Question

Discuss bank actions and solutions to minimize loss from rising credit risk and bank insolvency.

Answer 1

The credit risk for the bank has increased significantly and it further becomes a serious concern for the bank when the economy is going through recession. In these circumstances the banks face liquidity issues and some banks even are not sure to lend other banks at federal funds rate to meet the excess reserve requirement. The banks have taken actions in the past to reduce the credit risk like taking a hedge on the high-risk portfolio. Most banks have asset-liability risk management committee which make sure that there is not too much duration gap between its asset and liabilities. On the consumer side the bank has increased the requirements like high credit score, Collateral requirement and reducing the loan to value ratio. High credit score does protect the bank that low credit score people are not taking up too much of banks loan portfolio. Collateral helps the bank in recovering in the case when the borrower defaults the bank can recover their money from the collateral. Reducing the loan to value ratio is when banks reduces the amount of loan it is providing against a collateral. On the bank side which are facing liquidity crisis because of some issues on their balance sheet the regulator normally either infuses capital or ask the promoter of the banks to raise fresh capital to meet the requirement. If they are not able to do then the regulator might recommend the merger of the banks with the other bank.