Credit risk

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Credit risk , counterparty risk or counterparty default risk is a term used in the banking sector , which is generally understood to mean the risk that a borrower cannot or does not want to repay the loans granted to him in full or in accordance with the contract. In general, credit risk is the most important type of risk for banks . Outside of the credit system, credit risk is used synonymously .

Systematics

When differentiating individual sub-terms from the general concept of credit risk, a distinction must be made between the banking operations and banking supervisory law perspectives, because both of them make different distinctions in their sometimes very different approach.

Banking perspective

The banking risk concept is not used consistently in the literature because of the interdependencies and overlaps within individual risk types. Hans Büschgen wants the concept of credit risk to be narrowed to the credit risk, i.e. the default of a debtor due to insolvency. For him, the credit risk only includes the coverage risks in the broader sense, for example in the area of ​​forward transactions. The limitation of the credit risk to creditworthiness and collateral risks of the lending business is widespread. The prevailing opinion is therefore only in the basic questions of the individual risk terms, but their mutual delimitation is already controversial.

The concept of credit risk in banking is more comprehensive than in the banking supervisory perspective and describes possible losses in value that result from a deterioration in the debtor's creditworthiness or even from his insolvency. This broad definition also includes the issuer, investment and collateral risk. In banking practice, the broadest definition of credit risk is at Sal. Oppenheim . Because here, in addition to the classic credit risk, the counterparty risks from trading transactions as well as the issuer risk and the country risk are understood as counterparty default risk.

Issuer risk

Issuer risk is the risk of a deterioration in creditworthiness or default of an issuer or a reference debtor. It arises from the purchase of securities for the banks' own holdings, securities issuing and placement transactions (in the syndication and underwriting phase ) and credit derivatives with an issuer underlying (in the case of credit default swaps for the so-called protection seller). In addition to traditional bonds , promissory notes and certificates, reverse convertible bonds and convertible bonds, each with their bond components, are also affected .

Investment risk

The equity investment risk is similar to the credit risk because it consists of the risk that the equity investments entered into by a bank lead to potential losses (due to loss of dividends, partial write-offs, losses on sales or a reduction in hidden reserves ) from equity provided, from profit and loss transfer agreements (loss assumptions) or from liability risks ( e.g. letters of comfort ). The investment risk extends to both strategic investments (in the banking-related area) and operational investments (in the non-banking sector).

Collateral risk

The collateral risk consists of the risk that the collateral received as collateral for a loan collateral during the loan term lose part or all of its value and, therefore, are not sufficient to cover the loans or can not even help. In order to reduce this collateral risk, percentage haircuts are made from the value of the collateral received by using lending values and lending limits, which limit the amount of credit that can be granted. Legal risks are not part of the collateral risk but are part of the operational risks of general banking operations.

Differentiation from other risks

The country and transfer stop risks, counterparty risks and replacement risks are no longer part of the credit risk in the narrower sense of the term. According to this, the country and transfer stop risk are not added to the credit risks. The risk types country risk and transfer stop risk, counterparty risk and replacement risk are organizationally monitored and controlled in a very different way in banks than credit risks in the narrower sense. Particularly for these types of risk, the content and scope of terms are used very differently in the literature. One of the decisive factors for the delimitation and allocation of these partial risks is their organization of control and monitoring in credit institutions.

Country and transfer stop risk

The country and transfer stop risk subsume all risks that relate to the default or moratorium of a country in which a borrower has his legal seat. In the case of cross-border payments, it can arise as a result of the unwillingness to pay (political risk) and / or the insolvency (economic risk) of a state and therefore forms an independent, higher-level risk sphere that cannot be influenced by creditors and borrowers. However, if another state (or, under certain circumstances, its subdivisions) is itself the debtor (in its own currency), the country and transfer stop risk is identical to the definition of credit risk or issuer risk.

Counterparty risk

Counterparty risk is the risk of the failure of a professional market participant (counterparty; the term is used in this context as the opposite of the customer). In addition to the classic credit risk - e.g. B. from money market transactions - in particular, the failure risks of derivatives positions or the processing result of financial transactions.

During the term of a derivative transaction, the so-called pre-settlement risk exists . This describes the risk that a business partner will default while a derivative transaction concluded with him has a positive economic value. The surviving business partner loses the economic advantage and has to undertake any replacement business (replacement) on terms that are less favorable for him.

