Credit Risk Modelling- A wheel of Risk Management
Banking institutions encounter two broad types of risks in their everyday business – credit risk and market risk. Credit risk may be defined as the risk that borrowers might default on their obligations, whereas market risk reflects the variability in the value of their financial position due to changes in interest rates, exchange rates, etc. Over the last decade, rapid strides have been made in developing Value at Risk (VaR) models for managing market risks in a portfolio context. Such models have also been recognized for regulatory capital setting for market risks. However, a similar approach to measure credit risk in a portfolio context was found difficult on account of certain crucial differences between credit risk and market risk.