Credit Risk Assessment free essay sample

There needs for a critical evaluation of the most popular credit risk assessment methods such as the judgmental method, credit-scoring and portfolio models along with limitations used. Survey interview process is needed for confirming that credit risk assessment methods should be combined for effective credit risk assessment. Accordingly, the study proposes a framework for improving credit risk assessment, which combines the strengths of these methods and copes successfully with study limitations. INTRODUCTION Credit risk covers risks due to upgrading or downgrading a borrowers credit worthiness which depend ob the potential sources of the risk who the client may be and who uses it as banks in particular are devoting a considerable amount of time and thoughts to defining and managing credit risk. There are two sources of uncertainty in credit risk: default by a party to a financial contract and a change in the present value of future cash flows that result from changes in financial market conditions as well as changes in the economic development. Credit risk considerations underlie capital adequacy requirements regulations that are required by financial institutions but financial borrowing as well as lending transactions are sensitive to credit risk, to protect themselves firms and individuals turn to rating agencies to obtain an assessment of the risks of bonds, stocks and financial papers they may acquire and after a careful reading of these ratings the investors, banks and financial institutions proceed to reduce these risks using risk management tools. Risk management is applied in finance. Financial economics deals with hedging problems in to order eliminate credit risks in a particular portfolio through a series of trades or contractual agreements reached to share and induce a reduction of risk by involved parties. Risk management should use financial instruments to negate the effects of risk by using better options, contracts and credit design plans so that such risks are brought to bearable financial costs as the tools cost money and requires a careful balancing of factors that affect credit card risks. When a company grants credit to its customers it incurs the risk of non-payment as credit risk management refers to the systems, procedures and controls which a company has in place to ensure the different collection of consumer payments and minimize its risks. Credit risk assessment and management will form a key part of the companys overall risk management strategy as weak credit risk management is a primary cause of many business failures and that such small business have neither the resources nor the expertise to operate a sound credit risk management system. RESEARCH QUESTIONS AND OBJECTIVES Research Questions Should people invest in a given stock whose returns are hardly predictable? Should people buy an insurance contract in order to protect themselves from theft? Should credit firms be rational and reach a decision on the basis of what they know and subjective assessment with the unfolding evidence? What are the principles of rationality and bounded rationality? How to control credit risks in a financial management? What are the proper risk management tools and techniques to apply? Objectives To have a useful assessment of credit risk in a financial management It is important to understand that no criterion is the objectively correct one to use as the choice is a matter of economic, individual and collective judgment imbued with psychological and behavioral traits To provide an approach to the selection of criterion of choice consistent and rational in making it possible to reconcile a decision and its manner of realization To be a practical investor by accepting a bounded rationality and will bear some risk in the end to have an essential motivation for financial risk management RESEARCH METHODOLOGIES Medium and small-sized financial institutions are on their way to establish basic credit risk management systems under certain measures. Since information derived from self-assessment can be useful in a wide range of activities from strengthening risk management systems to formulating business strategy large differentials in business management are likely to arise among financial institutions depending on the utilization of this valuable information. As the Bank of Japan has introduced the Tracing Method of asset assessment and loan losses in order to support financial institutions to maximize the use of their own assessments as a management tool. The Tracing Method is used to observe changes in the condition of individual assets in a time series and is one way to utilize financial institutions self-assessment of assets. The Bank conducted a follow-up analysis in the recent on-site examination to analyze how many of the loans classified in the previous examination (1993-94) were later written off and others in relation to financial losses from support by renunciation of claims, and losses from sales of nonperforming loans to the Cooperative Credit Purchasing Company. The empirical study using the Tracing Method suggests the following points of importance for enhancing credit risk management. 1. Importance of strengthening the early warning functions It is vital to control loans classified as substandard because the likelihood of loan losses in terms of write-offs and others reaching a substantial size in the long term may vary substantially depending on the adequacy of the long-term management of this classification of loans. . Importance of utilizing statistical methods which cover the life-span of loans For example, for loans, there is a tendency for the loan-loss ratio to rise after the third year following the assessment. 3. Importance of avoiding loan concentration Financial institutions with highly concentrated loans in terms of industry had higher loan-loss ratios, while institutions with diversified loan portfolios had relatively low ratios. 4. Importance of gathering financial institutions own default data for risk quantification The Tracing Method covers all these data and enhances establishment of financial institutions own default data for credit risk quantification. There is a continuation to check and monitor the credit risk management systems at financial institutions on the off-site basis and also during the on-site examination in a more risk-focused, seamless and flexible manner, taking individual institutions circumstances into consideration. In addition, there continue to use research methods of quantifying credit risks as well as conducting follow-up analysis of the Tracing Method, in line with the worldwide trend to further enhance credit risk assessment within the financial management. In-house credit scoring improves speed and accuracy. SAS Credit Risk Management includes a solution for in-house scorecard development and monitoring. Applying SAS advanced statistical techniques to own proprietary credit data enables person to perform more accurate credit risk assessments. The solution supports a wide range of modeling techniques including classification trees, neural networks, time-series modeling and others. Using the SAS solution, person can develop complex roll rate models, predict delinquencies and perform vintage curve analysis to generate highly accurate credit loss forecasts. Once the analysis is complete, customizable templates enable reports to be published via e-mail or wireless devices and allow managers to quickly identify problems and meet regulatory requirements related to credit risk. ANTICIPATED FINDINGS/CONTRIBUTIONS TO KNOWLEDGE Credit Policy is then crucial for the assessment The management of accounts receivable begins with the decision whether to grant credit to a customer on how much and what terms as it is a logical starting point for the examination of credit policy to include the companys systems and procedures. Credit policy needs to be operated in a balanced way and if it is operated too much then the sales and profits will be lost and if it is less operated then risk of non payment and bad debt will increase. There needs to have an appropriate process for handling credit by the financial management so as to avoid major risks in the process. There needs to apply and create an ideal credit selection, selecting the right customers that will be given the grant for credit in determining individual credit limitations, it is important to be aware of the credit standards that must be acceptable by both sides of the process which is the assessment of potential customers credit quality. There needs to have an understandable credit terms and conditions and a more accessible collection policy to avoid credit risk occurrences. The decision to grant credit to a doubtful account requires an assessment of whether the account is one of a group for which as a group profits after bad debt losses will allow for a least a minimally acceptable return on investment. It depends first on the evaluation of the credit risk on the assessment of the likelihood of getting repaid or losing the goods shipped on credit. There needs to figure out what the profitability of the account will be if it proves successful. The more profitable the account, the greater the credit risk that can be occur as a high risk customer may not get credit from banks but can get ample lines from finance companies as certain types of credit risks have been found amendable to formula evaluation once the relevant credit characteristics have been identified. Most business credit is still granted after an individual evaluation of a credit request in lieu of using factor approach in analyzing and granting credit loans as credit card companies have adopted such technique in the process. The approach cannot be directly be applied to customers whose business is significant to the enterprise that it does not represent a group as credit should be granted to major customers relative to their financial status range even if larger customers is of better advantage.