Question

Why does an expected default rate overstate credit risk relative to a default loss rate?

Answer 1

The expected default rate overstates the credit risk relative to default loss rate as the credit risk is the major risky component in lending. It denotes the chances of the borrower not paying the money that he/she has taken from the bank or any other financial institution. The expected default rate overstates the credit risk so as to be cautious and take an informed decision by being prepared to face the consequences of giving a loan to a person who has high credit risk. Default loss rate is the rate at which the bank or the financial institution may lose money if the borrower fails to repay the loan. This is after the borrower has already defaulted. But credit risk is based on the previous credit score of the borrower.