Please wait while the transcript is being prepared...
0:00
My name's Marwa Hamman
and I'm the Executive Director
of the Cambridge Master
of Finance program.
I also lecture on credit.
I've developed a course
called Fundamentals of Credit,
which I teach here
on the MFin program
and another course that
covers more advanced topics.
Today's talk
is looking at credit.
Credit as an asset class,
but also the skill set
and the toolkit required
to analyze credit
from a qualitative as well
as a quantitative perspective.
0:30
So before getting
into the specifics
of credit instruments
and credit risk,
I'd like to start
by setting the stage,
perhaps, by starting
with a big picture
on how credit is generated
and the banking space
and regulatory
pressures in general.
Banks are intermediaries between
depositors and investors.
They have an important role
to play in creating
money in the economy.
By creating money
or extending credit
in the form of loans
to their clients,
they are naturally
taking on credit risk.
In order to offset that risk,
banks are required
to set aside
reserves to ensure
that they are
sufficiently capitalized
and that those reserves
are commenced
with a level of risk
within the loans
that they have extended.
Loans constitute one
of the largest elements
of the asset side of any typical
commercial bank's balance sheet.
On the next slide,
I will be showing you
a sample balance sheet
where you'll see
that they can go up
to about two-thirds
of the size of the assets book.
1:33
As I just mentioned,
loans constitute
a very large part
of the balance sheet
of a typical commercial bank.
They provide an opportunity
for the banks
to generate accrual income
in the form of the interest
that is paid as well
as any commitment fees,
but they're also very expensive
to maintain on the book
because of the capital charge
that I've just explained.
So the loan loss reserves
are maintained,
these are almost allowances
for loan losses or provisions
that are set aside
in order to offset
any potential risk arising
from credit default.
The allowances
are largely there
in order to absorb any losses
resulting from
probability of default
migrating over
the life of the loan
or the loans
within the portfolio.
Any actual losses that
are incurred are written off,
so they are charged
against the provisions,
and the provisions would
then need to be replenished
through the income statement.
And this would obviously
be an expense
that hits the bank's P&L.
In the case of
asset-backed loans
where there is
a form of security,
the loss sustained by
the bank generally reduces.
This is a concept called
"loss given default."
So I've already referred
the probability of default,
the other piece of
estimating or in estimating
expected credit loss
is loss given default,
which is basically the amount
or the quantum of the loss
in the event of a default
situation unfolding.
