CREDIT RISK MANAGEMENT

CREDIT SCORING
 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.
 The use of credit or identity scoring prior to authorizing access or granting credit
is an implementation of a trusted system.

USES OF CREDIT SCORING

 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.
 Lenders also use credit scores to determine which customers are likely to bring
in the most revenue
 Credit scoring is not limited to banks. Other organizations, such as mobile phone
companies, insurance companies, landlords, and government departments
employ the same techniques.

5 Cs OF BORROWERS IN CREDIT SCORING

 The five Cs of credit is a system used by lenders to gauge the creditworthiness of
potential borrowers.
 Financial institutions use credit ratings to quantify and decide whether an
applicant is eligible for credit and to determine the interest rates and credit limits
for existing borrowers.

 CHARACTER
 Character measures how reliable and trustworthy you are.
 Your credit “character” speaks to your overall trustworthiness as a borrower.
 Character helps lenders recognize your ability to repay a loan.
 Particularly important to character is your credit history.
 It provides insight into your ability to make on-time payments.

 CAPACITY
 Capacity measures your ability to repay your debt.
 The lender wants to know how much you owe versus how much you own.
  The lower your debt-to-income ratio, the more favorable a bank will look at your
request for credit.

 CAPITAL
 Capital shows lenders you're serious and committed to the credit you're seeking.
 For individual loans, this means a down payment when applying for a loan.
 For a business loan, this means you've invested some of your own money into
the business.

 COLLATERAL
 Collateral provides assurance to the bank in case you're unable to pay for the
loan. 
 Collateral is the assets you pledge to support your loan. 
 Collateral serves as a backup in the case the borrower fails to pay back the loan.
 The collateral can be your house property, land, equipment, inventory, real
estate, accounts receivable, or any other item holding monetary value in the
market.

 CONDITIONS
 This refers to the current economic health of the market and the industry you
work in. 
 Conditions can refer to how a borrower plans to use the money.
 It measures the borrower’s circumstances, e.g. market conditions, competitive
pressure, seasonal character etc.

CREDIT SCORING AT DIFFERENT STAGES

APPLICATION SCORING

TYPES OF SCORING
 Targeted Scoring
 Internal and external scoring
 Counter party and facility scoring

CREDIT RATING
The goal is to generate accurate and consistent risk ratings, yet also to allow
professional judgment to significantly influence a rating where this is appropriate.

METHOD OF CREDIT RATING

 THROUGH THE CYCLE
In this method of credit rating, the rating of the client will depend upon the “worst
point in the business cycle”.

 POINT IN TIME
In this method of credit rating, the rating of the client will depend upon the
“current condition”.

PARAMETERS FOR CREDIT RATING

 QUANTITATIVE FACTORS
 Growth in sales, profits
 Return on capital
  Debt Equity ratio
 Current ratio
 Level of contingent liabilities
 Speed of debt collection
 Operating Cycle

 QUALITATIVE FACTORS
 Compliance with regulator
 Experience of top management
 Corporate governance initiatives
 Performance of affiliate concern
 Ability to cope with any major technological, legal, fashion etc changes
 Product characteristics

TYPES OF LENDINGS AND RATINGS

 WHOLE SALE EXPOSURE
Following factors in the credit rating process for whole sale lending.
 Industry analysis
 Financial Analysis
 External return
 Analytical tools
 Quality of financial data
 Firm Size
 Management

 RETAIL EXPOSURE
Two vital issues need to be addressed:
 Borrower’s ability to service the loan
 Borrower’s willingness to service the loan

FUNDAMENTAL REASONS FOR VARIOUS GRADING

 Signaling default risks of an exposure
 Measure the credit risk of an exposure
 Comparison of risks to aid decision making
 Compliance with regulatory requirements
 Compliance with terms and conditions
BASEL CAPITAL ACCORD
 The accord agrees upon a minimal capital regulation framework for
internationally active commercial banks so as to reduce the risk of the
international financial system.
 The Basel Accords refer to a series of three international banking regulatory
meetings that established capital requirements and risk measurements for global
banks.
 The Basel Accords refers to a set of banking supervision regulations set by the
Basel Committee on Banking Supervision (BCBS).

BASEL II FRAMEWORK WITH 3 PILLARS