To reduce the settlement risk, arrange professional market players derivative transactions normally under framework agreements that netting agreements (English netting agreements ) include. If a partner defaults, the mutual claims from all transactions concluded under the framework contract are offset against each other, so that the replacement risk only exists in the amount of the remaining balance. In addition, z. T. via so-called collateral attachments (English credit support annexes ) agreed in addition, the mutual points of collateral in order to reduce the risk further.

The importance of counterparty risk in derivatives business became clear during the financial market crisis of 2007 with the near collapse of the American International Group . AIG acted extensively as protection seller in credit default swaps .

The fulfillment of due spot and derivative transactions leads to what are known as settlement risks. Their character differs according to how the processing is carried out. To reduce risk , transactions are partly routed through a clearing house , which operates as a representative of both parties and only processes the respective transaction step by step (also called delivery versus payment ) when both parties have provided (purchased) the assets necessary to process the transaction. have (so-called "matching"). For example, a clearing house for securities only transfers assets when buying securities when the buyer has purchased the purchase price and the seller has purchased the papers from the clearing house. The settlement risk is then reduced to a short-term replacement risk: if one counterparty defaults, the other counterparty does not have to pay either. His risk is reduced to the fact that he has to conclude a replacement transaction and the course has changed to his disadvantage during the settlement period.

This residual risk can practically be eliminated if a central counterparty acts for clearing . The business partners then no longer work directly to each other. Rather, the central counterparty steps in between them, who fulfills regardless of the failure of a business partner. This possibility of risk reduction is available through the Continuous Linked Settlement system .

If the transaction is not carried out step by step, one speaks of a free-of-payment transaction . Both counterparties cause their obligations to be fulfilled independently of one another. If one of the counterparties defaults, it may be that the other has already performed, but does not receive anything in return ( performance risk ). In the case of free-currency transactions, the settlement risk is essentially the same as the amount to be paid, i.e. it has a much greater amount of damage than in a step-by-step transaction. In foreign exchange trading, one speaks of the Herstatt risk .

Replacement risks from derivative transactions and settlement risks are side effects from the banking business. In contrast to classic credit risks from corporate banking, these are not taken specifically to generate income. Rather, like operational risks, they are an inevitable consequence of conducting certain business activities.

Banking regulatory perspective

The treatment of credit risks for banks in Germany by the German Banking Act (in particular derived and regulations Kapitaladäquanzverordnung (abbreviation CRR), the GroMiKV and MaRisk ) prudentially regulated.

Initially, the Solvency Ordinance (SolvV) , which has been in force since January 2007, dealt in detail with credit risks and classified them as part of the overriding counterparty default risks. The CRR, which has been in force since January 2014, has replaced the SolvV and contains all regulations relating to credit risk. The CRR does not define the credit risk directly, but speaks of the fact that it is linked to the maintenance of risk positions (Art. 1a No. 57, 58 CRR). Risk positions in turn are balance sheet assets or off-balance sheet items ( contingent liabilities ; Art. 5 No. 1 CRR). This broad definition includes both the credit risk from monetary credits and from contingent liabilities assumed by a credit institution ( credit lending such as guarantee credits ). In addition, the financial risks of the institutes from their investments are subsumed here.

A settlement risk is under Art. 378 CRR ago, when in the case of transactions in which debt instruments , equity instruments, foreign currencies and commodities (excluding repurchase agreements and securities or commodities-and securities or commodities borrowing) after their due delivery no settlement is done. Then the replacement cost (difference between the settlement price and the current market value) must be determined. The foreign currency risk is mentioned frequently (Art. 92 No. 3 CRR), but not defined. The foreign currency risk is the possibility of a loss as a result of changes in the exchange rate or parity .

The counterparty risk is called counterparty default risk in the Capital Adequacy Ordinance , as the English word counterparty was not translated as 'counterparty' but as 'counterparty'. According to Art. 272 ​​No. 1 CRR, it is the risk of the counterparty of a transaction defaulting before the final settlement of the payments associated with this transaction. A credit institution may not enter into a business relationship with a counterparty without having assessed its creditworthiness (Art. 286 para. 2a CRR). According to Art. 379 CRR, a bank has a wholesale risk if it has paid for financial instruments before it has received delivery or vice versa or, in the case of cross-border transactions, if at least one day has passed since payment or delivery. The difference between settlement and advance performance risks is whether both contracting parties have not (yet) performed although they were obliged to perform (settlement risk) or whether only one partner has not fulfilled its obligation to perform (advance performance risk). In addition, the wholesale risk is limited by law to the trading book , while the settlement risk also extends to the banking book of an institution.

