Showing papers on "Credit risk published in 1993"

Did Risk-Based Capital Allocate Bank Credit and Cause a `Credit Crunch' in the U.S.?

Abstract: This paper examines the reallocation of bank credit from loans to securities in the early 1990s using data on virtually all U.S. banks from 1979 to 1992. The spectacular increase in bank and thrift failures in the 1980s raised concerns about depository institution risk and spurred interest in public policy prescriptions to reduce this risk. One of these pre-scriptions was the Basle Accord on risk-based capital, which mandates that international banks operating in the major industrialized nations hold capital in proportion to their perceived credit risks. Because capital is more expensive to raise than insured deposits, risk-based capital (RBC) may be viewed as a regulatory tax that is higher on assets in categories that are assigned higher risk weights. Therefore, it would be expected that implementation of RBC would encourage substitution out of assets in the 100% risk category, such as commercial loans, and into assets in the 0% risk category, such as Treasury securities. Thus, the allocation of credit away from commercial loans may have caused a "credit crunch," which the authors define as a significant reduction in the supply of credit available to commercial borrowers. Consistent with these expectations, U.S. banks did reduce their commercial loans and increase their holdings of Treasuries in the early 1990s. A number of alternative explanations for this change in bank behavior have been offered. The authors suggest several other hypotheses including the leverage credit crunch hypothesis reflecting banks' interest in reducing their required leverage capital ratio; the loan examination credit crunch hypothesis reflecting the more rigorous examination process which encouraged substitution into safe assets; the voluntary risk retrenchment credit crunch hypothesis reflecting management's voluntary substitution of safer assets to lower the cost of funding and reduce the risk of bankruptcy; and the macro/regional demand-side hypo-thesis reflecting the reduction in overall loan demand because of the downturn in the economy and the steep slope of the term structure. An additional hypothesis is that the decline in commercial lending reflects continuation of longer term trends in the declining demand for bank intermediation services. Unfortunately, all of these hypotheses are roughly consistent with the aggregate data, leaving unknown whether risk-based capital played a major part in the reallocation of bank credit or whether a supply side "credit crunch" even existed. It is possible that all of the theories were correct simultaneously. The paper takes a close look at the data at the micro bank level to try to distinguish among the alternative hypotheses, with emphasis on RBC. The method used by the authors is to examine how bank portfolios changed in the early 1990s from the 1980s, and to see how these changes are related to the risk-based capital ratios and other key variables. The authors' tests relate the growth rates of bank asset categories to several measures of perceived bank risk, including the Tier 1 and Total RBC ratios. The findings suggest that the RBC credit crunch hypothesis fares the worst of all the alternative explanations of the bank credit reallocation of the 1990s. They find that the effects of the RBC ratios on lending did not get consistently stronger in the early 1990s, and that the Tier 1 and Total RBC ratios generally acted to counteract each other in their effect on credit allocation. The other credit crunch theories examined are somewhat more consistent with the data, given that the relations to the leverage ratio and the "problem" loan categories generally have the predicted signs. However, the quantitative effects are not substantial. The only other evidence that is roughly consistent with the credit crunch hypotheses is that large banks, banks with weaker capital ratios, and banks supervised by the OCC have much more substantial credit allocation effects and greater lending reactions to perceived risk than do other banks. While it is difficult to disentangle these groups, since large banks tend to have weaker capital ratios and national charters, in none of these groups are most of the decreases attributable to the credit crunch hypothesis directly. The authors note that the findings do not rule out non-risk related credit crunch expla-nations. The authors state that such theories cannot be easily identified econometrically because they are not associated with observ-able variables on which to base a test. They conclude that the demand-side effects on lending are relatively strong, but exact attribution to the different hypotheses cannot be determined from their model.

