What is Involved in a Credit Risk Analysis?

A credit risk analysis consists of three phases: the history of the subject, the current prospects of the subject and the future direction of the subject. While it is best to have good marks in all three areas, many creditors will issue money even if one of them isn’t as good as the others. This is especially common with individuals who have proven their abilities in the past and are attempting to enter into a risky area. Whether the analysis is directed at an individual or at a multi-billion-dollar company, the steps are basically the same and the information required is nearly identical.

The three phases of a credit risk analysis attempt to paint a clear economic picture of the debtor. This will allow the creditor to make a more informed decision based on where the petitioner came from and where he is going. The history looks at past credit history, loans and outstanding debt. The present focuses on collateral and current activities. Lastly, the future phase attempts to determine if the overall goals of the debtor are likely to work out.

The history portion of a credit risk analysis is often the most involved and important part. When the petitioner has an established credit history, there are often years of credits and debits to look over. This financial history helps to establish whether the debtor is likely to repay his debts and weather those repayments will be on time. When the debtor doesn’t have an established credit history, it is often difficult to secure a loan since the creditor simply doesn’t have anything to work with.

When looking at the current situation of a petitioner in a credit risk analysis, one of the biggest parts is collateral. This part focuses on the wealth and income of the debtor to determine if repaying debt is likely or even possible for the person. Collateral is substance or real value, such as a car or house, that can repay the credit if the debtor defaults. Collateral possession is especially important in bank or business loans. When issuing a line of credit, such as with a credit card, it is more common to look at money in savings and annual income.

The last segment of a credit risk analysis is future prospects. While this section is partly guesswork, it is still important to find large holes or false assumptions in the debtor’s planning. For small loans or lines of credit, this phase is minor and often overlooked. When dealing with larger credits, particularly when businesses are involved, this phase is generally the most time-consuming. It will often involve contacting third parties for specific information and insight.