Credit Portfolio Management
Category: Financial Risk Management
It should be clear from all of our discussions so far, that exact assessment of risk is impossible. The future holds many surprises!
To counteract our inability to predict the exact risk with any one particular credit facility, banks try to keep overall risk within acceptable limits by several means, such as those highlighted on next.
Credit portfolio management:
— Balanced Portfolios
— Designated Credit Decision Making Procedures
— Supervisory and Audit Controls
— Procedures following default
Some of these are considered in detail in further modules in this series, but now we will briefly look at Balanced Portfolios and Procedures following default.
Balanced Portfolios
In the same way as any bank customer takes risks by being over-reliant on one particular client, supplier or market, so a bank must avoid having portfolios which are not balanced. The sort of factors that need to be taken into account in considering the overall balance of portfolios are show in next.
Portfolio balance:
— Location
— Industrial Sector
— Services
— Currencies
Let us look at these in a little more detail
A balanced portfolio with regard to location can be extremely important for a number of reasons:
Banks operating internationally will not wish to be over reliant on one particular country as the quality of their risk in each country can be hugely influenced by political, economic and legal developments there. Diversifying the portfolio between countries will enable the bank to cope better with adverse circumstances in any one location.
Within countries, particular regions may be over-dependant on certain types of industry (e.g. agriculture) which in turn may be dependant on specific factors such as climatic conditions. It is obviously not very prudent banking to have a portfolio which is significantly affected by the weather in any particular location!
Similarly, individual regions can suffer a specific downturn in the local economy. For instance, the major employer in the locality may suffer adverse trading conditions and be forced to reduce its level of activity, or perhaps even close down completely. This would seriously affect local suppliers, service industries, retailers etc.
The need to balance a lending portfolio between different industries and services should be reasonably self evident. Any particular sector can suffer a downturn for any number of reasons. Next lists a few obvious reasons
Some sources of sectoral problems:
— Fashion / Uneven Demand
— Competition
— Obsolescence / Technical Innovation
— Availability of Raw Materials
— Input Prices
— ETC.
Banks which operate internationally need to be particularly careful about currency risk. Movements on currency markets over the past number of years highlight how difficult it can be to forecast future developments. Banks must be extremely careful to balance this exposure and ensure that individual customers are not over-exposed to any particular foreign currency.