![]() ![]() The Overarching Purpose of Credit Risk AnalysisĬredit analysts may use various financial analysis techniques, such as ratio analysis Ratio Analysis Ratio analysis refers to the analysis of various pieces of financial information in the financial statements of a business. ![]() The 5 Cs of Credit incorporate both qualitative and quantitative financial measures, and the lender may analyze different documents, such as the borrower’s income statement, balance sheet, credit reports, and other documents that reveal the financial situation of the borrower. The lender uses the factors to evaluate the characteristics of the borrower and conditions of the loan to estimate the probability of default and the subsequent risk of financial loss. Financial institutions use credit ratings to quantify and decide whether an applicant is eligible for credit and to determine the interest rates and credit limits for existing borrowers.” The factors include the borrower’s capacity to repay credit, character, capital, conditions, and collateral. When calculating the credit risk of a particular borrower, lenders consider various factors commonly referred to as the “ 5 Cs of Credit 5 Cs of Credit The "5 Cs of Credit" is a common phrase used to describe the five major factors used to determine a potential borrower’s creditworthiness. Borrowers who present a high level of credit risk are charged a high interest rate on the loan to compensate the lender for the high risk of default. Performing credit risk analysis helps the lender determine the borrower’s ability to meet debt obligations in order to cushion itself from loss of cash flows and reduce the severity of losses. When the borrower defaults on his/her obligations, it causes an interruption in the cash flows of the lender. The lender uses the interest payments from the loan to compensate for the risk of potential losses.
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