Organizations today are enveloped by different kinds of risks. Therefore, companies must prepare to manage these risks and come out of these situations without any major losses. Credit risk is one such risk that can push companies into major troubles.
Credit risk analysis refers to the analysis of risks that comes with a particular borrower. In the process of credit risk analysis, the creditworthiness of an individual is assessed. Based on the results, the decision is being taken if the loan should be given or not.
What is a Credit Risk Analysis?
Credit Risk Analysis is performed to check if a borrower will be able to pay back the loan or credit taken from the company. It also aims at ascertaining the creditworthiness of the person. This helps the lenders in understanding if the borrower will be able to pay back the money or not.
A borrower may not be given the loan if his credit risk analysis reports deem him to be someone who can bring a potential credit risk to the company. The loan is given to the borrower if his risk profile is acceptable to a credit risk analyst. A person can become a credit risk analyst by registering himself or herself in an online credit risk course and understanding how risk analysis and the other closely related systems work.
A credit rating is also assigned to the borrower after the credit risk analysis process is complete. This score will give a clear picture to the lenders who may then decide to sanction the loan or act otherwise.
Parameters driving the Credit Risk Analysis
Credit risk is analyzed to get an overview of the following parameters:
- Chances of default: This refers to the event where a borrower might not be in a position to pay back the principal amounts and make the interest payments. The credit rating of an individual or a person helps the lender in deciding if the money should be given or not.
- Loss in the event of default: The lender might have to bear huge losses in case the repayments of loans are not made. Losses are calculated based on the exposure of the portfolio to the loss arising due to the non-payment of dues.
- Exposure to default: This refers to the extent to which the lender is exposed to a particular default risk. Different companies use different models to calculate risk exposure.
How does credit risk analysis work?
Credit risk analysis is a three-step process. These steps are usually followed by all the institutions that lend money frequently. These steps include:
- Collection of information: These analysts collect different pieces of information about the financial health of a borrower. They check the credit history of the person. This is done to understand the payment history of the borrower. Also, this gives an idea of any defaults made in terms of payments by the borrower. This information is important as this will decide if the loan should be given or not.
- Analysis of Information: Once all the financial information is collected, the credit risk analyst analyses the borrower’s profile to check the creditworthiness and the financial health of the borrower. He also checks different financial statements to see the inflow of cash and then ascertains the rating of the borrower.
- Approval or rejection of the application: Based on the analysis report and the credit rating of an individual, the lender decides whether a loan should be given to the borrower or not.
Credit risk analysis is a complicated process. It involves a collection of financial data which can be a cumbersome task. It then involves the analysis of all the data points. Credit risk analysts play a very important role in the functioning of the lender’s company.