How to analyz bank credit risk

Expert Solution

Answer:-

Credit risk analysis is a form of analysis performed by a credit analyst such as banks on potential borrowers to determine their ability to meet debt obligations. The main goal of credit analysis is to determine the creditworthiness of potential borrowers and their ability to honor their debt obligations.

Hence, Credit risks are assessed depending on the overall ability of the borrower to adhere to the original contractual terms of loan repayment.

When calculating the credit risk, various factors commonly referred to as the “5 Cs of Credit” are considered. The 5 Cs of Credit incorporate both qualitative and quantitative financial measures, and the banks may analyze different documents, such as the borrower’s income statement, balance sheet, credit reports, and other documents that reveal the financial situation of the borrower. So, the important 5 Cs that any bank pursues are:-

• Capital in business or own-contribution of borrowers is important. Higher the cash flows and equity capital lower the leverage and better the loan terms. The thumb rule here is that more is better.

• Capacity to repay considers the cash-flow, ability to repay, and the terms of repayment.

• Credit history, how reliable and trustworthy the credit handling has been, foreclosures, bankruptcies, court cases and judgments revealed in the credit history which will be evaluated by banks.

• Conditions of the loan depend on economic policies, current market rates, taxes, industry-relevant or economic conditions, size of the loan, intended use and market impact on the loan.

• Collateral associated with the loan cover the risks associated in case of non-repayment. Adequacy, acceptability of asset and market values can be gainfully leveraged when applying for loans.

Assessing the risk is done in several ways like the points-based system, personal appraisals by trained risk-assessors or by departments for credit-risk assessment of loan-customers.

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