What is 'Credit Exposure'

Credit exposure is the total amount of credit extended to a borrower by a lender. The magnitude of credit exposure indicates the extent to which the lender is exposed to the risk of loss in the event of the borrower's default. Credit exposure can be minimized through purchasing credit default swaps or other types of financial instruments.

BREAKING DOWN 'Credit Exposure'

For example, if a bank has made short-term and long-term loans totaling $100 million to company A, its credit exposure to company A is $100 million. In general, a bank seeks to have greater credit exposure to its customers with the highest credit rating and less exposure to clients with a lower credit rating. If a customer encounters unexpected financial problems, the bank may seek to reduce its credit exposure to mitigate the risk of loss arising from a potential default.

How Lenders Control Credit Exposure

Lenders have several methods for controlling credit exposure. Certain practices are simple, such as a credit card company setting credit limits based on its estimation of a borrower's ability to repay. Limiting a college student with no credit history to a $300 limit until he establishes a seasoned track record of making payments on time while offering a $100,000 limit to a high-income customer with a FICO score above 800 is an example of a credit card company reducing its credit exposure to a higher-risk borrower and increasing its exposure to an A-paper borrower.

More complex methods to limit credit exposure include purchasing credit default swaps, which effectively transfer credit risk to a third party. The swap buyer makes premium payments to the seller, and the seller agrees to assume the risk of the debt and compensate the buyer with interest payments – and return his premiums – if the borrower defaults. Credit default swaps played a major role in the financial crisis of 2008, as sellers misjudged the risk of the debt they were assuming when issuing swaps on bundles of subprime mortgages.

Credit Exposure vs. Credit Risk

The terms "credit exposure" and "credit risk" are often used interchangeably. Actually, credit exposure is one component of credit risk. It measures the potential magnitude of loss if a default occurs. The probability of default measures how likely it is the borrower is unable or unwilling to repay the debt. The recovery rate quantifies the portion of the loss likely to be recovered through bankruptcy proceedings or other collection efforts.

RELATED TERMS
  1. Credit Default Insurance

    The use of a financial agreement - usually a credit derivative ...
  2. Credit Limit

    The amount of credit that a financial institution extends to ...
  3. Credit Event

    Any sudden and tangible (negative) change in a borrower's credit ...
  4. Credit Rating

    An assessment of the creditworthiness of a borrower in general ...
  5. Loan Credit Default Swap (LCDS)

    A type of credit derivative in which the credit exposure of an ...
  6. Credit Default Contract

    Security with a risk level and pricing based on the risk of credit ...
Related Articles
  1. Personal Finance

    What Do Credit Score Ranges Mean?

    Take a closer look at what credit scores in each range mean for your financial future.
  2. Personal Finance

    The Importance Of Your Credit Rating

    A great starting point for learning what a credit score is, how it is calculated and why it is so important.
  3. Personal Finance

    Take the Right Steps to Build Excellent Credit

    There are several things you can do to protect and improve your credit score.
  4. Personal Finance

    Is Your Credit Score at 850? It Can Be!

    Use these tips to increase your credit score and your ability to get low interest rates on loans.
  5. Personal Finance

    Build Your Credit Score

    Here are four good ways to build your credit score when you're starting from scratch. Do it right and you'll end up with excellent credit.
  6. Personal Finance

    6 Ways To Build Credit Without A Credit Card

    It's definitely possible – if a bit more complicated – to build a credit history without traditional credit cards. Just follow these steps.
  7. Investing

    Understanding Credit Risk

    Credit risk arises whenever a borrower is expecting to use future cash flows to pay a current debt.
  8. Investing

    Revolving Credit vs. Line of Credit

    Revolving credit and a line of credit are arrangements made between a lending institution and a business or individual.
  9. Personal Finance

    How Your Credit Score Compares to the Average American's

    While only a small percentage of Americans have terrible credit scores, a whopping 30% have poor or bad credit, according to the Consumer Financial Protection Bureau.
  10. Personal Finance

    How To Establish A Credit History

    Can't get a credit card without a credit history, and can't get a history without a card? Break the Catch-22.
RELATED FAQS
  1. Why do high profiting sales mitigate credit risk?

    Learn more about credit risk in loaning to individuals and businesses. Understand how credit risk is determined and the impact ... Read Answer >>
  2. What information do lenders need when I apply for a credit limit increase?

    Increase your credit limit by making sure your current credit is paid on time and by paying the largest amount you can afford ... Read Answer >>
  3. What is the difference between available credit and credit limit?

    Explore the difference between available credit and credit limit and the implications different account balances have on ... Read Answer >>
  4. How do I get a higher limit on my credit cards?

    Understand how credit limits work with major credit card companies and things you can do to get a higher limit on your credit ... Read Answer >>
  5. Can a Best Buy credit card help you build credit?

    Learn about how using a Best Buy credit card responsibly can lead to a higher credit score and lower interest rates on mortgages ... Read Answer >>
  6. What is the difference between a loan and a line of credit?

    Learn to differentiate between lines of credit and standard loans, and determine when you are likely to use each method of ... Read Answer >>
Hot Definitions
  1. Gross Margin

    A company's total sales revenue minus its cost of goods sold, divided by the total sales revenue, expressed as a percentage. ...
  2. Current Ratio

    The current ratio is a liquidity ratio measuring a company's ability to pay short-term and long-term obligations, also known ...
  3. SEC Form 13F

    A filing with the Securities and Exchange Commission (SEC), also known as the Information Required of Institutional Investment ...
  4. Quantitative Easing

    An unconventional monetary policy in which a central bank purchases private sector financial assets in order to lower interest ...
  5. Risk Averse

    A description of an investor who, when faced with two investments with a similar expected return (but different risks), will ...
  6. Indirect Tax

    A tax that increases the price of a good so that consumers are actually paying the tax by paying more for the products. An ...
Trading Center