Credit Risk Management and Strategic Capital Allocation

 If a lender does not receive his due interest amount from the borrower then it is called default. This process is called as credit risk. The accessing and managing of credit risk is important for many companies. The credit given may range from few hundreds to 1000 of crore rupees. If the credit analysis is not done perfectly the lender may end up making huge loss. Most of the big credit companies have their strong credit analysis team, whose main function is to identify the ability of the customer to pay interest.

The analyzing of the borrower must be made before lending of money. Most lenders use their own model to analyze the borrower. They also use appropriate strategy to get back their money. Lender charge higher rate of interest from borrower with high risk whereas lower rate of interest from borrower with low risk. Credit scoring model is the model which is often used these days in case of rating the borrowers. The borrowers will be rated regularly and scored accordingly based on the paying ability of the borrower in the past.

Strategic capital allocation for credit is an important factor in case of lenders. The lenders must take sufficient care when allocating fund for lending purpose. The fund should not be lent to the one defaulters, the fund should be lend to the borrowers who won’t default. The following things must be taken care before lending they are,

• Fund must not be allocated to defaulters. The most important thing any lender must keep in mind. This default money cannot be regained by any mean. It is as equivalent to loosing money. 
• Fund must be mostly allocated to low risk borrowers. The lower the risk the higher is the probability of gaining back the investment.
• Only a portion of the fund must be allocated to high risk borrowers. This is needed because low risk investment are often less yielding, whereas the higher risk investment are often more yielding. This risk however must be taken only from a very limited percentage of the capital

Question

• What is credit scoring?
• What are various strategies adopted while allocation of capital for lending purpose?