Question

Which of the following would you consider as the main drivers of credit risk:

a) Economic factors, borrower characteristics and legal infrastructure

b) Recovery rates, credit exposure and probability of default

c) Interest rates, probability of defaults and concentration of lending

d) Counterparty credit ratings, loss given default, and exposure at default

Give a short explanation justifying your answer.

Answer 1

Credit Risk

The possibility of borrower's failure to the repayment of the loan or failure to meet out other obligation is considered as credit risk. Basically, it is impossible to identify, who will do default on the obligation and who not. The credit risk is estimated on the basis of the borrower's overall ability to the repayment of the loan. The assessment is done with the help of the credit history of the customer, capacity of repayment, the loan conditions and associated collateral.

Main drivers of credit risk
The counterparty credit rating refers to the ratings given by authentic another party who have already involved with the person.
The loss given default refers to to the default in case of giving a huge amount of money to a person. If the organization is giving a huge amount of loan tour a normal person it will increase the credit risk. The total loss exposure is also the main driver of credit risk.

So from all of the above option (D) Counterparty credit rating, Loss given default, and Exposure at default are correct.