It is a Credit Risk Management Framework - and a more Forward Looking Management Tool

It is a statistical model of credit default risk that makes no assumptions about the "causes of default This approach is similar to that taken in market risk management, where

What can PARMS be applied to.

It can be applied to credit exposures arising from all types of products including:

  • 1. Corporate and Retail loans,
  • 2. Derivatives, and
  • 3. Traded Bonds.

What does PARMS do.

It addresses all aspects of Credit Risk

  • It utilizes a Quantitative Model.
  • Develops practical approaches to Managing Credit Risk.

In addition to the traditional techniques of setting

  • 1 Individual Obligor Limits, and
  • 2 Concentration Limits.

How does PARMS do it.

  • We use Portfolio Approach and Analytical Techniques used in related Financial Industry.
  • A methodology for calculating Economic Capital for Credit Risk.
  • A Credit Risk Modeling Methodology which assists in making provisions and
  • Provides a means of measuring Diversification and concentration to assist in Portfolio Management.

What does PARMS need.

Information relating to the following is used in the modeling of Credit Default Risk:
  • Size and Maturity of the Exposure.
  • Credit Quality and Systematic Risk of the Obligor.

What is Credit Risk?

Credit default risk is the risk that an obligor is unable to meet its financial obligations. In the event of a default of an obligor, a firm generally incurs a loss equal to the amount owed by the obligor less a recovery amount which the Firm recovers as a result of foreclosure, liquidation or restructuring of the defaulted obligor. All portfolios of exposures exhibit credit default risk, as the default of an obligor results in a loss.

Credit default risk is typically associated with exposures that are more likely to be held to maturity, such as corporate and retail loans and exposures arising from derivative portfolios.

How PARMS treats Default.

By treating the default rate as a discrete variable, a simplification of the continuous process is made. A convenient way of making default rates discrete is by assigning credit ratings to obligors and flapping default rates to credit ratings. Using this approach, additional information is required in order to model the possible future outcomes of the default rate. This can be achieved via a rating transition matrix that specifies the probability of keeping the same credit rating, and hence the same value for the default rate, and the probabilities of moving to different credit ratings and hence to different values for the default rate.

The discrete approach with "rating migrations and the continuous approach with a default rate volatility are different representations of the behavior of default rates. Both approaches achieve the desired end result of producing a distribution for the default rate.

It considers default rates as continuous random variables and incorporates the volatility of default rates in order to capture the uncertainty in the level of default rates.

In addition background factors which may cause the incidences of credit default to be correlated are taken into account. This may include factors like the state of the Economy. This s done through the use of default rate volatility and sector analysis rather than using default correlation as explicit inputs into the model.

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