Credit Risk Management

CREDIT RISK MANAGEMENT
CREDIT SCORING
 A credit score is a numerical expression based on a statistical analysis of a
person's credit files, to represent the creditworthiness of that person.
 The use of credit or identity scoring prior to authorizing access or granting credit
is an implementation of a trusted system.
USES OF CREDIT SCORING

 Lenders, such as banks and credit card companies, use credit scores to evaluate
the potential risk posed by lending money to consumers and to mitigate losses
due to bad debt.
 Lenders use credit scores to determine who qualifies for a loan, at what interest
rate, and what credit limits.
 Lenders also use credit scores to determine which customers are likely to bring
in the most revenue
 Credit scoring is not limited to banks. Other organizations, such as mobile phone
companies, insurance companies, landlords, and government departments
employ the same techniques.
5 Cs OF BORROWERS IN CREDIT SCORING

 The five Cs of credit is a system used by lenders to gauge the creditworthiness of
potential borrowers.
 Financial institutions use credit ratings to quantify and decide whether an
applicant is eligible for credit and to determine the interest rates and credit limits
for existing borrowers.
 CHARACTER
 Character measures how reliable and trustworthy you are.
 Your credit “character” speaks to your overall trustworthiness as a borrower.
 Character helps lenders recognize your ability to repay a loan.
 Particularly important to character is your credit history.
 It provides insight into your ability to make on-time payments.
 CAPACITY
 Capacity measures your ability to repay your debt.
 The lender wants to know how much you owe versus how much you own.
 The lower your debt-to-income ratio, the more favorable a bank will look at your
request for credit.
 CAPITAL
 Capital shows lenders you're serious and committed to the credit you're seeking.
 For individual loans, this means a down payment when applying for a loan.
 For a business loan, this means you've invested some of your own money into
the business.
 COLLATERAL
 Collateral provides assurance to the bank in case you're unable to pay for the
loan.
 Collateral is the assets you pledge to support your loan.
 Collateral serves as a backup in the case the borrower fails to pay back the loan.
 The collateral can be your house property, land, equipment, inventory, real
estate, accounts receivable, or any other item holding monetary value in the
market.
 CONDITIONS
 This refers to the current economic health of the market and the industry you
work in.
 Conditions can refer to how a borrower plans to use the money.
 It measures the borrower’s circumstances, e.g. market conditions, competitive
pressure, seasonal character etc.
CREDIT SCORING AT DIFFERENT STAGES

APPLICATION SCORING
TYPES OF SCORING
 Targeted Scoring
 Internal and external scoring
 Counter party and facility scoring
CREDIT RATING
The goal is to generate accurate and consistent risk ratings, yet also to allow
professional judgment to significantly influence a rating where this is appropriate.
METHOD OF CREDIT RATING

 THROUGH THE CYCLE
In this method of credit rating, the rating of the client will depend upon the “worst
point in the business cycle”.
 POINT IN TIME
In this method of credit rating, the rating of the client will depend upon the
“current condition”.
PARAMETERS FOR CREDIT RATING

 QUANTITATIVE FACTORS
 Growth in sales, profits
 Return on capital
 Debt Equity ratio
 Current ratio
 Level of contingent liabilities
 Speed of debt collection
 Operating Cycle
 QUALITATIVE FACTORS
 Compliance with regulator
 Experience of top management
 Corporate governance initiatives
 Performance of affiliate concern
 Ability to cope with any major technological, legal, fashion etc changes
 Product characteristics
TYPES OF LENDINGS AND RATINGS

 WHOLE SALE EXPOSURE
Following factors in the credit rating process for whole sale lending.
 Industry analysis
 Financial Analysis
 External return
 Analytical tools
 Quality of financial data
 Firm Size
 Management
 RETAIL EXPOSURE
Two vital issues need to be addressed:
 Borrower’s ability to service the loan
 Borrower’s willingness to service the loan
FUNDAMENTAL REASONS FOR VARIOUS GRADING

 Signaling default risks of an exposure
 Measure the credit risk of an exposure
 Comparison of risks to aid decision making
 Compliance with regulatory requirements
 Compliance with terms and conditions
BASEL CAPITAL ACCORD
 The accord agrees upon a minimal capital regulation framework for
internationally active commercial banks so as to reduce the risk of the
international financial system.
 The Basel Accords refer to a series of three international banking regulatory
meetings that established capital requirements and risk measurements for global
banks.
 The Basel Accords refers to a set of banking supervision regulations set by the
Basel Committee on Banking Supervision (BCBS).
BASEL II FRAMEWORK WITH 3 PILLARS

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CREDIT RISK MANAGEMENT

USES OF CREDIT SCORING

5 Cs OF BORROWERS IN CREDIT SCORING

CREDIT SCORING AT DIFFERENT STAGES

METHOD OF CREDIT RATING

PARAMETERS FOR CREDIT RATING

TYPES OF LENDINGS AND RATINGS

FUNDAMENTAL REASONS FOR VARIOUS GRADING

BASEL II FRAMEWORK WITH 3 PILLARS

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