The credit risk is the risk that a borrower fails to repay all or part of his credit to the deadlines set by the contract signed between him and the organization lender (usually a bank). The control of credit risk is at the heart of the banker’s job because it determines the profitability of the operations carried out. If the financial institution underestimates this risk, the amount lent and interest due will not be collected and will be recorded as a loss. The assessment of credit risk requires a good knowledge of the client and, if it is a company, a good evaluation of its project and the sector in which it operates. The bank relies for its credit risk assessment on its experience and possibly on statistical tools (scores or expert systems). For a given operation the credit risk may be reduced by the taking of guarantees ( bonds of a person or of, real securities such as mortgages …) but also by incorporating in the interest rate a margin whose value depends on the level of risk. When the transaction concerns a large company the bank can also reduce this risk by limiting its participation by a portion of the amount borrowed through the establishment of a banking pool .
Risk assessment for business customers
Assess the risk of credit is primarily up to the question of the solvency of the company (or individual) considered. This solvency depends both on elements that are purely internal to the company, but also on contextual factors such as its geographical location, the overall economic situation and the sectoral outlook.
Considering the business environment is a prerequisite for risk assessment since a company is not a self- sufficient entity : it interacts with a set of external actors (other companies, individuals, banks , insurance, States, the political situation (stable or not), local taxation, legislation (labor law, business law, safety and environmental regulations …) Notwithstanding the situation of the company in itself, the quality of its location and the prospects of evolution in its country of origin can seriously handicap or greatly favor it depending on the case, thus influencing its future.
To help assess the quality of the geographical context of a company, the main rating agencies (such as Standard & Poor’s ), insurance companies and large investment banks publish ratings where each country is given a rating (number or letter) summarizing the data deemed relevant. The note is usually accompanied by a comment explaining the assessment that has been made and indicating the main favorable and / or adverse factors.
Sector Outlook Perspectives
The sector in which the company operates also influences its good economic health. If an expanding sector augurs an almost certain increase in the activity of the company in the following years, a sector in crisis gives rise to greater risks for the company that operates there; this is all the more true in certain sectors that are particularly sensitive to the international context (raw materials, transport, light industries, etc.) An in-depth analysis of a sector finally gives a good idea of the outlook for the coming years and makes it possible to refine the evaluation of any company that carries on its business.
The macroeconomic situation
This point mainly concerns companies with strong international activity. Dependent on multiple markets, trading on several different currencies, they are particularly sensitive to the vagaries of the global or continental economy and the sometimes abrupt changes in currency exchange rates.
For this aspect, it is mainly purely financial criteria that come into play, and a few simple calculations can give a fairly accurate idea of a client / borrower’s ability to repay debt in a timely manner. Here is a non-exhaustive list of significant data:
- Turnover Annual
- Current level of indebtedness (short and long term)
- Operating profit
- Flows Cash (Cash flow) generated
- Availabilities (id is the cash of the company)
- bottom line
From these data, the calculation of certain basic ratios allows an initial assessment of the solvency of the company. Thus, if the ratio of indebtedness to annual turnover is too great, granting new credit can be very risky. A low operating result in relation to the turnover may also indicate difficulties in the repayment of the loans (which must not exceed the amount of EBITDA or EBITDA ).