[Effectiveness of Structural Credit Risk Models in the UK Banking Industry]

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Acknowledgement

I would take this opportunity to thank my research supervisor, family and friends for their support and guidance without which this research would not have been possible.

DECLARATION

I, [type your full first names and surname here], declare that the contents of this dissertation/thesis represent my own unaided work, and that the dissertation/thesis has not previously been submitted for academic examination towards any qualification. Furthermore, it represents my own opinions and not necessarily those of the University.

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Abstract

Credit risk is always treated as the major risk inherent in a bank's banking and trading activities. And if not well managed, this kind of risk may drag a bank into great trouble or even bankruptcy, which can be proved by various bank failure cases. For banks, managing credit risk is not a simple task since comprehensive considerations and practices are needed for identifying, measuring, controlling and minimizing credit risk. In this dissertation, the credit risk management practices of major British banks are examined through the quantitative research on all Major British Banking Group members and qualitative analysis on the four sample banks. The key areas in the generalization and comparison of techniques and practices of sample banks are chosen according to the Basel (2000, 20) requirements, which are also adopted as benchmarks in the evaluation of banks credit risk management. The robustness and weakness of larger and smaller major British banks in managing credit risk are identified respectively, which indicates the areas for further improvements as well.

Table of Content

ABSTRACTIII

CHAPTER 1: INTRODUCTION1

Motivation and Objectives of Study1

CHAPTER 2: LITERATURE REVIEW3

The Credit Risk of Banks3

Categories of Credit Risk3

Default Risk4

Counterparty Pre-Settlement Risk4

Counterparty Settlement Risk5

Country or Sovereign Risk5

On-Balance Sheet Exposures6

Off-Balance Sheet Exposures7

Credit Risk Measurement10

Credit Risk Modelling12

Merton-based Models13

Ratings-based Models13

Actuarial Models14

Macroeconomic Models15

Traditional Methods for Controlling Credit Risk16

CHAPTER 3: METHODOLOGY19

Research Aims and Objectives19

Research Design19

Research Sample and Data Description21

A Brief Introduction on the Structure of UK Banking21

Research Sample Selection21

Research Data Source and Description22

Quantitative Data22

Qualitative Data24

Limitations of the Study26

CHAPTER 4: DISCUSSION & ANALYSIS28

The Overall Level of Major UK Banks' Credit Exposure and Quality28

Credit Risk Management Techniques and Practices at RBS and Barclays31

Credit Risk Management Techniques and Practices at RBS and Barclays33

Quantitative Credit Risk Measurement35

Generalization and Comparison with Basel Regulations47

Credit Measurement and Monitor Process49

Credit Risk Management Practices at Bradford & Bingley and Northern Rock50

Credit Risk Measurement51

CHAPTER 5: CONCLUSION54

REFERENCES56

APPENDIX64

Chapter 1: Introduction

According to Duffie and Singleton (2003, 27), credit risk can be defined as the risk of default or of reductions in market value caused by changes in the credit quality of issuers or counterparties. Generally speaking, it is common in every business. Whenever a payment or performance to a contractual agreement by counterparty is expected, this risk exists. Conventionally, credit risk arises through lending, investing as well as credit granting activities and concerns the return of borrowed money or the payment for sold goods. Besides, it also appears through the performance of counterparties in contractual agreements such as derivatives (Horcher, 2005, 14). Undoubtedly, when the obligation is not discharged completely, a loss ...