Credit risk is an internal calculation performed by banks and lending institutions before credit is granted to a borrower. It is used for all types of loans, including individual loans, enterprise loans, and national debt.
Credit Risk Assessment
To minimize the risk of default by borrowers, lending institutions rely heavily on credit risk.
In consumer financing, credit risk is calculated based on the five Cs:
- Credit history
- Repayment capacity
- Lending condition
The combination of these factors associated with an application determines the credit risk for a specific loan.
Understanding Credit Risk Factors
Complex algorithms and financial calculations determine the correlation between these five factors. However, knowing what factors are considered when measuring your credit risk can be beneficial.
The Role of Banks and Lending Institutions
Banks and lending institutions pay the utmost attention to the risk of default by borrowers.
They usually have dedicated credit risk management departments that calculate individual credit risk scores for new borrowers.
These departments also create risk assessments for the bank or lending institution’s combined loan value. Banks need to maintain a relatively low level of risk exposure.
Managing Credit Risk through Collateral
Even though credit risk is relatively new in the cryptocurrency sphere, some principles of risk calculation from traditional finance have already found their place in the crypto world.
Risk management and risk aversion are among the most crucial protection mechanisms banks have in place when lending money.