Credit risk – what is it? How to reduce them?

Each financial institution, by providing funds to its client – whether in the form of a loan or credit – bears the financial risk associated with non-payment of the obligation. It significantly influences the decision on granting funds and specifying the terms of their repayment. We, as potential borrowers, should know the parameters according to which the bank will assess us. See towelrootapkdld.com for further editorial

Credit risk – what is it?

Credit risk - what is it?

The simplest definition of credit risk is that it is the probability that the borrower or counterparty will fail to fulfill his financial obligations, including breach of contractual obligations. It is therefore an indicator that determines the borrower’s credibility. To determine it, several factors are taken into account. This is a mutual relationship, because the risk borne by the borrower directly translates into financial risk borne by the bank, especially when the phenomenon would be massive.

Types of credit risk

Types of credit risk

The types of risk that may arise in relation to a single borrower and the overall financial and economic situation, of which the bank is part, have been systematised so that they can be better managed. The basic ones include:

  • acceptable and unacceptable risk,
  • active credit risk – related to the borrower’s default on obligations,
  • passive credit risk – related to the need to raise funds for the bank’s own business (refinancing).
  • portfolio risk – that is, total risk related to non-payment of all liabilities that the bank has granted.

Acceptable risk and unacceptable risk

Acceptable risk and unacceptable risk

The most important from the point of view of a bank that grants a loan to a specific person or entity is the so-called acceptable and unacceptable risk. The first one defines the negative but acceptable threats that the bank is willing to take when granting a loan. This can be, for example, other, but small liabilities, that the borrower has, or an employment contract that is not indefinite, but concluded for a sufficiently long time.

Unacceptable risk defines the upper limit of risk, which is characterized by granting funds to a given borrower and which the bank cannot accept. These include, for example, a negative credit history, having other liabilities, and unstable employment.

Factors increasing credit risk and improving creditworthiness

Factors increasing credit risk and improving creditworthiness

Factors increasing credit risk and improving creditworthiness are related – by eliminating or reducing the impact of the former, we become a more credible borrower. It is a stable form of employment based on an employment contract, an appropriate amount of monthly income, and no other obligations.
The chances of obtaining a loan increase (improving creditworthiness) also when: we apply for him / her with a spouse (loan for an apartment), we have a girary, we buy a loan insurance or we provide collateral in kind.

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