Country risk

Finally, the country and transfer stop risk is also subsumed under the credit risk without this term appearing in the law. For this purpose, section 9 (1) sentence 3 SolvV a. F. succinctly states that several counterparty default risk positions can arise from one transaction. This also means that a loan to a borrower with a legal seat abroad initially represents a credit risk, but also country and transfer stop risks can prevent loan repayment in whole or in part. This is both isolated (either the borrower is insolvent and there are no country risks or vice versa) and cumulative (the borrower is insolvent and there is a transfer freeze).

Several counterparty default risk positions also arise with convertible bonds , as BaFin clarifies in its response to an inquiry. According to this, convertible bonds with conversion rights of the obligee ("convertibles") consist of a balance sheet counterparty default risk according to § 10 SolvV a. F. with regard to their bond components and a derivative counterparty risk position according to § 11 SolvV a. F. in relation to the option component.

Summary of risk groups

Within a bank's loan portfolio , the credit risk of one borrower may be related to the risk of one or more other borrowers.

According to Art. 4 Paragraph 1 No. 39 Letter a CRR, a group of affiliated customers exists if two or more natural or legal persons form a unit in that one of them has direct or indirect control over the other or if There are dependencies between these persons, which make it seem likely that if one of these customers has financial difficulties, other customers will also find themselves in financing or repayment difficulties. In addition, according to Art. 4 Para. 1 No. 39 Letter b CRR, a “risk group” must be formed if economic difficulties of one company lead to economic difficulties for another company (so-called “ domino effect ”). Regarding the scope of the risk group, the European supervisory authority a. Statements in the CEBS ( Guidelines on the implementation of the revised large exposures regime ) and so far in Germany in the BaFin circular 8/2011 and in Austria in the directive on large exposures registration of September 2011 . According to the latter, a risk group is usually presumed if a person renders or purchases goods or services to another company that exceed 30% of its own total output or has receivables or liabilities towards the other company that exceed 20% of its own balance sheet total , or Has made loss coverage commitments , liabilities , guarantees , letters of comfort or similar statements of assistance to the other company in the amount of more than 30% of its own equity . These risk groups are to be summarized internally as a uniform credit risk.

Collateral risk

A major difference between the banking and banking supervisory systems is the collateral risk. This is understood to mean the risk that the loan collateral taken to secure a loan may expire partially or completely in value during the term of the loan and is therefore no longer sufficient to cover the loan claim. This collateral risk is treated as a credit risk mitigation technique that is not part of the counterparty risk. Any legal risks that could make the credit security unusable for legal reasons are also not part of the collateral risk for regulatory purposes, but are assigned to operational risks in accordance with Art. 4 (1) No. 52 CRR. If the collateral risk materializes, the credit parts not covered by the proceeds from the realization of the collateral are part of the credit risk. If an institution is prevented from realizing a loan security for legal reasons, the resulting losses are to be allocated to operational risks.

Credit risk metrics

The expected loss of an individual credit exposure (abbreviation EL from expected loss ), also known as standard risk costs , can be determined from three key figures that also play a central role in the new Basel Capital Accord (see minimum capital requirements for credit risks ):

with the following sizes:

  • PD - probability of default , i.e. the probability that the debtor will default (abbreviation PD from English probability of default )
  • EaD - default loan amount , i.e. the expected amount of the claim at the time of default (EaD abbreviation from English exposure at default , in Principle I also referred to as credit equivalent amount ): The EaD comprises current outstanding debts as well as expected future claims by the borrower. It is of particular importance in the case of credit lines and overdrafts , as experience has shown that credit lines are often more heavily used than normal or even overdrawn in the event of default .
  • LGD - default loss rate , ie the percentage of the claim amount that is expected to be lost in case of failure (abbreviation LGD English loss given default ): Key factors which influence the LGD, the nature and degree of collateralisation and the ranking of amounts receivable. The LGD tends to be lower with a high level of collateralisation and high value retention of the collateral, but higher with subordinated claims.

