Credit risk refers to the chances that a borrower will fail to meet its obligations in accordance with agreed terms.
Risk factors associated with a loan default:
(1) lax standards for borrowers
(2) poor portfolio risk management
(3) failure to notice changes in circumstances that could lead to a deterioration in the credit standing of a borrower
Preventative measures:
(1) sound processes for evaluating borrowers and issuing credit
(2) use of collateral to secure the loan
(3) credit insurance
(4) diversification of the borrower pool to avoid concentration risk
(5) use of user covenants, requiring the reporting on economic status and other information
(6) imposing an interest rate commensurate with the risk
(7) periodic review of a borrower's economic status
