CREDIT RISK MANAGEMENT

CREDIT:
A contractual agreement in which a borrower receives something
of value now and agrees to repay the lender at some date in the
future, generally with interest. The term also refers to the
borrowing capacity of an individual or company.

RISK:
The chance of inquiry damages or losses. The degree of
probability of loss.
Dispersion in likely outcome.
The chance that actual outcome from an investment will
differ from the expected.

RISK MANAGEMENT:
The forecasting and evaluation of financial risks together with
the identification of procedures to avoid or minimize their impact

METHODS TO IDENTIFY RISK:

1: Brainstorming:
This process encourages a group of people meeting face to face
to put forward all their thoughts and ideas on a specific topic.
During a brainstorming session all input is encouraged without
evaluation. Evaluation of ideas occurs at the completion of the
session when the ideas are analyzed. The diversity of participants
will have an impact on the nature of the ideas and perspectives,

so some thought will need to be given to who will participate in

the process.

2: Focus groups:
A focus group is made up of individuals who are invited to attend
one or more meetings in order to focus their attention and provide
information and feedback on a specific topic or area of concern.

3: Flow charts:
These
allow
a
dynamic
process
to
be
represented
diagrammatically on paper. The process may then be analyzed for
critical activities and areas of higher risk.

4: SWOT analysis:
An effective method for prospective risk identification is a
Strengths, Weaknesses, Opportunities and Threats (SWOT)
analysis. A SWOT analysis is a tool commonly used in planning
and is an excellent method for identifying areas of negative and
positive risk.

5: Analysis of systems:
This involves studying the way a system or process functions and
interacts within an organization in order to find any weaknesses.
System may refer to the management processes as well as to the
policies and procedures that support those processes. It may also
refer to an operational system of interlinking procedures or
processes.

6: Audits:
This is the name given to the process of analyzing a management
system, checking to see that the documented procedures and
operational methods are the same.

7: Scenario building:
In this process a situation or condition is created either on paper
or as a model to reflect potential outcomes. These fictitious
situations allow analysis and treatment options to be considered
where, for example, an event have not occurred before and no
data is available.

8: Accident investigation or failure analysis:

This process involves looking at previous accidents and incidents
and analyzing them to determine what went wrong or why the
process failed or broke down. This will highlight risk areas for
future situations.

9: Checklists:
This involves using a list of items against which to check a
situation, event, scenario, process, etc.

10: Risk identification forms:

These forms generally include standardized questions or a set of
steps to be followed in order to help identify risks. They are often
tailored to specific situations, processes, scenarios, etc.

11: Feedback and communication:

This includes safety meetings, customer feedback forms or phone
calls, complaints handling, etc.
12: Interviews:
Interviews are an effective way to identify risk areas. Group
interviews can assist in identifying the baseline of risk on a
project.
The interview process is essentially a questioning
process. The interview can be conducted before or after the

brainstorming session. However if it is accomplished before the

brainstorming session, the results should be shared with the
group after they have provided their input to the risk li

13: Experiential Knowledge:

Experiential knowledge is the collection of information that a
person has obtained through their experience. Caution must be
used when using any knowledge based information to ensure it is
relevant and applicable to the current situation.

14: Documented Knowledge:

Documented Knowledge is the collection of information or data
that has been documented about a particular subject. This is a
source of information that provides insight into the risks in a
particular area of concern. Caution must be used when using any
knowledge based information to ensure it is relevant and
applicable to the current situations.

Risk Analysis:
1-Qualitative Analysis
2-Quantitative Analysis

Tools and Techniques for Qualitative Risk

Analysis:
1-Risk probability and impact assessment:
Risk probability and impact assessment investigating the
likelihood that each specific risk will occur and the potential effect
on a project objective such as schedule, cost, quality or

performance (negative effects for threats and positive effects for

opportunities), defining it in levels, through interview or meeting
with relevant stakeholders and documenting the results.

