Differences in Assessing and Managing Credit Risk in Investment Essay

Differences in Assessing and Managing Credit Risk in Investment Banking and Commercial Banking - Essay Example Credit risk represents the possibility of loss due to the inability of the obligor to fulfill the terms in the financial obligation (bond, note, lease, installment debt etc.). The credit risk is known by slightly different terms in investment and commercial backings. Counterparty credit risk is important for investment banking mainly in trading operations and loan credit risk is crucial in commercial banking. Though both may be caused by the same reason, default, they are managed differently. Credit risk becomes a very serious issue if accompanied by poor banking operations. Proper systems and controls should be in place for effectively assessing and managing credit risks in both type of banking operations. Credit risk arises when a borrower of a loan fails to repay it (in commercial banking) or when an issuer of a security or a bond fails to fulfill his financial obligation (a corporate who issued a bond may go bankrupt) to the borrower . For assessment of credit risks in the financial products the investment banking firms (which is more complex compared to assessment in commercial banking) rely on the credit rating assigned to the issuer by the major credit rating companies. To arrive at the credit rating, the agencies carry out a research and an assessment of the account statements (income and expenditure, balance sheet), quality of the management, previous business and financial track records, the potential business and financial risks and the ability of the management to mitigate them effectively. ... Proper systems and controls should be in place for effectively assessing and managing credit risks in both type of banking operations. Assessing Credit risk in Investment Banking and Commercial Banking Credit risk arises when a borrower of a loan fails to repay it (in commercial banking) or when an issuer of a security or a bond fails to fulfill his financial obligation (a corporate who issued a bond may go bankrupt) to the borrower (in investment banking). For assessment of credit risks in the financial products the investment banking firms (which is more complex compared to assessment in commercial banking) rely on the credit rating (considered as the representation of the financial strength of the issuer or the product that is issued to meet its financial obligations) assigned to the issuer by the major credit rating companies. To arrive at the credit rating, the agencies carry out a research and an assessment of the account statements (income and expenditure, balance sheet), quality of the management, previous business and financial track records, the potential business and financial risks and the ability of the management to mitigate them effectively. Based on the data collec ted and analysis of the same, the agencies issue a credit rating, which is a qualitative judgment of the ability of the issuer to meet his financial obligations. Standard & Poor, Moody's (US) and Fitch-IBCA (UK) are some of the leading and reputed credit rating agencies whose ratings carry more value in the financial market. The companies/products who exhibit least risk are given investment grades and with increasing possibilities of risk, the rating is graded down to the ones with definite possibility for default are