The Objectives of a Credit Risk Rating

Any time a bank loans money to a consumer through a credit card or loan, there is a level of credit risk since the consumer may default on the loan or credit card, causing the bank to lose money. To protect their assets, banks use a credit risk rating to determine which customers are eligible for credit cards and loans. Banks also use this rating system to set credit limits, interest rates and loan amounts.

Credit Approval

Financial institutions use credit risk ratings to determine eligibility for credit cards and retail cards. By reviewing a potential customer's credit score and credit rating, the bank can estimate how risky the customer may be. For example, consumers with a low credit score may be more likely to default on their credit card payments. The bank also uses the information in a credit risk rating to determine the amount of credit they can extend to the consumer. The banks may also use credit risk to determine the interest rates on credit cards and set other charges such as annual fees.

Loan and Interest Rating Financing

Like credit cards, financial institutions use credit risk ratings to determine eligibility for their loan products such as personal loans, auto loans, home equity loans and mortgages. Once the bank determines eligibility they use the information in a credit risk rating to set the terms of the loan. For example, a person with a higher risk rating may have a larger interest rate then a person with a lower risk rating. Banks may set stricter repayment terms or require collateral to back up the loan for higher risk customers.

Account Management

Financial institutions periodically review their portfolio, including any credit cards, retail cards or loans they have leant to customers. During these reviews, banks may raise interest rates for higher risk customers or offer higher credit limits for customers who have lowered their credit risk rating while doing business with the bank. Utilizing credit risk ratings helps banks protect their assets and increase their profits. For this reason, consumers with a higher risk credit rating are reviewed more frequently then consumers with a lower risk credit rating.