What Is Credit risk ???

What Is Credit risk ???

Credit risk is defined as the possibility of losses associated with diminution in the credit quality of borrowers or counterparties. In a bank’s portfolio, losses stem from outright default due to inability or unwillingness of a customer or counterparty to meet commitments in relation to lending, trading, settlement and other financial transactions. Alternatively, losses result from reduction in portfolio value arising from actual or perceived deterioration in credit quality.

Credit risk emanates from a bank’s dealings with an individual, corporate, bank, financial institution or a sovereign. Credit risk may take the following forms:

in the case of direct lending: principal /and or interest amount may not be repaid; 

in the case of guarantees or letters of credit: funds may not be forthcoming from the constituents upon crystallization of the liability;

in the case of treasury operations: the payment or series of payments due from the counter parties under the respective contracts may not be forthcoming or ceases;

in the case of securities trading businesses: funds/ securities settlement may not be effected;

in the case of cross-border exposure: the availability and free transfer of foreign currency funds may either cease or restrictions may be imposed by the sovereign.

In this backdrop, it is imperative that banks have a robust credit risk management system which is sensitive and responsive to these factors. The effective management of credit risk is a critical component of comprehensive risk management and is essential for the long term success of any banking organisation. Credit risk management encompasses identification, measurement, monitoring and control of the credit risk exposures.