Default Risk and Limit System 

Purpose

This component enables you to measure, analyze, and control default risks. Default risk refers to the potential loss arising from a financial transaction should the business partner not fulfill his contractual obligations either due to specific, economic or political reasons. Default risks are classified as follows:

Counterparty/issuer risk describes the danger of a loss in the value of a receivable due to a worsening of the creditworthiness of the business partner. Country risk is similar to counterparty/issuer risk but refers instead to a worsening of the creditworthiness of a country relevant for country risk. It is used to describe the country that influences the payment of a transaction. Counterparty/issuer risks are subdivided into credit risk and settlement risk (previously divided into third-party settlement risk and direct settlement risk).

Settlement risk is calculated only as part of counterparty/issuer risk.

The existence of credit risk and settlement risk depends on when the transaction is analyzed. Credit risk exists over the whole term of the transaction. Settlement risk exists only during the settlement period. Credit risk can consist in just a counterparty risk, or an issuer risk, depending on the transaction category (for example, securities transactions).

The country risk functions are used in SEM Banking only, and are not available in TRM. The documentation refers to the relevant functions.

Implementation Considerations

The monitoring of market prices and default risks resulting from trading transactions by means of a system of risk-controlling limits is a requirement of banking supervisory bodies, and a recommendation of the Basel Committee on Banking Supervision. In Germany, for example, the German Federal Banking Supervisory Authority requires the overall risk situation of the bank to be compiled and represented daily, as well as up-to-date information from the respective traders concerning their utilization of the relevant limits.

Features

·        Attributable Amount Determination - Market-Based Quantification of Various Exposures

The system calculates attributable amounts for each single transaction entered, showing the risk content of the respective transaction. Credit and settlement risks from classic credit transactions and trading book transactions are taken into account when quantifying default risk. Default risk is calculated based on counterparties and issuers.

The default risk amount of classic credit transactions is calculated from the amount of capital committed, and the current drawn amount.

The default risk amount of trading transactions depends upon the potential replacement cost that would arise if the business partner defaulted. Any additional loss from a potential positive change in the market value of an existing transaction can be covered by transaction-specific markup rates.

The calculated risks are assigned to all the portfolio segments affected, for example, the counterparty, the industry sector, the product, or a combination of these.

·        Limit Management – Controlling Risk by Setting up and Monitoring Limits

You set up various limits centrally in Limit Management. These can relate to one or more criteria (Limit Characteristics). Limits reflect the allocation of the total limit within the bank as a whole.

·        Updating Limits and Comparing Attributable Amounts with Limits

When you create a transaction, you can use the single transaction check to measure the risk of the transaction, and to check the transaction against the relevant limit. In end-of-day processing, or in the single transaction check, the utilization of limits by transactions can be updated. For risk control purposes, the relevant limit utilizations are shown in aggregated form.

You find the functions of the Default Risk and Limit System in the application by choosing Accounting ® Bank Applications ® SEM Banking ® Default Risk and Limit System. All subsequent menu paths contained in the documentation for the Default Risk and Limit System start from this point.

You find the corresponding Customizing settings in the Implementation Guide by choosing SAP Banking ® SEM Banking ® Default Risk and Limit System.