A Risk Professional's Survival Guide: Applied Best Practices in Risk Management

CHAPTER 7 Commercial Credit Risk Overview

A common denominator in estimating credit risk on commercial and consumer loans is that both require estimates of the probability (or, frequency) of default (PD) and loss given default (LGD). When applied against the notional value of a loan at default—that is, the exposure at default (EAD)—an estimate of expected loss can be made on the loan or a portfolio of loans. However, commercial loans also have a number of characteristics that require a somewhat different approach to estimating losses.

Commercial loans can be categorized broadly into two groups: commercial and industrial (C&I) loans are loans made to businesses large and small to support their operations. These can include standard loan contracts secured by collateral such as plant and equipment, or receivables and inventory, or may include unsecured lines of credit. Another type of commercial loan is for real estate lending—commercial real estate, or CRE—such as for office space, apartments, shopping centers, hospitals, and other commercial buildings.

Commercial loans to small and in some cases medium-sized businesses, may have sufficient uniformity and scale to allow the bank to use statistical techniques such as underwriting scorecards to assess credit risk. Large commercial loans are characterized by their general lack of uniformity and size, which limits the application of standard modeling to estimating losses associated with such loans. Commercial risk management commonly ...