Credit Risk Review: More than Loans
Credit risk refers to the potential loss arising from the failure of a borrower or counterparty to fulfill its financial obligations. While the primary focus of credit risk review historically centered on lending portfolios, U.S. interagency regulatory guidance is clear in its requirement that an effective credit risk review function also assess credit risk arising from non-lending activities, especially as deterioration in these areas can often be overlooked. Common non-lending activities which may result in credit risk include:
- Counterparty Credit Risk: Credit risk arising from transactions with other financial institutions or counterparties, particularly those related to derivative contracts (e.g., swaps, options, and futures), hedging and securities lending.
- Investment Portfolio Risk: Credit risks from potential issuer and/or guarantor defaults.
- Off-Balance-Sheet Exposures: Credit risk arising from guarantees, letters of credit, and loan commitments which could turn into on-balance-sheet obligations and result in credit losses.
- Securitization Activities: Credit risks generated by the creation or investing in asset-backed securities (ABS) and mortgage-backed securities (MBS) and potential changes in the performance of the securitized assets.
- Foreign Exchange/Commodity Transactions: Credit risks from trading and/or counterparty failures and volatility in the foreign exchange and commodities markets.
- Intercompany Transactions: Credit risks resulting from transactions between group entities, including internal loans or guarantees that could impact the institution’s overall credit risk profile.
An effective credit risk review program must routinely assess each of these non-loan credit risks to ensure the institution’s overall exposure is comprehensively understood and managed, going beyond traditional lending risks to cover a broader spectrum of potential credit-related threats.
Contact Kane Garland now to learn how our experts can help you establish a comprehensive credit risk review program for your unique organizational requirements.