Credit Risk

Credit Risk

Credit risk is an internal calculation performed by banks and lending institutions before a borrower is granted credit. Credit risk is calculated for all types of loans, including individual loans, enterprise loans, and even national debt. 

It is important for lending institutions to mitigate the risk of defaulting borrowers as much as possible. Considering this, credit risk is one of their most valuable tools. In consumer financing, credit risk is calculated based on the five Cs’: credit history, capacity to repay, capital, lending conditions, and collateral. The combination of these factors associated with an application will determine the credit risk for a given loan. For example, if you have a good credit history, and collateral presented for the loan, but you don’t have any starting capital, your credit risk score might become higher. 

The correlation between these five factors is determined by complex algorithms and financial calculations. However, it is important to know what is taken into account when your credit risk is measured. 

For example, if a person with high credit risk goes to a traditional lender, they might be declined a mortgage. However, as the percentage of people with subpar credit ratings is growing, there are lending institutions that cater to high-risk borrowers. Subprime mortgage lenders offer mortgage loans to customers with fairly bad credit scores. However, it is important to note that subprime mortgages often have significantly inflated interest rates and APR terms. 

The risk of defaulting borrowers is one of the things banks and lending institutions pay utmost attention to. There are usually dedicated credit risk management departments within these institutions. The credit risk management department is responsible for calculating the individual credit risk score for new borrowers. Additionally, these departments are in charge of creating risk assessments for the combined loan value of the bank or lending institution. It is important that banks maintain a relatively low level of risk exposure. 

While credit risk is still widely new in the cryptocurrency sphere, some principles of risk calculation from traditional finance have already found their place in the crypto world. For example, many crypto lenders are now turning to collateral as a way to ensure that their investment is relatively protected. 
Risk management and risk-aversion are among the most important of the protection mechanisms banks have in place when lending money.
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