Commercial Mortgage Defaults: Proportional Hazards Estimation Using Individual Loan Histories

Abstract: This paper examines the theory of commercial mortgage default and tests it using a data set of 2,899 loan histories provided by a major multi-line insurance company. A default model is estimated which relates subsequent default incidence and timing to contemporaneous loan term, borrower, property and economic/market conditions. Maximum likelihood estimation is used to estimate a hazard function predicting conditional probability of default over time. Results confirm many expected default relationships, in particular the dominance of loan terms and property value trends over time in affecting default. The effectiveness of the model in discriminating between “good” and “bad” loans is explored. Implications for underwriting practice and credit risk diversification are noted. Finally, suggestions are made for extending these results in pricing applications.

A credit scoring model for development banks: an African case study

Abstract: Loan portfolio quality could improve through a suitable creditworthiness analysis specifically designed to adapt to the particular LDC's context. In a broader perspective, an effective control of credit risk is a crucial aspect of bank management, especially in a development setting. This is the case of the Caisse Nationale de Credit Agricole of Burkina Faso where the model proposed in this paper is tested. Two major problems concerning loan analysis are evident: 1. the difficulty and the high cost of collecting relevant information on borrower-customers businesses; 2. the absence of benchmark procedures by loan analysts consistent with bank lending policy. As regards the first point, loan evaluation procedures can be improved through a more efficient diffusion and use of the information necessary to estimate the probability of repayment. The paper identifies the relevant information and defines the criteria through which it can be weighed in the loan evaluation process. Two hypotheses are offered. The first assumes there are some factors affecting the borrower's behavior that are likely to increase the probability of default. Second, the problem of the quality of information is explored. It is assumed that some mistakes can be made in credit risk evaluation related to the difficulty of obtaining the commonly used information on the customers' ability and willingness to repay. To overcome the widespread absence of correct information, evaluation models are used to identify symptoms of the borrower's performance and behavior. For this purpose symptomatic variables are employed to create indicators of the borrower-customers' ability and willingness to repay. As concerns the second point – the credit evaluation procedures – there is often a need for shared decisional frameworks and coordination between the head office and bank branches in order to avoid arbitrary decisions. For this purpose an application of a quantitative model for creditworthiness based on multivariate discriminant analysis is proposed; input variables are factors obtained from a wider set of variables. The quantification of the judgement in a score is also important because it gives responsibility to loan officers for the decisions they take according to the score or for an alternative choice. This last aspect is crucial in development banks, where accountability of loan officers is often a problem. The proposed model is also relevant for the theoretical interpretation of credit risk determinants: objective circumstances – personal or firm specific –, the ability of the bank to correctly evaluate these circumstances and the bank capacity to establish loan conditions to reduce uncertainty. The model demonstrates that the theoretical framework presented in the paper is applicable in an LDC's context. This clear relationship between theory and the interpretation of results can be an important tool in improving portfolio management for development banks and the bank personnel decision-making and learning processes.

Handing Over the Keys: A Perspective on Mortgage Default Research

Abstract: This paper is the text of the 1992 Presidential Address for the American Real Estate and Urban Economics Association. A comparative evaluation of mortgage default research finds that both the residential and commercial markets evolved from informal underwriting rules, to formalized (though unvalidated) ratios and rules of thumb, to early risk ratings based upon empirical evidence, to gener-alizable econometric models of default, to option-based pricing models. The commercial market lagged the residential market by about 10 to 20 years at first but is now only about five years behind. The survey finds that research and progress in understanding mortgage credit risk has been precipitated by a public policy need or mandate, data availability, and adequate technology. The absence of any one of these factors has hindered progress in the past. Finally, six emerging issues in default research are identified and discussed: (1) the degree of “ruth-lessness” with which default is exercised, (2) loan recourse, (3) the magnitude and timing of revenues and losses associated with default, (4) loan modification, (5) default in a portfolio context, and (6) leasehold default. Progress in these areas will enhance the efficiency of both the residential and commercial markets.

