The credit lifecycle · RiskAtoms Academy

By the end you will be able to

1Describe the stages of the credit lifecycle, from origination to collections and recovery, and what is decided at each.
2Explain delegated authority, the credit committee and the four-eyes principle, and who sits in which line of defence.
3Find your way around RiskAtoms Bank's credit book: its corporate borrowers, retail segments and master scale.
4Compute a facility's EAD, LGD and expected loss the way the book does, and see how a new request changes them.

Why it matters

Sallowmere Logistics, a German warehouse operator, wants RiskAtoms Bank to raise its credit line from £55m to £70m. The relationship manager who looks after the company is keen: more lending, more fees. Before a penny moves, the request will be analysed, rated, written up, challenged by someone with no stake in the deal, approved by a committee, documented and then watched for as long as the loan is alive. Most credit losses can be traced to a step in that chain that was skipped or rushed.

Core explanation

The life of a loan

L2.2.03: Credit and counterparty risk named credit risk and its three numbers: the probability of default (PD), the loss given default (LGD) and the exposure at default (EAD). L1.2.01: Commercial banks: the business model showed why lending is a bank's core business. This module follows how a bank actually runs that risk, loan by loan, using one book throughout.

Illustrative dataRiskAtoms Bank plc's credit book

One made-up lending book, in pounds, at one made-up year end: twelve invented corporate borrowers (exposure at default £587m, expected loss £2.81m a year), 152,100 retail accounts in mortgages, personal loans and cards (exposure £4.485bn), a ten-grade master scale and an illustrative rating transition matrix. No firm or person in it is real. The same book runs through every lesson in Module 3.3, so the figures agree from lesson to lesson.

Six stages

Every loan, from a credit card to a syndicated loan to a utility, passes through the same credit lifecycle. Retail lending runs it at industrial scale, with scorecards and automated rules; corporate lending runs it by hand, with analysts, credit papers and committees. Click each stage.

ExploreThe credit lifecycle

Click a box to see what happens there.

1. Origination

The relationship manager (or, for retail, an application form or app) takes in the request: how much, for what, for how long, and with what security. The bank checks who the client is (know-your-customer and anti-money-laundering checks) and gathers accounts, forecasts and bureau data. A deal that does not fit the bank's risk appetite (L2.3.05: Risk appetite frameworks) should stop here.

Who decides: delegated authority and four eyes

The board sets the bank's appetite for credit risk and delegates the power to approve loans down a chain, with smaller limits at each step. RiskAtoms Bank's grid gives each approver a cap on the total limit to one borrower group, lower for weaker grades: a credit officer may sign up to £25m for a grade 1–5 borrower but only £5m for grade 8–9. Above the credit committee's cap, the board's risk committee decides. Today 6 of the twelve corporate limits sit with a senior credit officer and 6 needed the credit committee.

The four-eyes principle means no one approves their own deal. The relationship manager is in the first line of defence (L2.3.04: The three lines model): paid partly on volume, so keen to lend. The credit officer who approves sits in an independent credit risk function, with a reporting line to the chief risk officer, and is judged on losses, not volume. A credit committee adds more eyes and a written record of who agreed to what. The tension between the two sides is the point.

Sort itWhich stage is it?

Put each task in the stage of the lifecycle where it belongs.

Checking the identity and owners of a new corporate client before taking its application.
Calculating debt to earnings from three years of accounts and writing the credit paper.
A senior credit officer cuts the requested limit by £5m and asks for a charge over the warehouse.
The quarterly covenant certificate shows interest cover has fallen from 4.5 to 3.2 times.
A credit card customer two payments behind is offered a six-month repayment plan.
The bank sells a defaulted borrower's lorries and applies the proceeds to the loan.

The book we will follow

RiskAtoms Bank's corporate lending is twelve borrowers in eight sectors and five countries, with £692m of limits, £474.5m drawn and an EAD of £587m. Its largest exposure is Pellcourt Properties Ltd at £120m; its largest expected loss is Graybeck Plastics Ltd, a grade 9 subordinated loan, at £1,018k a year. The grade is the bank's own rating on its ten-grade master scale (grade 1 strongest, grade 10 the watchlist), built in L3.3.04: Internal ratings and master scales.

