What Is Bank Loan Portfolio Credit Risk - Assignment Example

COMMERCIAL BANKING AND FINANCE STUDENT’S NAME: INSTITUTION: INSTRUCTOR’S NAME: DATE: 1. What is bank loan portfolio credit risk?    Bank portfolio credit risk is the situation whereby a loaned party is unable to meet its obligation of in the future and therefore subjects the bank at a risk of not being able to give credit to the future customers. It is obvious that money circulates and when one borrows loans, the bank will give the credit because the previous loans borrowed will be returned to the bank. Credit risk has been one of the most challenging situations in a bank because it places the bank in a position that it will not invest through credits. Banks face credit risks in not only loan sector but other sectors such as foreign exchange transactions, acceptance, trade financing, financial futures and bonds, options, guarantees and transaction settlements. When borrowers and counterparts fail to meet the requirements of loan repayments standards it will pose a threat to the bank and hence the reason as to why we define the bank to be in a loan portfolio credit risk (Bankers, H. K. 2012). Even though loans prove to be the first cause of credit risk, there are some other sources like on and off credit balance and factors related to the banking book and trading book. A bank that emphasizes on credit risk management is likely to encounter few cases of credit risks. Banks should, therefore, develop systems to address credit risks and come up with strategies on how to operate the loan granting and repayments such that there will be minimal or at most zero credit risks. 2. What is the difference between a general reserve for credit losses and specific provision? According to the banking systems, the general reserve for credit losses is used to reflect the amounts of losses likely to be incurred during the credit risk. Most banks have bad debts that are used to offset the losses that occurred as a result of credits. Bank reports are the appropriate tools that provide the status of the general reserve for credit losses. For a bank to consider the future results of the credit, it has to assess the type of borrower and the ability of the borrower to repay back the loan. Determining the status of the borrower enables the bank to place their report on the general reserve for credit losses. Analyzing the borrower involves aspects such as economic status, present collateral status, structure of the loan and the type of industry the borrower ventures in. All the information is important because it helps the bank to predict on the future situation of credit. The specific provisions, on the other hand, are the process taken by the bank to settle their credit cases, and this is done when the borrowers and the counterparts repay back the loans. 3. (i) Graph on two separate lines (1) loan loss reserve/gross loans, (2) impaired loans (NPLs) gross loans from 2006 to 2013. Please include the four major Australian banks and 2 smaller banks from the following options (Suncorp-Metway Ltd, Bendigo and Adelaide Bank Ltd, Bank of Queensland Ltd) (ii) Interpret these banks’ credit quality over 2006-2013 (8 marks) The role of analyzing the credit quality of a bank begins from analyzing the borrower’s ability from repaying back the loans. From the graphs, we can view the gross loans for the four major banks and the smaller banks; we can also analyze the credit quality of the banks considering the first graph that shows how loans flow from the borrowers to the lenders. Banks, on the other hand, are pay attention to how the borrowers will score concerning their loans repayments. However, they do not consider their ratings whether they could be credit worth. Rating the banks credit quality is important because it enables the bank to be able to discover the situations that might place its potential to offer credits to their customers. From the analysis of the four major banks in Australia, we find that in the year 2006, the gross loan was way low and therefore the ability to give credit to the customers was also low. In the first graph on the borrower and lender, we find that the four major banks depended on Foreign-owned banks, and the small banks depended on the major banks. This shows that the major banks were credit worth since they depended on the foreign-owned banks. Also, the major banks have investments that help to safeguard the credit condition of the bank such that economic changes can affect the loan rates and hence subject the bank to losses, this will result to inability to give loans. The credit quality of the bank is also determined by the investments it has and not only the amount of money in the borrower’s hands (Wagner, N. 2012). When it comes to the following years until 2013, we find that the graph displays the progress of credit quality for major banks and the smaller banks of Australia. There is a gradual increase in the gross loans and therefore subjects the banks quality for credits and also portrays the investment levels of the banks. At the end of every year, the banks analyze their gross loans and determine the position of their borrowers to repay back the loans. Such issues as the economic changes and the number of increasing lending institutions are also analyzed. Banks should consider that these ratings could be unreliable because they use analysis of the past trends to forecast their future credit quality. In this case when the credit rating is unreliable, it can be a challenge especially to the customers because they will not be able to borrow loans. When the credit quality of a bank is rated low, there are risks such as shutting down or closing of other bank branches to reduce the costs and save the dropping rate of credit ability, also retrenching staff will occur due to the fact that the bank is not able to cater for more employees since their ability to lend loans is decreasing. The graphs show the trend of the gross loan performance and from the analysis it is clear that these banks are credit worthy and hence qualify to give loans to borrowers and counterparts. 