The Credit Risk Evaluation Process

The risk evaluation process is the most important part of granting a credit. The risk evaluation process starts with a thorough analysis of the borrower’s ability to repay. This factor is vital as the borrower’s good intention to pay is not enough. The availability of sources of repayment is more important.  

In addition, analyzing the risk in a credit exposure supports credit risk mitigation.

When analyzing the risk in a credit exposure, examiners will consider factors including the following:

• The borrower’s present and expected financial condition. We may look at the borrower’s cash flow, liquidity, leverage, free assets, and any other elements representing the means of repayment.

• The borrower’s ability to withstand adverse, or “stressed,” conditions;  

• The borrower’s history of servicing debt, whether projected and historical repayment capacity are correlated, and the borrower’s willingness to repay;

• Underwriting elements that are part of the loan approval and loan agreement, such as loan undertaken, covenants, amortization, and reporting requirements;

• Collateral pledged. This is the need to evaluate the amount of the collateral, the quality of the collateral, and the ease of liquidation if needed. Also, verify the control over collateral, and other credit risk mitigates.

• Qualitative factors such as the caliber of the borrower’s management, the strength of its industry, and the condition of the economy.

Managing Risk keys:

Risk factors are classified based on the type of the risk. For example, the credit risk affects the financial position of the bank/lender and therefore also affects results shown on the balance sheet where provisions take place. When the bank books a provision against expected credit risk, the expenditure account would be debited reducing the profitability. The outstanding amounts of a credit shown as assets in the balance sheet are reduced by the amount of the provision. Credit risk, capital risk, interest risk, technological risk, liquidity risk, foreign exchange risk and liquidity risk are the risk factors affecting the balance sheet. Some other factors are a reflection of the delivery channels, such as operations risk and subsidiary risk.