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

shop loans are linked to a specific item or items ± for example.1 INTRODUCTION TO CREDIT You are granted credit when an organization or individual makes a sum available for you to borrow. Home loans. and personal or mortgages. There are two main types of credit. 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. a new kitchen. 1. in a wide range of retailers and other outlets . or mortgages.1.

can be repaid in variable installments but most personal loans specify fixed repayments of approximately equal amounts.1 INTRODUCTION TO CREDIT Repayment ‡ Loans are normally repaid in regular time. Mortgages. . you need to negotiate a new loan. installments over an agreed period of time. ‡ If you want to make another major purchase when you have finished paying off one loan.1. or home loans.

And every time you pay off some of the outstanding amount. .1 INTRODUCTION TO CREDIT Repayment Revolving credit means that you always have access to the amount of your line of credit that remains unspent. 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. ‡ Simple and Compound Interest .1. lenders generally charge interest on loans and revolving credit. credit. You must remember this when you are calculating your repayments.

you can repay as credit. loans. a week. . ‡ With revolving credit.1. With fixed repayment loans. at any point.1 INTRODUCTION TO CREDIT Interest ‡ Interest may be compounded after any period ± a day. much or as little as you want. the amount of interest is worked out in advance and added into the repayments. 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. a month and so on.

1 INTRODUCTION TO CREDIT Credit Score ± A credit score is a numerical expression based on a statistical analysis of a person's credit files. ± A credit score is primarily based on credit report information typically sourced from credit bureaus / credit reference agencies .1. which is the perceived likelihood that the person will pay debts in a timely manner. to represent the creditworthiness of that person.

at what interest rate.1. . such as mobile phone companies. Lenders use credit scores to determine who qualifies for a loan. employers. ‡ The use of credit or identity scoring prior to authorizing access or granting credit is an implementation of a trusted system. such as banks and credit card companies. and what credit limits. companies. use credit scores to evaluate the potential risk posed by lending money to consumers and to mitigate losses due to bad debt. insurance companies. and government departments employ the same techniques.1 INTRODUCTION TO CREDIT Credit Score ‡ Lenders. Credit scoring is not limited to banks. Other organizations.

‡ Identity score components can include (but are not limited to) personal Identifiers . ‡ Identity scores incorporate a broad set of consumer data that gauges a person¶s legitimacy.1. predicted behavior patterns based on empiric data.1 INTRODUCTION TO CREDIT Identity Score ‡ An identity score is a system for tagging and verifying the legitimacy of an individual¶s public identity. government records. corporate data. public records. . Internet data. and credit records. Identity scores are increasingly being adopted as a means to prevent fraud in business and as a tool to verify and correct public records.

in many countries. The term "credit reputation" can either be used "credit reputation" synonymous to credit history or to credit score.1. a record of an individual's or company's repaying. including information about late payments and bankruptcy.2 CREDIT HISTORY ‡ Credit history or credit report is. score. past borrowing and repaying. this report has become even more important since it is usually the sole element used to choose the annual percentage rate . bankruptcy. risk‡ With the adoption of risk-based pricing on almost all lending in the financial services industry.

1. terms.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. lower the interest while the lower the credit rating. the history² rating. ‡ Interest rates on loans are significantly affected by credit history²the higher the credit rating. if at all. ‡ 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. . used to offset the higher rate of default within the low credit rating group of individuals. The increased interest is interest. the higher the interest.

.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. 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 history. approved because of lack of credit history.1. ‡ For example.

high and low balances. 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. including payment information. history. This information can be quite detailed and arduous to navigate by a potential lender dealing with a new applicant. To address this issue. are all reported regularly (usually monthly). The data agencies. scoring was invented. and balances. credit applicant. credit limits. . ‡ Detailed account information.2 CREDIT HISTORY Adverse Credit ‡ A consumer or business' credit history is regularly tracked by credit rating agencies.1. any aggressive actions taken to recover overdue debts.

payments.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. Repeated hits can lower the score and trigger what is called a negative credit rating or adverse credit history. .1. payments. a "hit" on the score is suffered. or trouble with collecting payments.

in recent years. corporation. determine employment eligibility. ‡ Credit ratings are calculated from financial history and current assets and liabilities. and establish eligibility. Typically. ‡ However. a credit rating tells a lender or investor the probability of the subject being able to pay back a loan. or even a country.3 CREDIT RATING ‡ A credit rating assesses the credit worthiness of an individual. credit ratings have also been used to adjust insurance premiums. the amount of a utility or leasing deposit. .1.

‡ 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).1. along with his or her credit report. ‡ An individual's credit score. affects his or her ability to borrow money through financial institutions such as banks. individual's credit history is compiled and maintained by companies called credit bureaus. . an States.3 CREDIT RATING Personal credit ratings ‡ In countries such as the United States.

saving patterns 5. spending patterns 6. interest 3. debt . amount of credit used 4.1. ability to pay a loan 2.3 CREDIT RATING The factors which may influence a person's credit rating are 1.

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B.1. ‡ These are assigned by credit rating agencies such as Standard & Poor's or Fitch Ratings and have letter designations such as AAA. and CC. CC.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. . B. bonds.

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. a country.3 CREDIT RATING Sovereign credit ratings ‡ A sovereign credit rating is the credit rating entity. It takes political risk into account.1.e. ‡ The sovereign credit rating indicates the risk level of the investing environment of a country and is used by investors looking to invest abroad. of a sovereign entity. i. country.

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Credit ratings for corporations and sovereign debt are assigned by credit rating agencies. Equifax. ‡ In the United States. Equifax. the main credit bureaus are Experian. agencies for individuals are Experian. and TransUnion and Innovis. UK: credit reference agencies). . the main credit reference Equifax. TransUnion and Northern Credit Bureaus/ Experian. Innovis. the main credit bureaus for individuals are Equifax. Callcredit. ‡ In Canada. and Callcredit. Equifax. ‡ In the United Kingdom.1.3 CREDIT RATING Credit rating agencies ‡ Credit scores for individuals are assigned by credit bureaus (US.

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