Credit risk and credit risk mitigation : a study on European banks

Abstract

This dissertation evaluates how the new Basel regulations impact on bank credit risk, capital adequacy and credit risk mitigation (CRM), with a particular emphasis on CRM and respective techniques. Malta was used as a country case study. Following a literature review, primary research activity included a literature review and a financial ratio analysis (FRA) for a sample of eight European banks the majority based in Malta. This FRA focused on the select key bank performance (profit) and condition (risk) ratios. Using this same bank sample, a qualitative analysis using survey techniques was then undertaken to develop a detailed insight into the main fields of research. This qualitative research was undertaken in three stages, each building on the preceding research activity. The first such survey focused on the Malta bank regulators. This survey evidence helped to inform a postal survey of the main bank sample, which was followed up (in the third stage of inquiry) with a series of focused interviews on a subset of the main bank sample. The main findings include that credit risk management is an important managerial function amongst banks and its importance has apparently increased after the 2007-08 global banking crisis. Capital adequacy, its relationship to credit risk and the importance of credit risk mitigation (CRM) have also increased in bank management and regulatory importance. More bank strategic and supervisory attention now appears to be focused on bank CRM techniques. The new (post-crisis) Basel regulations significantly impacted banks’ credit risk processes whereby new procedures and systems had to be applied. Basel also aimed to provide for greater risk sensitivity by requiring banks to hold more capital for higher credit risk assumed. In order to reduce their credit risk exposures, CRM techniques appear to be increasingly used by banks to reduce and manage their respective credit risk exposures, and hence applied in their internal credit risk and management systems. The study identifies those CRM techniques that do not attract supervisory capital, such as responsible lending and risk avoidance. The study concludes that if Basel- recognised CRM techniques are in place, required bank regulatory capital to mitigate credit risk exposures should be correspondingly reduced. However, the study also found that these regulatory-recognised CRM techniques are still new and comparatively untested.