Question

Banks manage Credit Risk as part of prudent lending policy, name and discuss each of the five main elements.  

Answer 1

Understanding that your client (KYC) is an important part of the process of credit risk management and is the foundation for all subsequent steps in the lending process. At the one hand, this requires mandatory checking of the credentials of new and current clients to prevent money laundering. At the other hand, it is also necessary to collect appropriate, reliable, timely information in order to create a solid customer relationship, so that the bank can position itself as a financial advisor and financial products and services provider.

Beyond an evaluation of creditworthiness, qualitative criteria also play an significant role in as-sessing a company's future. Non-quantifiable parameters are among the intangible performance parameters ("soft factors") which can have a lasting adverse impact on the growth of businesses. Here, the financial institution pays careful attention to evaluating the success criteria which are important for the company's future growth.

Establishing a banking relationship and lending is related to numerous benefits but also risks. Therefore, borrowers will know how and for what they are using the requested funds, and whether they are supposed to be repaid. Furthermore, the credit risk management process should define, categorize, and prioritize all risks associated with the customer. To grasp the numbers, the attention will be on the financial results of the company-the economic condition of the company is analyzed for this reason. Reports are reviewed concerning the company's net assets and profits.

One of the main elements of credit risk management is setting an acceptable price. Qualitative and quantitative evaluations form the basis for determining the risk associated with a business being given loans. Rating methods or other valuation models are used for risk assessment and is then used to measure the interest rate. The end interest rate is calculated by a variety of dynamic variables. Among the most important are (1) the economic condition of the company (creditworthiness), and (2) the collateral offered (collateral value retention). The theory is: the greater the company's financial condition, and the more expensive the collateral offered, the lower the interest rate.

An significant requirement for approving and closing the deal is the well-founded and competent communication of the ranking and scoring results and the costs. Credit decisions are not to be taken based solely on credit scores. It will not be full without equal focus on qualitative elements like organizational competence, competitive, etc. There is nothing more in the way of completing the deal after the analysis, structuring, and pricing are done.