When market and credit risk collide
The financial crisis highlighted that interactions between market risk and credit risk could expose banks to greater risks than had been assumed. Banks are responding by altering their structure and the models they use – but it is by no means an easy task. By Peter Madigan
It all used to be so easy. A loan intended to be held to maturity was put in the banking book, with changes in credit risk closely monitored. Shifts in market prices didn’t really matter – the primary risk was default. Meanwhile, if an instrument was expected to be held for a short period, it was dumped in the trading book, where it was perceived to be subject to market risk. In this simple view of the world, credit risk wasn’t really an issue for trading book positions. Liquidity risk barely
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