Bank credit risk is a risk associated with non-payment of obligations and may be defined as the creditor 's uncertainty that the borrower will be able and will intend to meet its obligations to repay and pay the loan in accordance with the terms and conditions of the loan agreement.
Careful selection of borrowers, analysis of the terms of the loan issue, constant monitoring of the borrower 's financial condition, its ability (and readiness) to repay the loan make it possible to avoid credit risk.
The fulfilment of all these conditions guarantees the success of the most important banking operation - the provision of loans.
By applying certain methods and instruments, credit risk is managed at all determining stages of the credit process:
- Development of basic provisions of banking policy,
- Initial stages (familiarity) of work with a potential client,
- Coordination of the bank 's objectives and client 's interests,
- Assessment of creditworthiness of the borrower, - structuring of quality characteristics of the loan,
- credit monitoring,
- Work with problematic loans,
- The application of sanctions, etc.
Credit risk management requires banks to constantly monitor the structure of the loan portfolio and their quality.
As part of the yield-risk dilemma, banks are forced to limit their rate of return by insuring themselves against unnecessary risk.
They should have a policy of dispersing risk and preventing the concentration of loans from several large borrowers, which could have serious consequences if a loan was outstanding by one of them.
The bank should not risk depositors "funds by financing speculative (though highly profitable) projects.
This is closely monitored by the banking review bodies during periodic audits.
Credit risk depends on external (related to the state of the economic environment, conditions) and internal (caused by erroneous actions of the bank itself) factors.
The ability to manage external factors is limited, although timely action by the bank can to some extent mitigate their impact and prevent major losses.
However, the main levers of credit risk management lie in the sphere of domestic policy of the bank.
Ultimately, the ability to manage credit risk depends on the competence of the bank 's management and the level of qualification of its ordinary staff, which is engaged in selection of specific credit projects and elaboration of terms of credit agreements.
In the process of credit risk management of a commercial bank it is possible to distinguish several common characteristic stages:
- Develop the bank 's credit policy goals and objectives
- Establish a credit risk management administrative structure and administrative decision-making system
- study of the borrower 's financial condition
- study of the borrower 's credit history, its business relationships
- development and signing of credit agreement
- Risk analysis of non-repayment
- credit monitoring of the borrower and the entire loan portfolio
- actions for the return of overdue and doubtful loans and the disposal of liens.
Credit risk management methods are quite diverse and diverse:
- neutralizing risk factor:
- assessment of creditworthiness (prevention, risk prevention) in the directions: borrower, environment (industry, competitors), project;
- Delineation of the authority to make a credit decision depending on the amount of credit and the amount of potential risk;
- related project financing, partly from the borrower 's own funds;
- availability in the management structure and organization of work with problematic loans;
- the protective conversion of conditions of a debt provided in contracts (improvement of information support, growth of pledges, penalties, a penalty fee, penalties, increase in percent, etc.);
- activities of internal special organizational structures (creditworthiness departments, security services, etc.);
- paid services of specialized firms that help the borrower (advice, financial support) to repay the debt;
- Use of legal liability (many countries have criminalized intentional bankruptcy, increased business risk, misrepresentation of information provided, etc.);
- as well as the resulting side of credit risk (minimum consequences, losses):
- Diversify the loan portfolio towards any or all of the quality characteristics of the loan in order to reduce the concentration of risk;
- creation of alternative cash flows (sometimes this method carries the name - ensuring return of loans) in the form of pledges, guarantees, guarantees, an insurance, creation of a reserve against risks;
- limit the amount of credit to one borrower;
- issue of the discounted loans;
- secueterization - sale of debt service to the 3rd person with discount.