Borrower	Grade	Limit	Drawn	EAD	LGD	EL a year	Approver
C01Thornvale Engineering LtdManufacturing, UK	4	£60.0m	£45.0m	£52.5m	31.0%	£45.6k	Senior officer
C02Bramwick Stores plcRetail trade, UK	6	£80.0m	£70.0m	£76.0m	45.0%	£386.5k	Committee
C03Pellcourt Properties LtdReal estate, UK	5	£120.0m	£120.0m	£120.0m	10.9%	£74.4k	Committee
C04Ostreth Energie GmbHEnergy, Germany	3	£100.0m	£40.0m	£70.0m	40.0%	£39.2k	Committee
C05Larkhollow Freight LtdTransport, UK	7	£30.0m	£26.0m	£29.0m	35.1%	£230.1k	Senior officer
C06Mirefield Care Homes LtdHealthcare, UK	6	£45.0m	£42.0m	£44.3m	19.3%	£96.5k	Committee
C07Quorrel Systems BVTechnology, Netherlands	5	£50.0m	£10.0m	£30.0m	45.0%	£77.0k	Senior officer
C08Hastemoor Construction LtdConstruction, UK	8	£25.0m	£22.0m	£24.3m	55.0%	£604.2k	Committee
C09Vellacourt Hôtels SASReal estate, France	7	£40.0m	£38.0m	£39.0m	21.7%	£191.2k	Senior officer
C10Cindral Pharma IncHealthcare, US	2	£75.0m	£15.0m	£45.0m	40.0%	£12.6k	Committee
C11Graybeck Plastics LtdManufacturing, UK	9	£12.0m	£11.5m	£12.0m	75.0%	£1,017.9k	Senior officer
C12Sallowmere Logistics GmbHTransport, Germany	4	£55.0m	£35.0m	£45.0m	30.8%	£38.9k	Senior officer

The retail book is far bigger and far more granular: 152,100 accounts and £4.485bn of EAD. Its expected loss is £19.96m a year, 0.45% of EAD, against 0.48% for the corporate book.

Portfolio	Segment	Accounts	EAD	PD	LGD	EL a year
Mortgages	LTV up to 60%	9,800	£1,470m	0.3%	5%	£0.22m
Mortgages	LTV 60–80%	8,200	£1,640m	0.6%	12%	£1.18m
Mortgages	LTV 80–95%	3,100	£710m	1.5%	20%	£2.13m
Personal loans	Score band A	21,000	£190m	1.2%	65%	£1.48m
Personal loans	Score band B	14,000	£130m	3.5%	70%	£3.19m
Personal loans	Score band C	6,000	£50m	9.0%	75%	£3.38m
Credit cards	Transactors	52,000	£91m	0.8%	80%	£0.58m
Credit cards	Revolvers	38,000	£204m	4.5%	85%	£7.80m

The formal version

How the book turns a facility into an expected loss

Each corporate facility $i$ has a limit $K_i$ , a drawn amount $U_i$ , a credit conversion factor $\mathrm{CCF}_i$ for the undrawn part, collateral worth $V_i$ with a haircut $h_i$ , and an LGD $\mathrm{LGD}^{u}_i$ on any unsecured part. The book combines them in four lines (each gets its own lesson: EAD in L3.3.09: Exposure at default, LGD in L3.3.08: Loss given default and recovery, EL in L3.3.10: Expected loss):

\begin{aligned} \mathrm{EAD}_i &= U_i + \mathrm{CCF}_i\,(K_i - U_i) \\ C_i &= \min\!\big(\mathrm{EAD}_i,\ (1-h_i)\,V_i\big) \\ \mathrm{LGD}_i &= \frac{\mathrm{LGD}^{u}_i\,(\mathrm{EAD}_i - C_i) + 10\%\times C_i}{\mathrm{EAD}_i} \\ \mathrm{EL}_i &= \mathrm{PD}_i \times \mathrm{LGD}_i \times \mathrm{EAD}_i, \qquad \mathrm{EL}_{\text{book}} = \sum_i \mathrm{EL}_i \end{aligned}

The part covered by collateral after its haircut, $C_i$ , still loses 10% (sale costs and delay); the rest loses the unsecured LGD. The PD comes from the borrower's grade. For Thornvale Engineering Ltd (grade 4, limit £60m, drawn £45m, CCF 50%, collateral £30m with a 30% haircut):

\begin{aligned} \mathrm{EAD} &= 45.0 + 0.50 \times (60.0 - 45.0) = \text{£}52.5\text{m} \\ C &= \min(52.5,\ 0.70 \times 30.0) = \text{£}21.0\text{m} \\ \mathrm{LGD} &= \frac{0.45 \times (52.5 - 21.0) + 0.10 \times 21.0}{52.5} = 31.0\% \\ \mathrm{EL} &= 0.28\% \times 31.0\% \times \text{£}52.5\text{m} = \text{£}45{,}570 \end{aligned}

Summed over the twelve borrowers, the book's EAD is £587m and its EL £2.81m a year. These two totals are the anchor for the whole module.

Try it

Pick a borrower, ask for a new limit and move its grade. The grid shows who must approve; the readouts show what the request does to the bank's numbers. Try Sallowmere Logistics GmbH at £60m and then £61m, and then make it grade 6.

Try itWho signs off this limit?

