Credit risk is risk that a borrower will fail to pay the debt. The risk is a primarily concern of the bank as it may lead to loss of principal and interest, disruption to cash flows, and increased collection costs.
The potential circumstances that contribute to the credit risk are:
- A borrower may fail to make a payment due on a mortgage loan, credit card, line of credit, or other loan
- A company is unable to repay asset-secured fixed or floating charge debt
- A business or consumer does not pay a trade invoice when due
- A business does not pay an employee’s earned wages when due
- A business or government bond issuer does not make a payment on a coupon or principal payment when due
- An insolvent insurance company does not pay a policy obligation
- An insolvent bank won’t return funds to a depositor
- A government grants bankruptcy protection to an insolvent consumer or business
Credit risk from your bank’s point of view
The credit policy of banks is determined by their management or Board of Directors. All managers and employees in the credit system of the bank must follow certain credit policy and inform promptly on deviations from it. It should be noted that the credit policies of banks are local guidelines regarding:
- loan portfolio;
- size, structure and proportions of borrowed and leased by the Bank;
- the level of credit risk, the bank can take according to their reserves and as instructed by the Central Bank.
The management of the credit risk of commercial banks is an activity that depends on external conditions such as the guidelines of the Central Bank and the very structure of the loan portfolio.