3(i) Outline the APRA regulations regarding credit risk for the large major banks and contrast them to those for smaller banks The bank regulator ensures that the major banks have enough capital in order to cover up on the credit shocks. This is an appropriate regulation because the banks lends more loans and it has quite a number of borrowers and counterparts, therefore when they experience a credit risk it is important to have capital so as to be able to continue its operations until the credit risks are settled (Tony Van Gestel D.2008). The bank regulator does this by annually checking on the financial position of the banks and its credit quality and therefore endorsing the banks activity of lending loans. Compared to those of small banks, the bank regulator does not assess the capital status since the banks do not give more loans and therefore they are unlikely to encounter credit risks, also the small banks will not impact much on the government economic situation if they incur credit risks unlike the major banks where the economic system will be subjected to risk. APRA also issues license to the banks; therefore, the license is a form of regulating the number of banks in the country. When it comes to the major banks, they are issued license that allows them to operate for a long term since these banks form the major part of economic developments. A bank that does not have a license from the bank regulator will be shut down since it will be considered credit unworthy. The same case applies to all the banks that operate within Australia and other credit unions and insurance companies. The purpose of bank regulator is to ensure that banks stick to their conditions of being financially fit and therefore issuing licenses is an approval that the bank and other lending institutions can serve their customers (Niamh M .2012). According to Hyman, (2012), the bank regulator also acts as risk management for the major banks because it assesses the ability of these banks to give higher loans. The risk management part occurs when the major banks are required to meet all the regulations and the requirements of operating loans. Credit ratings are one of the risk management that the bank regulator asses in order to determine credit worthiness of the bank. For small banks, the credit rating also determines the ability of the bank to give loans in the future. The bank regulator is responsible for providing requirements that the borrowers and counterparts should meet before applying for the loans. It also helps the bank to analyze the ability of the borrowers to repay back the loans. Therefore, these regulations are essential for the performance of the banks. Also, they ensure that the banks allow successful circulation of money that is used in economic development of Australia. When a bank is not credit worthy, it means that it will not be able to meet the interests of the depositors since they might want to withdraw back their money and since the bank has used them to lend loans, it will have failed to meet the obligations to policy makers, fund members and depositors. (ii) Comment on whether the four major or smaller banks benefit from the current regulatory setting regarding bank credit risk and why? The bank regulator is responsible for setting standard that banks should meet before commencing on money operations. Therefore, it ensures s that the banks meet the obligations of the depositors and also can give loans. It is obvious that without a system that regulates the bank operations, the Australian economy would be down because these money institutions would operate even without enough finance and cases of credit risks could be common. The four major banks and the smaller banks in Australia therefore benefit the current regulatory setting when it comes to credit risk and management because of the fact that the banks regulator will prevent the banks from credits risks through application of strategies to manage the risks. The regulations expose the banks on factors to consider when it comes to managing financial risks, and therefore provide experience for the banks to always pay attention to the flow of money in and out of the bank, this will enable their credit ratings to produce good results and hence the banks will continue operating (International Monetary Fund. 2012). Another benefit concerns the issues such as pricing and the rates the banks should use to lend loans. The bank regulator is responsible for ensuring that the banks stick to the pricing strangers and also the rates; this will enable banks to operate while considering economic changes since they get information from the bank regulators. The banks will, therefore, make changes considering the reports from the regulator and therefore is beneficial for the success of the banks strategies. For the case of the major banks, the bank regulator ensures that they have enough capital that will be used to absorb credit shock during the risk. This is a benefit to the major banks because they can analyze the rates of the credits and thus able to evade the risks associated with credit. Analyzing the gross loan and the loan loss reserve is also another responsibility that the banks should meet in order to determine their financial ability to lend credit; this benefits the depositors because when a bank is able to meet the obligation of the depositor, it will attract more customers to the bank. Therefore bank regulators contributes towards the success of a bank because they ensure that a bank is able to absorb credit risk and meet the interest of customers and hence able to contribute towards economic development and comply with the rules of money circulations. Another benefit is the risk weighing done by the bank regulator, this is done through analyzing all the factors that might lead to risks and developing a system that weight the level of credit risk, this will enable the banks to prepare on how to handle the risk situation (Margarita S. 2014). Reference Read More