Models for Management of Banks ' Credit

Taking risks is an integral element of banking operations. Sound bank-ing operations are characterised partly by having an overview of the risks which the bank's operations entail, and partly by the bank's earn-ings being in reasonable proportion to those risks. Granting of credit is central to ordinary banking operations, and quite naturally this is the principal source of the risks to which banks are exposed. In its simplest form, the risk on credit granting (credit risk) is that the borrower fails to meet its payment obligations to the bank. Traditionally, banks ' management of credit risk has been related to the credit assessment of individual customers. The basis for credit as-sessment is the customer's financial situation, which gives a picture of the customer's creditworthiness. A key issue for the bank is whether the customer has both the will and the ability to fulfil its obligations to the bank, i.e. to service the debt. It is also important for the bank to spread its lending on different segments, in order to avoid excessive concentration of risk. This is be-cause different sectors develop differently. Some are cyclically depend-ent, while others are less sensitive to business cycles. When a bank diver-sifies its exposures on several sectors, problems in individual sectors will have less impact on the bank's financial stability. Technological progress in particular, including improved possibilities for complex computation of large amounts of data, has given the banks greater scope to apply credit models to their management of credit risk. Another catalyst in this process is recent years ' international considera-tion of the implementation of new capital-adequacy rules. In the draft proposal for a new Capital Accord the Basle Committee has discussed the possibility of allowing financial institutions at some time in the fu