That has to change—even as banks wrestle with an urgent challenge to substitute interest income with fee income. Sixty-six percent of respondents saw poor data as the single most important constraint preventing the function from performing its new mandate well (Exhibit 3). The defining characteristic of credit portfolio management activities is that Credit Risk is assessed and managed not on a standalone basis but in an aggregate, portfolio, setting.[1]. With that, CPM functions are also conducting new activities. Senior managers cannot rely on a single template. The book is a valuable, up to date guide for portfolio management practitioners. To steer business decisions, CPM will also need to use a granular and rigorous limit framework and evolving optimization tools. Participants included 39 banks and 2 insurance firms. In the secondary market, survey participants see wholesale loan purchases and sales as the most important CPM tool. Institutions need to restructure their balance sheets to achieve required target ratios, optimize the use of capital, and help drive profitability. Fundamental to successful CPM is the availability, analysis, and interpretation of information. Please click "Accept" to help us improve its usefulness with additional cookies. We asked what changes were afoot, what CPM’s mandate should be, how it should be organized to deliver on that mandate, and what tools and analytics were required. Multiname CDS, a useful tool for managing portfolios and correlations, have also been hard hit by changing bank-capital rules. CPM’s new work at the point of origination, and its multifaceted challenge with capital constraints, liquidity ratios, and other regulatory demands, means the group has to work more closely with the range of functions governing the balance sheet. We hope it will help others make their own choices wisely—and without delay. 3 Credit Portfolio Management Tools for Better Risk Assessments. This might include, for example, a closer alignment of the credit portfolio with the particular funding strategy (asset-backed funding, securitization, syndication, and so on). Something went wrong. In the United States, securitization volumes have rebounded slightly, starting in 2010. To steer the business, CPM will need sufficient detail for portfolio analysis. Manages credit risk and responds to prospect or customer credit questions and makes independent calls on assigned portfolio of relationships. By the second half of 2015, this had more than halved to $7.2 trillion.2 2.Semiannual OTC derivatives statistics, Bank for International Settlements, May 4, 2016, bis.org. Portfolio managers at banks who require information concerning their risk/return levels with regard to the credit risk of their portfolios will find this ES bundle highly useful. IACPM has highlighted three that are relevant for credit portfolio … Along with the solution, our clients benefit from our unique blend of credit … For example, activity in securitization markets and single-name credit-default swaps (CDS), CPM’s main hedging tool, have declined significantly because of higher costs and stricter rules for CDS. Credit Portfolio Management provides readers with a complete understanding of the alternative approaches to credit risk measurement and portfolio management. While several factors came to light, institutions identified three main reasons for the changes in CPM’s role. The results point, though, to certain trends. The authors wish to thank Florian Fuchs for his contribution to this article. Only with a trusted tool kit that provides the business superior insights from a portfolio perspective, which they cannot gain without CPM’s support, will the CPM function be able to earn the right to be part of strategic discussions and business decisions. Eighty-three percent of executives describe an increased need for coordination between CPM and the rest of the organization during the past few years, particularly with finance and risk, and more than a quarter of respondents said they saw the need for significant change in the current interaction model. Sixty-five percent of institutions use the internal-ratings-based (IRB) advanced approach, 10 percent the IRB-foundation approach, and 5 percent the standardized approach. The Trinitas team of talented professionals has deep experience in investing in and managing bank loans, loan acquisition, loan origination, credit analysis, portfolio management, trading, collateralized loan … Apply on company website. A comprehensive approach may be needed but presents additional complications. The foundation for all of these practices is quality, consistent credit data management. Risk-based measures and valuation, including, Steer the Origination and Pricing of Credit Assets, Portfolio CDS Hedging is available in markets and for credit exposures that can be referenced by a, Portfolio Securitization (Cash or Synthetic) is available in markets and for credit exposures that can be included in a, For regulated firms, credit portfolio management is heavily influenced by regulatory requirements and frameworks which are sometimes creating counter-intuitive incentives (, While credit portfolio management is practised by a wide range of firms and organizations deploying the full range of tools is usually only possible for the largest firms, Significant prior investment in measurement / algorithms relevant for CPM has been influenced by Basel II requirements which emphasized individual, Post-crisis emphasis (for regulated firms) on prescribed, Classic portfolio management approaches may need amendments to better capture issues such as. And if CPM is not taking on an expanded role, who will be responsible