Sukaik

Credit risk management is a profession that focuses on reducing and preventing losses by understanding and measuring the probability of those losses. Credit risk management is used by banks, credit lenders, and other financial institutions to mitigate losses primarily associates with nonpayment of loans. A credit risk occurs when there is potential that a borrower may default or miss on an obligation as stated in a contract between the financial institution and the borrower.

Attaining good customer data is an essential factor for managing credit risk. Gathering the right information and building the right relationships with the selected customer base is crucial for business risk strategy. In order to identify potential issues and risks that may arise in the future, analyzing financial and nonfinancial information pertaining to the customer is critical. Risks such as that in business, industry of investment, and management risks are to be evaluated. Credit risk management evaluates the company’s financial statements and analyzes the company’s decision making when it comes to financial choices. Furthermore, credit risks management analyzes where and how the loan will be utilized and when the expected repayment of the loan is as well as the reason behind the company’s need to borrow the loan.

Expected Loss (EL) is a concept used for Credit Risk Management to measure the average potential rate of losses that a company accounts for over a specific period of time. The expected credit loss is formulated using the formula:

Expected Loss = Expected Exposure X Expected Default X Expected Severity

Expected Exposure refers to exposure expected during the credit event. Some factors impacting expected exposure include expected future events and the type of credit transaction. Expected Default is a risk calculated for the number of times a default will likely occur from the borrower. Expected Severity refers to the total cost incurred in the event a default occurs. This total loss includes loan principle and interests. Unlike Expected Loss, organizations have to hold capital for Unexpected Losses. Unexpected Losses represent losses where an organization will need to predict an average rate of loss. It is considered the most critical type of losses as it represents the instability and unpredictability of true losses that may be encountered at a given timeframe.