Credit Risk

Ahraz Sheikh

6.1 INTRODUCTION

Chapter 1 showed that credit risk is the most material risk type for most banks. This is reflected in the level of regulatory capital (at both Pillar 1 and Pillar 2) as well as provisioning. Credit risk relates to lending, which is a key activity for most banks. Lending ensures that firms across all segments of the economy have ready access to liquidity and funding. Bank portfolios typically cover the following types of obligors.

  • Corporate: these are large, publicly traded firms that use banks to finance plans for growth, acquisitions, new initiatives or machinery. This finance can take the form of loans, guarantees, lines of credit and revolving credit facilities. Such firms also issue debt in the form of corporate bonds as a source of funding. Banks also routinely trade corporate bonds, as part of the trading book.

  • Commercial: this consists of small businesses and small-to-medium-sized enterprises (SMEs) requiring funding for purposes similar to those of corporate lending.

  • Sovereigns: governments and central banks of countries obtain funds by issuing debt in the form of sovereign bonds. Banks often trade in such bonds, which in some

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