Credit Risk deals with the risks associated with the provision of credit. The factor of credit risk is considered at the time of interest rate determination. Credit risk can also be classified into different categories.
Explanation of Credit Risk
Credit risk may be explained as the amount of risk the lender faces when he provides a loan. It can be called the amount of chance a lender has of losing his money if the borrower is not able to pay back the loan at time. It is also applicable in case of the payment of premium or interest.
Importance of Credit Risk
The factor of credit risk is an important phenomenon in the context of the modern day financial world as it is one of the factors that come into play when the lender gives a loan to the borrower. It is based on the amount of credit risk perceived by the lender that the rates of interest of the loan is decided.
Types of Credit Risks
There are several versions of credit risks. However, there are some that are more prominent and commonly seen:
- Credit risk of individuals
- Credit risk of lenders from the customers
- Credit risk of business entities
- Credit risk of lenders from business entities
Credit Risk of Lenders from the Customers
The credit risk that is faced by the lenders from their customers is also known as consumer credit risk. In case of the consumers most of the lenders use their personal models. These models are used in order to find out the risk potential of various clients.
In case of certain types of debt instruments the lenders charge comparatively higher rates of interest if they perceive the borrower to be risky enough. Examples of such services would be the personal loans that are not secured and the various mortgages.