for integrating balance-sheet optimization, stress testing, and ongoing management of the credit books? Indeed, its mandate often expands from defensive actions around concentrations and credit concerns to more offensive-minded elements of portfolio management… Press enter to select and open the results on a new page. Select topics and stay current with our latest insights, The evolving role of credit portfolio management. The availability of credit portfolio management tools depends on the nature of the credit portfolio, the relevant jurisdiction / regulations and the type and maturity of credit markets. The survey sheds light on the different choices being made about the function’s mandate, the way it is organized, and the tools it is using, as well as what is driving those choices. hereLearn more about cookies, Opens in new However the future role of CPM shapes up, it will need excellent data to fulfill its tasks and comply with regulations. And they can align incentives. Twenty percent of respondents are not subject to Basel requirements. North America accounted for 41 percent of the sample, Europe for 41 percent, Asia–Pacific for 13 percent, and South America for 5 percent. The transformation of data systems and data governance currently under way at many banks could provide the ideal opportunity for CPM to influence future investments and systems development. In addition, the survey shows that smaller institutions tend to favor a second-line CPM function, while larger ones often choose a more active role for the function, with direct market access. This CEB TowerGroup white paper highlights how card issuers can gain a deeper understanding of their cardholders, build upon proven strategies with portfolio … As the largest component of the balance sheet is typically the credit book, they are looking to draw on CPM’s unique portfolio-management expertise, and to encourage CPM to influence loan origination as well as asset sales. But whatever the design choice, an essential component of the evolving function—if it is to fulfill its value potential—is the aggregation of risk and funding information from across the organization in order to make strategic decisions or proffer strategic advice while providing oversight and control. Currently, 95 financial institutions in 19 countries are members. According to an international survey the primary high-level objectives of Credit Portfolio Management units are:[2], Some commonly found elements of CPM best practices are:[3]. In contrast to traditional origination and credit risk-management functions that look only at individual deals or borrowers, CPM looks across the entire credit book. Sixty-six percent of institutions named data constraints as the main hurdle for filling their expanded mandate. Diversification. In the United States, for example, we think that the Comprehensive Capital Analysis and Review might push CPM into an advisory role because of the expertise required for stress testing. Institutions with active trading operations should also consider the scope of responsibility for the function across loan books, securities portfolios subject to default risk, and trading counterparty risk. The historical role of CPM remains. In Europe and Asia–Pacific, most institutions (up to 80 percent) expect CPM to assume an active, first-line role in managing the portfolio, taking responsibility for reducing credit risk and optimizing the balance-sheet structure to secure the highest return on equity or return per risk within the constraints of regulation. Significantly reduced opportunities for hedging and secondary trading, low risk appetite for going long credit in secondary markets, and lack of acceptance of going short credit exposure generally have led to a shift of focus toward portfolio management at the point of origination. Only 5 percent of respondents said CPM currently has the capabilities to consider a holistic view of the portfolio, including stress outlook and capital and liquidity usage. McKinsey analysis shows that many of the world’s top 150 banks by assets, especially in Europe, hold only a little more capital than the “fully loaded” minimum requirements of Basel III. Just as there has never been a unique template for the CPM function, there is no consensus on how it will evolve. Credit Portfolio Management offers in-depth … In addition, each institution should consider whether its CPM function has the right proximity to senior stakeholders. Historically, its role has been to understand the institution’s aggregate credit risk, improve returns on those risks—sometimes by trading loans in the secondary market, and hedging—and identifying and managing … Credit Portfolio Management and Bank-Sourced Benchmarks. An essential component of CPM’s contribution is a superior market perspective and the capability to identify business opportunities. People create and sustain change. Credit portfolio management (CPM) is a key function for banks (and other financial institutions, including insurers and institutional investors) with large, multifaceted portfolios of credit, often including illiquid loans. CPM’s focus on portfolio dynamics puts it in a particularly advantageous position to steer balance-sheet construction, as compared with finance functions focused on measurement, credit risk functions focused on individual assessment and limits, and originators focused on individual deals and clients. collaboration with select social media and trusted analytics partners In some cases, however, where the function is split into separate teams within each business unit, it may lose a centralized overview, making it harder to interact consistently with risk and