Borrower

Limit requested£70m

Grade at review4 (today)

Grade band	Credit officer	Senior credit officer	Credit committee	Board risk committee
Grades 1–5	up to £25m	up to £60m	up to £150m	above £150m
Grades 6–7	up to £15m	up to £40m	up to £100m	above £100m
Grades 8–9	up to £5m	up to £15m	up to £50m	above £50m
Grade 10	none	none	up to £25m	above £25m

Approved byCredit committee

Proposed byRelationship manager

Share of corporate book EAD8.8%

EAD today → requested£45.0m → £52.5m

LGD30.8% → 32.9%

Expected loss a year£38.9k → £48.3k

EAD = drawn £35.0m + 50% of the undrawn part. Collateral stays at today's value, so a bigger limit raises LGD as well as EAD. A weaker grade both raises the PD and lowers every approver's authority.

Worked example

Sallowmere's request, from origination to drawdown

Sallowmere Logistics GmbH: £55m to £70m

Step 1 of 6

1
Origination
The relationship manager receives the request: a £15m increase in the revolving facility to fund two new warehouses, with three years of accounts and a business plan. The company already has £35m drawn of £55m, secured on property worth £28m.

Regulatory lens

The Basel Committee's Principles for the Management of Credit Risk (September 2000) group sound practice under four headings: an appropriate credit risk environment, a sound credit-granting process, proper credit administration, measurement and monitoring, and adequate controls over credit risk. In the European Union, the European Banking Authority's Guidelines on loan origination and monitoring apply to loans granted from 30 June 2021 and set detailed expectations for creditworthiness assessment, credit decisions, pricing, collateral valuation and monitoring, including early-warning indicators and watchlists. How credit risk turns into capital requirements is in M4.2: Credit risk capital.

Spark Atoms

Spark AtomCredit means belief

The word comes from the Latin credere, to believe or to trust. Every stage of the lifecycle is a way of checking whether that trust is still deserved.

Spark AtomWhen the lender does not keep the loan

Before 2007 many US mortgages were made to be sold on in securitisations (“originate to distribute”). Amiyatosh Purnanandam (2011) found that banks most active in that model made markedly poorer-quality mortgages that are not explained by what was observable about the borrowers: a lender that will not bear the loss has less reason to screen.

Key takeaways

Every loan passes through origination, analysis and rating, approval, documentation and drawdown, monitoring, and repayment or collections and recovery.
Delegated authority caps what each approver may sign, by size and grade; weaker grades go higher up the chain.
Four eyes: the business proposes, an independent credit function approves. The tension is deliberate.
The book computes EAD = drawn + CCF × undrawn, LGD from the collateral cover, and EL = PD × LGD × EAD.
RiskAtoms Bank's corporate book: twelve borrowers, EAD £587m, EL £2.81m a year. Retail: £4.485bn of EAD.

Reaction

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Glossary

Credit lifecycle: The stages a loan passes through: origination, analysis and rating, approval, documentation and drawdown, monitoring, and finally repayment or collections and recovery.
Origination: Finding and taking in a borrower's request for credit, with the information needed to judge it.
Relationship manager: The banker who owns the client relationship and proposes new lending. Part of the first line: the business.
Credit paper: The written case for a credit decision: who the borrower is, what it wants and why, the analysis, the rating, the risks and the proposed terms.
Delegated authority: The limits, set by the board, on how much credit each person or committee may approve, usually by size and by grade.
Four-eyes principle: The rule that no credit decision is taken by one person alone: someone independent of the proposer must check and approve it.
Credit committee: A group of senior credit officers (and often business heads) that approves the largest or riskiest loans.
Covenant: A promise in the loan agreement, such as keeping debt below three times earnings. A breach lets the bank renegotiate or demand repayment.
Conditions precedent: Conditions precedent: what must be in place (signed documents, security, insurance) before the borrower may draw the money.
Annual review: The periodic (at least yearly) re-examination of a borrower: new accounts, a new rating, and a decision to keep, change or reduce the limit.
Collections: Chasing missed payments on loans that are behind, mostly retail, by letters, calls and payment plans.
Workout: The specialist team that takes over a troubled or defaulted corporate loan and tries to maximise what the bank recovers.
Limit and drawn amount: The most the borrower may borrow under a facility. The drawn amount is what it has borrowed so far.

Deep Dives & Origins

Deep Dives

J. Bessis, Risk Management in Banking, 4th ed., Wiley, 2015, the chapters on credit risk and the credit process. Intermediate.
J. B. Caouette, E. I. Altman, P. Narayanan and R. Nimmo, Managing Credit Risk, 2nd ed., Wiley, 2008. Intermediate.

Origins

Basel Committee on Banking Supervision, Principles for the Management of Credit Risk, Bank for International Settlements, September 2000.
European Banking Authority, Guidelines on loan origination and monitoring (EBA/GL/2020/06), May 2020.
A. Purnanandam, “Originate-to-distribute model and the subprime mortgage crisis”, Review of Financial Studies 24(6), 2011, pp. 1881–1915.

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