Loan advice

Banks have many different types of exposure to larger corporates including the following:

Credit products. Direct loans to the holding companies or subsidiaries of the group, syndicated loans and facilities. Some of these loans may be in foreign currency and booked in overseas branches. The bank may also hold some of the company’s commercial paper and bonds.

Guarantees. Guarantees for letters of credit and so on. The main company of an extended group may have taken loans itself and also have acted as a guarantor for loans made to subsidiaries, associates or other companies with which it has a relationship. Derivatives. A bank may have multiple exposures in the form of derivatives such as interest rate and foreign currency swaps, futures and forward contracts. At any given moment in time some of these positions may result in a credit risk where the bank is a net receiver. Positions where a bank is a net payer and there is no current credit risk may change over time and the bank becomes a net receiver. Settlement exposures. The bank is also likely to have short-term exposures from ongoing settlement of trades and other customer-driven transactions. The level of these exposures will vary from day to day and is normally subject to bank-imposed limits.
For large complex groups collateral and guarantees also pose specific problems and for larger companies that have better credit ratings than the banks themselves many short-term exposures will in practice be unsecured at the group level.
In developed markets virtually all large corporates are subject to credit rating agency scrutiny and while this does not completely remove the responsibility for the bank to perform its own credit risk assessment these will be largely based on work already done by the rating agencies.
Some common errors that banks make are assuming that a company is too large to fail, that the government will honor historic but implicit guarantees and bail out creditors to partic- ular companies and a failure to ensure that cross-border group-level guarantees are legally enforceable.
Large companies that default are only very rarely liquidated and restructuring agreements usually involve scores and even hundreds of financial creditors, multiple legal actions and claims. They can drag on for years and result in considerable legal and other costs.
Default probabilities can be estimated from historic bond default data, where this is avail- able. Losses on secured loans and derivative positions can be estimated based on the volatility of the prices of pledged collateral and recovery rates.