Elements of Credit Risk Analysis

Credit Risk is the risk that borrower shall not be able to service the interest obligation on loan or repay the loan. Credit Risk is also described as ability of the borrower to repay. The Risk of not being able to recover the principal amount of loan and interest accruing thereon during the tenure of the loan.

Apparently, Credit Risk is made up of Three (3) principal elements:

  • Amount of Loan
  • Repayment Tenure
  • Availability of cash resources with Borrower to service the loan

The correct estimation of free cash flow of the borrower over the loan duration is the most critical aspect of credit risk analysis. If the borrower has definitive sources accruing free cashflow to service the interest and honor the repayment obligations on due dates, the Credit Risk is very low. The only factor, in such case, would be the possibility of disruption of the free cash flow of the borrower. The free cash flow of the borrower is subject to large number of forces including market forces, geo-political forces, government policies, natural forces and so on.

The process of estimation of free cash flow is done based on the documentary evidences. Traditionally, the lenders relied on the documents and information collected from the borrower itself. The most important document is historical Audited financial statements of the borrower.  The unqualified Financial statements are taken as face value. These documents are corroborated with the third-party documents such as Bank statements, Income tax returns which are also generally called form the Borrowers. Sight visit, physical inspections, interview of the partners / Directors/ key management, stock statements, examination of asset ownership documents are the periphery checks a traditional banker depends on.

How Credit Risk Assessment done?

It is crucial for a banker to have access to authentic and reliable information from independent sources which can be sued for credit Risk evaluation or even for cross checking the veracity of the documents / information obtained from potential borrower. We are doing business in Digital India where most information concerning a business is available digitally and on demand. A banker can use slew of authentic and independent information sources for Credit Risk Assessment such as Ministry of Corporate Affairs, E-courts providing vital information about litigations in more than 100,000 courts across India, information about non-compliant, defaulting and debarred entities published by Regulators, Credit Bureaus, Tax Department and Government, Credit Rating information, Regulators’ websites publishing the list of non-compliant and defaulting companies, Tax departments’ websites showing information about non-compliant and defaulting entities, Credit scores published by Bureaus and independent analytics firms and so on.

As a matter of fact, the lenders may face altogether a different kind of challenge and that is how to source such a huge information and how to analyze the same. New age data technology firms like Corpository has resolved this issue by providing all the information needed for credit risk analysis in digital format through demand. The new age lenders have also started integrating many public APIs for sourcing the data on demand. With valuable business information available on demand and in digital form, the credit risk assessment process is also getting transformed form manual to automatic. India is taking a big lead in this direction and the its young and smart fintech firms are showing the way forward.

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