Credit Portfolio Management

From Open Risk Manual

Definition

Credit Portfolio Management (CPM) denotes a set of principles, tools, processes that underpin the management of Credit Portfolios (collections of credit assets). The defining characteristic of credit portfolio management activities is that Credit Risk is assessed and managed not on a standalone basis but in an aggregate, portfolio, setting.[1]

Related Concepts

  • The term Credit Risk Management (CRM) is used sometimes as a synonym for Credit Portfolio Management. Yet CRM is also frequently used to denote more specifically the analysis of individual credit risks
  • CPM is closely related to the broader concept of financial asset Portfolio Management. Financial portfolio management encompasses also the management of marketable (liquid) portfolios of assets such as (stocks or bonds) but also portfolios of insurance liabilities. Yet CPM has its own specific characteristics that reflect the nature of underlying credit portfolios and the associated business models.
  • Modern credit portfolio management relies quite heavily on credit risk quantification yet as a discipline it is not identical to Risk Management. For example credit portfolio management has an important function in supporting Credit Origination. As a function CPM may be practised separately from risk management.
  • Balance Sheet Management and Asset and Liability Management are broader terms that may involve also the management of liquidity / interest rate risk and integrate also the management of the firm's liabilities. CPM is a subset of those activities
  • Enterprise Risk Management is another organizational scheme that may partially overlap with credit portfolio management

Credit Portfolio Management Approaches

Given the wide variety of borrowers, credit products and markets it is not surprising that there are substantially different management approaches:

  • The term Originate and Hold denotes a traditional portfolio management approach that
    • builds credit portfolios via Credit Origination
    • maintains ownership of these assets for the length of their life
  • The term Underwrite and Distribute denotes a more market oriented portfolio management approach that

Active Credit Portfolio Management

The term Active Credit Portfolio Management (ACPM) is used to denote a specialized CPM function that is involved directly in the management of a credit portfolio, e.g. via identifying suitable investments and executing hedging activities.

Primary Objectives

According to an international survey the primary high-level objectives of Credit Portfolio Management units are:[2]

Elements of Credit Portfolio Management

Some commonly found elements of CPM best practices are:[3]

Organizational Aspects

  • Defining in some detail the scope of credit portfolio management activities (including identifying which portfolios, clients or counterparties are in scope)
  • Identifying the roles and high level objectives of credit portfolio managers, including the Credit Portfolio Strategy
  • Depending on context, a CPM function may be considered a business activity or a risk management activity.

Data Infrastructure and Analytics / Measurement Tools

Policies and other Management Tools

Market Tools

The availability of credit portfolio management tools depends on the nature of the credit portfolio, the relevant jurisdiction / regulations and the type and maturity of credit markets. Indicatively:

  • Diversifying Investments
  • Portfolio Secondary Sales
  • Portfolio CDS Hedging is available in markets and for credit exposures that can be referenced by a Credit Derivative
  • Portfolio Securitization (Cash or Synthetic) is available in markets and for credit exposures that can be included in a Securitization

Issues and Challenges

  • For regulated firms, credit portfolio management is heavily influenced by regulatory requirements and frameworks which are sometimes creating counter-intuitive incentives (Regulatory Arbitrage)
  • While credit portfolio management is practised by a wide range of firms and organizations deploying the full range of tools is usually only possible for the largest firms
  • Significant prior investment in measurement / algorithms relevant for CPM has been influenced by Basel II requirements which emphasized individual Risk Parameters over sectoral / macro dependencies in the portfolios

Post-Crisis Issues

A significant fraction of what were once considered best practices in credit portfolio management have been challenged by the unfolding of the Financial Crisis of 2008:

Technology Issues

Sustainability Issues

  • Integrating the principles of Sustainable Finance into credit portfolio management is a major challenge

References

  1. BIS, Range of practices and issues in economic capital frameworks, March 2009
  2. Principles and Practices in Credit Portfolio Management, Findings of the 2011 IACPM Survey
  3. IACPM, Sound Practices in Credit Portfolio Management, 2005

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