Directed Credit Programs for Agriculture and Industry: Arguments from Theory and Fact

Abstract: The motives behind government programs to provide directed credit to agriculture and industry can be traced to problems of asymmetric information in capital markets and, consequently, to benefits from relaxing the constraints on financing. In agriculture, directed credit programs that help farmers accumulate sufficient wealth to own the land they cultivate may improve the allocation of resources. In industry, the benefits of government credit may include product and factor market externalities as well as the direct benefits from relaxing borrowing constraints. In both sectors, government credit can be useful in overcoming obstacles faced by private intermediaries when lending entails initial fixed costs that intermediaries cannot recapture. Whether government intervention in credit markets can achieve legitimate objectives depends on the mechanism chosen to implement directed credit. In some cases influence-peddling and soft repayment constraints lead to inefficiencies from government involvement. In other cases these problems are avoided by establishing credible mechanisms that ensure the proper allocation and repayment of funds. Evidence on industrial credit programs in Japan shows an apparent link between that country's success in directing credit to machine-tool producers and the decision making process that governs the distribution of credit.

Eastern Europe's experience with banking reform: Is there a role for banks in the transition?

Abstract: Are there lessons to be learned about how Eastern European countries have dealt with problems in their banking systems? What role have these countries assigned to banks during the transition? How have they used banks in dealing with the enterprise problem? The author addresses these questions by analyzing experience in Bulgaria, Hungary, Poland, Romania, and the former Czech and Slovak Federal Republic. Most of these countries have made substantial progress in restructuring their banking systems, but few have used their banking systems to improve the allocation of credit and hence stimulate the supply response. The author finds the following. The problem is not whether banks hold nonperforming loans but how banks can avoid accumulating more nonperforming loans. The underlying problem is how to close loss-making and nonviable enterprises. The countries that have encouraged the establishment of new private banks, that have introduced regulation and supervision, and that have tried to make banks more competitive have been more successful at improving the allocation of credit and achieving more control over loss-making enterprises. Banks must focus on assessing risk - and for this, capital, private ownership, and adequate regulation are crucial. How quickly banks achieve independence in credit decisions depends on how fast new governance structures can be introduced. In this, the five countries have been less successful. The objectives of bank recapitulation should be to prevent banks from accumulating more nonperforming loans (that is, dealing with the enterprise problem) and to give them the governance structure that would prevent them from incurring new nonperforming loans. This requires introducing a system of risk and reward - by making banks comply with capital adequacy requirements, by privatizing a critical number of banks, and by introducing strong regulation and supervision. Government should see that banks provide efficient payment systems, the basis for trust in banking systems. Introducing adequate regulation and supervision has been difficult as it requires knowing what the banks' role should be. Evidence strongly supports the need to recapitalize and privatize a critical number of banks. Authorities cannot rely on banks to exert control on enterprises early in the transition. In the early stages, control over state-owned enterprises should be exercised by a semipublic institution.

Credit Unions and Low-income Communities

Abstract: Since the late 1980s the number of community-based credit unions in Britain has grown steadily. These are financial co-operatives based on low-income neighbourhoods, owned and controlled by local residents, which aim to provide savings and low-cost credit facilities to their members. Although located in economically disadvantaged communities, credit unions are not exclusively used by the poor. While better-off groups save and borrow more, a greater proportion of low-income users would not have purchased goods and services in the absence of a credit union. Credit unions are making useful but marginal contributions to the credit and debt problems of low-income families. They could probably achieve more with additional resources, but any intervention by external agencies should be sensitive and avoid damaging the strong mutual aid foundations upon which credit unions are based.

Bottomline Banking: Meeting the Challenges for Survival & Success

Abstract: Presenting a paradigm of banking, this book uncovers and tackles the pivotal changes that lie ahead. Areas covered include: shareholder value as the key barometer for charting success; management of credit risk to maximize risk-adjusted returns; and why embracing change means embracing the future.

