subject: 4 Easy And Effective Ways To Measure Credit Risk [print this page] The banks and the financial institutions measure credit risk before approving the loan applications of the consumers. There are various ways by which one can measure credit risk. This article highlights four ways by which one can measure credit risk.
Credit risk measurement
Banks measure credit risk in the following ways:
1.Consumer credit: The lenders approve the loan applications of the borrowers when they have good FICO (Fair Isaac Credit Organization) score. A good credit score ranges between 760-850. However, if the borrower has a very bad credit score then the lenders don't approve the loan applications.
2.Probability of default: The risk managers check the borrowers credit history before approving his loan application. This is because the borrowers payment history is recorded in the credit report. Thereby, the risk managers can easily know whether the loan applicant is a responsible borrower. If the potential borrower's payment history is bad then there is a great probability that the borrower will default on the loan. Some risk managers can even determine the exact month in which the borrower will default on the loan. Thus the lenders can determine whether they should grant a loan or not.
3.Credit exposer: The risk managers look at how big the amount of debt will be in the event of loan default. Normally, the risk managers examine this when the amount of loan is huge (more than 50 million). Generally, businessmen apply for such big loans. They look at the current economical status of the businessman, the performance of the industry in which the business is in, and the reason for the loan.
4.Estimated rate of recovery: When the risk managers realise that in the event of loan default, the lending company will suffer greatly, then they look at the loan's estimated rate of recovery. Basically, they look at the part of debt that can be recovered through the liquidation of assets and collateral of the borrower. The loans will be granted only when the value of the loan is equal to the value of the assets.
Credit risk limits
Nowadays, banks and financial institutions instigate credit risk limits. They specify the maximum amount of loan that a borrower can get. This has been a boon to lenders as they can't give a loan more than what they are able of paying.
