Related Terms
DEFINITION
Risk Rating
A risk rating is a measure used by banks and other financial institutions to determine the risk of conducting business with a given individual or legal entity. A credit assessment is an example of how risk ratings are determined. Risk ratings also make up a key part of different financial regulations, such as Anti-Money Laundering and Combating the Financing of Terrorism regulations.
Synonyms
Risk level evaluation, default risk score, financial risk classification
Acronyms
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Synonyms
Risk level evaluation, default risk score, financial risk classification
Acronyms
–
Examples
Two businesses apply for a loan. The first has been in operation for over ten years, turning a consistent profit, and is only asking for a small loan. After the bank performs its Due Diligence, they determine that this business is low-risk. This means the bank can offer them additional benefits such as smaller interest rates.
On the other hand, the second business is relatively new, has yet to make a significant profit, and is asking for a very large loan. After performing their Due Diligence, the bank determines that they are willing to take on the risk but flag the customer as a high risk. They therefore enforce larger interest rates and stricter terms.
FAQ
What factors influence a person’s risk rating?
Many different factors are taken into account when determining a risk rating. For example, the financial institution’s risk appetite and risk policy as well as the borrower’s credit history, income stability, business sector risks, etc.
How does a risk rating affect loan terms?
Generally, individuals that are seen as a high risk will be given stricter loan terms, such as higher interest rates. The financial institutions may even decide to deny the application if the risk is too high. Alternatively, an individual who is seen as low risk may be offered more favorable loan terms.
What is the 5x5 risk matrix?
The 5x5 risk matrix is a tool used to visualize and more easily determine the risk rating of a given individual or entity. It is often used to establish risk thresholds as the matrix helps more clearly visualize and categorize risk based on likelihood and impact.
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