Question

1. Why is credit risk analysis an important component of FI risk management? What recent activities by FIs have made the task of credit risk assessment more difficult for both FI managers and regulators?

Answer 1

Solution :

Credit risk is the risk associated with the default of the loan. So, Credit risk analysis is used to understand the credit risk profile.

This is important because it gives information about the

• Default rates
• Information regarding the loan covenants
• Probability and timing of the default

Credit risk assessment has become more difficult due to various activities under financial shenanghans. There are few ways in which a company can engineer or change the financial statement and make it difficult for the FI and regulator

1. Capitalisation of the operational expense

2. Off balance sheet items

3. Creation of Special Purpose Vehicles etc.