Frankly speaking, credit is a bank service that will lend money by trusting the company to pay back over time. It could be in a credit card or loan. But this article does not focus on its base regulations. Instead, it talks about bank business risk in credit. The topic covers credit exposure and risk.
First of all, credit exposure is a measurement on how a business can face maximum potential loss. Sometimes, it happens because the lender borrower defaults on payment. The example could be, when the bank made a number of short-term and long-term loans totalling $100m to a company, the credit exposure would be $100m.
In this case, credit exposure signals credit risk for the bank, indicating maximum loss to a lender if the borrower defaults on a loan, summed Investopedia. Default is the failure of debt repayment. It covers interest or principal on a loan or security. Corporations or countries failing to pay the debt obligation because they cannot is the default risk.
Sometimes, it is inevitable to avoid default especially during volatile markets and prices surge due to Covid and Russia invasion. But, there is this credit rating system helping lenders to limit credit exposure. Practically, the bank extends credit to customers with high credit ratings. By doing the same, the bank avoids clients with lower ratings.
The bank sometimes indicates whether or not the client has problems.
If the client faces unexpected financial problems, the bank finds a way to reduce credit exposure by mitigating loss. Loss mitigation is vital to avoid potential default. The simple example is when a card user misses the debt payment, they must pay a penalty fee. In addition, they must get a higher interest rate for the future purchases. In the case of card issuer, the practice can reduce credit issuer potential.
