Understanding Credit
                     Understanding 
Credit
Introduction
Credit analysis is a process undertaken 
by lenders to understand the 
creditworthiness of a prospective 
borrower, meaning how capable (and 
how likely) they are of repaying 
principal and interest obligations. 
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Commercial 
Lending
The borrower, also known as the 
debtor, could be an individual or a 
business entity; the former is referred 
to as retail (or personal) lending, and 
the latter is what’s known as 
commercial lending.
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Creditors
Lenders, also known as creditors, 
employ a variety of qualitative and 
quantitative techniques (including risk 
models) when conducting credit 
analysis in order to quantify and 
effectively price risk.
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What is 
Credit?
Credit is “created” when one party 
receives resources from another party, 
but payment is not expected until some 
contracted date (or dates) in the future. 
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Trade credit
The resource may be cash, as is the 
case with a bank loan. Alternatively, the 
resource may be a physical product (like 
inventory); this is called trade credit. In 
both cases, credit risk exists. 
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Credit Risk
This is defined as the risk that a creditor 
will advance resources to a debtor, but 
that payment (or repayment) will not 
be made. 
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Credit 
Analysis 
Credit analysis is conducted in order to 
understand the level of credit risk 
presented by a borrower, given the 
parameters of a specific credit request.
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Qualitative 
techniques
Qualitative techniques include trying to 
understand risks in the external 
environment, like where interest rates 
are heading and the state of the 
broader economy, among others. A 
framework like PESTEL is often 
employed. 
Source: corporatefinanceinstitute.com
Quantitative 
techniques
Quantitative elements of the analysis 
include assessing financial ratios using 
risk models, understanding financial 
projections, employing sensitivity 
analysis, and evaluating the strength of 
any physical collateral that could serve 
as security against the credit exposure.
Source: corporatefinanceinstitute.com
Credit Analysis 
Framework – 
The 5 Cs
A popular credit analysis framework is 
the 5 Cs of Credit; the 5 Cs underpin the 
component parts of most risk rating and 
loan pricing models. The 5 Cs are:
1. Character 
2. Capacity
3. Capital
4. Collateral 
5. Conditions
Source: corporatefinanceinstitute.com