Credit risk is the process whereby a party may have a possibility loss due to the failure to follow financial contract terms and conditions (Bonsall et al., 1445). For instance, the inability of the investor to pay the loan and its interest. Banks as financial intermediaries are always exposed to this type of risk due to their lending operations hence the need to assess and manage this risk. To control the credit risk of a bank, then the risk management department must first determine the risk. The credit risk assessment is done based on the client’s repayment ability.
Lenders use the five Cs of credit ratings: capital, credit history, conditions of the loan, repayment capacity, and collateral associated, to assess the credit risk (Pokorná et al., 455). To get the credit history, companies look at the historical credit data to evaluate the creditworthiness of a customer. For example, companies track the records in the Credit Revenue Bureau through technology to see if the client has cases of defaulting in the past. The capital and collateral available are vital in the assessment of credit risk. An investor or a borrower with high amounts of money and assets that can be used as a guarantee is considered to have low chances of default that the one with little or no capital (Oreski).
The conditions of the loan, such as credit ratings, interest rates, the intended use of the loan, help the companies and the investors get a picture of the credit risk associated (Ahmed et al., 578). A loan with a high rating translates to low default chances while the one with a high score translates to a high probability of default. How a customer intends to use the loan, determines if the lender will approve it. For example, a loan to be used for business expansion maybe easily approved because the chances are high that the borrower will repay than a loan taken for a holiday trip.
Works Cited
Ahmed, Sufi Faizan, and Qaisar Ali Malik. "Credit Risk Management and Loan Performance: Empirical Investigation of Micro Finance Banks of Pakistan." International Journal of Economics and Financial Issues 5.2 (2015): 574-579.
Bonsall IV, Samuel B., Eric R. Holzman, and Brian P. Miller. "Managerial ability and credit risk assessment." Management Science 63.5 (2016): 1425-1449.
Pokorná, Martina, and Miroslav Sponer. "Credit Risk Assessment." European Financial Systems 2015
(2015): 455.
Oreski, Stjepan, and Goran Oreski. "Genetic algorithm-based heuristic for feature selection in credit risk assessment." Expert systems with applications 41.4 (2014): 2052-2064.
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