MEASUREMENT OF LOAN PORTFOLIO RISK

Abstract

The reasons for a bank’s poor performance may be various. The key reason of serious problems lies in poorly set credit standards related to the assessment of future debtors’ credit rating, poor loan portfolio management, as well as other circumstances leading to the deterioration of the customer’s credit rating. Therefore, the key reason for poor performance of a bank is its poor risk management. The goal of credit risk management is to maximize risk-adjusted return on capital, while simultaneously maintaining the exposure to credit risk within acceptable limits. In the mid 90s of the 20th century, commercial and investment banks began to implement VaR methodology in order to measure credit risk. This paper briefly explains the VaR concept and VaR models applied in the measurement (quantification) of loan portfolio risk. Special attention was paid to CreditMetrics model, indicating its main features, while presenting and explaining the evaluation of a loan portfolio by applying this model on a specific example.