Credit is essential in the modern world and creates wealth, provided it is used wisely. The Global Credit Crisis during 2008/2009 has shown that sound understanding of underlying credit risk is crucial. If credit freezes, almost every activity in the economy is affected. The best way to utilize credit and get results is to understand credit risk. Advanced Credit Risk Analysis and Management helps the reader to understand the various nuances of credit risk. It discusses various techniques to measure, analyze and manage credit risk for both lenders and borrowers. The book begins by defining what credit is and its advantages and disadvantages, the causes of credit risk, a brief historical overview of credit risk analysis and the strategic importance of credit risk in institutions that rely on claims or debtors. The book then details various techniques to study the entity level credit risks, including portfolio level credit risks. Authored by a credit expert with two decades of experience in corporate finance and corporate credit risk, the book discusses the macroeconomic, industry and financial analysis for the study of credit risk. It covers credit risk grading and explains concepts including PD, EAD and LGD. It also highlights the distinction with equity risks and touches on credit risk pricing and the importance of credit risk in Basel Accords I, II and III. The two most common credit risks, project finance credit risk and working capital credit risk, are covered in detail with illustrations. The role of diversification and credit derivatives in credit portfolio management is considered. It also reflects on how the credit crisis develops in an economy by referring to the bubble formation. The book links with the 2008/2009 credit crisis and carries out an interesting discussion on how the credit crisis may have been avoided by following the fundamentals or principles of credit risk analysis and management. The book is essential for both lenders and borrowers. Containing case studies adapted from real life examples and exercises, this important text is practical, topical and challenging. It is useful for a wide spectrum of academics and practitioners in credit risk and anyone interested in commercial and corporate credit and related products.
Preface xvii 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 1.4.1 Merits of Credit 7 1.4.2 Demerits of Credit Usage 9 1.4.3 Is Wealth Creation Through Use of Credit Easy and Simple? 10 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 2.7.1 The Art and Science 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 3.8.1 Stages of Credit Risk Management in Financial Intermediaries 31 3.8.2 Credit Risk Management Process 33 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 4.1.1 Business Risks or Operating Risks (OR) 37 4.1.2 Financial Risks (FR) 38 4.2 Risk Matrix 39 4.3 Different Risk Levels 39 4.3.1 Low Operating Risk and Low Financial Risk 39 4.3.2 Low Operating Risk and Medium Financial Risk 39 4.3.3 Low Operating Risk and High Financial Risk 40 4.3.4 Medium Operating Risk and Low Financial Risk 40 4.3.5 Medium Operating Risk and Medium Financial Risk 40 4.3.6 Medium Operating Risk and High Financial Risk 40 4.3.7 High Operating Risk and Low Financial Risk 40 4.3.8 High Operating Risk and Medium Financial Risk 41 4.3.9 High Operating Risk and High Financial Risk 41 Questions/Exercises 42 5 External Risks 43 5.1 Business Cycle 43 5.1.1 Benefits of Study of Business Cycles 45 5.1.2 Credit Risk in the Business Cycle 46 5.2 Economic Conditions 46 5.2.1 Private Consumption 47 5.2.2 Government Spending 47 5.2.3 Investment 48 5.2.4 Imports and Exports 48 5.2.5 How to Link NI Components to the Firm 48 5.2.6 Benefits of Study of National Income 49 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 6.1.1 Sector vs. Industry vs. Market Segment 61 6.1.2 Challenges of Industry Classification 62 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 6.8.1 Competition Among the Existing Firms Within the Industry 68 6.8.2 Threat of New Entrants 68 6.8.3 Threat of Substitute Products 69 6.8.4 Bargaining Power of Buyers 69 6.8.5 Bargaining Power of Suppliers 70 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 7.3.1 Interviews and Questioning 82 7.3.2 Market Developments and Peer Comparison 83 7.4 SWOT Analysis 83 7.5 Business Strategy Analysis 84 7.5.1 Cost Leadership 85 7.5.2 Differentiation 86 7.5.3 Contraction 86 7.5.4 Market Penetration 86 7.5.5 New Markets 87 7.5.6 New Products/Product Synergy Diversification 87 7.5.7 Product/Market Diversification.
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