the debt the issue on a scale of
information to CIC and CIC provides
AAA to D, indicating their degree of
credit reports to the borrowers.
investment risk.

CISA
❖ MOODY’S
● (CISA) or Credit Information System
Act or the Republic Act no. 9510 is the
-Moody’s long-term ratings are opinions of
the relative credit risk of financial act of forming the Credit Information
obligations with
Corporation.
an original maturity of one year or more.
-In Moody’s Investors Services ratings
● CISA recognizes the need to establish a
system, securities are assigned a rating from
Aaa to C, comprehensive and centralized credit
with Aaa being the highest and C the lowest information.
quality.

THE TWO ECONOMIC THEORIES

❖ FITCH THAT AFFECTS THE TERM
STRUCTURE INTEREST GRADE.

-FITCH rates the viability of investments

relative to the likelihood of default. Expectations Theory
● The theory predicts future short-term

THE CIS AND CISA IN THE interest rates based on current long
PHILIPPINES term interest rates.
● Expectation theory holds that the
CIS long-term interest rate is a weighted
● (CIS) or credit Information System is average of present and expected future
designed to directly address the short-term interest rates
requirement for borrowers' credit
information that is reliable. Liquidity Premium Theory
● The liquidity premium is a type of
 AE18-ACT8:Managing Credit Risk in Money Market

additional compensation. Compensation flow management is one of the

built into the system return of a potential causes.
non-recoverable asset cashed in quickly
or easily. FOUR RISKS THAT ARE INHERENT
TO FINANCIAL TRANSACTIONS
● It talks about how investors can earn
higher returns by taking additional risks
LEGAL RISK
● These risks arise as a result of a
FOUR RISKS THAT ARE INHERENT
TO FINANCIAL TRANSACTIONS company's lack of internal controls,
technological failures, mismanagement,
DEFAULT RISK human error, or a lack of employee
● Credit risk, also known as default training.
risk, is the danger of borrowing ● Legal risks may result in:
money. The borrower will default if (i) claims against the institution,
they are unable to repay the loan. (ii) fines, penalties, and punitive
damages,
Credit risk affects investors by
(iii) unenforceable contracts due to
reducing their income from loan
defective documentation,
repayments as well as losing
and ;
principal and interest.
(iv) loss of institutional reputation.
Documentation is an important part of
LIQUIDITY RISK the

● Liquidity risk arises from an banking and financial sectors.

investment's inability to be bought or

sold quickly enough to avoid or minimize MARKET RISK

a loss. It is typically reflected in ● Market risk is primarily caused by

unusually wide bid-ask spreads or large economic uncertainties, which can

price movements. have an impact on the performance

● It is the possibility that a company will of all companies, not just one. These

fail to meet its obligations. Poor cash sources of risk include changes in
 AE18-ACT8:Managing Credit Risk in Money Market

the prices of assets, liabilities, and

derivatives.