What is 'Credit Exposure'

Credit exposure is the total amount of credit made available 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'

Credit exposure is the maximum amount that will be lost if the counterparty to a contract defaults. 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 estimate of a borrower's ability to repay. Limiting a college student with no credit history to $300 until he establishes a seasoned track record of making on-time payments 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 Limit

    Credit limit is the amount of credit that a financial institution ...
  2. Credit Rating

    A credit rating is an assessment of the creditworthiness of a ...
  3. Credit Derivative

    A credit derivative is a financial asset in the form of a privately ...
  4. Credit Reporting Agency

    A credit reporting agency is a business that maintains historical ...
  5. Bad Credit

    A qualification of an individual's credit history that indicates ...
  6. Credit Control

    Credit control includes the strategies a business uses to encourage ...
Related Articles
  1. Personal Finance

    Take the Right Steps to Build Excellent Credit

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

    Lines of Credit: The Basics

    Learn how lines of credit, hybrids of credit cards, and normal loans, can help or hurt your finances. Determine what is right for you.
  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

    Credit score ranges: What do they mean?

    Understand what credit scores in each range mean for your future. Learn how to improve your credit score and how it affects your ability to borrow money.
  6. Personal Finance

    Why and How to Use Credit Cards Effectively

    When used responsibly, credit cards play a big role in establishing a good credit score that can help you obtain loans, mortgages and insurance.
  7. 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.
  8. Personal Finance

    Analyzing a Career in Credit Analysis

    If you're a number-cruncher and responsibility doesn't scare you, this could be the job for you.
  9. Personal Finance

    Should Your Credit Rating Scare You?

    Take the mystery out of credit scores by learning the most important ways it can impact your life.
RELATED FAQS
  1. 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 >>
Hot Definitions
  1. Gross Profit

    Gross profit is the profit a company makes after deducting the costs of making and selling its products, or the costs of ...
  2. Diversification

    Diversification is the strategy of investing in a variety of securities in order to lower the risk involved with putting ...
  3. Intrinsic Value

    Intrinsic value is the perceived or calculated value of a company, including tangible and intangible factors, and may differ ...
  4. Current Assets

    Current assets is a balance sheet item that represents the value of all assets that can reasonably expected to be converted ...
  5. Volatility

    Volatility measures how much the price of a security, derivative, or index fluctuates.
  6. Money Market

    The money market is a segment of the financial market in which financial instruments with high liquidity and very short maturities ...
Trading Center