Bank Performance
Adequately managing credit risk in financial institutions (FIs) is critical for the survival
and growth of the FIs. In the case of banks, the issue of credit risk is of even of greater
concern because of the higher levels of perceived risks resulting from some of the
characteristics of clients and business conditions that they find themselves in.
Banks are in the business of safeguarding money and other valuables for their clients.
They also provide loans, credit and payment services such as checking accounts, money
orders and cashier’s checks. Banks also may offer investment and insurance products and
a wide whole range of other financial services (in accordance with the 1999 Financial
Services Modernization Act by the US congress) which they were once prohibited from
selling (by the Glass-Steagall or Banking Act of 1933 in the USA).
Credit creation is the main income generating activity for the banks. But this activity
involves huge risks to both the lender and the borrower. The risk of a trading partner not
fulfilling his or her obligation as per the contract on due date or anytime thereafter can
greatly jeopardize the smooth functioning of a bank’s business. On the other hand, a bank
with high credit risk has high bankruptcy risk that puts the depositors in jeopardy.
Among the risk that face banks, credit risk is one of great concern to most bank
authorities and banking regulators. This is because credit risk is that risk that can easily
and most likely prompts bank failure.
Credit risk management is a structured approach to managing uncertainties through risk
assessment, developing strategies to manage it, and mitigation of risk using managerial
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resources. The strategies include transferring to another party, avoiding the risk, reducing
the negative effects of the risk, and accepting some or all of the...
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