The Hindu Business Line : Ignorance of risks is high-risk

John Ruskin said, "Large fortunes are all founded either on the occupation of land, or lending or the taxation of labour." Of the three, the riskiest is often the second. For, large fortunes can be wiped off by bad loans.

To avert such a possibility, here's help from Credit Risk Analysis, by Ciby Joseph, from Tata McGraw-Hill (www.tatamcgrawhill.com). The author, a fellow member of the Institute of Chartered Accountants of India, currently heads the Financial Analysis Unit in Credit Risk Management of HSBC Bank Middle East Ltd, Dubai.

Beginning with definition of credit and ending with intangible security, Joseph handholds the reader from the basic concepts to the esoteric ones, to achieve `a tryst with strategic prudence'.

Credit risk is "the probability of the loss (due to non-recovery) emanating from the credit extended, as a result of the non-fulfilment of contractual obligations arising from unwillingness or inability of the counter party or for any other reason," defines Joseph. Credit risk "exists whenever a product or service is availed with a promise to settle payment in future," and you can study it from two angles — firm and portfolio.

The first is about a single customer, while the second is macro in comparison. Joseph discusses the two aspects of firm risk, that is, operating and financial, in all their combinations, through a risk matrix. Essential read is the chapter on financial risks, where the author elaborates on the importance of financial statements, and delves into analytical tools.

Joseph advocates the use of an `integrated view' because "two or more of EIIF (external, industry, internal, and financial) risks can work together to trigger a business collapse". Of immense value are the practical illustrations and examples included in the book. The section on credit portfolio risks has a chapter on Basel accords.

While the strategy of keeping the eggs in many baskets does ensure portfolio risk mitigation, what is more important is the ability to identify and create baskets, points out Joseph.

"During the 1998 forex crisis in the Far East, portfolios and sub-portfolios of many financial institutions were hit," he narrates, citing as examples Prudential (Hong Kong) and Nedungadi Bank.

Read about CDS (credit default swap), TR (total return), CO (credit option), CSO (credit spread option), CDLN (credit default linked note), and VAR (value @ risk) in the chapter on portfolio credit risk mitigants. And in the chapter on pricing, catch up with RORAC (return on risk-adjusted capital) a.k.a. RORA (return on risk assets), RAROC (risk-adjusted return on capital), and ROCAR (return on capital at risk).

Ignorance of risks is high-risk. Of higher risk is to lend a book such as this!

BooksOfAccount@TheHindu.co.in

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