The foundation for all of these practices is quality, consistent credit data management. Postcrisis market conditions are a third dimension in the evolution of CPM, though less important than rising capital needs and cost pressures: only about 40 percent of surveyed institutions felt that this is a key driver for change. Subscribed to {PRACTICE_NAME} email alerts. Senior managers must ask themselves whether the quality and availability of data is sufficient to enable CPM to form insights of value to the business. The former will need a global overview and advice on risk positions and improving cross-selling, while the latter might benefit more from active portfolio management at a sector level. But securitizations in Europe declined by more than 50 percent since 2010 and are still below 2007 levels.3 3.Securitisation data report, fourth quarter 2015, a joint report from the Association for Financial Markets in Europe (AFME) and the Security Industry and Financial Markets Association (SIFMA), March 17, 2016, sifma.org. 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. That has to change—even as banks wrestle with an urgent challenge to substitute interest income with fee income. COVID-19 update: To expedite the processing of your dispute, please take advantage of our online dispute option. IACPM has highlighted three that are relevant for credit portfolio … With its unique position at the center and in between many related functions, CPM can be in the optimal spot to define business requirements, with an overarching perspective on business, finance, and risk data and system needs. Please click "Accept" to help us improve its usefulness with additional cookies. There are then various measures, including job rotation, that can promote better integration. Credit Portfolio Management and Bank-Sourced Benchmarks. Much will depend on the institution and its business model. Senior managers will also find this ES bundle very helpful. If you would like information about this content we will be happy to work with you. Currently, 95 financial institutions in 19 countries are members. Diversification. In some cases, depending on the nature of their business, banks may face a significant capital shortfall under the provisions of the so-called Basel IV rules, driven by regulations currently under consultation, such as a changed credit risk standardized approach, new internal-ratings-based approaches, and potential capital floors. In this context, CPM has had to rethink its main job, of mitigating risk within the portfolio and maximizing risk returns. Exhibit 4 shows the current distribution of the various options. Wherever they were located, the vast majority felt CPM should be engrained in the organization if it is to fulfill its new mandate. Until recently, CPM teams could manage the loan portfolio largely independently from the rest of the balance sheet. Indeed, its mandate often expands from defensive actions around concentrations and credit concerns to more offensive-minded elements of portfolio management… Their use is growing. A comprehensive approach may be needed but presents additional complications. Luis Nario is a partner in McKinsey’s New York office; Tamara Pfister is an associate principal in the Munich office, where Thomas Poppensieker is a senior partner; Uwe Stegemann is a senior partner in the Cologne office. Credit Portfolio Management in the IFRS 9 / CECL and Stress Testing Era: The post-crisis world presents portfolio managers with the significant challenge to asimilate in day-to-day management the variety of conceptual frameworks now simultaneously applicable in the assessment of portfolio credit … Various case studies add a real world element to the theory presented in the book while also offering in-depth instruction on how to avoid the pitfalls of active credit risk management.' 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. The Action Plan highlights the 16 different actions. The survey reveals broad agreement on the need to evolve the role of CPM, and to do so promptly to respond to the current industry environment. via identifying suitable investments and executing hedging activities. The design choice appears to be driven by historical precedents, market context, management priorities and regulatory emphasis; the size of the institution is also a factor. Such a role is needed without delay, given the balance-sheet constraints that institutions already face, and the prospects of further tightening. To win in this environment, must look at credit portfolio management through an enhanced lens that yields unique insights about the life event triggers that affect your portfolio over time. 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. Sixty-six percent of institutions named data constraints as the main hurdle for filling their expanded mandate. 'Credit portfolio management is at the heart of the current banking crisis, and this book offers practitioners a complete and comprehensive guide to the subject. That’s a problem: as an example, when profit optimization was carried out centrally, only 35 percent of survey respondents said significant improvement was required. The authors wish to thank Florian Fuchs for his contribution to this article. We discovered that there is broad agreement on the need for change—and change is under way in many institutions. Many respondents cited business proximity and alignment as important design principles for the CPM function. We strive to provide individuals with disabilities equal access to our website. 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? Some 59 percent of surveyed institutions named the resulting cost and margin pressure as a motive for CPM’s evolution. Credit professionals should feel compelled to own, lead, and drive internal change. In contrast, tools such as index options and single-name CDS hedges are losing influence. Credit Portfolio Management (CPM) denotes a set of principles, tools, processes that underpin the management of Credit Portfolios (collections of credit assets). Survey respondents identified tools for measuring regulatory capital and capital allocation (that is, discipline at origination) as the most important for the CPM function, and growing in importance; 88 percent plan to use regulatory capital-allocation mechanisms. 