A company has to follow three key principles in its credit risk management which are selection, limitation and diversification.<\/p>\n\n\n\n
Selection<\/u><\/strong><\/p>\n\n\n\n The first requirement is to whom to lend. This is usually based on customer\u2019s request. A model loan request would be in terms of filing all the information required which elicit information about the amount of loan, purpose of loan, repayment and collateral. Information on the organization of the business, trade area and other banking relationships would be required.<\/p>\n\n\n\n The 6 C\u2019s of Credit<\/u><\/strong><\/p>\n\n\n\n The evaluation of the loan request by the bank involves the 6 C\u2019s of credit.<\/p>\n\n\n\n Most common risk metric is the adequacy of loan loss provisions and the size of the loan loss reserve in relationship to the total exposures of the bank. Allowance for loan losses creates a cushion of credit losses in the bank\u2019s credit portfolio. Primarily it is intended to absorb the bank\u2019s expected loan losses. Historically credit decisions were made in a case by case basis.<\/p>\n\n\n\n Growing sophistication and automation of lending and the increasing complexity of credit products have spawned the development of computational approaches to credit assessment and evaluation of individual retail and commercial borrowers.<\/p>\n\n\n\n Introduction of bank-wide credit risk software has accelerated in part driven by regulatory pressures, as regulators demanded improved analysis and oversight of the risk assessment process.<\/p>\n\n\n\n Estimating Credit Losses<\/strong><\/p>\n\n\n\n Banks are expected to hold reserves against expected credit losses which are considered a cost of doing business. The most basic model of expected loss considers two outcomes: default and non-default.<\/p>\n\n\n\n In the event of non-default, the credit loss is 0. In the event of default, the loss is loss given default (LGD) times the current exposure (EAD).<\/p>\n\n\n\n Statistical approaches are used to estimate the distribution of possible loss values. For individual products in default, loss amounts are not deterministic due to uncertainty about LGD and collateral value. For a portfolio of credit products with defaults, loss amounts are also uncertain due to correlation of defaults between products.<\/p>\n\n\n\n Credit loss distributions tend to be largely skewed as the likelihood of significant losses is lower than the likelihood of average losses or no losses. Active loan portfolio management embracing diversification of exposures across industries and geographic areas can reduce the variability of losses around the mean.<\/p>\n\n\n\n Unexpected Loss represents the minimum loss level for a given confidence level a UL(a) is the maximum loss a bank will suffer a% of the time.<\/p>\n","protected":false},"excerpt":{"rendered":" Among the various financial risks that a company or a bank comes across, the most important are liquidity risk and credit risk. Credit risk is an inherent part of a commercial bank\u2019s intermediary operations. Credit is the primary source of business for a bank and it is based on this that a bank\u2019s quality and…<\/p>\n","protected":false},"author":1,"featured_media":0,"parent":0,"menu_order":0,"comment_status":"closed","ping_status":"closed","template":"","meta":{"footnotes":""},"categories":[],"tags":[],"class_list":["post-106634","page","type-page","status-publish","hentry"],"acf":[],"yoast_head":"\n![\"Image](\"http:\/\/www.vskills.in\/lms\/wp-content\/uploads\/2016\/05\/Image-1-8.jpg\")
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