Major Portfolio Risks

Portfolio Management Issues: To manage a credit portfolio well, an individual needs to know all the risks associated with the portfolio and not just the firm credit risk involved. A portfolio provides a holistic view of the pooled risks. The choice to undertake a relevantly greater risk at a firm level becomes feasible if the portfolio risk stays within an acceptable tolerance level. This portfolio perspective is more pertinent now as more markets are facing increasing competition.

Concentrations and Correlations: The knowledge of portfolio risk is necessary to determine, monitor, and control risk correlations, on a regular basis. Frequent review of the credit portfolio addresses the following issues.

  • Increase or decrease in the size of the portfolio
  • Adequacy of provisions
  • Industry Concentrations
  • Exposure of derivatives
  • Credit-grade portfolio movements
  • Other relevant credit issues.

Credit quality dilemma: The knowledge of portfolio risk is helpful in monitoring the credit quality of loan portfolios. The variables that are important in this regard are the industry exposures with higher risks, which need to be managed through the imposition of exposure caps. After a portfolio approach in credit risk analysis is carried out, a knowledge base and expertise can be established in credit/lending to specialised industries. It is helpful to place caps or manage down concentration and tackling of possible weaknesses in the portfolio. A good comprehension of credit portfolio risks indispensible in order to execute tasks with the purpose of attaining maximum credit quality.

Diversification Issues: Diversification is the prime objective of businesses with significantly sized credit portfolios. Careful diversification involves scientific function of determining numerous credit asset correlations and minimizing the overall portfolio credit risks is a pre-requisite for developing an optimally diversified portfolio.

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