The Valuation of Credit Risk in Swaps: Methodological Issues and Empirical Results

Abstract: Department of the Istitirto Mobiliare Italian0 in Rome. nancial institutions are more and more concerned with the credit risk of off-balance-sheet instruments. The valuation of derivative products has so F far been based on the assumption of no default risk, although the credit risk inherent in such instruments can have important implications for the management of risk exposure. Quantifying a “credit equivalent” for off-balance sheet operations allows a financial institution to determine the absorption of credit lines and to monitor exposure limits. In other words, it enables institutions to 1) include these operations in their general system of loan risk management, and 2) evaluate the results of their various activities in light of allocated capital. This article first discusses the nature of credit exposure of derivative securities, and outlines some standardized valuation criteria proposed by regulatory authorities. We then use historical data to quantify the effective credit exposures of various types of currency and interest rate swaps. Monte Carlo simulations allow valuation of the potential exposure bounds as a function of both residual life and the currency in which contracts are denominated. The resulting grid of Salues for particular types of swaps provides a tool for a prudent measurement of credit risk.

Reducing credit risk in over-the-counter derivatives

Abstract: During 1992, there has been much discussion of the staggering size and dramatic growth in the use of derivative and off balance sheet financial products and the potential risks these products present to the global financial system. A number of events in particular have led to greater concerns surrounding management of credit risk arising from derivative and off balance sheet products. While the term "derivatives" is used to describe a variety of nontraditional financial instruments such as interest rate swaps, financial futures, and options, most risk concerns are focused on the proliferation of over-the-counter (OTC) products which bear direct counterparty credit exposure. OTC derivatives include a myriad of swap and option products linked to interest rates, currencies, equities, and commodities. Unlike exchange traded futures and options contracts with margin requirements, OTC off balance sheet products incur credit risk due to the potential default of the counterparty prior to contract maturity. The bankruptcy of Drexel Burnham Lambert and the subsequent failures of the Bank of New England, Development Corp. of New Zealand, and British & Commonwealth Merchant Bank caused many market participants, especially corporations, European users, and investment funds, to restrict their OTC derivatives credit exposure to only AAA and AA firms) The more recent bankruptcies of Olympia & York and other corporate entities with fairly substantial derivative books further illustrated the dangers in conducting OTC derivatives business with weak corporate counterparties outside of the interbank arena. Besides the actual bankruptcies that have occurred, many other firms have been downgraded recently, causing credit sensitivity in OTC derivatives to increase substantially. Other factors contributing to the recent credit concerns include the increasing complexity and maturity of the deals, the increased participation of weaker corporations, uncertainty about legal remedies, and increased difficulty in judging the creditworthiness of derivatives users due to current accounting rules.' These credit constraints have the potential to impact the number and nature of market participants as well as impede the dramatic growth of off balance sheet financial products. Major commercial and investment banks that have been downgraded have already lost market share and fee income from high margin corporate customers that are in some cases authorized to deal with only AAA or AA firms. The remaining AAA and AA market makers are also reducing their exposure to the downgraded firms, threatening the ability of lesser rated entities to participate in these markets safely and profitably. These pressures could trigger a migration to exchange traded markets, especially in light of the fact that recent regulatory changes will likely

