How to Manage Credit Risk in Financial Institutions

By Aaron Brown

Part of Financial Risk Management For Dummies Cheat Sheet

In financial risk management, the failure of an external entity to keep a promise is a credit risk you take on every day. This is expected, to a certain point. Managing that risk is the important part.

If a customer doesn’t make a routine payment or a supplier fails to make a promised delivery, you and your organisation may face serious hardship to the point of having your organisation fail. On the other hand, the failure of an entity to perform opens up a profitable market niche for you if you can take advantage of the opportunity.

You must balance your credit risk. If you keep your credit risk too low by dealing only with the most reliable counterparties and forcing them to accept all uncertainty in your business relationship, you may cut yourself off from innovation and knowledge sharing, and pay too much for services. If your credit risk is too high, the accumulation of defaults will likely derail any business plan.