What is meant by credit risk management?

Credit risk management is the practice of mitigating losses by understanding the adequacy of a bank’s capital and loan loss reserves at any given time – a process that has long been a challenge for financial institutions.

What is the importance of credit risk management?

Why is credit risk important? It’s important for lenders to manage their credit risk because if customers don’t repay their credit, the lender loses money. If this loss occurs on a large enough scale, it can affect the lender’s cash flow.

How is credit risk management done?

Credit risk management is the practice of mitigating losses by understanding the adequacy of a bank’s capital and loan loss reserves at any given time – a process that has long been a challenge for financial institutions. But banks who view this as strictly a compliance exercise are being short-sighted.

What is credit risk in simple words?

Credit risk is the possibility of a loss resulting from a borrower’s failure to repay a loan or meet contractual obligations. Traditionally, it refers to the risk that a lender may not receive the owed principal and interest, which results in an interruption of cash flows and increased costs for collection.

What are the causes of credit risk?

The main source of micro economic factors that leads to credit risk include limited institutional capacity, inappropriate credit policies, volatile interest rates, poor management, inappropriate laws, low capital and liquidity levels, direct lending, massive licensing of banks, poor loan underwriting, laxity in credit …

What are the two types of credit risk?

These are two main categories, but sub-categories include: Credit Spread Risk: Credit spread risk is typically caused by the changeability between interest rates and the risk-free return rate. Default Risk: When borrowers are unable to make contractual payments, default risk can occur.

How do you mitigate credit risk?

How to reduce credit risk

1. Determining creditworthiness. Accurately judging the creditworthiness of potential borrowers is far more effective than chasing late payment after the fact.
2. Know Your Customer.
3. Conducting due diligence.
4. Leveraging expertise.
5. Setting accurate credit limits.