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. Select topics and stay current with our latest insights, The evolving role of credit portfolio management. An essential component of CPM’s contribution is a superior market perspective and the capability to identify business opportunities. We use cookies essential for this site to function well. How the new role of the CPM function takes shape will vary by institution, ranging from advisory to active portfolio management. Whatever the function’s mandate and the way it is organized, it will need outstanding analytic capabilities. Press enter to select and open the results on a new page. Credit Portfolio Management provides readers with a complete understanding of the alternative approaches to credit risk measurement and portfolio management. Currently, 95 financial institutions in 19 countries are members. The financial crisis of 2007 changed the way most functions at these institutions operate, and CPM is no exception. Rather than using this ES bundle from a profit center perspective portfolio managers would do, this ES bundle is also very useful from the perspective of controlling risk, enabling the creation of integrated of risk and return reporting for the bank's senior management. 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. While several factors came to light, institutions identified three main reasons for the changes in CPM’s role. This will help focus efforts to drive the change, which in many cases is already under way. Credit Portfolio Management (CPM) denotes a set of principles, tools, processes that underpin the management of Credit Portfolios (collections of credit assets). Credit Portfolio Management (CPM) has grown as a discipline over the past 15 years in response to financial institutions’ continuing efforts to measure credit risk more accurately and to manage it more … However, new regulatory requirements, especially with respect to capital and liquidity, increasing cost and margin pressure, and changed market conditions have pushed CPM into a broader role with the need to align closely with other areas, such as finance, treasury, risk data and methodology, and business-origination functions. 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. Funding and leverage were not an issue for CPM. 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. Flip the odds. The new limit system needs to be in line with overall targets and limits for the balance sheet, reflecting the multitude of key performance indicators the institution has to optimize for. In the secondary market, survey participants see wholesale loan purchases and sales as the most important CPM tool. Clearly, interaction is naturally supported if CPM has a representative within each business unit. Learn more about cookies, Opens in new Liberty Mutual Surety™ has an excellent opportunity for a Bond Manager on our Surety Plus team in Plano, TX…This includes preparing the budget and business plans, marketing, underwriting, training, and monitoring a business portfolio, and coordinating management … Yet despite all the investment in data management and digitization, largely in response to regulations such as Basel Committee of Banking Supervision (BCBS) 239, as well as digitization, results are lackluster. 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. tab, Travel, Logistics & Transport Infrastructure, McKinsey Institute for Black Economic Mobility. The defining characteristic of credit portfolio management activities is that Credit Riskis assessed and managed not on a standalone basis but in an aggregate, portfolio, setting. The new CPM mandate may entail some changes in organizational structure. In decentralized instances, the figure was 75 percent. Some 85 percent of institutions surveyed said that regulations relating to the levels of capital and liquidity that banks must hold—and the prospect of even tighter regulation ahead—were the main reason. Capital optimization (88 percent) and the development of risk frameworks top the list. 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. According to the Bank for International Settlements, single-name CDS outstanding had a global notional value of $18.1 trillion in the second half of 2010. For example, 54 percent of respondents said they already observed a change in the scope of the function and the tasks it was conducting, with an increasing focus on loan origination, expanded analytics (for example, on deposits and client profitability), use of additional metrics (such as the leverage ratio), more explicit alignment with risk appetite, and additional legal entity reporting. Unleash their potential. Our flagship business publication has been defining and informing the senior-management agenda since 1964. Increasingly, CPM teams will need analytics to meet needs such as advanced pricing, an improved combination of risk and finance data (for better capital optimization), a more detailed and solid link from the risk strategy and appetite to origination, and macro and industry insights (to aid mitigation at the macro level and through the business cycle). The team was free to manage for return on equity. London, England, United Kingdom. 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 … From 2010 to 2015 the cost-income ratio of the 150 largest institutions in Europe increased from 59.1 percent to 65.6 percent, while the income-asset ratio was essentially unchanged. Use minimal essential collaboration with select social media and trusted analytics partners With that, CPM functions are also conducting new activities. The results point, though, to certain trends. To steer business decisions, CPM will also need to use a granular and rigorous limit framework and evolving optimization tools. 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). 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. Reinvent your business. In addition, the survey showed a likely shift in the way CPM makes hedging and sale decisions. And they can align incentives. Please try again later. 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. 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. 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. The issue is most significant in Europe, where 71 percent of participants named cost pressure as a factor. To optimize the portfolio within current and future constraints, risk and finance data needs to be integrated. 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. The Stellus team has spent the majority of its careers in credit with additional experience in private equity, restructuring, and operations. 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. , depending on context, a CPM function, there is, however no. 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