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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). A loan is a type of debt. ...
For other senses of this word, see interest (disambiguation). ...
Faced by lenders to consumers
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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 careful setting of credit limits. Some products also require security, most commonly in the form of property. Consumer Credit Risk (AKA Retail Credit Risk) is the risk of loss due to a customers non re-payment (default) on a consumer credit product, such as a mortgage, unsecured personal loan, credit card, overdraft etc. ...
Credit Scorecards are mathematical models which attempt to provide a quantitive measurement of the likelihood that a customer will display a defined behavior with respect to their current, or proposed, credit position with a lender. ...
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: Covenant, in its most general sense, is a solemn and bilateral promise to do or not do something specified. ...
- limit the borrower's ability to weaken his 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. In formal bookkeeping and accounting, a balance sheet is a statement of the book value of all of the assets and liabilities (including equity) of a business or other organization or person at a particular date, such as the end of a fiscal year. ...
A credit default swap (CDS) is a swap designed to transfer the credit exposure of fixed income products between parties. ...
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. Net 30 is a form of trade credit which specifies payment is expected to be received in full 30 days after the goods are delivered. ...
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 Moody's and Dun and Bradstreet provide such information for a fee. Moodys Corporation (NYSE: MCO) is the holding company for Moodys Investors Service which performs financial research and analysis on commercial and government entities. ...
The Dun & Bradstreet Corp (NYSE: DNB), headquartered in Short Hills, New Jersey, USA, is among the leading providers of business information on business. ...
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. Wikibooks has more about this subject: Marketing Distribution is one of the four aspects of marketing. ...
A drawing of a self-service store Retailing consists of the sale of goods/merchandise for personal or household consumption either from a fixed location such as a department store or kiosk, or away from a fixed location and related subordinated services (Definition of the WTO (last page). ...
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). A collection agency is a business that pursues payments on debts owed by individuals or businesses. ...
A write-down is a partial reduction of a fixed assets accounted value. ...
Faced by individuals Consumers may face credit risk in a direct form as depositors at banks or as investors/lenders. They may also face credit risk when entering into standard commercial transactions by providing a deposit to their counterparty, e.g. for a large purchase or a real estate rental. Employees of any firm also depend on the firm's ability to pay wages, and are exposed to the credit risk of their employer.
In some cases, governments recognize that an individual's capacity to evaluate credit risk may be limited, and the risk may reduce economic efficiency; governments may enact various legal measures or mechanisms with the intention of protecting consumers against some of these risks. Bank deposits, notably, are insured in many countries (to some maximum amount) for individuals, effectively limiting their credit risk to banks and increasing their willingness to use the banking system.
References - ^ Principles for the management of credit risk from the Bank for International Settlement
- Bluhm, Christian, Ludger Overbeck, and Christoph Wagner (2002). An Introduction to Credit Risk Modeling. Chapman & Hall/CRC. ISBN13 978-1584883265.
- de Servigny, Arnaud and Olivier Renault (2004). The Standard & Poor's Guide to Measuring and Managing Credit Risk. McGraw-Hill. ISBN13 978-0071417556.
- Darrell Duffie and Kenneth J. Singleton (2003). Credit Risk: Pricing, Measurement, and Management. Princeton University Press. ISBN13 978-0691090467.
J. Darrell Duffie is super cool, amazing, and generally awesome. ...
Kenneth J. Singleton is an American economist. ...
See also Consumer Credit Risk (AKA Retail Credit Risk) is the risk of loss due to a customers non re-payment (default) on a consumer credit product, such as a mortgage, unsecured personal loan, credit card, overdraft etc. ...
A credit rating assesses the credit worthiness of an individual, corporation, or even a country. ...
// A credit reference is information, the name of an individual, or the name of an organization that can provide details about an individuals past track record with credit. ...
In finance, default occurs when a debtor has not met its legal obligations according to the debt contract, e. ...
Distressed securities are securities of companies that are either already in default, under bankruptcy protection, or in distress and heading toward such a condition. ...
Risk modeling refers to the use of formal econometric techniques to determine the aggregate risk in a financial portfolio. ...
Other types of risk Market risk is the risk that the value of an investment will decrease due to moves in market factors. ...
Interest rate risk is the risk that the relative value of a security, especially a bond, will worsen due to an interest rate increase. ...
Legal and regulatory risk: Sometimes governments change the law in a way that adversely affects a banks position. ...
Liquidity risk arises from situations in which a bank cannot sell an asset because nobody in the market wants to trade that asset. ...
According to §644 of International Convergence of Capital Measurement and Capital Standards, known as Basel II, operational risk is defined as the risk of loss resulting from inadequate or failed internal processes, people and systems, or from external events. ...
Volatility risk in financial markets is the likelihood of fluctuations in the exchange rate of currencies. ...
Settlement risk, also known as the Herstatt risk is the risk that a counterparty does not deliver security or its value in cash as per agreement when the security was traded after other counterparty or counterparties have delivered security or cash value as per the trade agreement. ...
Please wikify (format) this article or section as suggested in the Guide to layout and the Manual of Style. ...
External links - The Risk Management Association - leading industry organisation for credit risk professionals
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