Exemplar Case Study On Risk Management To Write After

Wellfleet bank faces a number of risks that include credit risk, political risk, reputation risk, market risk, country risk, operational risk, liquidity risk, and compliance risk. In reviewing the proposal to extend a credit facility of $1 billion to Gatwick Gold Corporation (GGC), the bank is facing credit risk, liquidity risk, reputation risk, and operational risk.
GGC is requesting the $1 billion credit facility in order to redeem a convertible bond that had a conversion price of $65 per share. Wellfleet expect that GGC will draw the entire $1 billion and in case of default, the loss would be significant. The bank’s model estimate GGC to have a credit score of 5B that translates to a probability default range of between 30% - 43%. The expected loss from such a loan using the probability would be between $300 million and $430 million. That represents a significant amount of credit risk. However, the bank intends to sell of half the loan to other lenders and this would reduce the credit risk by half.
The amount involved in the transaction is quite large, and in case of default or delay in recovery of the loan, the bank may not have sufficient liquidity to meet demand for withdrawals. An in ability for the bank to meet withdrawal demands would likely trigger a panic amongst depositors and would adversely affect the bank’s reputation as a credible financial institution.
The operational risk emanates from the probability the models that the banks are using to forecast the risk of the transaction may be wrong. In case of errors in the model, there is a possibility that the bank would misprice risk and either refuses to grant credit to otherwise borrowers of good credit standing and miss the profits on such a transaction, or grant credit to a borrower of dubious credit and suffer default losses.