Credit Problems and Credit Risk

This chapter presents the point that banks rely on their internal credit risk rating or credit scoring models for loan sanctions and loan pricing; however, if the rating framework is not comprehensive or periodically tested for validity, the rating will be erroneous. Banks may suffer large losses for relying solely on collateral for lending, either due to decline in collateral values or absence of a market for sale of collateral, or because of the long-drawn-out court procedure involved in realizing collateral values. Credit problems may arise in cases of related parties, because systems and procedures laid down for granting credit may not be followed in their entirety. Common multiple causes, which lead to credit risk, are imprudent credit decisions, deficient credit management, emergence of unexpected events, and the recalcitrant attitude of borrowers. Combination of external and internal factors generates credit risk for banks.