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Credit risk: Difference between revisions
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The [[risk]] that your [[counterparty]] will go [[bankrupt]]. | The [[risk]] that your [[counterparty]] will go [[bankrupt]]. | ||
The classic example of a credit risk is a [[bank deposit]], although the JC has known [[credit officer]]s<ref>Who, one would like to think, are not long for this employment. </ref>to express surprise at this assertion. | The classic example of a credit risk is a [[bank deposit]], although the JC has known [[credit officer]]s<ref>Who, one would like to think, are not long for this employment. </ref> to express surprise at this assertion. | ||
If you give your money to a bank, contrary to popular opinion, it does not put it in its safe in a special tin labelled with your name. It will use the money you have given it - which is now its money, not yours<ref>This is a frequently misunderstood point, even by [[credit officer]]s. When you give money to the bank (or anyone else) it is no longer ''your'' money. The bearer [[for the time being]] of [[cash]] owns it absolutely against all other claims. Instead, you have a [[debt]] claim for the payment of that amount of cash. You are a [[creditor]].</ref>- to fund its operations, and make money for itself. It will lend the money to other counterparties, amdtthus become a creditor. You become a [[creditor]] of the bank - an [[unsecured creditor]], to be precise - under a deposit [[contract]]. It owes you the money (and [[interest]]), but if the investments it makes go bad, the risk remains it will not be able to repay your deposit. | If you give your money to a bank, contrary to popular opinion, it does not put it in its safe in a special tin labelled with your name. It will use the money you have given it - which is now its money, not yours<ref>This is a frequently misunderstood point, even by [[credit officer]]s. When you give money to the bank (or anyone else) it is no longer ''your'' money. The bearer [[for the time being]] of [[cash]] owns it absolutely against all other claims. Instead, you have a [[debt]] claim for the payment of that amount of cash. You are a [[creditor]].</ref>- to fund its operations, and make money for itself. It will lend the money to other counterparties, amdtthus become a creditor. You become a [[creditor]] of the bank - an [[unsecured creditor]], to be precise - under a deposit [[contract]]. It owes you the money (and [[interest]]), but if the investments it makes go bad, the risk remains it will not be able to repay your deposit. | ||
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This risk is called credit risk. Banks are prudentially regulated to make this risk lower - they have to keep a buffer of [[regulatory capital]] in free cash, and there are certain measures they must take to ensure they do not themselves have large exposures to other counterparties. | This risk is called credit risk. Banks are prudentially regulated to make this risk lower - they have to keep a buffer of [[regulatory capital]] in free cash, and there are certain measures they must take to ensure they do not themselves have large exposures to other counterparties. | ||
{{ | {{seealso}} | ||
*[[credit risk mitigation]] | *[[credit risk mitigation]] | ||
*[[Insolvency]] | |||
{{ref}} | |||