Fixing the Credit Problem

Abstract: A practical guide to rethinking the organization and management of a bank's credit processes Until recently, most European economies had witnessed relatively few bankruptcies, and their banks had enjoyed generous lending margins. This meant that the banks could succeed by avoiding truly bad loans: only minor benefit derived from being distinctively competent at risk rating, pricing, and monitoring. No longer is this the case. Throughout Europe, banks are now experiencing losses of unprecedented proportions. It is tempting to blame the current economic climate and hope that all will be better in a year or so, when the economy improves. But as a McKinsey study of credit risk management has found, both the underlying nature of the risk and its importance to a bank's profitability equation have fundamentally changed. So much so, in fact, that financial institutions need to develop a whole new technical and organizational approach to managing credit, which will radically alter the culture of traditional universal banks. "OF COURSE, financial ratios and local information are important. But one of my most reliable sources of judgment on credit risk is having my assistant observe the behavior of a client waiting for a credit negotiation meeting to begin." According to the senior credit officer of a major European bank, such "eye contact" methods have long characterized the art of lending. Together with limit hierarchies, multiple signature systems, and annual reviews, they helped banks to identify prospective bad loans. Most lenders, after all, were generalists skilled in relationship building, and they could, with training, provide adequate credit risk evaluation. For the most part, this approach worked well enough in an environment of comfortable margins and low loss levels, allowing banks to focus improvement efforts on volume growth and geographic diversification. In the meantime, however, the underlying nature of credit risk has changed, driven by four external forces: * Although bankruptcies are cyclical, the current environment has produced, in both commercial and personal segments, two to three times as many defaults as in past recessions. This is related to the increase in debt built into balance sheets now as compared with the late 1970s. It is likely that bankruptcies will continue to be cyclical but at a structurally higher level. * Disintermediation -- the process by which companies access the capital markets directly -- has continued to allow good credit to avoid the banking system entirely. This trend, combined with the rapid lending growth of the late 1980s, the mispricing of risks, and the development of new financial technologies such as securitization, has resulted in a deterioration of the balance sheet of the banking industry as a whole (Exhibit 1). * Margins for all lending, especially large corporate loans, have fallen dramatically over the past decade. This means that both the level of losses and their volatility are now fundamental determinants of profitability. In the past, they were a relatively stable and predictable cost of doing business. * The current recession has cut into the historic price stability of assets (particularly land and buildings) in a manner not seen in Europe for many years. This drop in wealth and income not only affects companies' ability to compete, but also means that the whole structure of bank collateral and guarantees is far less effective (Exhibit 2). To be fair, banks have, to some extent, seen this coming, and have made improvements at the margin (for example, by installing rating systems and relationship profitability models) to help measure risks. Yet most have not addressed the real challenge of radically revising the organizational processes, structures, incentives, and culture of their credit functions. The time has come to put such a challenge at the top of senior managers' agendas. …

Interest rate structure and the credit risk of swaps

Abstract: Swap contracts have grown tremendously in the last decade. Most are interest-rate swaps, the simplest being an exchange of one party’s fixed-rate interest payments for another’s floating-rate payments. Swaps can lower borrowing costs for both parties as well as provide a tool for managing interest-rate risk. As the market for swaps grows and matures, understanding and measuring the accompanying credit risk remains a concern of bankers, regulators, and corporate users ; The credit risk of swaps arises when one party defaults and interest rates have changed in such a way that the other party can arrange a new swap only on inferior terms. It involves only the cash flows exchanged by the counterparties, and not the underlying notional principal. Previous work has used simulations of the future course of interest rates to analyze swaps’ credit risk. This study adds the interest rate forecast implicit in the yield curve to the randomly generated interest-rate scenario used in the simulations. The author shows that credit exposure is greater for longer maturities and when future rates are expected to be higher, and that the risk rises and then falls over the life of the swap.

Aspects of credit and debt

Abstract: Perspectives on credit and debt in the 1990's credit and debt choices for poorer consumers lending to those in need the responsibilities of lenders, borrowers and regulators credit, class and the normalization of debt default economic factors in the regulation of the consumer credit market controlling unjust credit transactions lessons from a comparative analysis classification and control the role of social fund loans credit unions in the UK possible legislative reforms to the Credit Unions Act 1979 social lending in Europe.

