Credit Risk
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From Wikipedia, the free
encyclopedi
Credit risk is the risk of loss due to a debtor's non-payment of a loan or
other line of credit (either the principal or interest (coupon) or both)
* 1 Faced by lenders to consumers
* 2 Faced by lenders to business
* 3 Faced by business
* 4 Faced by individuals
* 5 Counterparty risk
* 6 Sovereign risk
* 7 References
* 8 See also
o 8.1 Other types of risk
* 9 External links
[edit] Faced by lenders to consumers
Main article: Consumer credit risk
Most lenders employ their own models (credit scorecards) to rank potential
and existing customers according to risk, and then apply appropriate
strategies. With products such as unsecured personal loans or mortgages,
lenders charge a higher price for higher risk customers and vice versa. With
revolving products such as credit cards and overdrafts, risk is controlled
through the setting of credit limits. Some products also require security,
most commonly in the form of property.
[edit] Faced by lenders to business
Lenders will trade off the cost/benefits of a loan according to its risks
and the interest charged. But interest rates are not the only method to
compensate for risk. Protective covenants are written into loan agreements
that allow the lender some controls. These covenants may:
* limit the borrower's ability to weaken their balance sheet voluntarily
e.g., by buying back shares, or paying dividends, or borrowing further.
* allow for monitoring the debt requiring audits, and monthly reports
* allow the lender to decide when he can recall the loan based on specific
events or when financial ratios like debt/equity, or interest coverage
deteriorate.
A recent innovation to protect lenders and bond holders from the danger of
default are credit derivatives, most commonly in the form of a credit
default swap. These financial contracts allow companies to buy protection
against defaults, from a third party, the protection seller. The protection
seller receives a periodic fee (the credit spread) as compensation for the
risk it takes, and in return it agrees to buy the debt should a credit event
("default") occur.
Credit scoring models also form part of the framework used by banks or
lending institutions grant credit to clients. For corporate and commercial
borrowers, these models generally have qualitative and quantitative sections
outlining various aspects of the risk including, but not limited to,
operating experience, management expertise, asset quality, and leverage and
liquidity ratios, respectively. Once this information has been fully
reviewed by credit officers and credit committees, the lender provides the
funds subject to the terms and conditions presented within the contact (as
outlined above).
[edit] Faced by business
Companies carry credit risk when, for example, they do not demand up-front
cash payment for products or services.[1] By delivering the product or
service first and billing the customer later - if it's a business customer
the terms may be quoted as net 30 - the company is carrying a risk between
the delivery and payment.
Significant resources and sophisticated programs are used to analyze and
manage risk. Some companies run a credit risk department whose job is to
assess the financial health of their customers, and extend credit (or not)
accordingly. They may use in house programs to advise on avoiding, reducing
and transferring risk. They also use third party provided intelligence.
Companies like Standard & Poor's, Moody's, Fitch Ratings, and Dun and
Bradstreet provide such information for a fee.
For example, a distributor selling its products to a troubled retailer may
attempt to lessen credit risk by tightening payment terms to "net 15", or by
actually selling fewer products on credit to the retailer, or even cutting
off credit entirely, and demanding payment in advance. Such strategies
impact sales volume but reduce exposure to credit risk and subsequent
payment defaults.
Credit risk is not really manageable for very small companies (i.e., those
with only one or two customers). This makes these companies very vulnerable
to defaults, or even payment delays by their customers.
The use of a collection agency is not really a tool to manage credit risk;
rather, it is an extreme measure closer to a write down in that the creditor
expects a below-agreed return after the collection agency takes its share
(if it is able to get anything at all). |
More related links about
Credit Risk
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Credit Risk - Definition of
Credit Risk on Investopedia - The risk of loss of principal or loss
of a financial reward stemming from a borrower's failure to ...
www.investopedia.com ›
Welcome to The Journal of Credit Risk
website. The Journal is an international refereed journal focusing on the
measurement and management of credit risk, ...
www.journalofcreditrisk.com/
With confidence in credit markets at an
all-time low, it is critical for banks to engage in better credit risk
management practices that can optimize ...
www.sas.com/industry/banking/credit/
Dr. Risk saw Peter Crosbie's
presentation on credit risk at a conference, recently. He had
graphs that indicated that methods 1 and 2, using market data, ...
www.margrabe.com/CreditRisk.html
Credit Risk (or Default Risk)
Management analyzes credit risk and credit exposure to determine
the value of credit transactions, and proactively implements ...
www.bettermanagement.com/topic/subject.aspx?f=705&s...
Credit risk is risk due to
uncertainty in a counterparty's (also called an obligor's or credit's)
ability to meet its obligations.
www.riskglossary.com/articles/credit_risk.htm
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