CREDIT RISK

• A credit risk is the risk of default on a debt

that may arise from a borrower failing to
make required payments. The risk is that of
the lender and includes lost principal and
interest, disruption to cash flows, and
increased collection costs. The loss may be
complete or partial.
• credit risk is often considered one way risk
because it exist when an organisation is owed
payment or an obligation by another party.
How credit risk arises:-

• credit risk arises through default on lending

,investing and credit granting activities and concerns
the return of borrowed money or the payment of
goods sold.
• credit risk also arises through the performance of
counterparties in contractual agreement such as
derivatives , when the counteparty cannot or will not
fulfill its obligations.
• poor economic conditions and higher interest
rates contribute to the likelihood of default for
many organisations.
• Credit default is also more likely when an
organisation has accumulated large losses or
when organisations creditors or counterparties
have financial difficulty or have failed to return
their borrowed money.
Types of credit risk:-
A credit risk can be of the following types:
• Credit default risk - The risk of loss arising from a
debtor being unlikely to pay its loan obligations in
full or the debtor is more than 90 days past due on
any material credit obligation; default risk may impact
all credit-sensitive transactions, including loans,
securities and derivatives.
• .Concentration risk – The risk associated with any
single exposure or group of exposures with the
potential to produce large enough losses to threaten a
bank's core operations. It may arise in the form of
single name concentration or industry concentration.
• Country risk – The risk of loss arising from a
sovereign state freezing foreign currency payments
(transfer/conversion risk) or when it defaults on its
obligations (sovereign risk); this type of risk is
associated with the country's macroeconomic
performance and its political stability.
• Legal risk - legal risk is the risk that an organisation is
not legally permitted aur able to enter into transactions
particulately derivative transactions .
• Counterparty pre-settlement risk - presettlement risk
or replacement risk arises from the possibility of
counterparty default once a contract has been entered
into but prior to the settlement.
• Counterparty settlement risk - settlement risk is a
transaction arising from exchange of payments
between parties to an agreement whenpayment is
made but not received and it may result in large losses
because the entire payment is potentially at risk during
the settlement process. The size of loss depends on
the size of payments , weather both parties make
payments, how payments are made.
 Credit risk managment
techniques:-
• Credit Decision Making- Companies generally do not grant
credit to every customer who requests it. They only provide
credit to those who are less risky by analyzing the customer's
credit report, which details their payment history. A history of
late payments indicates that the customer is more likely to
continue paying bills late. such customers are not opted for
lending.
• Credit rationing- credit is granted where the most attractive
risk to return trade off is available. This involves assigning higher
interest rates to highest transaction to compensate for the
additional risk.
• Collateral- collateral is something pledged as
security for repayment of a loan, to be forfeited
in the case of a default.
• Credit derivatives - credit derivative refers to
any one of "various instruments and techniques
designed to separate and then transfer the credit
risk or the risk of an event of default of a
corporate or sovereign borrower, transferring it
to an entity other than the lender or debtholder.