When a person is applying for a credit card and later own use it to loan money from the bank, the most important thing that the bank or other issuing institution will take into consideration is credit risk. This actually refers to the risk of loss that the investor is likely to suffer in the event of late or inexistent payments. This is also called a default or counterparty risk.
Different issuing institutions of credit card may have various different policies when it comes to investigating the credit risk before issuing the card. Since the losses can relate to both losing the principal amount together with the interest rates, cash flow of the particular issuer can be significantly decreases and that is the main reason why some financial institutions have very firm policies regarding the selection and elimination of potential borrowers.
The main cause of such financial loss that issuers of credit cards can undergo is consumers and businesses not making timely credit card loans.
The credit risks are divided into several categories:
Credit default risk, which is a loss risk brought about by the inability of the user to fully pay the credit obligations and a payment that is more than 3 months late. This can affect all of transactions that are credit sensitive (derivates, loans and securities).
Concentration risk is the type of risk where one or more exposures can jeopardise the crucial bank operations. It can refer to a single name or the concentration of industries.
Finally, country risk is the form that arises when a supreme or sovereign state freezes the foreign payments (transfer or conversion risk) it when it fails to pay and fulfil its requirements (sovereign risks).
Assessments of the credit risks are conducted with the usage of numerous up to date programs and sophisticated tools which perform the analysis of the customer’s financial stability and reliance. The techniques used are not always the same and all major credit cards issuers have their own systems. Most of the companies have special departments that are responsible for monitoring the financial state of the clientele and use the acquired information to extend or deny the credit extension. Apart from the software specially designed for these purposes, third parties are often used and there are companies whose specialty is to acquire the requested info.
If a client belongs to a higher credit risk group and breaches the agreement by not paying the credit card dept, it can affect many areas of his or her life. Not only will it raise the interest rates and increase the overall amount that one needs to pay, but it will also affect your career and the possibility of promotions since many companies examine the credit report status of their potential employees/promotion candidates. On the other hand, placing you in a low risk group can bring numerous advantages and the clients are often rewarded for making timely payments and respecting an agreement.