Credit Exposure

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. Credit Default Contract

    Security with a risk level and pricing based on the risk of credit ...
  6. Good Credit

    A qualification of an individual's credit history that indicates ...
Related Articles
  1. Personal Finance

    The Basics Of Lines Of Credit

    Lines of credit are potentially useful hybrids of credit cards and normal loans. Learn how a line of credit can help (and hurt) your finances, and how to find the best one to suit your needs. ...
  2. Investing

    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. Investing

    What Do Credit Score Ranges Mean?

    Take a closer look at what credit scores in each range mean for your financial future.
  4. Investing

    How To Increase Your Appeal To Prospective Lenders

    Making a business eligible for loans/credit cards at the best possible rates requires crafting an excellent credit profile through the smart use of credit.
  5. Investing

    Understanding Credit Risk

    Credit risk arises whenever a borrower is expecting to use future cash flows to pay a current debt.
  6. Personal Finance

    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.
  7. 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.
  8. Personal Finance

    Use Your Credit Card To Boost Your Credit Score

    Misusing credit cards can blow your credit – but using them well can boost your score. How to grow a history, fix bad credit, make good credit even better.
  9. Personal Finance

    What Lenders Look At On Your Credit Report

    What do lenders consider when they look at your credit report? Several things, including your income and payment history.
  10. Investing

    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. Is it possible to have a credit limit that's too high?

    Avoid these pitfalls when working with high credit limits, and learn how to increase your credit score by increasing your ... Read Answer >>
  3. What is the difference between bad credit and no credit?

    The answer to this question will depend on what information (if any) is found on your credit report, such as any bankruptcy ... Read Answer >>
  4. What are some good alternatives to taking out a line of credit?

    Read more about how opening a line of credit might not be the best answer for you and determine available alternatives if ... Read Answer >>
  5. 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 >>
  6. 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 >>
Hot Definitions
  1. Quantitative Trading

    Trading strategies based on quantitative analysis which rely on mathematical computations and number crunching to identify ...
  2. Bond Ladder

    A portfolio of fixed-income securities in which each security has a significantly different maturity date. The purpose of ...
  3. Duration

    A measure of the sensitivity of the price (the value of principal) of a fixed-income investment to a change in interest rates. ...
  4. Dove

    An economic policy advisor who promotes monetary policies that involve the maintenance of low interest rates, believing that ...
  5. Cyclical Stock

    An equity security whose price is affected by ups and downs in the overall economy. Cyclical stocks typically relate to companies ...
  6. Front Running

    The unethical practice of a broker trading an equity based on information from the analyst department before his or her clients ...
Trading Center