Credit risk, the chance that money owed may not be repaid, is hardly a new concept. There can be little doubt, however, that awareness of credit risk has continued to grow. This has been accompanied by an increasing recognition across many sectors of the economy that credit risk needs to be actively managed. Finally, sometimes as a result of these trends and sometimes as a precursor to them, tools and techniques to manage credit risk have become both increasingly sophisticated and more readily available.
Defaults on credit obligations have always been a fact of economic life, but the world’s economies have increasingly seemed to create spikes in default rates that have been truly punishing, not just for banks and bond investors, but for corporations and other institutions as well. That has contributed significantly to heightened awareness of credit risk and the idea that credit risk exposures need to be more actively and effectively managed. For banks, the new Basel regulatory proposals provide an added impetus for a reexamination of their approach to credit risk management. Finally, and most fundamentally, for all types of organizations, the need to use their capital as efficiently as possible—and thus the need to understand how much should properly be allocated to offset credit risk—is a key driver for a renewed focus on credit risk management.
With the increased attention on credit risk comes a growing need to better understand its elements as well as the continuing development of tools and techniques to manage it. Arnaud de Servigny and Olivier Renault do a wonderful job of taking on this challenge. They provide robust explanations of the elements of credit risk and the range of approaches available to analyze and manage it. They cover credit risk analysis from both a qualitative and quantitative perspective, effectively providing insights into the role both can play in an effective credit risk management program. They deal with loss recovery as well as default. They provide a strong foundation for a review of credit portfolio analytics by first reviewing credit correlation issues. They tie all of this effectively to capital allocation. Finally, they recognize the growing trend toward active trading of credit through an examination of the market’s treatment of credit risk.
For management of banks, insurers, finance companies, asset managers, corporations, government agencies, and others, understanding the credit risk issue and the available solutions is increasingly one of the keys to their success. Measuring and Managing Credit Risk by de Servigny and Renault is an invaluable aid in helping to understand how to do it right.
ROY TAUB
Executive Managing Director
Standard & Poor’s Risk Solutions