Definition of Credit rating Risk
Credit Risk is the risk of standard by customer due to incapability and/or unwillingness to repay his debts relative to the arranged terms and conditions.
Factors deciding Credit Risk
The credit risk of a bank's collection depends on both equally external and internal elements. The external factors may be economy vast as well as company specific. A few of the economy large factors will be:
State with the economy
Wide swings in commodity rates
Fluctuations in foreign exchange prices and interest rates
Government policies, etc .
Some business specific factors are:
The internal factors within the traditional bank, influencing credit risk for a bank is: Deficiencies in loan policies/administration
A shortage of prudential credit rating concentration restrictions
Badly defined loaning limits pertaining to Loan Officers/Credit Committees Zero appraisal of borrowers' financial position
Abnormal dependence on collateral without ascertaining its quality/realisability Lack of risk pricing mechanisms
Absence of financial loan review device
Inadequate system of monitoring of accounts
While the traditional bank can effect and control the internal elements to improve quality of it is credit portfolio, the risk as a result of external elements can be reduced by proper diversification around industries and by initiating important changes in the financial loan portfolio pending adverse advancements. Development of powerful risk examination and monitoring systems can help in improving the quality of credit rating decisions thereby reducing loan losses on an on going basis and thus gradually improving the standard of loan profile.
Need for Credit rating Risk Management
The liberalisation in the Indian overall economy has brought regarding sweeping modifications in our economic environment. Changes in economic environment possess induced fresh anticipated and unforeseen dangers in financing. The examination of these dangers is essential to facilitate prudent credit decisions.
The stipulations of loans & developments sanctioned to borrowers (i. e. the retail price, the maturity, the form of credit etc . ) determine the profit that accrues towards the bank as a result loan. In the event the terms will be decided without proper assessment with the credit risk, the bank could possibly be charging low interest rates from low quality customers therefore sustaining deficits due to default, and charging high costs from high-quality customers therefore driving these people away to other financial institutions.
The increasing pressure on spreads in the banking industry and competition on both sides in the balance sheet makes an efficient credit rating risk management program essential for banking companies. In this significantly competitive condition a sound credit risikomanagement system can be quite a source of competitive advantage for the bank.
The RBI has issued guidelines to all or any banks to have proper credit risk management program in place. Credit rating risk can be associated with individual borrowers. Minimisation of credit risk needs a system to assess and deal with the risk linked to individual debtors. The attention of risk in person risk regularly e. g. the same sector should be averted to reduce this attention risk, also called portfolio risk.
Credit Risk Rating
Credit risk score is a score assigned to borrowers, depending on an evaluation of their potential and readiness to repay your debt taken from your bank. This ranking is assigned on a range, which generally has six to eight levels. Companies falling in the same credit rating risk category have comparable probability of default. Better the score, lower is the probability of default. The probability of default boosts in an dramatical manner as the credit rating risk score deteriorates.
Uses of Credit rating Risk Ranking
Credit risk rating is one of the important tools to decide inside the following things:
Whether to lend to a borrower or not: The credit risk rating of a borrower...