Strictly speaking, the EL is not a risk measure , as it reflects the expected value of the future loss from loan defaults and therefore does not contain any information about the uncertainty regarding the future loss (unexpected loss, abbreviated to UL for unexpected loss ). The value at risk is a measure of the uncertainty .

Credit risk management

When measuring, managing and monitoring credit risk, the banking and regulatory perspectives are largely merged. In particular, the SolvV and MaRisk specify the specific requirements, instruments and goals that are intended to enable the credit risks to be managed uniformly at banks. The aim of credit risk management is to ensure that a credit institution's risk-bearing capacity as required by supervisory law is met at all times. The risk-bearing capacity of a credit institution is largely determined by its ability to compensate for the loss of assets or earnings due to the occurrence of risks without jeopardizing its existence and without serious negative effects on its business opportunities (impairment of development).

In this sense, credit risk management can be understood as all precautions for recording, consolidating and managing the risks associated with credit transactions. The effects of risk occurrences, the resulting losses, the fees received for the assumption of risk and the valuation gains and losses are then shown in the annual financial statements (accounting).

Determination of credit risks

The credit risk of an institution is first identified through adequate use of suitable selection processes from the entire database and then quantified by combining the individual risk contributions so that it can form the basis for determining the risk-bearing capacity as part of the overall risk. The credit risk is measured with the help of key figures in credit ratings : the worse the rating, the higher the probability of default. With risk-based pricing, borrowers with a poor rating have to pay surcharges on the loan interest as a risk premium . If risk-based pricing does not take place, this can lead to a negative “adverse selection” for the relevant bank or insurance company. Adverse selection means: bad borrowers stay, good borrowers switch to a bank that is cheaper for them.

In the next step, the individual sub-forms of credit risks that the respective institution considers suitable are aggregated into an overall figure. The aim of this regular calculation is also to identify cluster risks or negative changes due to deteriorated credit ratings.

control

Risk management includes all measures planned or taken to deal with the identified and analyzed risks. One of the most important - implicit - requirements of the SolvV is the uniform reference value “borrower”, on which the control process must be focused. The rating procedures and processes, which prescribe the classification of borrowers into certain risk categories, are then expressly and in detail regulated. These risk classes are then given graded default probabilities. On the basis of the probability of default determined, the total credit risks can then be divided into different rating levels, with the institutes also aiming, as part of the control, to reduce the proportion of the lower-rated risks in the overall portfolio.

monitoring

In a further step, credit risks are monitored using a comprehensive set of quantitative parameters and measuring instruments. Some instruments are applicable to several types of risk, while others need to be tailored to the characteristics of certain risk categories.

  • Limit control :

Each debtor and each risk group is assigned a risk-oriented credit limit (maximum permitted amount of credit), the amount and duration of which is based on the individual credit rating. In this way, there are credit limits for individual borrowers and borrower groups ( borrower unit ), sectors, other borrower groups with uniform positive correlation and country limits. These limits can be refined with sublimits.

  • economic capital :

is a measure for determining the amount of equity capital that must be able to absorb extreme unexpected losses from the loan portfolio . “Extreme” denotes a confidence level of at least 99.5% for the economic capital determined. This means that the unexpected losses occurring within a year are covered by equity with a probability of 99.5% or more.

  • Expected Loss :

The expected loss measures the hypothetical loss that can be expected within one year from credit risks on the basis of historical loss data. In order to determine the expected loss from the credit risk, credit ratings, credit terms and loan collateral are taken into account in order to measure the risk content of the credit portfolio . Therefore, this key figure is suitable for measuring the credit risk. The calculation results can also be used to determine the allowance for loan losses in the annual financial statements.

  • Stress tests :

The measurement and assessment of credit risks can be expanded to include stress tests . This can be used to simulate the influence of hypothetical changes in the economic framework conditions on all or part of the loan portfolio. This also makes the resulting changes with regard to the rating changes of the credit portfolio and thus the core capital ratio of a credit institution visible. With the help of stress tests, potential hazards or concentrations are also to be uncovered.

Effects on the granting of loans

The risk-bearing capacity of banks required by banking supervisory law is aimed at protecting depositors and their financial investments. Risk-bearing capacity in this sense means the maximum possible resilience of the equity of a credit institution through losses incurred from the risks taken.

