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How to setup credit limits?

How to setup credit limits?

how to setup credit limits 1

What do we want from robust corporate credit risk management?

In the last post we have written about the dangers of credit risk. The logical next step is to give recommendations on how to best construct a credit risk management system, that accounts for the issues outlined in the previous post.

 What do we want to achieve with credit risk management system?

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Credit risk is like syphilis

Credit risk is like syphilis

Credit risk is like syphilis, but more contagious and unpredictable.

No harm intended with the above comparison, but for all my life the best way to understand a phenomenon was by finding parallels from real life or nature. The thing that intuitively drops to mind is something contagious, with dire consequences and that limits the benefits of (financial) interaction, thus comparison with syphilis.

To be more specific, here are in short a few reasons why credit risk resembles syphilis.

It’s purely a negative experience

Getting infected is synonymous with your client defaulting. It is purely a negative experience. Namely, credit risk in contrast to other types of risks faced by companies such as price risk, FX risk, commodity risk etc. exclusively causes only negative financial impact. Consider for example price risk: an increase in price of goods sold will (in general) result in an increase in profit, a reduction in price results in a decrease in profit, whereas realization of credit risk results (assuming no long position on credit risk via financial instruments) can only have negative financial impact. It’s also heavy tailed and not in our favor.

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