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Professional Risk Managers’ International Association

Global Event SeriesFebruary 2008

Credit Risk

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The PRMIA Global Event Series is a focused examination of current risk issues related to a

single key theme.

The series includes three major one-day conferences, one each in Europe, North America

and Asia that anchor the series. Additional events will be held during each month throughout

the PRMIA chapter network.

Each series includes a survey of the PRMIA members on the designated theme. The following results are for the February series on Credit Risk.

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My role in the risk profession is:

606 bankers, 331 consultants, 56 regulators and 423 “other” (service providers, vendors and academics) participated in the survey.

606

331

56

423

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700

Practitioner/Banker (w orking at a bank or other f inancial entity in the credit risk area or directly involved orresponsible for credit risk) Consultant/Vendor (w orking for a client or clients in the credit risk area)

Regulator (w orking in areas responsible for credit risk management in regulated f irms)

Other

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Regional Breakdown

Respondents were globally spread; 456 from EMEA, 341 from the Americas & 256 from Asia Pacific. They were spread very evenly by Role.

0%

10%

20%

30%

40%

50%

60%

70%

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90%

100%

Bankers Consultants/Vendors Regulators Other

EMEA Americas Asia Pacific

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Relative to other banks in your country, how would you describe the size of your organization? Bankers Only

Survey participants reside in 89 different countries, with 55.2% of bankers who participated reporting that they represent institutions that are among the largest in their country.

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What is your primary responsibility in your organization as it relates to credit risk management? Bankers Only

32% of banking respondents had managerial responsibility for their credit risk systems.

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Are you actively consulting with a bank that is implementing credit risk management? Consultants/Vendors Only

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What is your primary responsibility in your organization as it relates to credit risk management implementation? Consultants/Vendors Only

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Which of the following credit-related activities is the most relevant at this point of time to your firm or to your current project? Bankers & Consultants/Vendors Only

Economic capital for credit risk is by far the most relevant to Consultants at present with 44% choosing this option.

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This is a selection of those who specified an “Other” reason to this question Bankers & Consultants/Vendors Only

• Potential future exposure calculations for derivatives

• Counterparty exposures• Basel II implementation and Models

development for Specialized Lending• Identify the fair value of the (non performing)

credits & the method of disposing these credits• Integration of risks and determination of

economic capital• Valuation of illiquid assets• Credit Card Risk Management• Model stress testing• Credit risk model lifecycle in SME and retail

bank setting• Analysis of credit drivers, especially quantifiable

low-beta risks, for alternative financing• Modeling PD accurately

• Retail Credit Risk Modeling • Valuation of capital intensive

assets• Market risk control and

monitoring of credit trading • Basel II Credit Risk data

warehouse• Continued development and

calibration of credit rating models

• Emerging Market Credit Risk• Implementation of a new

credit policy manuals as far as the respect of Credit Policy Rules

• Requirements definition / Linkages with market risk and operational risk

• Derivative Valuation• Credit Limits and Exposure

Management• Counterparty credit exposure

calculation

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Does your firm have a formal quality plan for validating your credit risk model(s)? Bankers & Consultants/Vendors Only

Acceptance that internal models need a formal validation process is growing with 56% of respondents saying that such processes existed where they worked.

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Who signs off for the validity of the credit risk model(s)? Bankers & Consultants/Vendors Only

Note that Basel II recommends that the Audit function should not have line responsibility for models – one assumes that this is a 2nd sign-off.

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• Chief Financial Officer• Credit Policy Committee• A vetting group separate

from the model developers• Senior Management

Committee• Respective Departmental

Heads• Quantitative Specialist• Head of Product

Management• Chief Investment Officer• Head of Credit Risk

Methodology• Head of Financial

Engineering• Global Risk Committee• Model Validation and

Approval Group

• General Counsel• External Independent Auditor• Board of Directors• Analytics Governance Committee• Model Validation Committee• Head of Market Operations • Nobody• Global Credit Risk Committee• External Auditors• Independent Decision Models Validation

Group• Consulting Actuary• Chief Actuary• Head of Global Analytics

This is a selection of those who specified an “Other” reason to this question Bankers & Consultants/Vendors Only

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Credit risk arises from a multitude of factors, including but not limited to underlying financial weaknesses, market disruption, operational lapses, liquidity crises, to name a few. Can credit risk be uniquely separated from market, operational, and other risks?

The majority of respondents (83.3%) chose No or Partially. Other variations to note are that Bankers had the highest number of “No” votes (44.8%) with Consultants and Regulators choosing “Partially”. Also Asia Pacific had the highest number of “No” responses (43.8%) with other regions choosing “Partially”.

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If your answer to the previous question was Partially, please specify for which asset class(es):

•According to Asset Class•According to Regulatory

requirement•According to Risk type•Consumer loans•Counterparty Risk•Credit Cards•Credit Derivatives•Credit Risk•Derivative other than CD’s•Energy Risk

•Extreme Events•Fixed Income• Integrated Credit and Market

risk•Loan Book / Banking Book•Market Risk•Not applicable to the

respondent •Reinsurance Risk •Stress Testing•Trading Book Assets

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The use of credit derivatives and the CDO market is a valid market-efficient way of redistributing risk. Do you agree with this statement?

The response was consistent on this question with the majority of respondents (67.1%) answering yes.

