Credit risk is the lifeblood problem of banking and finance. Loans and credit are necessary for any modern economy, and yet, the greater the credit, the higher the risk. When economies reach hard times, credit risks increase. But these are precisely the times when more money is required to jump start an economy. Credit risk, therefore, is a central economic problem for all economic factors from middle class individuals to large countries.
What is Credit Quality?
This is a general concept used by lenders when considering extending a loan or a line of credit. It is a complex concept in that it deals with such variables as cash flow, the state of the financial market, the client's managerial skills and credit history, as well as speculation about the future of the client's business, job or other source of income. An example of a person with excellent credit quality is one who has a lifetime of business success, substantial reserves and tremendous management experience. Such a person will rarely get turned down for a loan.
What is Maximum Exposure?
This concept relates mostly to banks and other organizations that extend credit. All loans are a risk, even for those with excellent credit quality. But risks are necessary for a bank to make a profit and remain solvent over time. Maximum exposure, therefore, is the maximum amount of risk a bank is willing to take at any given time. For example, a bank might be invested in some high yield bonds that are of a low quality and yet have the potential for great rewards. But this exposes the bank to great risk, exposing more assets than the bank is willing to lose. Therefore, investing in some conservative investments like Certificates of Deposits and Treasury Bills might be a good idea to mitigate risk. In short, maximum exposure is the amount of assets a bank or other institution is willing to lose.
How Can I Improve My Credit Quality?
For an individual, there are a few ways that this can be done. Most common are getting co-signers to any line of credit or loan, spreading the risk to more than one person. Mobilizing your present assets as collateral is also a common method. Getting credit insurance can also help. For a business, improving cost control and basic management might also be a way to impress credit agencies as much as collateralizing or getting insurance. Countries can improve their credit qualities by increasing banking transparency, controlling inflation and budget deficits and improving accounting procedures.
What is Netting?
Netting is for more complex than regular financial transactions. Let's say two businesses are regularly exchanging money. It might be a good idea for these two businesses to figure what the exchanges will be in a particular day or week, and agree to a single payment to cover it all. This simplifies accounting, streamlines administration, and frees up resources for other things. Netting is another way for firms to improve their credit scores.
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