Volume 4— Credit Risk Management © Copyright 2002, CCRO. All rights reserved. 17 V MONITORING Integral to the success of managing counterparty risk is a comprehensive set of procedures and information systems to monitor counterparty credits across various portfolios. These procedures should define criteria for identifying and reporting potential problem credits and transactions to ensure that they are subject to more frequent monitoring as well as possible corrective action, reclassification, and allocation of appropriate reserves. (See the Governance and Controls White Paper for information on segregation of duties.) Key monitoring aspects of an integrated credit risk management system follow. • Allow for monitoring to occur at various levels within the organization – management, operational, and analyst • Ensure that the company understands the current financial condition of the counterparty • Monitor compliance with existing contractual provisions • Identify contractual payment delinquencies and classify potential problem credits on a timely basis • Direct problems for corrective action • Monitor the composition and quality of the credit portfolio • Identify areas of concentration • Determine the adequacy of reserves (Note that there are a number of approaches for determining adequate reserves. The Credit department should work with the Accounting department to determine the right approach.) • Capture current and potential counterparty exposures that are large relative to allocated capital resources, including large exposures with low probabilities of default and smaller exposures with high probabilities of default • Identify correlated risks, including correlated market and counterparty credit risks • Identify uncorrelated risks that may become large if they become correlated under stressed market conditions. For the various components of credit administration to function appropriately, senior management must understand and demonstrate that it recognizes the importance of monitoring and controlling credit risk and must allow proper systems, policies, and procedures to be put into place. The complexity of many credit exposures requires utilizing an approach based on large risk reporting, not just large exposure reporting. Large exposures might include exposures that are large in absolute size, large relative to their applicable limits, large within their rating categories or large in terms of economic capital usage (large risks).