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Credit risk is the risk that a debt holder takes on by accepting the risk that a debtor will default on a loan. There are three different kinds of credit risk, and a credit risk system has evolved to satisfy the needs of each. The first type of credit risk is known as default risk. This is the most common kind of credit risk. The second type is known as credit spread risk. Finally, creditors and businesses worry about a phenomenon known as downgrade risk.
The most common of the credit risk systems relate to the credit risk known as default risk. When performing a credit risk analysis for default risk, the main concern is that the debtor will not be able to meet his or her obligations when it comes to paying back the debt in question. In these cases, a credit risk report is generated, based on the debtor's credit history, assets, and finances.
Credit spread risk requires credit risk systems that analyzes the spread between securities, which are without risk, and certain bonds, which may be incredibly risky. While the spread may seem stable prior to purchase, a credit risk analysis is necessary in order to predict any variations in the spread after the initial purchase. Certain types of credit risk software are available to help investors and other financial specialists predict behaviors in various markets, but there is always the chance of a jolt, such as a credit crisis.
Credit risk systems are also used to analyze the potential for downgrade risk. Downgrade risk occurs when there is the possibility that a rating agency will lower their rating of a particular debtor after a loan is issued. This risk can be significantly lowered through the use of a thorough credit risk analysis. It's important that credit histories are carefully analyzed and that a credit risk management program is used to give a detailed analysis of potential benefits versus potential losses.
All successful credit risk systems perform a number of key functions. First, these systems allow users to maintain a process of credit granting that is sound and consistent. It is also important that these systems help establish an environment of credit risk that is appropriate to given situations. Since credit risk is always a reality, credit risk systems help to create a comfortable degree of risk. They allow users to effectively set credit limits. To optimize the value of credit risk systems, though, users must ensure compliance with those limits.
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