What is Credit Portfolio Management?
Credit portfolio management refers to the process of building a series of investments based upon credit relationships and managing the risks involved with these investments. Such a portfolio gains its value from the interest from issued loans but is susceptible to credit default. For that reason, credit portfolio management includes assessing the risk involved with each potential loan and analyzing the total amount of risk the portfolio incurs as a whole. The process is crucial to individual investors who deal in bonds and to banks who issue loans as a major part of doing business.
It is impossible to imagine how the business world would operate without the loans that enable different parties to undertake various financial initiatives. Whether it is an individual looking for a loan to buy a house or a business seeking a loan to open a new location, loans often supply the source of income that allow these things to happen. For the party issuing the loan, it is a form of investment that provides monetary rewards through regular interest payments. Portfolio management is a necessary component of any business that deals with loans on a regular basis.
Banks and other lenders often have a credit portfolio management team devoted to looking at the big picture containing all of the loans issued by such an institution. These managers can assign different risk levels to each of the loans and reach a final assessment about whether or not the lender is too exposed to damage done by potential defaults. This management team usually works in conjunction with the personnel in charge of issuing loans on a case-by-case basis.
To minimize the risks involved with credit portfolio management, lenders usually look at the past credit histories of the people and groups who come in looking for loans. If any of these entities represents a risk of default too high for the lender's standards, they will be refused. A bank or other loan may perhaps proceed with some risky loans, but only by first attaching more favorable interest rates as a way of balancing out the risk.
Individual investors who deal primarily in fixed income securities, so named because they promise regular returns, also have to be concerned with credit portfolio management. The primary fixed income instrument is a bond, which is essentially a loan given from investor to institution in return for interest payments and eventual repayment of principal. Bond investors must be wary of the credit ratings of the bond issuers in their portfolios to make sure that their entire portfolios aren't at risk from multiple defaults.
@Vincenzo -- That all sounds easy enough, but lenders come under a lot of pressure from consumer groups is they are too restrictive in their lending policies. The sad fact is the economy is totally reliant on the availability of credit. When credit is not freely available, people can't purchase cars, houses and other major items. Combine that fact with pressure from consumer groups and you will find lenders not being restrictive as they maybe should be.
If lending policies are too lenient, then you get an economic mess and the government steps in and forces its own lending requirements on banks and such. That is not a good situation, either.
The point is there is a fine line between being too restrictive and not restrictive enough. Finding that line is challenging.
This illustrates exactly why the economy tanks when one segment of the lending industry (mortgages, commercial construction or whatever else) completely tanks when it becomes common to issue risky loans. Why would a bank make a risky loan? Because the bank knows it can sell that loan on a secondary market to people buying investments based on credit relationships.
That is precisely why it is crucial for lenders to assess risk realistically and issue loans accordingly. Otherwise, you've got a mess when risky loans default.
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