8 Credit Research Ingredients For Your Risk Analysis Recipe

Robin Khan By Robin Khan, 9th May 2015 | Follow this author | RSS Feed | Short URL http://nut.bz/le3r3eh9/
Posted in Wikinut>Business>Accounting & Finance

Obtaining timely and accurate information with adequate resources to analyze and produce actionable intelligence and decisions is paramount to seeking Credit Research and Risk Analysis.

Credit Research & Risk Analysis

In the last few years, many of us have heard the news reporting that governments have had bond ratings reduced, companies having difficulty in repaying debt or their employees continue to work "at risk," bank insolvency, many employees live paycheck to paycheck while managing the balancing act of paying bills and surviving, leading market indicators are rapidly in flux such as oil, currency exchanges, and manufacturing orders. Today, information is available almost instantly, both actual and fabricated, and society continues to have an insatiable appetite for data and, just like a wild fire which is out of control, is quick to propagate the Internet regardless of time or location.

Defining what risk actually means and formulating an answer is not trivial but requires adequate resources and time in which to collect this data, analyze it, model this data, and form a decision or gauge the risk associated with assigning credit or a rating. Financial intelligence is a team sport and one which is continuously conducted on a daily basis and not a single event. Today's markets are much more volatile and unpredictable and more so due to the technological advances with Internet-based services.

Banks and other lending institutions must carefully navigate the financial regulatory waters and maintain situational awareness. Knowing the local and international rules and regulations governing investments, accounts, and the sharing and reporting of information can seem daunting and, at times, impossible. For example, the US Foreign Account Tax Compliance Act (FATCA) legislation, Basel III, and the Volcker Rule are just a few which includes prohibitions and framework in which banks must operate.

Among industry leaders, there are three types of risk associated with lending institutions: the type which is present during transfers with others; those associated with firms, and ones which can only be mitigated and not completely eliminated that are associated with simple business practices. There are eight different categories of risk: foreign exchange risk; interest rate risk; counter-party risk, liquidity risk, credit risk, operational risk, legal risk, and other risks. Therefore, to manage and mitigate risk, the organization must employ a multi-step process.

Analyzing risk or risk analysis typically includes five steps such as credit review, collateral and risk assessment, documentation, and approval. There are also pre-analysis and post-analysis steps too. In performing the analysis, credit research is often the initial area of concern and one which requires vigilance and constant monitoring. There are eight areas that may be used to indicate whether or not the institution is considered a high performer and thus leading towards a favorable credit rating; capital adequacy; growth; liquidity; earnings quality; interest rate sensitivity; productivity and efficiency (non-interest and interest); and capital adequacy.

Capital adequacy

This component includes many parts and is protected by a strong capital base. Finding the "sweet spot" regarding the balance of enough capital may be problematic if unbalanced; either too much or too little. Ratios become very important in determining the "balance" and any deviation from the ideal balance is viewed negatively. For example, an ideal or target capital ratio of 9.0% would represent the "sweet spot." However, a percentage point either way and this may alarm a few analysts.


Most of the growth ratios are ranked from high to low. There are two measures, total growth and balanced growth, which are not usually found; however, operating expenses is a type of growth which is not particularly attractive. The balanced growth is important but there are three rates which, in particular, that are key: equity, loans, and deposits. These key rates play into the factor of a balanced system, too low or too high and it's out of synch unless it is zero - this is balanced growth.


Many of us are very familiar with liquidity. This ratio is one with a short-term focus on assets and liabilities and may also include loans and other factors such as off-balance sheet lending or liens. The real problem with this component is that it is very fluid, such as 90-day or 180-day maturities. One primary liquidity measure is the loans-to-deposits ratio wherein a low value is preferred.

Earnings quality

The earning quality component focuses on assessing the earnings potential or power of the organization. Various rates of returns and yields must be included as well as accountability for assets and liabilities. Typically, most institutions have adequate equity unless they are new and have not yet been established. All historical values or rates and returns will be identified as well as the current market results including valuation.

Interest rate sensitivity

The measures for interest rate risk including shock tests and other calculations all have a need for data but typically this is not available from call reports. The investments, deposits, and loans' maturity data are typically the only data available and therefore ratios are the surrogates for real assessments of interest rate risk.

Productivity and efficiency (non-interest and interest)

The net income is impacted directly by the non-interest revenues and expenses. Another factor, operating expenses, as well as fees and charges all help to diminish the productivity and efficiency. Over the past decade, operating expenses have dramatically increased and will continue to be a major concern.

Capital adequacy

This is a major performance area for both lending and investing quality. Asset quality ratios are the most prominent factors regarding the strategic financial vision. This includes the investment portfolio market value, any delinquent loans values, and all available loan/loss statistics. The ratios representing about 20% of the total performance ratio sets identifies the quality of the loan portfolios and is one area which is well developed.

There are many challenges regarding Credit Research and Risk Analysis so you need an army of practitioners and experts to serve your requirements, and then contact an industry leader who knows your business and standard.


Credit Research Risk Analysis, Credit Research Ingredients

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