The Five C's Of Credit Risks

Credit risk is the potential for gain or loss due to changes in the credit worthiness of a customer or counterparty (Fraser and Simkins. 2010). There are many types of risks, customer credit risk, sovereign risk, and funding risk. Customer credit risk occurs when a customer cannot or will not pay an obligation or debt. Nonpayment can be due to financial hardships, dishonesty, or legal reasons. For example, a person lost their job and could not afford to make the house payments any longer, due to the loss of income. A sovereign risk is the risk that a sovereign (e.g. government) imposes a regulation or laws that prevents the timely payment of an obligation or leads to an asset being seized in some way. A funding risk is the risk that the corporation

The size of the risk is composed of three parts, potential exposure, the likelihood of a default, and the loss. Each component is riddle with great uncertainty in their measurement. Thus, firms implement the procedure of assuming that the exposure is the size of the maximum allowable credit limit granted to the counterparty. The five C’s of credit analysis (capacity, capital, collateral, conditions, and character) is method a firm can employ to assess credit worthiness. Capacity is the ability of the firm to pay its obligations by way of the cash flows generated by the business. Capacity is assessed by examining various accounting ratios such as the coverage ratio- a financial indicator that suggests a firm’s ability to meet its debt obligations. Capital is the amount of readily available cash. Whereas collateral is based on the quality of the asset(s) being sold to repay an obligation, if an event occurs. It is the security used to receive credit; for instance, a lien place on vehicle. Conditions are the general business conditions specific a firm and industry. Character is the willingness of a firm to meet its obligations in a timely manner; in short, the firm’s reputation and

2017). There are market risks within this industry that raises concerns. Interest rate risk: this is the potential negative deviation from the expected value of a financial instrument due to changes in the level of interest rates (Market and Liquidity Risk management in the Insurance company : CSOB case studies. 2017). Currency price risk is the potential negative deviation from the expected value of a financial instrument due to changes in the currency exchange rates (also referred to as foreign exchange rate risk). Credit spread risk is the potential negative deviation from the expected value of a financial instrument due to changes in the credit spreads. To manage the market risks, insurance companies