Knowing what is credit risk and how it differs from credit score is important. After all, lenders decide whether or not to approve your loan application based on your creditworthiness.
To know more about what credit risk assessment and credit score are and how they differ from each other, read on.
What Do You Mean by a Credit Score?
Check out a few vital pointers on what it means:
- This is a three-digit numerical summary that reflects your creditworthiness based on your repayment history
- Lenders use this parameter to gauge whether you made timely repayments for the debts you owed in the past
Here are a few things to keep in mind when applying for a personal loan:
- This credit scoring system ranges between 300 – 900
- A higher score reflects better financial management of previous debts
- There are four credit scoring companies authorised to issue credit scores in India
- The CIBIL score issued by TransUnion CIBIL is the most popular one
- Most lenders consider a score of 750 or above as optimal
- A score lesser than 600 may lead to a delay or even a rejection of the loan application
- It is also one of the critical factors affecting your personal loan interest rates
- If you have a higher score, lenders perceive you as a trustworthy borrower and offer lower interest rates
The calculation of credit scores is based on numerous factors, as listed below:
- Your past credit history, which makes up 30% of your total CIBIL score
- The tenure of your credit, accounting for a total of 25% of your score
- Other miscellaneous factors make up for the remaining 20%
- Credit utilisation ratio, which constitutes 25% of the total score
Remember that maintaining an optimal credit score does not necessarily guarantee loan approval. Instead, it simply increases your chances and helps you negotiate loan terms quickly with the lender.
What Does Credit Risk Assessment Imply?
Here’s what this terminology means in simple words:
- This is the probability of financial loss of principal and interest to the lender due to the borrower’s failure to repay the amount
- It assesses the probability of defaults
- Lenders consider the credit risk along with credit scores when deciding on a loan application
Here are five factors lenders assess when executing the credit assessment process:
- Your past credit history
- The terms and conditions associated with the loan
- Collateral associated with the credit, if any
- Capital
- The repayment capacity of the borrower
Remember that credit risk analysis has a critical impact on your loan interest rate. Here’s what you need to know:
- As the credit risk of a borrower becomes higher, the interest rate of the credit will also subsequently increase
- In instances when the credit risk rating of a particular individual is very high, lenders may even decline the loan application
How to Analyse Credit Risk
A financial institution generally considers these measures to quantify credit risk:
- Probability of Default: It is the likelihood of a borrower being unable to pay their scheduled debt obligations
- Loss Given Default: It is the amount that the lender stands to lose in case the borrower defaults on loan repayment
- Exposure at Default: Abbreviated as EAD, it is the assessment of total loss exposure for a bank or NBFC at any given point
How Does Credit Risk Analysis Help to Improve Your Cash Flow
Here is how credit risk analysis assists lenders in improving their cash flow:
- The assessment allows lenders to determine a borrower’s repayment ability accurately, ensuring that they can set appropriate credit limits
- It also helps financial institutions to identify high-risk customers and implement risk mitigation measures to eliminate chances of losses
- Credit risk assessment also allows them to detect early signs of financial distress and address them promptly
Credit Score Vs Credit Risk Assessment: Key Learnings
Knowing the differences between credit score and credit risk assessment is crucial before you apply for a loan. Here are a few additional pointers to know:
- While both rely on past credit history, the methodology applied to assess credit risk differs from the former
- These assessments provide a comprehensive view of a borrower
- Most lenders also implement credit risk management, helping them mitigate and measure the risk associated with any form of credit
- By evaluating the credit risk involved well in advance, lenders can tackle unexpected events of defaults more efficiently
Banks and big financial corporations are likely to use credit scores as an important, perhaps leading factor in their assessments. This is in contrast to new-age lending portals like Fibe. We offer personal loans using a broader approach to credit risk assessment that does not rely on just credit scores. Fibe factors in your ‘Social Worth Score’ based on a range of factors, allowing us to arrive at a more accurate estimation of your borrowing capabilities.
Looking for an instant personal loan? Get started with Fibe to get an Instant Cash Loan of up to ₹5 lakhs. Download our Personal Loan App and get quick loan approvals at affordable interest rates and convenient repayment tenors.
FAQs on Credit Score vs Credit Risk Assessment
What are the various credit risk types?
The three types include:
- Concentration risk
- Default risk
- Institutional risk
There are two other types of risk, too, such as:
- Downgrade risk
- Country risk
What factors affect credit risk assessment?
Lenders conduct a credit risk assessment by factoring in the 5Cs:
- Credit history
- Capability to repay
- Conditions of the credit
- Capital
- Collateral offered
Are risk scores and credit scores the same?
No, both are different. The latter gives a more comprehensive idea about the possibility of a borrower defaulting on repayment.
How to calculate credit risk score?
Different credit agencies evaluate scores by factoring in a range of factors related to your credit repayment ability.
What is a good credit risk score?
A good credit risk score is AAA, AA, A, and BBB. Any score lower than BBB is considered a low credit risk score.
What are the five 5 principles of credit risk management?
The 5 principles of credit risk management rely on the following criteria:
- Providing a feasible environment for credit risk assessment
- Supervising the process accurately
- Implementing proper controls effectively
- Granting credit in an efficient way
- Deploying the right administrative system
What are credit risk parameters?
The most common credit risk parameters include:
- Probability associated with loan defaults
- Loss related to the default
- Exposure a lender faces at the time of default
Analysing such parameters well in advance forms the basis of credit risk management.
What is the credit risk rating or CRR?
CRR measures the probable degree of risk associated with a borrower who has availed or is yet to avail of a loan.
What is the credit risk limit?
A credit risk limit is the maximum limit constraining an individual or the maximum amount of credit exposure related to the outstanding loan balance.
What is an example of credit risk analysis?
An example of credit risk analysis is the debt service coverage ratio. This ratio measures the cash flow available with a company that they can utilise to service their current debt obligations.
