A credit risk is the risk of default on the debt that may arise from the borrower failing to make the required payment. In the first attempt, the risks are from the lender and include loss of principal and interest, cash flow disruption, and increased collection fees. Losses may be complete or partial. In an efficient market, a higher level of credit risk will be associated with higher borrowing costs. Therefore, the size of borrowing costs such as yield spreads can be used to infer the level of credit risk based on valuation by market participants.
Losses can appear in a number of circumstances, for example:
- Consumers may fail to make payments due to mortgage, credit, credit line or other loan.
- The Company can not pay fixed or floating debt costs guaranteed assets.
- Businesses or consumers do not pay trade invoices when they are due.
- Businesses do not pay wages earned by employees at maturity.
- The issuer of government or government bonds does not make payments on coupons or principal payments at maturity.
- Insolvent insurers do not pay policy obligations.
- The insolvent bank will not refund the depositors.
- The government provides bankruptcy protection to a bankrupt consumer or business.
To reduce the credit risk of the lender, the lender may conduct a credit check on the prospective borrower, may ask the borrower to take the appropriate insurance, such as mortgage insurance, or seek security over some borrower's assets or guarantees from third parties.. The lender can also take out insurance against risks or sell debt to other companies. In general, the higher the risks, the higher the interest rate that the debtor will ask to pay the debt. Credit risk primarily arises when the borrower can not pay for voluntary or unwillingness.
Video Credit risk
Jenis
Credit risk can be of the following types:
- Default credit risk - The risk of loss arising from the debtor that is not possible to pay the full loan obligation or the debtor more than 90 days ago due to material credit obligations; default risk can affect all sensitive-credit transactions, including loans, securities, and derivatives.
- Concentration risk - Risks associated with single exposure or group exposure with the potential to generate substantial losses to threaten the bank's core operations. This may appear in the form of single name concentrations or industrial concentrations.
- Country risk - The risk of loss arising from the freeze of state currency payments (risk of transfer/conversion) or when the default obligation (sovereign risk); this type of risk is clearly linked to the country's macroeconomic performance and political stability.
Maps Credit risk
Assessment
Significant resources and advanced 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 provide credit (or not) accordingly. They can use in-house programs to advise on avoiding, reducing and transferring risks. They also use the intelligence provided by third parties. Companies like Standard & amp; Poor's, Moody's, Fitch Ratings, DBRS, Dun and Bradstreet, Bureau van Dijk and Rapid Ratings International provide such information for a fee.
For large companies with physically traded corporate bonds or Credit Default Swaps, the spread of bond yields and credit default swap spreads indicates the market participants' assessment of credit risk and can be used as reference points for a price loan or trigger a guarantee call.
Most lenders use their own models (credit cards) to rank potential and existing customers according to risk, and then implement the right strategy. With products such as unsecured personal loans or mortgages, lenders charge higher prices for high-risk customers and vice versa. With rotating products such as credit cards and overdrafts, risk is controlled through setting a credit limit. Some products also require a guarantee, usually a pledged asset to guarantee repayment of the loan.
The credit rating model is also part of the framework used by banks or lending institutions to provide credit to clients. For corporate and commercial borrowers, this model generally has qualitative and quantitative sections that outline various aspects of risk including, but not limited to, operating experience, management expertise, asset quality, and leverage and liquidity ratios, respectively. Once this information has been fully reviewed by credit officers and credit committees, lenders provide funds subject to the terms and conditions presented in the contract (as outlined above).
Risk of sovereignty
The credit risk of the state is the risk of the government being unwilling or unable to meet its loan obligations, or denying the loan it secures. Many countries have faced sovereign risks in the global recession of the late 2000s. The existence of such risks means that creditors must take a two-stage decision process when deciding to lend to a company based in a foreign country. First of all we must consider the quality of the risk of state sovereignty and then consider the credit quality of the company.
The five macroeconomic variables that affect the probability of scheduling the state debt are:
- Debt service ratio
- Import rate
- Investment ratio
- Export earnings variant
- Growing domestic money supply
The probability of rescheduling is the increasing function of debt service ratio, import ratio, variance of export earnings and growth of domestic money supply. The possibility of rescheduling is the decline in the function of the investment ratio due to the increase in economic productivity in the future. Rescheduling opportunities for debt can increase if the ratio of investments increases as foreign countries can become less dependent on external creditors and so less worried about receiving credit from these countries/investors.
Counterparty Risk
Counterparty risk, also known as default risk, is a risk that will not be paid by the other party as a liability in bonds, derivatives, insurance policies, or other contracts. Financial institutions or other transfers may hedge or take credit insurance or, especially in the context of derivatives, require posting of collateral. Offsetting counterparty risk is not always possible, eg. because of temporary liquidity problems or long-term systemic reasons.
The risk of the opposing party increases as risk factors are positively correlated. Accounting for the correlation between portfolio risk factors and counterparty defaults in risk management methodologies is not trivial.
Mitigation
Source of the article : Wikipedia
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