lnLroducLlon

CredlL rlsk ls mosL slmply deflned as Lhe poLenLlal LhaL a bank borrower or counLerparLy wlll fall Lo meeL
lLs obllgaLlons ln accordance wlLh agreed Lerms
MarkeL rlsk has recelved an lnordlnaLe amounL of aLLenLlon ln recenL years buL managlng credlL rlsk ls
Lhe ''bread and butter'' of mosL commerclal banks Lvery commerclal bank by denlLlon has a loan
porLfollo lncreases ln credlL rlsk wlll ralse Lhe marglnal cosL of debL and equlLy whlch ln Lurn lncreases
Lhe cosL of funds for Lhe bank
1echnlques for credlL rlsk managemenL are well known because Lhe banklng secLor has had a long
hlsLory of experlence ln Lhls area noneLheless loan quallLy problems are an lmporLanL cause of bank
fallure lor Lhls reason all bankers noL [usL Lhose ln a credlL rlsk deparLmenL should be aware of Lhe
key facLors affecLlng Lhe quallLy of a loan porLfollo and Lhe meLhods for managlng lL
Coal of CredlL 8lsk ManagemenL
Coal ls Lo maxlmlze a banks rlskad[usLed raLe of reLurn by malnLalnlng credlL rlsk exposure wlLhln
accepLable parameLers
8anks need Lo manage Lhe credlL rlsk lnherenL ln Lhe enLlre porLfollo as well as Lhe rlsk ln lndlvldual
credlLs or LransacLlons 8anks should also conslder Lhe relaLlonshlps beLween credlL rlsk and oLher rlsks
1he effecLlve managemenL of credlL rlsk ls a crlLlcal componenL of a comprehenslve approach Lo rlsk
managemenL and essenLlal Lo Lhe longLerm success of any banklng organlsaLlon



Credit risk consists oI three factors.
1. Probability of default - this is the possibility of failure to pay over the period stipulated in the
contract. The computation for that year may be termed as the projected default rate.
2. Exposure of Credit - how big of an amount will the debt be in case default should occur.
3. Estimated Rate of Recovery - what portion of the debt can be regained through freezing of assets
and collateral and the like, should default transpire.
Credit Risk Decisions: Retail versus Corporate
To understand this better, remember that each risk is composed of two essentials - exposure (credit
exposure) and the quality of credit (probability of default and estimated recovery rate).
If a bank is looking to minimize its aggregate credit risk, then good risk management of retail and
corporate lending is essential. The approaches taken for retail and corporate loans differ considerably,
mainly because a corporation is able to produce a variety of hnancial ratios, which are not available
when the suitability of an individual or a small hrm for a loan is being assessed. Most bankers concede
that lack of information makes retail lending more difficult than corporate lending. On the other hand,
loans to corporates which turn out to be bad can be very serious for the bank because of the large
sums involved.
W Countless cases abound: Maxwell and a number of London-based banks; Schroder and
Deutsche Bank; and the collapse of Enron and WorldCom.
The number of incidents where retail loan defaults have had serious consequences for a bank is very
much lower, and usually occurs if a bank is over-exposed in one area such as mortgages, and
property prices collapse at the same time as interest rates rise.