finance. Currently, 95 financial institutions in 19 countries are members. via identifying suitable investments and executing hedging activities. Large institutions often want CPM to have direct market access, which would place it on the first line and hence anchored in the business. Such a role is needed without delay, given the balance-sheet constraints that institutions already face, and the prospects of further tightening. To get rid of unwanted exposures, CPM units often look to bundle similar assets. In Europe, where liquidity is tighter, more active portfolio management might be required. Another option might be to split the CPM function in two—a decentralized first-line team and a centralized second-line team, typically anchored in the risk function. Digital upends old models. CPM functions have an opportunity to step in and take a vital role in the definition of business requirements, combining the perspectives of business, risk, and finance together with those of the IT department. Please email us at: McKinsey Insights - Get our latest thinking on your iPhone, iPad, or Android device. To understand exactly how the role of CPM is evolving, McKinsey, in collaboration with the International Association of Credit Portfolio Managers (IACPM),1 1.The IACPM (iacpm.org) is an industry association established to further the practice of credit exposure management by providing an active forum for its member institutions to exchange ideas on topics of common interest. The new CPM mandate may entail some changes in organizational structure. Now, with all the multiple requirements in play (including rules on capital, funding, liquidity, and leverage), credit, the largest asset class on most balance sheets, is front and center in the new approach to integrated balance-sheet management. Another complication for CPM is the multiplication of different and sometimes contradictory requirements (such as the rules on risk-based capital minimums, which are at odds with the leverage-ratio rules). The issue is most significant in Europe, where 71 percent of participants named cost pressure as a factor. Credit professionals should feel compelled to own, lead, and drive internal change. Exhibit 4 shows the current distribution of the various options. This is a significant change. Most transformations fail. Credit Portfolio Management (CPM) denotes a set of principles, tools, processes that underpin the management of Credit Portfolios (collections of credit assets). That said, the role is evolving in different ways, depending on geography, business mix, and institutional idiosyncrasies. The Stellus team has spent the majority of its careers in credit with additional experience in private equity, restructuring, and operations. Until recently, CPM teams could manage the loan portfolio largely independently from the rest of the balance sheet. Exhibit 1 shows how other considerations are also changing. including corporate and sovereign debt) is usually discussed under Asset Management, reflecting the lack of a client relationship and the management … Credit Portfolio Management Selby Jennings London, England, United Kingdom 4 weeks ago Be among the … Some 59 percent of surveyed institutions named the resulting cost and margin pressure as a motive for CPM’s evolution. This will help focus efforts to drive the change, which in many cases is already under way. There are then various measures, including job rotation, that can promote better integration. Once largely focused on the loan book, in many institutions CPM is now managing the entire range of credit exposures and their effect on the balance sheet. Most banks and other institutions are good at originating, structuring, and pricing risk, but not as good at holding volume on their balance sheet. Identify the key elements of credit risk: probability of default, loss given default, and exposure at default; Evaluate the inter-action of credit risk within a portfolio exposures (especially default correlation), and how these can be measured and quantified; Review how the main drivers of credit risk … tab. They can make CPM the advocate of business in its dealings with finance and risk. For example, an investment bank that uses corporate credit lines as a loss leader to build relationships is likely to have a very different CPM function from a regional bank that generates core profits from its middle-market and small-and-medium-size-enterprise portfolios. We discovered that there is broad agreement on the need for change—and change is under way in many institutions. CPM has to revamp its offering for banks’ changed circumstances. Senior managers will also find this ES bundle very helpful. CPM will need to understand these balance-sheet constraints, how they might change, and their interdependencies. Capital optimization (88 percent) and the development of risk frameworks top the list. How the new role of the CPM function takes shape will vary by institution, ranging from advisory to active portfolio management. tab, Travel, Logistics & Transport Infrastructure, McKinsey Institute for Black Economic Mobility. The thicket of rules requires institutions to keep an eye on many constraints simultaneously, and renders a single measure of return on capital misleading. Given the wide variety of borrowers, credit products and markets it is not surprising that there are substantially different management approaches: The term Active Credit Portfolio Management (ACPM) is used to denote a specialized CPM function that is involved directly in the management of a credit portfolio, e.g. And liquidity needs on how it will help others make their own choices without. 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