Credit Risk

What is credit risk?

Credit risk is the risk to an organization’s financial condition and resilience arising from a third party’s (or other creditor necessary to that third-party relationship) failure to meet the terms of a contract with the organization or failure to perform as agreed. One aspect of credit risk typically involves the financial health of the third party itself.

How does credit risk fit into a TPRM program?

Credit risk is a particularly important consideration when third parties are engaging in some form of financial services activity for an organization, such as originating loans or financing, or engaging in some forms of customer services activities, account management, or collections activities.

Credit risk also impacts the resilience of supply chains – if critical suppliers (or their suppliers) become insolvent, it is unlikely they we be able to meet the terms of your contract and provide the products and services critical to your business goals. This type of failure can have huge financial, operational and reputational impacts.

There are several types of credit risk, including:

• Concentration risk (link to concentration risk glossary subpage): Concentration risk arises from exposure to a single party or sector, and can produce large losses to core operations. This lack of diversification leads to further vulnerability.
• Credit default risk: Credit default risk can happen when a borrower cannot pay the loan obligation or when the borrower is past the due date of the loan repayment. This can affect all financial transactions that are credit-sensitive.
• Country or region risk: Country risk can occur when foreign currency payment obligations are frozen, which results in a default on obligations. Factors like political and economic instability can leave operating profits and asset values vulnerable and affect all companies whose third and fourth parties are located in that country or region.

How can Aravo help companies strengthen their financial resilience?

Aravo for Financial Services helps organizations automate assessments, scoring, due diligence, continuous monitoring (link to continuous monitoring glossary subpage), issue management, and corrective action processes to avoid threats to their TPRM program, such as credit risk. Aravo has a built-in credit-strength test model (Altman Z-Score) that gauges a company’s likelihood of bankruptcy. It is an important data-point in establishing the financial health of third-parties. Aravo also integrates with financial health ratings services such as Rapid Ratings. Aravo’s cloud-based application is designed to help firms manage third-party relationships in accordance with increased and expansive regulatory expectation.

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