Credit Risk Models: Lessons for Nigerian Banks
29 Pages Posted: 3 Mar 2017
Date Written: February 1, 2017
Abstract
Credit risk arises because of the possibility that promised cash flows on financial claims held by banks and other financial institutions (BOFIs) will not be paid in full. Virtually all BOFIs face this risk. BOFIs are operating in markets with asymmetric information wherein prospective borrowers have more information about their repayment ability than the lenders. A key role of BOFIs involves gathering information which acts as reliable signal and to provide incentives for screening and monitoring loan applicants to ensure funding of the most credit worthy loans. This paper delves into these issues. It begins by explaining the various types of loans advanced by BOFIs, determinants of return on a loan and evaluation of issues in measurement of credit risk. The key idea here is that a top-down risk analysis facilitates the design of targeted controls or safeguards against credit risk losses. Various default risk models were also reviewed and the article concludes that credit control should emphasize appropriate chains of approval, collateral requirements, accurate pricing, the optimal loan size for specific borrowers, credit monitoring and knowledge of market dynamics to determine loan performance sensitivity to changing market conditions.
Keywords: Credit risk models, advanced credit risk analytics, default risk models
JEL Classification: C0, G10, G20, G21, G28
Suggested Citation: Suggested Citation