Credit risk simply defined as the probability of loss due to a customer’s failure to make payments on any type of debt. The risk accrues to the suppliers of goods , finance  and services and  relates to loss of  principal and interest, disruption to cash flows as a result of delayed payments  and increased collection costs. The loss resulting from credit risk may be complete or partial and can arise in a number of circumstances including the following;

• Where a customer may fail to make a payment due on a debt, credit card, line of credit, or other loan where a  customer  is unable to repay asset-secured fixed or floating charge debt
• Where a business or consumer does not pay a trade invoice when due
• Where a business does not pay an employee’s earned wages when due
• Where a business or government bond issuer does not make a payment on a coupon or principal payment when due
• Where an insolvent insurance company does not pay a policy obligation
• Where an insolvent bank won’t return funds to a depositor
• Where a government grants bankruptcy protection to an insolvent consumer or business
• Where in the case of cross-border obligations, any default arising from the flow of foreign exchange and/or due to restrictions imposed on remittances out of a country Credit Risk Management

Reduction of credit risk

The credit risk can be reduced in the following ways;

• Adequate credit management
• Performing  a credit check on the prospective borrower
• The customer  taking  out appropriate insurance
• Obtaining adequate security which can be easily realized
•  Guarantees  by  a financially strong   third party

Common Causes of Credit Risk

• Credit Concentration – relating to concentrating credit on  a few customers  or  sector
• Ineffective  credit appraisal processes
• Credit Exposure in the market and liquidity-sensitive sectors

Challenges in  credit risk management

• Lack of information  on the potential customers for credit appraisal purposes
• Ineffective risk mitigation strategies.
• Lack of  capacity for risk management in terms of human resources and tools to apply

Conclusion

To effective manage credit risk there is need to gain a complete understanding of  the customers  overall credit risk by viewing risk at various levels.

 

Author 

Kasemiire Agnes Akiiki

kasemiire25@gmail.com

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