The regulatory instruments available to maintain this risk-bearing capacity, on which the risk management of the individual credit institutions is ultimately based, has a procyclical effect, however. In the event of economic recession or individual economic crises for their borrowers, the banks tend to reduce their loans and select more cautiously when granting new loans, because they have to back more own funds due to the rating and have to fear higher loan defaults due to increasing credit risks. In these cases, the core capital ratio of the institutions falls as a result of rating downgrades for their borrowers, without any new loans being granted. In doing so, they may reinforce the economic downtrend; conversely, this also applies to upswing phases.

See also

literature

  • Thorsten M. Bröder: Risk Management in International Banking. A holistic analysis with special consideration of steering and control. ( Banking and financial research. Volume 375). Haupt Verlag, Bern / Stuttgart / Vienna 2006, ISBN 3-258-07078-4 .
  • G. Cesari et al .: Modeling, Pricing, and Hedging Counterparty Credit Exposure: A Technical Guide. Springer Finance, Heidelberg / Berlin 2010, ISBN 978-3-642-04453-3 .
  • Johannes Wernz: Bank Control and Risk Management , Springer Gabler, Heidelberg / Berlin 2012, ISBN 978-3-642-30555-9 .

Individual evidence

  1. ^ Wilhelm Schmeisser, Carola Mauksch, Falko Schindler: Selected procedures for analyzing and controlling risks in the lending business. Hampp, Munich 2005, ISBN 3-87988-984-8 , p. 7.
  2. ^ Hans E. Büschgen, Bankbetriebslehre: Banking transactions and bank management , Gabler, Wiesbaden 1998, ISBN 3-409-42077-0 , p. 923
  3. ↑ Stephan Germann: Strategic Implications of Credit Risk Management in Banks. German Univ.-Verlag, Wiesbaden 2004, ISBN 3-8244-8031-X , p. 78.
  4. ↑ Sal. Oppenheim jr. & Cie. SCA: Group management report risk management. 2008.
  5. ↑ i.e. capital shares in another company
  6. ↑ In its “Guide to overall bank risk management”, the Austrian National Bank and the Austrian Financial Market Authority assume that the “credit risk category can be subdivided into counterparty, investment, securitization and concentration risk”; January 2006, p. 39.
  7. ↑ Büschgen: The small bank lexicon. 2006, p. 558.
  8. ↑ Wolfgang Grill, Hans Perczynski, Hannelore Grill: Wirtschaftslehre des Kreditwesens. Bildungsverlag EINS, Troisdorf 2009, ISBN 978-3-441-00303-8 , p. 528.
  9. ↑ Stephan Germann: Strategic Implications of Credit Risk Management in Banks. 2004, p. 78 ff.
  10. ↑ “Financial counterparties” (“counterparty”) are CRR credit institutions , investment firms , insurance companies , reinsurance companies , company pension schemes or investment funds approved according to Art. 2 No. 8 Regulation (EU) No. 648/2012
  11. ↑ the Deutsche Bundesbank explains in the explanatory memorandum to SolvV of January 17, 2007 , p. 9, using the example of the Credit Linked Note , that its protection seller has both a balance sheet counterparty risk position vis-à-vis the issuer of the bond (the security seller) and an off-balance sheet position vis-à-vis the Debtor of the reference liability justified. The offsetting of both counterparty default risk positions represents a stricter, guideline-compliant and, in particular, risk-adequate interpretation compared to the regulation in Principle I.
  12. ↑ Inquiry T005N002F002 dated December 18, 2008
  13. ↑ “Reverse convertibles” contain, in addition to the repayment claim, an implicit standstill obligation on the part of the creditor from a put option, so that in addition to the balance sheet counterparty risk position according to § 10 SolvV a. F. also an off-balance sheet counterparty default risk according to § 13 para. 1 no. 3 SolvV a. F. arises
  14. ↑ BaFin, Circular 8/2011 (BA) - Implementation of the CEBS Large Exposure Guideline of December 11, 2009 as well as further interpretative decisions on large exposure regulations of July 15, 2011, reference BA 52-FR 2430-2009 / 0003
  15. ↑ Austrian National Bank, Guideline on Large Loans Registration from September 2011 , p. 35
  16. ↑ IdW auditing standard: The assessment of the risk management of credit institutions as part of the audit. (IDW EPS 525), March 6, 2009, p. 10.