What is Counterparty risk?
Counterparty credit risk is traditionally defined as the risk that a counterparty to a transaction fails to perform under its contractual commitment for the variety of products that the Bank trades with the counterparty such as forex instruments, letters of credits, repossessions, derivatives, etc. Counterparty credit risk is an inevitable component of capital markets trading businesses and banking activities. The ability to measure, aggregate and monitor counterparty credit risk ensures that bank’s external customers are willing and able to honor their contractual commitments and credit losses are minimized. Any changes to the credit quality and the exposures should be regularly evaluated and communicated to the senior management to make prudent credit decisions in their investment portfolios and to reduce exposure to the deteriorating counterparties.
Why is it important?
A counterparty credit rating reflects the best expectation of its Probability of Default (PD) based on an analysis of its economic and financial strength. In our experience it is typically assessed at the level of senior unsecured creditor. Some of the banks and financial institutions also consider country risk ratings and adjust the counterparty rating based on this. This rating reflects a long term view of the creditworthiness of the counterparty (i.e. through a credit cycle) though suitable adjustments (normally downgrades) are made based on the market data.
All trading counterparties are categorized into broad, high level industry classes. These broad classifications are designed to identify pools of counterparties with similar business environment, regulatory requirements and common macro-economic risk drivers. This segmentation helps in tracking credit quality across different portfolios and setting portfolio limits.
What should you look for in a framework that captures all analytics dimensions?
Counterparty risk analytics framework should provide automated aggregation of data from various source systems that house the credit and limit information for domestic and international counterparties. Additionally this should enable automation of the agency ratings and CDS swap spread data based on the information available.
The framework should help create a central risk database that stores master data around counterparties, products, exposures and risk factors. It should also provide an application to extract and manipulate exposure & ratings data from underlying source system. MS Excel files can be linked to load data into the historical risk database. This database can be used to produce a set of reports and dashboards that enables senior management to take critical decisions around counterparties and their exposures.
The framework should also create a work flow to make manual additions and changes to the counterparty and exposure information easily. Also provide critical alerts for risk rating and exposure downgrades and upgrades in the desired frequency.
Some of the common business benefits are
- Reduce your turn around time for consolidation of counterparty reporting.
- Create a Master repository of counterparties, grouping, products, exposures and risk factors.
- Get alerts for ratings, total exposure fluctuations beyond thresholds.
- Monitor trends for dimensions mentioned above and faster decision making.
Technical benefits are
- Pre-Built connectors across source systems using excel interfaces
- Prebuilt data models , Business metrics and scenarios
- Prebuilt data loaders
- Standard KPIs covered
- Prebuilt Reports and Dashboards
- Data and Report Centralization