A process approach for managing credit asset portfolios in a South African bank

Abstract

The operating environment in which banks conduct their business, especially the credit risk environment, underwent significant changes since the latter half of the previous decade. Developments have resulted in a bombardment of quantitative and qualitative credit risk information and data on the one hand, and on the other an absence of a clear focus and management approach and philosophy to effectively manage credit risk. The primary objective of the research was the formulation of a process approach that could be applied in the management of credit risk of credit asset portfolios. Part of the objective was an implicit requirement that it should form the foundation from where the management of credit risk can be leveraged to exploit all the dimensions of credit risk while focussing on the maximisation of shareholder wealth. A literature study was undertaken to determine the theoretical aspects regarding the management of credit asset portfolios, credit risk management, the credit portfolio risk management approach and its principles. An empirical study aimed to establish the credit risk management practices being applied in the South African Banking Industry. The process approach developed for managing credit asset portfolios incorporate the account life cycle as point of departure. This was necessary to facilitate the various processes that need to be considered for effective credit portfolio risk management. The specific data requirements, as it culminate in a credit portfolio risk management functionality, enable the credit portfolio risk management approach and principles to be applied to credit asset portfolios within the context of two perspectives to credit portfolio risk management, namely: > The economic value perspective (also referred to as the shareholder wealth perspective) which has an ex post focus (after default has occurred) and which calculates the impact of credit risk on Credit RAROC or shareholder value; and > The earnings perspective which has an ex ante focus (before default occurs) and which addresses the bank's loss in income as a result of, and associated with, deterioration in credit standing (the cash flow implication to be considered when credit standing deteriorates). Applying the developed process approach to credit asset portfolios, two distinctive but dependent dimensions with underlying sub-dimensions to portfolio risk management is identified namely, micro portfolio risk management and macro portfolio risk management. The former focuses on the credit asset portfolio and the latter on the group portfolio in the context of all risks impacting the organisation. The final stage in the process approach is to establish a Business Health Forum that reports to the Board appointed committees. The forum ensures an independent view of all the risks and activities of the business, including credit risk. Adopting and applying the developed framework regarding the process approach to managing credit asset portfolios in a South African bank will assist executive management to ensure that the requirements (processes, systems, data) for effective credit portfolio risk management are met. It would also broaden the understanding regarding the interdependency between profit, sustainable growth and effective credit portfolio risk management.