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Credit Risk

Credit Risk is defined as the potential financial loss arising from the failure of an obligor or counterparty to meet its contractual obligation. In the Banking sector, Credit Risk is a crucial factor while determining the interest rate for a potential loan. Usually, the longer the term of the loan the higher the interest rate applied. This is commonly called credit exposure.

The Bank for International Settlements (BIS) defined Credit Risk in the following way:

Credit risk is most simply defined as the potential that a bank borrower or counterparty will fail to meet its obligations in accordance with agreed terms. The goal of credit risk management is to maximise a bank’s risk-adjusted rate of return by maintaining credit risk exposure within acceptable parameters. Banks need to manage the credit risk inherent in the entire portfolio as well as the risk in individual credits or transactions. Banks should also consider the relationships between credit risk and other risks. The effective management of credit risk is a critical component of a comprehensive approach to risk management and essential to the long-term success of any banking organisation.



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