Investors, e.g., lenders, are exposed to the obligors, e.g., borrowers.
Any default of the obligor from fulfilling the agreed obligations will result in losses, in most times, to all parties involved in the agreement. In a loan, for example both the lender and the guarantor are exposed to the borrower.
Any credit event on default or downgrading of the borrower will result in economic losses to both lender and guarantor as well as loss in the obligor's solvency.Credit exposure is a fundamental measurement in credit risk analysis. There are different types of credit exposures that an investor, e.g., credit institutions, or a lender in a market place lending system, must identify, measure and report. As illustrated in Figure 9.1, the gross exposure at a current or future point in time is separated into the net amount of credit exposure and the amount covered by credit enhancements. The former (also called exposure at default) contains the expected recoveries whereas the latter is expected to have fluctuations since it is market driven. Recoveries together with credit enhancements define the gross recovery of the exposure. When it substitutes the gross exposure, the loss given default is defined.
In this chapter, we will discuss the main types of credit exposures, with particular emphasis on the ones that are considered in the analysis of loan portfolios. Such exposures are mainly used to estimate the expected credit losses.
9.1