No sooner had the banking sector adopted the Basel II regulations and begun to feel at ease with its credit risk management systems than the US subprime crisis popped up and subsequently spilled over to become the most severe financial crisis since the Great Depression. In times of market turmoil, several weaknesses of risk management systems that had been developed in relatively benign market environments became apparent.
In the area of credit risk, the shortcomings were most evident in relation to the assessment of structured and complex products, like mortgage-backed securities and collateralized debt obligations. Not all banks, however, performed equally poor. A March 2008 survey of the Senior Supervisors Group noted: “Generally, management at the better performing firms had more adaptive (rather than static) risk measurement processes and systems that could rapidly alter underlying assumptions in risk measures to reflect current circumstances.”
As a consequence, the challenge today lies in refining and enlarging the traditional credit risk management repertoire on the one hand and in being more creative in the modeling and management of innovative credit products on the other. Furthermore, a successful risk management system will allow for the interdependencies among credit risk, liquidity risk and market risk, and will contrast various quantitative analyses with qualitative considerations. Only an integrated approach has the chance of giving a reliable picture of the upside and downside of the overall bank portfolio, and credit risk management will play a critical role as part of an integrated enterprise risk management system going forward.
For more in depth information about this topic, read the white paper Credit Risk Management: Challenges and Opportunities in Turbulent Times.