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UMAD5W-15-3 Credit Risk Analysis And Management

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UMAD5W-15-3 Credit Risk Analysis And Management

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Course Code: UMAD5W153
University: La Trobe University

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Country: Australia


You have recently secured a junior analyst job with one of the three largest credit rating agencies. Your first assignment was to investigate the recent sovereign debt crisis with a view to reassessing the sovereign ratings of EU countries. Your assessment will have far reaching implications on the banks’ exposures with the region.
Ensuring financial stability:

Discuss critically the background to the recent sovereign debt crisis in the EU.
How has the crisis impacted on banks’ credit risk exposures especially as it concerns making capital provisions for their credit portfolios?
What are the wider implications for policy makers both within the region and globally?

Learning outcomes tested by the report
Subject-specific skills

Understand and explain the issues leading to the rise in the sovereign debt concerns in the EU
Familiarise yourselves with the impacts of the sovereign debt crisis on banks’ exposure.
Explain and analyse the policy responses by regional and global regulators


This particular study aims to discuss the recent sovereign debt crisis in regards to the reassessment of the sovereign ratings belonging to the different EU countries. The study further consists of a discussion and aims to analyze the recent sovereign debt crisis and the reflection over the banking sectors that are present in the European countries. Furthermore, the capital provisioning related to the portfolio, results and the responses of the policies has been discussed and scrutinized in this particular study.
In the risk, conference that takes place annually the ECB emphasizes the importance on the practices related to the effective management and the development of the financial sector. Moreover, the report will result in the displaying of the challenges and the practices related to the management of risk that the financial institutions of the country along with the central bank has been facing collectively. The alteration in the type of financing problems is one of the major reasons for the facing of such problems. The aspect of financing is a huge process that consists of the factors, which influence the process of financing, and the risk associated with it. It must be noted here that between the financial years of 2009 and 2010 the imbalances that have been fiscal in nature has resulted in the levels of volatility that are high. In regards to the financial events, it had been assumed by the financial sector that the participants of the market will result in the dishonoring of the financial obligations that will increase the credit risk, associated. It must be further understood that the aspect of credit risk consists of two essential elements like the defaulting of the security holders and the counterpart risk that has been involved in the transactions that are proceeded over the counter (Afonso and Leal 2017). Therefore, it can be concluded that the report consists of the discussion that is detailed in nature and consists an explanatory review of the management risks in the central and other general banks.
General Principles that are applied for the management of risk
The principles that have been applied by the financial institutions for the purpose of managing the risks which took place in regards to the financial crisis in the mid 2007 has been accepted but not explained in details. It must be noted here that the term credit monument aims to cover a varied degree of features which can be listed down as follows:

The counterparties should be known
The investment should be proceeded only in the products that can be understood
The outsourcing of the policies related to the management of the credit risk should be carried out by putting the reliance on the credit assessments that have been external in nature
The reliance should not be put upon quantitative models

