BANK 4.5.2 Choice of CRM techniques
(1) CRM techniques include:
(a) accepting collateral, standby letters of credit and guarantees;
(b) using credit derivatives or other derivative instruments;
(c) using netting agreements; and
(d) purchasing insurance.
Note Credit risk mitigation using collateral and guarantees is usually dealt with at the time credit is granted. In contrast, credit derivatives and netting agreements are often used after the credit is granted, or used to manage the firm's overall portfolio risk.
1 A banking business firm should not rely excessively on collateral or guarantees to mitigate credit risk. While collateral or guarantees may provide secondary protection to the firm if the counterparty defaults, the primary consideration for credit approval should be the counterparty's repayment ability.
2 A banking business firm that provides mortgages at high loan-to-value ratios should consider the need for alternative forms of protection against the risks of such lending, including mortgage indemnity insurance, to protect itself against the risk of a fall in the value of the property.
(2) In choosing a CRM technique, the firm must consider:
(a) the firm's knowledge of, and experience in using, the technique;
(b) the cost-effectiveness of the technique;
(c) the type and financial strength of the counterparties or issuers;
(d) the correlation of the technique with the underlying credits;
(e) the availability, liquidity and realisability of the technique;
(f) the extent to which documents in common use (for example, the ISDA Master Agreement) can be adopted; and
(g) the degree of recognition of the technique by financial services regulators.
|Derived from QFCRA RM/2014-2 (as from 1st January 2015).|