Overview
The current example of performance attribution breaks out the banks pnl among the deposit group, each loan division, and the treasury. However, it does not attribute bank PnL to the various risks that the bank takes. In order to effectively do this, the bank sets up various risk desks that sell derivatives to the other desks that hedge out each risk.
Credit Desk View
The first risk that a bank faces in a customer loan, is credit risk, that is, the risk that the borrower will default on their loan.
To attribute the bank PnL to this risk, the bank sets up a credit desk. This desk is solely responsible for selling credit default swaps to the various loan departments in order to hedge out the credit risk on the loan.
From the loan department's perspective, it enters into the following transaction.
Now the loan department is hedged from credit risk. The credit desk should charge a premium that is the equivalent of what the market would charge the bank.
Option Desk View
In addition to hedging out credit risk, the loan department will want to hedge the prepayment risk (if present). In order to do this, the bank sets up an option desk, that sells an option to the loan department. The option desk should charge a premium that is the equivalent of what the market would charge the bank.
Liqudity Desk View
If a bank decides to charge a liquidity charge against the loans it makes, it may set up a liquidity desk which functions like the other risk desks. It sells a liquidity option to the loan originators.
In reality, the liquidity desk is typically just a fiction, set up in order to track liquidity risk. That is, it collects the liquidity charge that are assigned to each loan. This is done so that the liquidity charge can be tracked, and moved off of the treasury's books. That is, once the liquidity charge is removed from the Treasury, the PnL in the treasury book is solely due mismatches from the banks assets and liabilities in terms of interest rate risk.
Full Attribution View
- Loan Department Performance - each loan department is charged the bank funding rate for its loans, in addition, it has purchased derivatives to protect itself from credit risk and prepayment risk. After paying the funding rate and the derivative premium, the resulting money is due solely to the banks abiility to make loans to the given sector, at a premium to the risks in the loan.
- Interest Rate Risk - the PnL attributed to the treasury department is due solely to interest rate risk.
- Credit Risk - the profit from the credit desk represents the money that the bank makes from taking credit risk.
- Optionality Risk - similar to the credit desk, the profit of the option desk represents the PnL that the bank makes from taking optionality risk.