Risk is the effect of uncertainty on objectives; the possibility of loss, injury, or other adverse or unwelcome circumstance; a chance or situation involving such a possibility.
Credit risk is most simply defined as the potential that a borrower will fail to meet his obligations in accordance with agreed terms.
Any measurement of risk is basically an estimate made using simple to complex statistical tools and methods. Simple way to measure risk is by application of probability theory. The probability of default is estimated by using the frequency of past missed payments. This is nothing but delinquency rate (%).
Delinquency rate is the total amount of past due as compared to the total instalments/ EMI billed/ matured, so far. This equals to ‘probability of default’.
Total receivables multiplied by delinquency rate give the total risk amount for a default account. This is very similar to the concept of LGD – Loss Given Default.
Pareto’s Principle - The 80-20 Rule
The 80/20 rule helps identifying high risk accounts. The 80/20 Rule means that in anything a few (20 percent) are vital and many (80 percent) are trivial.
You can apply the 80/20 Rule to almost anything, from the science of management to the physical world.
Applying Pareto rule here, top 20% of rank order list of defaulters based on delinquency rate can be considered as High Risk. Invariably, these high risk accounts will constitute 80% of the credit loss.
Limitation here is that some of ‘early’ defaulters on technical grounds will also appear as high risk accounts. To eliminate such accounts as high risk, DPD (90 days) is used, to differentiate. That is how our Quadrant-I accounts are classified/ segmented as “High Delinquency - High Risk”.
On follow up and serious field investigation, you will be sure to find the following in Quadrant-I:
1. Customer is not traceable
2. Asset is not traceable
3. Skip
4. Asset is with unrelated party
5. Lien is NOT marked
6. Asset is in accident condition
7. Asset is confiscated by authorities for misuse
8. Asset is attached and rotting in the Courts.
9. Asset is with a thug, lawyer or politician
10. File along with contract/ agreement is missing
11. Asset is double financed
12. Fraud
An early and serious action would help salvage; and minimize losses. Will these still constitute 80% of the credit loss?
Yes, it will.
Credit risk is most simply defined as the potential that a borrower will fail to meet his obligations in accordance with agreed terms.
Any measurement of risk is basically an estimate made using simple to complex statistical tools and methods. Simple way to measure risk is by application of probability theory. The probability of default is estimated by using the frequency of past missed payments. This is nothing but delinquency rate (%).
Delinquency rate is the total amount of past due as compared to the total instalments/ EMI billed/ matured, so far. This equals to ‘probability of default’.
Total receivables multiplied by delinquency rate give the total risk amount for a default account. This is very similar to the concept of LGD – Loss Given Default.
Pareto’s Principle - The 80-20 Rule
The 80/20 rule helps identifying high risk accounts. The 80/20 Rule means that in anything a few (20 percent) are vital and many (80 percent) are trivial.
You can apply the 80/20 Rule to almost anything, from the science of management to the physical world.
Applying Pareto rule here, top 20% of rank order list of defaulters based on delinquency rate can be considered as High Risk. Invariably, these high risk accounts will constitute 80% of the credit loss.
Limitation here is that some of ‘early’ defaulters on technical grounds will also appear as high risk accounts. To eliminate such accounts as high risk, DPD (90 days) is used, to differentiate. That is how our Quadrant-I accounts are classified/ segmented as “High Delinquency - High Risk”.
On follow up and serious field investigation, you will be sure to find the following in Quadrant-I:
1. Customer is not traceable
2. Asset is not traceable
3. Skip
4. Asset is with unrelated party
5. Lien is NOT marked
6. Asset is in accident condition
7. Asset is confiscated by authorities for misuse
8. Asset is attached and rotting in the Courts.
9. Asset is with a thug, lawyer or politician
10. File along with contract/ agreement is missing
11. Asset is double financed
12. Fraud
An early and serious action would help salvage; and minimize losses. Will these still constitute 80% of the credit loss?
Yes, it will.
