Introduction to Credit Risk Modeling and Assessment

Abstract

Credit is a fundamental tool for financial transactions in the private and public sector, providing the liquidity needed for all forms of economic activity for consumers and corporate activities. This chapter sets the basis for understanding the concepts and aspects of credit risk management and the current practices in this field. The discussion starts with a presentation of the recent trends in credit provision, and an outline of the regulatory framework. Then, some fundamental factors that create uncertainties are outlined, and the main elements of credit risk modeling are identified, namely the estimation of the probability of default, loss given default, and exposure at default. The requirements set by the Basel Capital Accords regarding these elements are discussed and different modeling schemes are outlined, including judgmental approaches, data-driven empirical models, and financial models. The chapter closes with some financial measures for assessing the loan profitability, such as risk-adjusted return on capital.