Credit Risk: Credit risk arises from the potential that a borrower will fail to meet its obligations in accordance with agreed terms. It also refers the risk of negative effects on the financial result and capital of the bank caused by borrower's default. It comes from a bank's dealing with individuals, corporate, banks and financial institutions or a sovereign.
A financial institution employ a four-step procedure to measure and manage
institution level exposure are mentioned below:
1. Risk identification: The institution must recognize and understand risks that may
arise from
both existing and new business
initiatives.
Risk
identification should be a continuing process, and should be understood at both the transaction and portfolio levels.
2. Risk Measurement: Once
risks have
been
identified, they
should be
measured in order to determine their impact on the banking institution’s profitability and capital.
3. Risk
Monitoring:
The
institution should
put
in place
an effective
management
information system (MIS) to monitor risk levels and facilitate timely review of risk positions and
exceptions that should be frequent,
timely, accurate, and informative.
4. Risk Control: The institution should establish and communicate risk limits through policies, standards, and procedures that define responsibility and
authority that should serve as a means to control exposure to various risks