Khoa Toán Kinh tế

Quantitative Risk Management

Nguyễn Thị Liên & Đinh Thị Hồng Thêu

Khoa Toán Kinh tế

Trường Đại học Kinh tế Quốc dân

August 5, 2024

Nguyễn Thị Liên & Đinh Thị Hồng Thêu Quantitative Risk Management 1
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Chapter 1. The Credit Decision and Credit Analyst

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 Learning Objectives
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1.1. The Credit Decision

- Definition of credit
- Willingness to pay
- Evaluating the capacity to repay
- Categories of credit analysis
- A quantitative measurement of credit risk
1.2. Credit Analyst
- Role of the bank credit analyst: scope and responsibilities;
- Credit analysis: tools and methods;
- The data for the bank credit analysis;

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 References
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Chapter 1: Credit Risk Measurement and Management

Chapter 2- Credit Risk Measurement and Management

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 1.1 Credit analysis process
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Credit is an agreement where one party receives something of value and

agrees to pay for the good or service at a later date
The creditor must have knowledge of the borrower’s character and
reputation as well as his financial condition
Borrower, obligor, counterparty, and issuer are all used to signify the
party receiving credit.
Lender, creditor, and obligee are primarily used to signify the party
granting credit
There is not a definitive yes or no answer to whether a borrower can
and will pay back a loan.The lender must address the question of
likelihood that the borrower will pay back the loan in accordance with
the terms of the agreement.

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 1.1 Credit analysis process
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Credit risk:
Credit risk is the probability that a borrower will not pay back a loan in
accordance with the terms of the credit agreement.
The risk can result from:
Default on a financial obligation.
An increased probability of default on a financial obligation.
A more severe loss than expected due to a greater than expected
exposure at the time of a default.
A more severe loss than expected due to a lower than expected
recovery at the time of a default.
Default on payment for goods or services already rendered (i.e.,
settlement risk)

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 1.1 Credit analysis process
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Credit Risk Evaluation Components

The borrower’s capacity and willingness to repay the loan.
The external environment and its effect on the borrower’s capacity
and willingness to repay the borrowed funds.
The characteristics of the credit instrument.
The quality and adequacy of risk mitigants

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 1.1 Credit analysis process
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Assume you are a credit analyst at a bank and you receive a loan request
from a firm. This firm operates in the field of electronic equipment
manufacturing and has requested a loan of $100,000 to expand its
business operations. what are the steps you need to take to conduct an
effective credit analysis?

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 1.1 Credit analysis process
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Credit Risk Evaluation Components

The borrower’s capacity and willingness to repay the loan.
What is the financial capacity to pay?
Is it likely the borrower can fulfill its financial obligations through the
maturity of the loan?
Are there outside forces that affect the borrower’s capacity and/or
willingness to pay? For example, does the ownership structure of the
firm, relationships within and outside the firm, and other obligations
of the firm affect the borrower’s ability to pay?
How does the business itself affect the borrower’s capacity to pay?
Are there credit risk characteristics tied to this particular industry or
sector?
Does the firm have a niche within the industry or sector?

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 1.1 Credit analysis process
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Credit Risk Evaluation Components

The external environment and its effect on the borrower’s capacity and
willingness to repay the borrowed funds.
The business climate,country risk, and operating conditions are
relevant to the lender.
Are there cyclical changes that will affect the level of credit risk?
Will political risks affect the likelihood of repayment?

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 1.1 Credit analysis process
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Credit Risk Evaluation Components

The characteristics of the credit instrument
Risk characteristics that are inherent in the credit instrument,
including legal risks and obligations that are specific to the
instrument.
The maturity of the instrument/Is the debt secured or unsecured? Is
there collateral backing the loan? Are there loan guarantors?
Is the debt subordinated or senior to other obligations? What is the
priority assigned to the creditor?
How do loan/bond covenants increase or decrease the credit risk for
each party? Can the borrower repay the loan early without penalty?
Can the lender call the loan? Can the security be converted to
another form (e.g., a convertible bond)?
What is the denominated currency of the obligation?
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 1.1 Credit analysis process
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Credit Risk Evaluation Components

The quality and adequacy of risk mitigants such as collateral, credit
enhancements, and loan guarantees:
Is the collateral pledged to, or likely to be pledged to, another loan?
Has there been an estimation of the value of the collateral?
If there is a loan guarantor, has there been sufficient credit analysis of
the third party’s willingness and ability to pay in the event the
borrower does not pay?

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 1.1 Credit analysis process
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Quantitative Techniques
Probability of default (PD)
Loss given default (LGD)
Exposure at default (EAD)
Expected loss (EL)
Time horizon

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 Example 1.1
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A Bank has examined its loan portfolio over the past year. It has
determined that the probability of default was 4%, adjusted for the
size of the exposure. The loss given default over the period was 80%.
Bank risk managers estimate that the exposure at default was 75% of
the potential exposure. Calculate the expected loss given a one- year
time horizon.

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 1.1 Credit analysis process
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Quantitative data
Demographics
Collateral Data
Internal-Financial Data
Bureau Data
Macroeconomic Variables
Credit Card Only

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 1.1 Credit analysis process
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Limitations of Qualitative and Quantitative Techniques

There are limitations associated with quantitative data, which
include: Historical nature of the data: may not be up- to- date or
representative of the future, Difficult to make accurate projections
using historical data
Given the shortcomings of financial reporting, lenders should not
ignore qualitative analysis. The quality of management, the
motivation of the firm’s management, and the incentives of
management are relevant for both nonfinancial and financial firms.
Even quantitative analysis is subject to interpretation.
In fact, many would argue that financial analysis is much more of an
art than a science. Judgment is as important as the quantitative
analysis supporting it. The most effective analysis combines
quantitative assessments with qualitative judgments.
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 1.2. Credit analysis
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Types of borrowers
Consumers
Corporations
Financial Institutions
Sovereigns

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