The risk management policy that has been established by E. Gerald Corrigan and Stephen G.’s original counterpart risk management policy that will result in the providence of a better knowledge in regards to the factors that are related to risk management in order to strengthen the financial systems. Furthermore, it has been stated that a specified trend should be highlighted which has been reflected in the previous years in regards to the reliance on the aspect of external assessment for managing the credit risks. A handful of financial institutions or rating agencies will result in the provision of such assessments. In order to handle the recent financial crisis the importance of the credit rating agencies have been huge. Moreover, it can be evidently stated that the credit rating agencies have become the role model of the economy (Amstad and Packer 2015).
Furthermore, the credit rating agencies have also been subjected to criticisms. This means that these agencies have been subjected to the questions in regards to the methodologies adopted by them in regards to the transparency of the areas of finance and the conflicts of interest arising from such situations. The performance of the agencies in the previous years has also raised potential concerns. The aspect of credit rating has been made mandatory by the different legislative bodies and regulations and other supervisory bodies, which establish regulations. These bodies have made the aspect of financing so important that the financial policies that have been established by the financial agencies has become majorly important for the purpose of ensuring the diligence of the investors at the time performing the evaluations of the results that have been provided by the credit rating agencies. Therefore, these agencies are trusted in such a way that they become the seal of approval in regards to the behavior of the investors. The credit rating agencies have been one of the most important financial regulations in regards to the aspect of debt financing (Cohn 2016).
The acknowledgement of the credit risks by the Central Bank
It is evident from the current situations that the central banks are not subjected to the risk of liquidity in regards to their own personalized currency. The central bank controls the market. Moreover, the banks also result in the attraction of the credit risks. The person or institution defaulting the loan result in the losses that result in the buffering of the financial portfolios. The implementation of the financial policies for the purpose of protecting the financial stability help the central bank to control the scarcity of the financial resources and the loss that has been undertaken as a result of the defaulting of the loans. It must be noted here that if the process of recapitalization becomes important in regards to the government then the central bank will be able to take over the aspect of independency of the monetary authority.
It can be further stated that the framework in regards to the management of risk is not required. This is because the central bank will result in the following of conservative policy that has been important in the management of risk. In regards to the financial crisis, the central bank tends to follow risk tolerance policy, which is totally different from the conservative policy and has been adopted by the different financial institutions. This means that during the time when the different factors of financing like the defaulting of the loans and the losses suffered due to it have been cut down upon by the different financial institutions, they relied on the interbank market with the help of increased margin in regards to requirements. This reflects the significance of the framework in relation to the management of risk that has been established by the central bank (Cohn 2016).
Assessment of the aspect of credit in the euro system
 The euro system has been established for the purpose of strengthening the framework in regards to the assessment of the risk in the financial crisis. It has been mentioned in the article 18.1 of the ECSB that all of the operations that have been conducted by the ECB and the National Central Banks (NCB) should be adequate for the purpose of supporting the credit standards that are high. The euro system has been designed for the purpose of meeting the standards. Moreover, the information that is required for the purpose of conducting the credit assessment is derived from the different sources. For instance, the sources of information that can be depended upon are the External Credit Assessment Institutions (ECAI) and the systems that have been developed on the basis of the Internal Ratings (IRB) systems and the tools that have been used by the third parties and the private enterprises. Furthermore, it has been reflected that the In House Credit Assessment Systems (ICAS) provide the required range of information to the euro system. Along with the euro system, the standards of credit are also analyzed and examined for the purpose of providing the guarantee and the protection to the holders of instrument which have been similar in nature. it should be also noted here that the euro system results in the monitoring of the performance of the accepted credit assessment system.
It should also be stated that the euro collateral framework has resulted in the launching of a consultation for the public, which consists of the information in regards to the different types of loans and the details in regards to the asset backed securities that is an essential requirement of the securitized transactions. These standards, which are of the highest quality, will result in the adequate analysis of the risk that has been involved in the asset pools of the asset backed securities. Therefore, it can be understood that they will not depend upon the assessments, which have been provided by the third parties during the period of crisis.
Lastly, the most important element of the euro framework is that it carries out its ratings beyond the ones that are provided by the ECAI. In this kind system, it can be stated that the system reserves the right for the assessment of the risk management prospects that has been dependent in regards to the fulfillment of the assets which have the highest credit standards (De Santis 2014).
The link between the liquidity and the credit risk
The aspect of liquidity risk is very important in regards to the management of the credit risk. This means that the financial institutions that have been deficient in regards to the providence of funding of the assets that have been complicated in nature have resulted in the triggering of the assets that have been complicated in nature and has resulted in the financial crisis.
It must be further stated here that the Basel Committee had resulted in the issuance of the management for the purpose of consultation along with the standardized set of documents. It has resulted in the promotion of the international framework for the management of the liquidity standards so that the importance of the liquidity risks can be understood and acknowledged. The two liquidity standards that have been issued can be listed down as follows:

A minimum liquidity coverage ratio – this means that the banks should possess enough liquid assets for the purpose of repaying its short term debts and liabilities
A net stable funding ratio that should be of a longer period of time – this means that the banks should get hold of the funds in order to ensure a stable source of income. It must be noted here that this amount depends on the liquidity characteristics of the financial institutions in regards to the assets and the other business operations that have been carried out by the corporate entity within the specified financial year.

It has been understood that the Central banks are the primary bodies that regulated the market and establish the policies at the time of financial crisis. It should be noted here that the proposal has not been adequate for the situations that did lead to higher risk concentration. Moreover, the factors that led to higher amounts of risk had not yet been considered.
The ECB, on the other hand has potential interest in regards to the proposal that has been conveyed by the Basel committee. This is because it leads to the connection of the standards in regards to liquidity risks which have to be implemented within the monetary policies. Moreover, it should be noted here that the liquidity standards that have been proposed should be reconciled and the different impositions on the financial institutions should be accounted for. Furthermore, it is recommended that the financial institutions like the banks should maintain proper financial metrics without having to compromise their operational efficiency and should try to rely more upon the guidelines and policies of the Central Bank (De Santis 2014).
Therefore, as it can be concluded from the above discussed piece of literature, the role of the Central Bank becomes very important in case of the occurrence of financial crises. Thus, the policies that are established by the regulatory body should be properly and accurately complied by the other financial institutions.
Afonso, A. and Leal, F., 2017. Sovereign yield spreads in the EMU: crisis and structural determinants.
Amstad, M. and Packer, F., 2015. Sovereign ratings of advanced and emerging economies after the crisis.
Bekaert, G., Ehrmann, M., Fratzscher, M. and Mehl, A., 2014. The global crisis and equity market contagion. The Journal of Finance, 69(6), pp.2597-2649.
Brooks, S.M., Cunha, R. and Mosley, L., 2015. Categories, creditworthiness, and contagion: how investors’ shortcuts affect sovereign debt markets. International Studies Quarterly, 59(3), pp.587-601.
Cohn, T.H., 2016. Global political economy: Theory and practice. Routledge.
De Santis, R.A., 2014. The euro area sovereign debt crisis: Identifying flight-to-liquidity and the spillover mechanisms. Journal of Empirical Finance, 26, pp.150-170.
Kalemli-Özcan, ?., Reinhart, C. and Rogoff, K., 2016. Sovereign debt and financial crises: theory and historical evidence. Journal of the European Economic Association, 14(1), pp.1-6.
Singh, M.K., Gómez-Puig, M. and Sosvilla-Rivero, S., 2016. Sovereign-bank linkages: Quantifying directional intensity of risk transfers in EMU countries. Journal of International Money and Finance, 63, pp.137-164.

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