An individual or corporate borrower actively takes part in the credit formulating process. The lender, while granting a loan tries to understand and scrutinize the conditions of whether the borrower would be able to repay the borrowed amount.
A close watch on the borrowers’ credit score helps the lender get a clear picture of an individual or a company’s creditworthiness. When a corporate or an individual borrower fails to meet their debt obligations, the phenomenon gives rise to credit risk. It is the probability that the lender will not receive the principal and interest payments of a debt required to service the debt extended to a borrower.
On the other hand, the lender’s cash flows will get disrupted and increase collection costs, since the lender may be forced to hire a debt collection agency to enforce the collection.
Credit risk arises when a corporate or individual borrower fails to meet their debt obligations. It is the probability that the lender will not receive the principal and interest payments of a debt required to service the debt extended to a borrower.
The lender gets a reward for accepting to bear credit risk in the form of the interest rate charged. Banks charge a high interest rate for high risks loans as a way of compensating for the high risk of default.
If a corporate borrower shows signs of poor credit history, the lender is granted the liberty to charge a high-interest rate for the loan or reject the loan application altogether. Lenders use different methods to assess the level of the credit risk of a potential borrower to mitigate losses and avoid delayed payments.
Keeping a close watch on your credit risks is sometimes very thoughtful.