A Risk Professional's Survival Guide: Applied Best Practices in Risk Management

CHAPTER 8 Credit Risk Mitigation

OVERVIEW

While identifying and measuring risk are critical activities for any risk management function, understanding how to use that information to shape the amount of risk exposure in a portfolio is equally important. Specifically, as loans or transactions build up in a portfolio, whether it is market, credit, or interest rate risk, the risk manager will want to maintain that the risk exposure lies within the bank’s risk tolerance as measured by VaR or other metrics. Understanding what tools are available to the risk manager in such cases is the focus of the next several chapters, beginning with this chapter on credit risk mitigation.

In the specific case of credit risk, there are a number of techniques and activities that the risk manager can undertake to manage the risk exposure of the credit portfolio. At the front end, credit policies, underwriting guidelines, concentration limits on certain risk attributes, and other restrictions define the general and specific contours of credit quality to be allowed into the portfolio. These criteria screen out unwanted credit risks early in the process, and as long as the bank applies strong controls on the process and has an effective way of monitoring loan quality coming into the portfolio on an ongoing basis, this is an important way to maintain the balance of credit risk to expectations. However, the mortgage boom ending in 2007 and leading to the mortgage crash following this period was in part ...