Understanding Credit Risk Management
Companies and other institutions, such as banks,
are often faced with certain risks. Risk is always a part in every
business. But if the risk involved is financial in nature, companies
must come up with a system that can help manage risk. In the financial
world, credit risk management plays an important role in managing
the risks that come with credit and investment.
For a company to have a good credit risk management
system, it needs a framework and must perform certain processes
to have better knowledge of their customers. The customer is always
a factor to the attainment of the company's goals. But if a company
does not recognize the risks in providing products and services
to their customers, the company is inclined to experience pitfalls.
Knowing your customers is very important. That
is why in marketing plan, a business must recognize their target
markets, whether they are of primary, secondary, or tertiary levels.
Recognizing the market is very significant. If the company targets
the wrong market, it is one step behind to its downfall.
In the financial world, credit risk is a great
concern among banks and lending companies. Credit risk is defined
as the potential risk of losses resulting from the default of payment
of the debtor. This is a kind of risk that potentially leads a financial
company to instability and insolvency. That is why it is important
to recognize, analyse, measure, and manage the credit risks.
Risks abound in granting loans. A debtor has the
potential to default in payment, even if at the first impression
he appears to be financially sound. Because of the probability to
experience losses from the granting of loans, banks and lending
companies must assess the risks that come in borrowing, as well
as with the person who obtains a loan. Before a person is to be
granted a loan, he is still brought the scrutiny of the department
that handles the investigation of the person's credit standing and
financial background.
The statistical data of credit history of a person
is one of the factors based by lending companies before extending
the credit to the loan applicant. The credit history of an individual
is among the different bases used. This practice is a norm in financial
institutions to assess the credit risks that come with the person.
When it comes to investment, credit risk management
is a helpful system to employ to determine the amount of capital
that a company must keep in its reserve. As a rule stipulated in
Basel II, a company that has greater exposure to credit risks must
have greater amount of capital to sustain its financial equilibrium
and solvency. The Basel II applies primarily to banking institutions
when it comes to the regulation of capital to be stored in its reserve.
Financial companies are not only the entities exposed
to credit risks. Any company that extends credit to its customers
is also faced with credit risk. For-profit entities that sell goods
and services on credit also have credit risks.
To manage credit risks effectively, a company must
employ a credit risk management system that is proven to provide
satisfactory results.
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