Credit risk is the potential for a loss when a borrower cannot make payments as obligated to a lender. Credit risk is commonly measured and communicated as the likelihood or probability of an individual borrower’s default. Most lenders employ sophisticated models to analyze risk, rank customers, and decide on appropriate strategies for managing this risk.
Effective techniques for managing and analyzing risk include:
- Understanding the risk and nature of each counterparty
- Modeling credit scorecards
- Performing Monte Carlo simulations
- Simulating credit risk based on probability of default or credit migration matrix
- Mitigating risk using credit derivatives
- Analyzing scenarios to assess risk exposure arising from borrowing or lending.