Incident Command System Essay Example

CREDIT RISK

INTRODUCTION.

Banks always gives money to borrowers in terms of loan/credit to borrowers with expectation of principal and interest in lump sum or as an annuity over a given period of time or at maturity. But sometime the borrower may default on the repayment. The default can be termed as the credit risk associated to the loan. Therefore, bank should carefully study the borrower for example engaging a credit rating firm in determining the potentiality of the borrower paying the credit advanced to him/her.

THE DIFFERENCE BETWEEN A LINE OF CREDIT AND A REVOLVING LINE OF CREDIT

Line of credit and revolving line of credit are all ways a firm can obtain money on credit to make any purchase but the two differ on extent to which it can be applied for example, line of credit use is multipurpose in terms of how expensive is the product you want to buy and the lender lets the borrower to vary the repayment and withdrawal which is done within the agreed period under a given interval they include purchase of machines and cars while revolving line of credit is used for small transactions done in the business such as buying of office stationery.

THE DIFFERENCE BETWEEN A LETTER OF CREDIT AND A LINE OF CREDIT

Letter of credit is a written document drawn by the bank to be used by its customer in order to act as a guarantees to seller that the bank will pay for the good or services on behave of its customer while line of credit is electronically configured with customers information and it is linked to your bank account for example personal credit cards which you only swipe and it will reflect account status.

EXAMPLE OF WHEN A BANK HAS AN EXPOSURE DUE TO AN INTEREST-RATE SWAP AND HOW ONE QUANTIFIES THE EXPOSURE

Interest rate swap is where let say bank X agree to pay company Y agreed amount at a fixed interest rate in exchange of floating interest rate from the original debtor of company Y. essentially it is transfer of a credit from the holder to a new holder. And the exposure is quantified by haircut based 10-working holding period days and the haircut is formulated by using square root time formula basing on rate of revaluation of credit protection.

UNEXPECTED LOSSES AND EXPECTED LOSSES

Unexpected losses are losses which keep occurring but one cannot predict when it will occur or loss will be of what extent and they are always amount incurred greater than expected loss but expected loss is the loss that company is plausibly expecting to occur. H=recap7 credit risk

Where: H-Hair cut

Hm-haircut at minimum holding period.

Tm-minimum holding duration for type of transaction.

Nr-actual number of business working days remaining for revaluation for secured transaction.

THE AREA IN RED REPRESENT

recap7 credit risk 1

The red area is the probability that the credit loss will be adverse and the bank capital can never cover the loss thus leading to bank failure. It always moves toward infinty and it is given as:

P (Fail)=f(xσ,∞)

STOCHASTIC

Stochastic means the state that it is non-deterministic but it depends on other variables which they can be determined. For example in the graph above probability distribution is non-determinant while capital and credit losses are determinants.

THE DIFFERENCE BETWEEN SPECIFIC PROVISIONS AND GENERAL PROVISIONS

Specific provision is allocation of the actual losses that the bank incurred in the preceding year and it was as a result of high rate of default while general provision is just random allocation of pre-determined possibility of occurrence of losses in future.

WHAT IS THE IMPACT OF PROVISIONING ON CAPITAL ADEQUACY

Provision of capital adequacy played a major role in ensuring that the banking system remains strong and maintain high profitability since capital requirement percentages faces out weak banks or initiates merges and reconstruction thus making banking system strong and consistent.

PRUDENTIAL LIMITS SET IN APS .

  1. Parties that were not related with ADI were capped at capital base of 25% for example government and central bank

  2. Unrelated ADI and their subsidiaries were restrict at 50% of capital base and subsidiaries at 25% of its capital base.

  3. Foreign banks and their subsidiaries were regulated at 50% of its capital base and subsidiaries at 25%.

ADI is limited by the constrain that he will not increase exposure by more than 25% but APRA can set their own specific limits on ADI exposure elements but should be in writing and each circumstance should be illustrated individually.

MAJOR CATEGORIES OF EXPOSURES

Exposure is categorized in four types that is:

  1. Sovereign exposure.

  2. Retail exposure.

  3. Corporate exposure.

  4. Quantifying revolving retail exposure

  5. Equity exposure.

  6. Eligible and purchased receivable exposure.

  1. Controlled amortized features of a credit.

  2. Non-controlled amortized features of a credit.

ROC Curve is always drawn on a graph of true positive values of the subject against the false negative values and is always a concave in shape.

Trade-off between sensitivity and specificity come in because with low discrimination threshold sensitivity is high and when discrimination threshold is high specificity is high therefore, opposite relationship between the two bring the trade-off .

Confusion matrix is combination of self-selection due to pricing having the positive test and the negative test of the variable tested.

Type II error comes in due to a false negative hypothesis and the cost is to deny credit and demand for payments while type I is false positive hypothesis and one extend credit only to be defaulted.

One should establish threshold and compare it with the score for example when score>determination threshold accept

if score< determination threashold reject.

CONCLUSION.

Credit extension by banks is one of the major sources of exposure to the risk that may cause failure of the banks which in return affect the depositors of the bank. Thus every bank should do a lot of credit rating of the borrower recognized credit rating companies (moody’s) and also make sure they take into account the guidelines set to them by IDA’s and APRA. In order to develop a very strong banking system and therefore, winning the trust of factors with capital surplus to save and the bank to lend to factors with capital deficit.

REFERENCE

Basel committee on banking supervision. (June 204). International Convergence of Measure and Capital Standard. Available at >http://www.bis.org/publ/bcbs118.pdf