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Applying mark to market principles when there are no bids is similar to stating that a house for sale has no value when there are no bids outstanding. Applying mark to market to structured credits leads to panic measures and uncontrollable downward spirals. Do you agree with this statement?

The response was consistent on this question; the only point of note being that very few Regulators did not have an opinion (only 3.9% as opposed to 13.8% & 15.3% from Bankers and Consultants respectively).

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Are alternative valuation methods needed for the structured credit markets?

The response was fairly consistent on this question with the majority of respondents (72.3%) answering yes. The only point of note being that Regulators had a higher % of no’s – 16.3%, as opposed to 7.1% & 8.1% for Bankers and Consultants respectively.

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For which structured products do you believe that risk management lacks accuracy?

Bankers & Consultants mostly opted for Operational Risk, whereas 30.6% of Regulators opted for “all of the above” as opposed to 14.1% of Bankers & 19.2% of Consultants.

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If your answer to the previous question was “None of the above”, please specify for which products:

•Business Risk , Strategic Risk and Economic Risk

•Don’t know•Liquidity Risk•Reputational Risk•Structured products,

Default probabilities and Rating Migration

•Transparency•Underlying Assumptions• I believe current risk

management is accurate•All risk areas can be

"accurately" quantified within an ERM framework

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What is your opinion on the usage of structured products in the future?

70.0% of all respondents think the use of structured products will increase in the future.

Bankers and Consultants were almost identical in their answers. A higher proportion (29.4%) of Regulators said the usage of structured products would decrease, as opposed to 17.3% of Bankers & 14.3% of Consultants.

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What do you believe will be the impact of regulation on the use of structured products? Will there be:

The response was consistent on this question with 81.0% of all respondents thinking there will be more regulation on the use of structured products.

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Do you consider that company ratings and CDO (tranche) ratings are:

Again Bankers and Consultants gave almost identical answers, whereas the majority of Regulators (60%) chose “completely different”, as opposed to 48.7% of Bankers & 51.2% of Consultants.

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How do you manage structured credit risk?

The response was consistent on this question with 48.1% of all respondents choosing “through a combination of market and credit risk tools”, however no Regulators at all measuring structured credit risk through market risk tools alone.

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Society requires home ownership. Therefore mortgages must be guaranteed by the government (and ultimately the tax payer).

78.6% of all respondents disagreed, however; the responses here varied somewhat by region; with 21.5% Asia Pacific answering yes, as opposed to EMEA (9.5%) and Americas (8.0%). This showed in the no answers too; Asia Pacific (67.6%), EMEA (79.8%) & Americas (85.3%)

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Do you believe that asset-backed securities supported by sub-prime mortgages are understood by the investors?

The response was consistent on this question, with 76.3% of all respondents answering no.

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A recent statement from a major hedge fund claimed that recent events represented an extreme move of greater than 25 Sigma and that there was nothing wrong with the models except that they could not anticipate a move of this magnitude. Which of the following is correct?

The responses here varied somewhat by region; with 60.1% of the Americas saying credit models have NOT performed according to expectations in the past 6 months, compared to EMEA (47.9%) & Asia Pacific (53.3%)

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Do you believe that the use of the ratings produced by the credit rating agencies is a valid method of calculating credit risk-weightings in a firm?

Regulators were more likely to choose no, without an alternative (57.1%) compared to Bankers (46.7%) & Consultants (41.5%) whereas Consultants were more likely to say no and specify an alternative (36.8%) compared to Bankers (23.3%) & Regulators (20.4%).

The Americas were least likely to chose yes (21.3%); EMEA (29.4%) & Asia Pacific (34.9%) and propose an alternative (34.5%); EMEA (25.3%) & Asia Pacific (15.7%)

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These were the alternative approaches to using rating agencies suggested by respondents:

• Assess effectiveness of rating agencies

• Change Model• Change Model - Approach and Inputs• Change Model – Include spread and

Volatility• Change Models - Improve Accuracy,

calibration and predictive power• Combine Internal and External Rating • Don’t know• Establish / Strengthen Internal

Ratings / Models• Establish Regulatory structures for

CDO / subprime / structured products

• Improve Governance of Rating Agencies • Increased Competition for Rating

Agencies• Increased disclosures by Rating

Agencies• Multiple ratings• Pay for ratings• Reduce conflict of interest in ratings• Separate rating for different risk types• Separate rating agency for Hedge funds• Strengthen Risk Management Practices /

due diligence• Stress testing

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There has been considerable debate, discussion and criticism of the role of rating agencies in the recent sub-prime crisis. The fees of the rating agencies are usually paid by the security originator/issuer. Does the rating agency owe a fiduciary liability to potential investors who use its data to make investment decisions?

The response was consistent on this question, with most respondents (71.3%) stating that the rating agencies have a legal obligation to produce independent and accurate ratings to the best of their ability.

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Has the Sub-prime Crisis resulted in a reduction of confidence in rating agencies in their ability to rate complex asset-backed products?

The response was consistent on this question with 59.9% of respondents answering yes and 29.2% answering partially.

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What do you believe is the future of the rating agencies?

The response was consistent on this question with the only divergence being that the majority of the Asia Pacific respondents (32.2%) answered that rating agencies will be more heavily regulated as opposed to EMEA (31.5%) & Americas (28.2%).

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Professional Risk Managers’ International Association

Global Event SeriesFebruary 2008

Credit Risk