Question

Discuss the importance of credit risk analysis to a financial institution. Your discussion should not be less than 250 words and please provide references.

Answer 1

Finance companies provide short to medium term funding to consumers and commercial businesses. Finance companies do not have access to cheap deposits like commercial banks do.Only a few finance companies in some states are allowed to raise a fixed deposit. Finance companies use loans from banks, commercial papers, bonds and capital as sources for their funds. Finance companies deploy their funds to make consumer loans, business loans, leasing and real estate loans. Finance companies offer personal loans and automobile loans. Finance companies also provide commercial loans to companies, factoring services,and funding for leverages buyouts and leasing.Consumer loans.Finance companies offer personal loans and automobile loans. Personal loans are offered to take care of a variety of expenses including home improvements, mobile homes etc. Automobile loans are provided to purchase vehicles.Consumer loans are sensitive to economic conditions. Once economic conditions worsens, layoffs take place.Laid off workers default in their loan obligations.Business loans.Finance companies provide commercial loans to companies, factoring services, funding for leveraged buyouts and leasing. Commercial loans are short term working capital loans used to finance purchase of inventor for production. Factoring services involve the purchase of accounts receivables at a discount. Finance companies also purchase equipment and lease them to commercial organizations.Many consumer of finance company Are not the consumers with the best credit capacity. Businesses are also small to medium sized businesses. So, they carry significantly more risk to default. This is in sharp contrast to the credit risk faced by other financial institutions. They have well diversified portfolios.Many of their clients have the best repayment capacity. As a result, other financial institutions feel the impact of deteriorating economics rather later. The impact itself is mitigated by the well diversified portfolio of credit. Finance companies face a greater degree of credit risk than other financial institutions.