Credit Risk Management

Chapter 1

Introduction to credit

risk management

Lending has always been the primary function of banking, and accurately

assessing a borrower’s creditworthiness has always been the only method

of lending successfully.

The method of analysis required varies from borrower to borrower. It also

varies in function of the type of lending being considered.

For example, the banking risks in financing the building of a hotel or rail

project, of providing lending secured by assets or a large overdraft for a

retail customer would vary considerably.

For the financing of the project, you would look to the funds generated by

future cash flows to repay the loan, for asset secured lending, you would

look at the assets, and for an overdraft facility, you would look at the way

the account has been run over the past few years.

In this book on credit risk management, we will be looking specifically at

the appropriate methods of analysis for lending to companies, a subject

more often known as ‘corporate credit’.

What is the role of credit analysis?

Credit analysis supports the work of marketing officers by evaluating

companies before lending money to them.

This is essential so that new loan requests can be processed, a company’s

repayment ability assessed, and existing relationships monitored.

The extent of the credit analysis is determined by

■ the size and nature of the enquiry,

■ the potential future business with the company,

■ the availability of security to support loans,

■ the existing relationship with the customer.

The analysis must also determine whether the information submitted is

adequate for decision-making purposes, or if additional information is

required.

An analysis can therefore cover a wide range of issues.

For example, in evaluating a loan proposal for a company, it may be

necessary to:

■ obtain credit and trade references,

■ examine the borrower’s financial condition,

■ consult with legal counsel regarding a particular aspect of the draft

loan agreement.

By making these checks you are ensuring that your report does not look

at a company’s creditworthiness in a narrowly defined sense. You will be

taking the further step of deciding whether the provisions in the loan

agreement are appropriate for the borrower’s financial condition.

Often it will be necessary for the analyst to place the assessment of the

borrower’s financial condition within the wider context of the conditions

existing in the industry in which it is operating.

For example: Is the company’s business cyclical or counter cyclical? How

will this affect the long-term cash flow of the firm? What are the consid-

erations of general economic conditions and, if appropriate, political

conditions in the country where the company is operating?

Credit Risk Management

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