FRSGlobal Solutions - Credit Risk

Counterparty credit risk is rapidly gaining importance in the financial industry as the key risk that needs to be identified and managed. Credit risk analysis is now the essential element of effective risk and profitability management.

Accurate measurement and efficient management of credit exposures is highly demanded by both C-level management and regulators. The challenge in the current and future credit exposure measurement is efficient combining of all the exposure drivers, which include counterparty as well as market financial analysis elements.

Credit enhancements play a critical role in measuring net credit exposures. Evaluating how much of the gross exposure would be recovered and under which conditions is a challenging yet essential part of credit risk analysis.

Ratings, credit spreads and probabilities of default are rarely regarded on the standalone basis anymore, but are included in risk analyses, where correlations between credit and market risk factors as well as behaviour elements are taken into account.

Most popular approaches to identifying and measuring credit risks are thus stochastic-based credit Value at Risk (VaR) models. CreditRisk+ and CreditMetrics are two such models which have become benchmarks for credit portfolio risk measurement in the financial industry. These models are mainly used for estimating unexpected and extreme credit portfolio losses and hence also provide nesessary measures for estimation of the economic capital.

Stress testing, which includes deterministic assumptions of the credit exposures and counterparty credit status, is increasingly accepted and used by institutions and regulators.

More than ever practitioners rely on both static analysis and dynamic simulation. The latter is employed under ‘going concern’ status, where credit characteristics of a counterparty change together with the evolution of market conditions. The integration of credit risk with other types of risks is becoming an essential requirement for the successful financial risk management process.