2-Probability and impact matrix:

Probability and impact matrix rating risks for further quantitative
analysis using a probability and impact matrix, rating rules should
be specified by the organization in advance.

3-Risk categorization:
Risk categorization in order to determine the areas of the project
most exposed to the effects of uncertainty. Grouping risks by
common root causes can help us to develop effective risk
responses.

4-Risk urgency assessment:

In some qualitative analyses the assessment of risk urgency can
be combined with the risk ranking determined from the
probability and impact matrix to give a final risk sensitivity rating.
Example- a risk requiring a near-term response may be
considered more urgent to address.

5-Expert judgment:
Individuals who have experience with similar project in the not too
distant past may use their judgment through interviews or risk
facilitation workshops.

Tools and Techniques for Quantities Risk

Analysis

1-Interviewing:
You can carry out interviews in order to gather an optimistic (low),
pessimistic (high), and most likely scenarios.

2- Probability distributions:
Continuous probability distributions are used extensively in
modeling and simulations and represent the uncertainty in values
such as tasks durations or cost of project components\ work
packages. These distributions may help us perform quantitative
analysis. Discrete distributions can be used to represent uncertain
events (an outcome of a test or possible scenario in a decision
tree).

TYPES OF RISK:
Following are the types of risk:

1-Systematic Risk:
Systematic risk is uncontrollable by an organization and macro
in nature.

Systematic risk is due to the influence of external factors on an

organization. Such factors are normally uncontrollable from an
organization's point of view.
It is a macro in nature as it affects a large number of
organizations operating under a similar stream or same domain. It
cannot be planned by the organization.

1. 1-Interest rate risk:

Interest-rate risk arises due to variability in the interest rates

from time to time. It particularly affects debt securities as they
carry the fixed rate of interest.

2. Market risk
Market risk is associated with consistent fluctuations seen in the
trading price of any particular shares or securities. That is, it
arises due to rise or fall in the trading price of listed shares or
securities in the stock market.

3. Purchasing power or inflationary risk:

Purchasing power risk is also known as inflation risk. It is so,
since it emanates (originates) from the fact that it affects a
purchasing power adversely. It is not desirable to invest in
securities during an inflationary period.

2-Unsystematic Risk:
Unsystematic risk is controllable by an organization and micro in
nature.

Unsystematic risk is due to the influence of internal factors

prevailing within an organization. Such factors are normally
controllable from an organization's point of view. Unsystematic
risk is controllable by an organization and micro in nature.

1-Business Risk:
Business risk is also known as liquidity risk. It is so, since it
emanates (originates) from the sale and purchase of securities
affected by business cycles, technological changes, etc.

2-Financial Risk:
Financial risk is also known as credit risk. It arises due to change
in the capital structure of the organization. The capital structure
mainly comprises of three ways by which funds are sourced for
the projects.
These are as follows:
Owned funds. For e.g. share capital.
Borrowed funds. For e.g. loan funds.
Retained earnings. For e.g. reserve and surplus.

3. Operational risk

Operational risks are the business process risks failing due to

human errors. This risk will change from industry to industry. It
occurs due to breakdowns in the internal procedures, people,
policies and systems.

SOURCES OF RISK:
1-Scheduled Risk:
Exposure to loss from a program not meeting its scheduled
objectives. Scheduled risk is the risk that the project takes longer
than scheduled. It can lead to cost risks.

2-Cost Risk:
Probability of loss due to cost overrun.

3-Technical Risk:
Exposure to loss arising from activities such as design and
engineering, manufacturing, technological processes and test
procedures.

4-Funding Risk:
The risk associated with the impact on a projects cash flow from
higher funding costs or lack of availability of fund.

5-Contract Risk:

Probability of loss arising from failures in contract performance.

Vendors have highest risk in fixed price contracts and least in the
cost type contracts.

6-Organizational Risk:
Organizational risk encompasses the totality of risk concerns as
defined by the stakeholders.
Example:
Organizational Risk includes:

investment risk
budgetary risk
program management risk
legal liability
inventory risk