1.

The word credit derives from the ancient Latin credere, which means “to
entrust” or “to believe.
2. lenders, or creditors, extend funds—or “credit”—based upon the belief
that the borrower can be entrusted to repay the sum advanced, together with
interest, according to the terms agreed.
3. the creditor’s confidence that:
1. The borrower is, and will be, willing to repay the funds advanced (the
creditor’s knowledge of the borrower (or the borrower’s reputation))
2. The borrower has, and will have, the capacity to repay those funds (the
creditor’s understanding of the borrower’s financial condition,)
4.Credit is the realistic belief or expectation, upon which a lender is willing to
act, that funds advanced will be repaid in full in accordance with the
agreement made between the party lending the funds and the party borrowing
the funds
5. Credit risk is the possibility that events, as they unfold, will contravene
this belief.
6. Success in banking is attained not by avoiding risk but by effectively
selecting and managing risk. In order to better manage risk, it follows that
banks must be able to estimate the credit risk to which they are exposed as
accurately as possible.
7. For purposes of practical analysis, credit risk may be defined as the risk of
monetary loss arising from any of the default of the counterparty.
8. The variables most directly affecting relative credit risk include the
following four:
1. The capacity and willingness of the obligor (borrower, counterparty,
issuer, etc.) to meet its obligations
2. The external environment (operating conditions, country risk, business
climate, etc.) insofar as it affects the probability of default,
loss severity, or exposure at default
 3. The characteristics of the relevant credit instrument (product, facility,
issue, debt security, loan, etc.)
4. The quality and sufficiency of any credit risk mitigants (collateral,
guarantees, credit enhancements, etc.) utilized

9. Credit risk is also influenced by the length of time over which exposure
exists.
10. In this way, the use of collateral tends to lower the probability of
default, and, more significantly, reduce the severity of the creditor’s loss in
the event of default, by providing the creditor with full or partial recompense
for the loss that would otherwise be incurred.
11. Credit risk mitigants are devices such as collateral, pledges, insurance, or
guarantees that may be used to reduce the credit risk exposure to which a
lender or creditor would otherwise be subject. The purpose of credit risk
mitigants is partially or totally to ameliorate a borrower’s lack of intrinsic
creditworthiness and thereby reduce the credit risk to the lender, or to justify
advancing a larger sum than otherwise would be contemplated.
12. Will the collateral provided by the prospective borrower be sufficient to
secure repayment?
13. A guarantee is the promise by a third party to accept liability for the
debts of another in the event that the primary obligor defaults. Unlike
collateral, the use of a guarantee does not eliminate the need for credit
analysis, but simplifies it by making the guarantor instead of the borrower the
object of scrutiny.
14. It is logical to rank capacity to pay as more important than willingness,
since willingness alone is of little value where capacity is absent.
15. Compared with willingness to pay, the evaluation of capacity to pay lends
itself more readily to quantitative measurement. Evaluating the
capability of an entity to perform its financial obligations through a close
examination of numerical data derived from its most recent and past financial
statements forms the core of credit analysis.
16. Credit analysis is as much art as it is science, and its successful
application relies as much on judgment as it does on mathematics. The best
credit analysis is a synthesis of quantitative measures and qualitative
judgments.
17. While capacity means having access to the necessary funds to repay a
given financial obligation, in practice the evaluation of capacity is undertaken
with a view to both the type of borrower (The four principal categories of
borrowers are consumers, nonfinancial companies (corporates), financial
companies—of which the most common are banks—and government and
government-related entities.)
18. The probability that a borrower will default on its obligation to the lender
generally equates to the probability that the lender will suffer a loss.
19. ECL=PD*LGD*ED . LGD deals with the severity of the default that
might be incurred. Was it the type of default in which payment ceases and no
further revenue is ever seen by the creditor, resulting in a substantial loss as a
result of the transaction?
20. The longer the tenor of the loan, the more likely it is that a default will
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occur.
21. Moreover, the costs of repairing a banking crisis typically far outweigh
the costs of taking prudent measures to prevent one.
22. Financial analysis is the process of arriving at conclusions concerning an
entity’s financial condition or performance through the examination of its
financial statements, such as its balance sheet and income statement.
Chapter 2
1. Particularly noteworthy are the Collateralized Loan Obligations (CLOs)
through which banks transfer pools of loans from their balance sheet.
While banks have frequently used loan sales to reduce risk in the past,
this new technique allowed banks to shed commercial loans (typically
the most informationally sensitive form of lending) on a large scale.
2. For one, they have done this through the use of credit derivatives, and
mostly in the form of Credit Default Swaps (CDS). These instruments
allow banks to trade credit risks on a variety of exposures.
3. Sovereign risk and bank credit risk are closely linked, and each affects
the other.
4. In other words, for credit risk to exist there must be a corresponding
financial obligation, either present or prospective, between the issuer
and the investor
5. By financial quality analysis is meant financial evaluation that goes
beyond reported numbers to look at the quality of those numbers and
the items they are measuring -asset quality, earnings quality—how real
is the income reported? and capital quality.
6. Ratios are simply fractions or multiples in which the numerator and
denominator each represent some relevant attribute of the firm or its
performance. The most useful financial ratios are those in which the
relationship between such attributes is such that the ratio created
becomes in itself an important measure of financial performance or
condition. To return to the initial example, return on equity, that is, net
income divided by shareholders’ equity, shows the relationship between
funds placed at risk by the shareholders and the returns generated from
such funds.
7. The process of bank analysis cannot be done in isolation. Instead, the
analyst must be aware of the risk environment of the markets in which
the bank is situated and in which it is operating, as well as the
economic and business conditions in the financial sector as a whole.
8. When reading a company’s annual report, the analyst should ask
himself or herself, “What points are being glossed over?” If liquidity
appears to be a weak point, how does the company treat this issue? Is
the concern addressed, or is it mentioned only in passing? What other
scenarios might unfold besides management’s rosy view of their firm’s
future?