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Commercial Banking

Credit Risk

It is an inherent part of a commercial bank’s intermediary operations. Credit is the primary source of business for a bank and it is based on this that a bank’s quality and performance are judged.

Many financial institutions and banks have suffered in the recent past as a result of poor loan quality. The credit risk management process of a bank is believed to be a good indicator of the quality of the bank’s loan portfolio. Banks are successful when the risks they take are reasonable, controlled and within their financial resources and competence.

It involves the risks that come with a borrower not fulfilling his/her obligations on time. Even when all the assets of a balance sheet match up exactly with all the liabilities, the only risk remaining on it would be credit risk. Credit risk exposure is measured by the current mark to market value.

The magnitude of credit risk depends on,

• the likelihood of default by the counter party
• the potential value of outstanding contracts
• the extent to which legally enforceable netting arrangements allow the value of offsetting contracts
• the value of the collateral held against the contracts

Obstacles

The task of credit risk management is difficult in developing markets because of intervening matters such as

• Government controls
• Political pressures
• Production difficulties
• Financial restrictions
• Market disruptions
• Delays in production schedules
• Frequent instability in the business environment
• Unreliable financial information
• Debt recovery is not supported by the legal framework