CASE STUDY
Risk Management at Wellfleet Bank
The 2007-2010 financial crisis has brought credit risk and default to the forefront of the regulatory and political discussion. This case illustrates risk management in the world of corporate lending which is quite different from the retail, subprime, and mortgage lending at the root of the recent banking turmoil. It is also interesting because Wellfleet (actually, Standard Chartered PLC; ticker symbol: STAN) is one of the few banks which successfully weathered the 2007-2009 credit crisis. Chief executive Alastair Dowes has to decide if the risk governance process is adequate to uncover mega-risks in light of the current risk-assessment process and the credit decision regarding a $ 1bn loan application. Working for the Chief Credit Officer (CCO) as a senior loan supervisor, you have been asked to assess and review the risks in the proposal and to make a credit recommendation, i.e., whether Wellfleet should accept the loan application or not. At the same time, you are worried about gray-area risk decisions and, in particular, the fact that risk-adjusted performance measurement can rarely be automated. Risk governance requires executives to strike a balance between risk modeling and qualitative business judgment a holistic (rather than silo-based) view of risks.
You are preparing either an executive memo to the CCO and CEO or a presentation to WellFleet's credit committee. The following questions are meant to guide your analysis:
1. How much credit risk should banks take? What avenues do they have to manage credit risk ex ante and ex post? 2. Research the history of WellFleet = Standard Chartered. How well has Wellfleet performed? Why and how has it avoided major problems in its corporate loan portfolio? Was the bank lucky or smart?
3. Analyze the risk management process at WellFleet Bank. What suggestions might you make to the CEO about improving the process?
(a) What are the objectives of loan officers and supervisors, respectively? What about the risk management unit? (b) Are the incentives of line and risk management units aligned? Why or why not? (c) How would you organize origination and risk management activities?
4. What risk factors drive the credit exposure to Gatwick? Analyze what a credit bet on Gatwick really amounts to.
(a) Download stock prices for pure gold-mining companies such as Barrick (ticker: ABX) and Newmont (ticker: NEM) as well as a gold prices and the S&P 500. Calculate the instanta-neous return Rit = In (pP.titi ). (b) Compute the correlation matrix for the 4 variables. How would you interpret the results? (c) Run a CAPM-type regression of the gold-miner's return Rit on a constant, the S&P 500 return Rmt the gold return Gt by OLS, i.e., estimate the following model: Rit = a +131:17nt +PyGt+ Et How would you interpret the results? What does it tell you about the credit exposure?
5. Calculate the Expected Loss, Economic Revenue, and Economic Pro t for the proposal. What would your decision regarding the credit proposal be? Why?
(a) What steps if any could Welleet take to reduce its credit exposure to Gatwick?
(b) What avenues are open to the bank to manage its credit exposure ex ante (before and in the lending process) and ex post (after the loan went onto its books)?
6. Given Welleet's new focus on large corporate deals and its need to recruit relationship managers from investment banks, what are the challenges for the risk culture of the organization, and its style of risk management in particular?