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by Emanuele Rosenberg Colorni (2002)






1. Risk as a function of operation


2. Risk as a function of bank commitment


3. Risk as a function of guarantees


4. Conclusions


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What are the issues banks consider and evaluate for assessing credit risk? The decision whether to grant a loan or other banking facilities for industrial or financial investment (as well as for consumption or other aims) depends mainly on the perceived risk of the credit, i.e. the probability that the borrower might not respect the contract with the bank. The borrower could not be able or not be willing to pay back the money, in full or in part, thus leading to a bank loss.

First of all, the banks consider the personal and institutional creditworthiness of borrower, which is the main issue. Secondly, they will examine the characteristics of the proposed operation, and they will probably fine-tune them in order to meet bank desired risk level for that borrower.

In this essay we won’t talk about the first point (how banks assess the creditworthiness of borrower), since there is plenty of literature about it. We just remember that banks consider, among other factors, the current and prospect patrimonialisation and profitability, the borrower's history, as well as its industrial sector and how the borrower is positioned in it. Instead, we will propose a general synoptic scheme about the other issues to be considered in the perspective of the bank.

We can distinguish three "risk drivers" (from the less to the most important):

  1. Risk as a function of operations;
  2. Risk as a function of the bank commitment;
  3. Risk as a function of guarantees;



These drivers apply to both cash credits and non-cash credits (e.g. commercial and financial bonds, issued by a bank on client's request).

We will now describe the content of the three drivers.

1. Risk as a function of operation

We can classify the range of the lending operations according to which control banks have over the amount granted and to their "auto-cashing" attitude. Now, we proceed from the most to the less risky operation.

Class Examples Description Risk degree
Blank credits

Overdraft credit

Banks have no control over the sum borrowed and the client uses the money for operations which – as far as banks know – don’t have a specific reimbursement source

Extremely high

Operations which enables bank control over utilisation of credit

Letter of credit, import facility, performance and advance payment bond

By the import facility, for example, banks grant a loan to pay a foreign provider and, at the same time, they transfer money to him (so they control the utilisation of the granted amount).

When a bank issues a performance bond on behalf of one of its clients, it knows exactly what the underling operation is and how the bond will be used.


Operations that have a specific reimbursement source

Accounts receivable financing; bid bond

Accounts receivable financing is an "auto-cashing" operation: when its client’s debtor will pay him, the client, in its turn, will reimburse the bank.

Rather High

Operations which have a specific reimbursement source and whose amount is directly collected by the bank

Accounts receivable financing with collection by the bank

As the former, but, in this case, the bank, by itself, should collect the amount directly by its client’s debtor.


Needless to say, other elements can balance the degree of risk as function of operation but one should remember that usually banks will require higher margins on more risky operations.

2. Risk as a function of bank commitment

In the ordinary credit facilities, bank commitment is very low. It means that a bank can call its money back at a moment’s notice (usually at two days notice). The credit facilities described in the former paragraph are usually granted as "day-to-day loan".

However, large companies are sometimes granted by "committed" facilities: the technical structure of the operations is usually very similar, but the bank commits itself, for a defined period, to keep the amounts at the disposal of the client without the possibility of calling back the credit line. This "service" is rewarded by a commitment fee, paid on the amount granted and not drawn at the date.

In long-term loans and mortgage loans the bank is highly committed: it can call its money back only when the borrower doesn’t pay at least two or more installments. For this reason, banks usually ask collateral (real-estate mortgage).

Finally, we should remember that bank commitment and duration has an effect not only on risk, but also on costs. Banks should fulfil some ratios provided by Central Banks. And long – term (as well as risky) facilities absorb more capital, which is the "limited resource" for banks.

3. Risk as a function of guarantees

What happens when a company can’t pay back its facilities and interests?

The bank should consider the so-called second barrier (the first barrier is the long-term profit and cash flow): guarantees and collaterals.

According to their effect to risk, how can we classify them? We will now explain the four groups of guarantees and collaterals, from the most to the least risky.

Class Examples Description
No guarantee





In this case, the bank has decided not to have a "second barrier": the creditworthiness of borrower is so strong, the competition among banks is so high, that the bank doesn’t ask for any guarantee or collateral.

Additional commitment of someone else's equity

Guarantee issued by another company or another bank; committed patronage letter

When granting loans to a "local" company, for example, banks usually ask the "mother" company to sign a committed patronage letter: if the local company is insolvent, the mother company should reimburse the bank on behalf of it.

Collateral needing assessment

Real-estate mortgage, listed securities, pledges

The borrower, one of its shareholder or another company of the same group, provides the bank with a guarantee on a "real" asset.

Collateral of known value

Government securities, money, bonds issued by the lending bank

As the former, but, in this case, due to the kind of securities, the value of the collateral doesn’t need to be assessed. The extreme case is a money collateral.

4. Conclusions

In this essay, we shortly illustrated a general scheme about the way banks tackle with credit risk. The purpose was not to exhaust the issue, but to provide a comprehensive scheme that considers together all the "risk drivers". By order of importance, we remember that banks usually evaluate first of all the creditworthiness of borrower, then, if necessary, guarantees and collaterals, then the type of commitment and, finally, the requested operations.

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To understand the effects that bank credit has on the whole economy, see this paper - A new approach to business fluctuations: heterogeneous interacting agents, scaling laws and financial fragility.

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