CREDIT RISK

• INTRODUCTION TO CREDIT

• PRINCIPLES FOR THE MANAGEMENT OF CREDIT

RISK

• CREDIT RISK ENVIRONMENT

• CREDIT ADMINISTRATION, MEASUREMENT &

MONITORING PROCESS
1.1 INTRODUCTION TO CREDIT

• Credit refers to the granting of a loan and the

creation of debt.
• It is any form of deferred payment. The first
party is called a creditor, also known as a
lender, while the second party is called a debtor,
also known as a borrower.
• In commercial trade, credit is used to refer to the
approval for delayed payments for goods
purchased.
1.1 INTRODUCTION TO CREDIT

You are granted credit when an organization or

individual makes a sum available for you to
borrow. There are two main types of credit.
1. Home loans, or mortgages, and personal or
shop loans are linked to a specific item or
items – for example, a new kitchen, or a house
2. Revolving credit on payment cards can give
you access to a fixed amount of money that
you can spend as you wish, in a wide range of
retailers and other outlets
1.1 INTRODUCTION TO CREDIT
Repayment
• Loans are normally repaid in regular
installments over an agreed period of time.
Mortgages, or home loans, can be repaid in
variable installments but most personal loans
specify fixed repayments of approximately
equal amounts.
• If you want to make another major purchase
when you have finished paying off one loan,
you need to negotiate a new loan.
1.1 INTRODUCTION TO CREDIT
Repayment
Revolving credit means that you always have
access to the amount of your line of credit
that remains unspent. And every time you
pay off some of the outstanding amount, that
proportion of your credit limit becomes
available for you to spend again.
1.1 INTRODUCTION TO CREDIT

Interest
• In order to cover the lending risk and to make
a profit on their money, lenders generally
charge interest on loans and revolving credit.
You must remember this when you are
calculating your repayments.
• Simple and Compound Interest
1.1 INTRODUCTION TO CREDIT
Interest
• Interest may be compounded after any
period – a day, a week, a month and so on.
With fixed repayment loans, the amount of
interest is worked out in advance and
added into the repayments.
• With revolving credit, you can repay as
much or as little as you want, at any point.
You can often avoid paying any interest at
all if you repay the total amount you have
borrowed on the date when the first
repayment is due.
1.1 INTRODUCTION TO CREDIT
Credit Score
– 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, which is
the perceived likelihood that the person
will pay debts in a timely manner.
– A credit score is primarily based on credit
report information typically sourced from
credit bureaus / credit reference agencies
1.1 INTRODUCTION TO CREDIT
Credit Score
• 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.
• The use of credit or identity scoring prior to
authorizing access or granting credit is an
implementation of a trusted system. Credit scoring
is not limited to banks. Other organizations, such as
mobile phone companies, insurance companies,
employers, and government departments employ
the same techniques.
1.1 INTRODUCTION TO CREDIT

Identity Score
• An identity score is a system for tagging and
verifying the legitimacy of an individual’s public
identity. Identity scores are increasingly being
adopted as a means to prevent fraud in business
and as a tool to verify and correct public records.
• Identity scores incorporate a broad set of
consumer data that gauges a person’s legitimacy.
• Identity score components can include (but are not
limited to) personal Identifiers , public records,
Internet data, government records, corporate data,
predicted behavior patterns based on empiric data,
and credit records.
1.2 CREDIT HISTORY

• Credit history or credit report is, in many

countries, a record of an individual's or company's
past borrowing and repaying, including
information about late payments and bankruptcy.
The term "credit reputation" can either be used
synonymous to credit history or to credit score.
• With the adoption of risk-based pricing on almost
all lending in the financial services industry, this
report has become even more important since it is
usually the sole element used to choose the
annual percentage rate
1.2 CREDIT HISTORY
Understanding credit reports and scores
• The information in a credit report is sold by credit
agencies to organizations that are considering
whether to offer credit to individuals or
companies.
• The consequence of a negative credit rating is
typically a reduction in the likelihood that a lender
will approve an application for credit under
favorable terms, if at all.
• Interest rates on loans are significantly affected
by credit history—the higher the credit rating, the
lower the interest while the lower the credit rating,
the higher the interest. The increased interest is
used to offset the higher rate of default within the
low credit rating group of individuals.
1.2 CREDIT HISTORY

International issues
• Credit history is typically local to one country.
Even within the same credit card network
information is not shared for different countries.
• For example, a person who has been using Visa
credit cards issued by banks in China or Canada
for many years who moves to the United States
and immediately applies for a Visa will not be
approved because of lack of credit history.
1.2 CREDIT HISTORY

Adverse Credit
• A consumer or business' credit history is regularly
tracked by credit rating agencies. The data
reported by these agencies is primarily provided
to them by creditors and includes detailed records
of the relationship a person or business has with
the lender.
• Detailed account information, including payment
history, credit limits, high and low balances, and
any aggressive actions taken to recover overdue
debts, are all reported regularly (usually monthly).
This information can be quite detailed and
arduous to navigate by a potential lender dealing
with a new applicant. To address this issue, credit
scoring was invented.
1.2 CREDIT HISTORY

Adverse Credit
• The higher the score, the better the credit
history and the higher the probability that the
loan will be repaid on time
• When creditors report an excessive number
of late payments, or trouble with collecting
payments, a "hit" on the score is suffered.
Repeated hits can lower the score and trigger
what is called a negative credit rating or
adverse credit history.
1.3 CREDIT RATING
• A credit rating assesses the credit worthiness of
an individual, corporation, or even a country.
• Credit ratings are calculated from financial
history and current assets and liabilities.
Typically, a credit rating tells a lender or investor
the probability of the subject being able to pay
back a loan.
• However, in recent years, credit ratings have also
been used to adjust insurance premiums,
determine employment eligibility, and establish
the amount of a utility or leasing deposit.
1.3 CREDIT RATING

Personal credit ratings

• In countries such as the United States, an
individual's credit history is compiled and
maintained by companies called credit bureaus.
• A common form of this analysis is a 3-digit credit
score provided by independent financial service
companies such as the FICO credit score (Fair
Isaac Corporation).
• An individual's credit score, along with his or her
credit report, affects his or her ability to borrow
money through financial institutions such as
banks.
1.3 CREDIT RATING

The factors which may influence a person's

credit rating are
1. ability to pay a loan
2. interest
3. amount of credit used
4. saving patterns
5. spending patterns
6. debt
1.3 CREDIT RATING

Corporate credit ratings

• The credit rating of a corporation is a
financial indicator to potential investors of
debt securities such as bonds.
• These are assigned by credit rating agencies
such as Standard & Poor's or Fitch Ratings
and have letter designations such as AAA, B,
and CC.
1.3 CREDIT RATING

Sovereign credit ratings

• A sovereign credit rating is the credit rating
of a sovereign entity, i.e. a country.
• The sovereign credit rating indicates the risk
level of the investing environment of a country
and is used by investors looking to invest
abroad. It takes political risk into account.
1.3 CREDIT RATING

Credit rating agencies

• Credit scores for individuals are assigned by credit
bureaus (US; UK: credit reference agencies). Credit
ratings for corporations and sovereign debt are
assigned by credit rating agencies.
• In the United States, the main credit bureaus are
Experian, Equifax, and TransUnion and Innovis.
• In the United Kingdom, the main credit reference
agencies for individuals are Experian, Equifax, and
Callcredit.
• In Canada, the main credit bureaus for individuals are
Equifax, TransUnion and Northern Credit Bureaus/
Experian.