Life Insurance Company Risk Exposure: Market Evidence and Policy Implications

Abstract: I. INTRODUCTION Failures of several large life insurance companies (LICs)--such as Mutual Benefit and Executive Life in 1991--raise the possibility of pervasive failures in yet another category of financial intermediaries that would require government intervention and taxpayer expense. ("LIC" refers to both life and life/health insurance companies.) Given the cost of the savings and loan (SL Kane, 1989; Brewer and Mondschean, 1994.) (iii) Most states allow LICs to credit guarantee fund assessments against premium taxes. Insurance failures thus could reduce expected tax revenues to state governments. Section II provides background information on recent industry performance and assesses the industry's current risk exposure. Section III analyzes several LICs that failed in 1991. Section IV examines the regulatory environment and the role of state guarantee funds. Section V reports empirical results on the stock market's assessment of LIC riskiness. Section VI discusses policy implications. II. BACKGROUND In the process of offering risk protection to customers, LICs expose themselves to a number of risks. Mortality and morbidity risk are related to the probability of a policyholder's dying, conditional on age, illness, and other variables. As financial intermediaries, LICs also face interest rate risk, credit risk, and liquidity risk arising from policyholders' right to borrow against policies or to cash in policies for their surrender value. Table 1 contains industry balance sheet data for selected years from 1970 to 1991. As of the end of 1991, LICs held over $1.5 trillion in assets. In the early 1980s, government securities as a percentage of total assets rose sharply. In the latter 1980s, corporate bond holdings also grew, especially between 1986 and 1988 when they rose from 36.5 to 41.2 percent of total assets. This rise in part was due to the growth in corporate debt securities that were not of investment grade--that is, that were "junk" bonds. From 1970 to 1991, direct mortgage loans declined from over one-third to less than one-fifth of total assets. These portfolio changes reflect the movement toward greater securitization of financial instruments as well as rapid growth in corporate debt outstanding. These securities have enhanced LIC portfolio liquidity but also may have exposed LICs to prepayment risk (in the case of mortgage-backed securities) and credit risk (in the case of junk bonds). The tables do not separate corporate securities from mortgage-backed securities because state insurance commissioners do not require LICs to separate these two classes of debt when reporting balance sheet data. Turning to the liability side of the balance sheet, one can observe the growing importance of pension and annuity business relative to traditional life insurance. Policy reserves for life insurance in force fell from 55.7 percent of total assets in 1970 to 24.0 percent in 1991 while reserves to cover annuity payments rose from 23.5 percent to 57.6 percent between 1970 and 1991. However, regulatory capital as a fraction of total industry assets declined from 9.4 percent in 1970 to 8.0 percent in 1991. Regulatory capital as a percent of general account assets (total assets less separate account assets) also fell from 9.7 percent in 1970 to 8. …

The International Rating Game: An Analysis of the Liability of Rating Agencies in Europe, England, and the United States

Abstract: I. INTRODUCTION In the business of debt and securities rating, the reliability of the agency rating is all important. Of the numerous rating agencies which exist,(1) only a hallowed few have a reputation for virtually unabridged reliability. But even these agencies make mistakes.(2) The largest of these have begun to branch out into the international financial markets as the companies they rate explore an increasingly global economy. Coupled with the international expansion of rating agencies and a growing potential for mistakes in foreign venues come disparate classes of liability in different jurisdictions. The globalization of national economies and the resulting development of international financial rating services is, in part, brought about by ever-increasing economic and political activity within the recently completed European Economic Area and border-free European Community,(3) as well as boom economies in the so-called "little dragons" of east Asia. In contributing to the discussion of economic globalization, we address the legal relationships between and the accountability of corporate raters to those rated and those who rely upon ratings and other kinds of rating agency communication. We take as our focus in this Article certain European Community jurisdictions and the United States not simply because they may be the venues for rating contracts and the sites where debt and securities rating liabilities will be determined, but further because the legal systems on both sides of the Atlantic will play a major role in influencing rating contracts and future liabilities of raters in Europe, America, and the world.(4) In establishing what the liabilities of rating agencies are and where those liabilities might expand, we look primarily at the duty of care of debt raters in England and the United States in two settings. First, we deal with a rating agency's duty of care to use reasonable skill where there is no contract with the injured party. Secondly, we look at possible defamation liability and defenses of rating agencies who falsely underrate the creditworthiness or securities offering of a company. In addition, we touch upon government influence over rating agencies in France and rating agency liability generally in Germany.(5) A. The Business of Rating Rating agencies are, simply put, predictors of a company's or even a government's ability to meet the financial obligations of its debt and its bond issues as they accrue. An agency's rating performs, according to one rater's definition, the isolated task of "credit risk evaluation."(6) In reality, the effect and influence of both the rater and its rating go far beyond this modest suggestion. Rating agencies rate everything from corporate public utilities and multinational corporations to municipal issuers and national governments as well as both foreign and English companies. Raters seek to remain independent from these issuers by refraining from direct investment in the companies they rate. The securities issuers sell bonds with varying degrees of security pledges and seniority and issue debt that is insured, structured, or otherwise complex. In the words of one rater, the rating of these varied types of debt and debt instruments provides "a single scale to compare among this array of different debt instruments."(7) In the case of American and British raters, rating agencies operate with no governmental mandate, subpoena powers or official authority. In France, the situation is somewhat different.(8) Raters consider themselves, at least in the case of the large American agencies, to be members of the media and thereby shielded from the usual liabilities, such as libel, by the substantial protections of the First Amendment.(9) Ratings, or credit risk evaluations, appear most often in the form of letter and/or number symbols.(10) From the rating agency perspective, a rating should be only one in a number of factors in the formation of an investment decision. …

