Credit risk: assessment methods and minimization methods

Cooperating with banks, we often come across a term such as credit risk. What it is? To put it simply, we can say that the credit risk is the probability that the counterparty (or the debtor) will not fulfill its obligations stipulated in the contract. That is, it is the risk of default of the debtor or counterparty. First of all, the carriers of credit risks are transactions of the following types:

• Direct and indirect lending.
• Purchase and sale of assets without prepayment by the counterparty.
• Transactions without guarantees of settlements by third parties.

Credit risks include the probability of deterioration of the debtor. And it is not just a matter of worsening the financial situation. No less significant factors are the following: reduction of the company's position in the region, lack of demand for the industry, deterioration of business reputation , etc. That is all that can prevent a person from paying the money. However, the inability to repay a loan is not the only loss that a bank can suffer. Credit risk can also be indirect (for example, if as a result of some actions the value of securities, shares, promissory notes of the issuer is reduced or it is required to increase the volume of credit reserves).

In the process of determining credit risks, attention is paid to several factors:

• Risk of default. The probability that the borrower will later be in a state of insolvency after some time.
• Credit rating. Evaluation of the reliability of various securities.
• Credit migration. The likelihood of a change in the credit rating of a debtor, an operation, a counterparty, or an issuer.
• The amount that is exposed to credit risk.
• The level of losses that a bank can suffer in the event of a default.

Practice shows that absolutely any operations, the basis of which is the entry of the parties into the relations of the creditor and the borrower, the emergence of debt obligations, carry a certain amount of risk. There is a concept of so-called risk-free investment - in this case, the credit risk is minimal and conditionally accepted as zero. However, even in this situation, he is present. And this should be taken into account.

Credit risk is what a bank should consider first of all when considering an application. The credit history provided by the borrower, the nature of its activities and all available information should be carefully studied. The very assessment of credit risks should be made by qualified specialists, because this is the sphere where the slightest miscalculation can lead to huge losses.

The credit risk of the bank can be minimized. The traditional way is to take a pledge. As such, the best asset is valuable property, liquid assets. In case of loss of collateral, the most effective method of minimizing credit risk is insurance. Also, many banks in their work resort to a system of limitation (customers of a group do not receive loans more than a certain amount).

Remember that a competent assessment of credit risks will allow you to remain afloat and not suffer losses even in a destabilized economic situation.