Collateral Risk Framework for Lombard Loan

The collateral risk framework shows the assessment of the risk of collateral for Lombard Loan
Diagram: Collateral Risk Framework for Lombard Loan
When it comes to Lombard Loan, Collateral risk always plays a critical role. Banks can either take it from third party's agencies like Moody or assess it themselves.
This article describes a Collateral Risk Framework that could be implemented in the risk management system.

Framework Input

There is no absolute Collateral Risk Rating which is a relative value against the benchmark of the relevant industry. We need to get the industry statistics in various aspects of a company as an input to the framework.

In addition, we need the latest and historical financial data of the company. In general, only shares or debts of listed companies are used as collateral, so this financial data is public information and could be obtained from the company's web site or the corresponding exchange.

We also need the company demographic data such as number of staff, years of operation, etc. The demographic data is also a means to quantify the qualitative data, such as the experience or integrity of the management. So that it could be used in the collateral risk assessment.

Lastly, other economic and market data, such as interest rate, exchange rate, country population, GDP, share price, etc, are also required as the input of the framework.

Assessment Model

The assessment model is a collection of financial models and business rules that analyze the input for the collateral risk. It varies from industry to industry. In general, following assessments are conducted.

  • The financial figures, such as liquidity ratio, debt level, net profit, cash flow, etc. These figures are important indications to the credit risk. For instance, the higher the liquidity ratio, the lower the collateral risk.

  • The consistency of the financial figures across the last 3 to 5 years. A single year financial figure is insufficient to evaluate the credit year. For instance, a consistent profitability means lower collateral risk.

  • The equity price volatility and liquidity. The higher the price volatility and lower liquidity, the lower the confidence of the investors and the higher the collateral risk.

  • The level of business diversification. There are various diversifications, such as product, market, operation, etc. The higher the diversification, the lower the collateral risk.

By having this information in numbers, the framework could evaluate the collateral risk that could be used in collateral valuation.

Thank you for reading this article. For the details of Lombard Loan and collateral risk, please contact us.

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