Placing Credit Portfolio Management within the Organizational Structure
Ingrassia, William, Greatrex, Peter, The RMA Journal
The credit portfolio management function within many financial institutions has evolved significantly as risk mitigation and distribution mechanisms have developed. Questions arise about whether it's better to have the credit portfolio management function inside or outside the originations process, on the private or public side of the information barrier, or with a narrow or wide scope. This article explores those issues as well as governance of the credit portfolio management function.
The liquidity explosion in recent years in both the credit default swap and secondary loan markets allows institutions of various sizes and scopes to better manage retained credit risk--whether such risk stems from commercial lending, derivatives, or other credit-related businesses.
Regardless of the form it takes, a key element in the success of credit portfolio management is a commitment to its mandate by senior management. This mandate should specify that all of the retained credit risk within an institution should be actively managed within the context of market liquidity, risk appetite, and the overall credit risk management effort of a firm.
The structure selected for portfolio management should also be influenced by the group's objectives. For example, various firms may prioritize the following common goals of credit portfolio management differently:
* Improvement of the risk-adjusted return of a retained credit portfolio.
* Mitigation of event risk (headline risk) by reducing single-name and industry concentrations.
* Reduction of exposure to deteriorating credits.
* Minimization of the economic capital required to support the extension of credit.
* Increase in velocity of capital so that it may be redeployed in higher-margin activities.
As these goals can conflict at times and must be achieved within budgetary constraints, the mandate of portfolio management should be transparent and well communicated. While recognizing that a one-size-fits-all approach to the design and structure of a portfolio management function remains elusive, this article will evaluate the following issues as they pertain to a broad spectrum of institutions:
* Organizational structure. Where is credit portfolio management placed within an organization, and what are the advantages and disadvantages of being aligned with or separate from the originating businesses?
* Public versus private. Is credit portfolio management a public-side group with relatively few trading restrictions, a private-side function with an ability to influence the onboarding of risk, or a hybrid of both?
* Scope. Which businesses and types of assets fall within the scope of credit portfolio management?
* Governance. How will the role of compliance affect both private- and public-side functions?
The decision of where to place credit portfolio management within an organization will hinge in large part on the mandate of the function, the scope of risk it manages, and the nature of the underlying retained risks emanating from the firm's client businesses. Portfolio management can reside in various parts of an organization, with the most common models placing portfolio managers either within the originating business or as part of a centralized risk management or finance function. The latter structure is more prevalent among larger institutions, according to a 2004 survey of credit portfolio management practices conducted jointly by the International Association of Credit Portfolio Managers (IACPM), the International Swaps and Derivatives Association (ISDA), and the Risk Management Association (RMA). This study indicated that 55% of respondents resided within the broadly defined risk management or finance functions.
There are several advantages to centralization. When a firm has a variety of businesses that hold retained credit risk, a broad, centralized risk management stripe allows aggregation of different risks to the same customers under one credit risk management umbrella. …