Credit Risk Management

Credit Risk Management

Introduction

Credit risk is a probability of losses that may arise from the reduction in the quality of credit counterparties or the borrowers. The losses of banks may arise due to the default by the customers or the inability of the counterparties or the reluctance of the counterparties to meet commitments that are related to lending, financial transactions or trading. Risk of credit can arise from the trading book and the banking book or off the balance sheet.

Credit risk can be managed by the use of credit derivatives or by securitisation process. Credit derivatives are contracts between two parties that are privately negotiable and bilateral in nature, in which the seller offers protection to the buyer against the risk of credit for a certain amount of fee. Credit derivatives have emerged as an important tool for the management of risk that uses the spread beyond insurance companies to banks, mutual funds, hedge funds, corporate department of treasury and pension funds.

New Zealand banks are associated to a number of risks while carrying out their functions. Market risk, credit risk, risk of operations, risk of reputation and liquidity risk are the risks that banks face. It has been observed that financial institutions and banks tend to face various difficulties, but credit risk is one of the most common failures that are caused to banks, and it causes the regulatory authorities to set down minimum benchmark for the management of credit risk. It is crucial for every bank at New Zealand to formulate a strategy for the management of credit risk that has particular objectives which provides a guideline to the credit granting activities of the banks and implement the policies that are necessary for carrying the activities of credit granting. The strategy of credit must be defined clearly for the credit appetite for the organization and the level of acceptance for the trade off of risk and return for the activities of credit granting.

Discussion

New Zealand is regarded to be currently one of the highly weighted banked countries among the OECD countries, which relates to larger financial activities involves banks rather trading in debt securities or shares and direct investment. For huge population banks provides a place to park savings, means of providing access to make daily payments, and the vital source of loans for things like home buying and business investment. In order to understand importance of banks in New Zealand, stats shows that around three quarters of all financial assets relates to New Zealand are held in banks. In comparison to Australia which shows around half financial assets are held in banks.

This strong presence of banks which are largely a part of international banking groups can results in to both huge benefits as well as high risks to New Zealand. On the benefit side, it is providing opportunity to effectively manage risk within the banking system, encourages the entry to new banking products and services, and give access to larger funds to control domestic economic ...