Using auctions to allocate and price long-term credit

Abstract: Most long-term credit in developing countries is allocated through negotiated agreements between government institutions and financial intermediaries or final borrowers, and often at administered rates. Yet may developing countries have no long-term credit market whose interest rates can be used as benchmarks for these loans. If credit is priced improperly, it will be allocated inefficiently and the development of capital markets may be stunted. In light of the generally disappointing experience with conventional methods of allocating development credit, some countries have introduced credit auctions as an alternative. Among the advantages are greater transparency and fairness, lower transaction costs, and increased competition and efficiency. Among the disadvantages are a greater vulnerability to collusion, which can lead to lower interest rates and revenue, and a tendancy to attract the least desirable participants (adverse selection) and to lend for riskier projects (moral hazard), which can lead to lower repayment rates and a higher probability of default. All these factors can lead to inefficiency in the allocation of funds. This article suggests ways to lessen these negative effects and presents various elements of auction design that affect the efficiency of credit auctions and their suitability to specific circumstances. When properly designed, auctions can be used in a variety of environments to allocate development credit more efficiently than current methods do.

Islamic credit: the iranian experience

Abstract: The replacement of the Shah's regime by an Islamic fundamentalist government in Iran resulted in the outlawing of interest-bearing credit and its replacement with a credit system which accords with the teachings of the Koran. Two forms of credit are acceptable: interest-free loans, and profit-and-loss-sharing loans. Although the latter have assumed only a small proportion of lending by the Agricultural Bank, they are potentially attractive to small risk-averse farmers because of their risk-sharing characteristics. In particular, they pass part of the business risk (e.g. due to uncertainty in yields and prices) back to the lender and avoid creating any financial risk for the borrower. A model is developed to explore the impact of Islamic credit on borrower behaviour and a numerical illustration is also provided. Results of a farm survey are reported, and indicate that small risk-averse farmers prefer the Islamic credit system, whilst medium and large-scale farmers prefer interest-based credit. Some of the obstacles to more widespread uptake of the Islamic credit system in Iranian agriculture are identified.

The Incidence of Risk under Credit Insurance

Abstract: The incidence of risk under a credit insurance policy depends on the original term of the policy and the policy duration at which the incidence of risk is considered. Section 3 of the paper describes the procedure used to fit a bivariate function to this incidence. Section 4 gives the numerical detail of this model. Section 5 makes a comparison of the model with the data from which it was developed. Section 6 adds some general comments.

Assessing the Market and Credit Risks of Long-Term Interest Rate and Foreign Currency Products

Abstract: (1993). Assessing the Market and Credit Risks of Long-Term Interest Rate and Foreign Currency Products. Financial Analysts Journal: Vol. 49, No. 4, pp. 75-79.

Interest Rate Products

Abstract: This chapter presents some perspectives on the current and prospective range of interest rate derivative products, in addition to some applications and regulatory implications. Amid the growth in innovations which continues from the previous decade, the banking industry of the 1990s will be faced with increased competitive pressures and a tighter regulatory regime; its customers will benefit from an unprecedented array of products offered, but will need to learn how to take maximum advantage of these instruments.

Classification of Risk

Abstract: As indicated in our risk management framework in Chapter 2, the accurate classification of risk is a vital first step in the entire risk management process. If a bank is unable correctly to identify and classify the risks it is facing, it will be unable to measure risk exposure properly. This chapter is devoted to a description of the different types of risk a bank is likely to face in the normal course of business.