Tuesday, August 4, 2009

credit risk and payment systems

credit commonly is extended in many transactions. For instance, if you purchase an item through the mail by sending a check for payment along with your order, you effectively have granted credit to the mail-order company until the time that you receive the item you order. As another example, if you mail in an order form for a magazine subscription and check the box that says "bill me," the time between when the company mails your first magazine and the time that you pay for your subscription is a period during which the magazine company extends credit to you.
Such extensions of credit entail credit risk for one of the parties to transaction. Economists commonly split credit risk into two categories. One concerns the market risk that debt is not repaid because the borrower defaults on the original transaction, requiring both parties to strike a new agreement. this causes the lending party to incur a loss that typically is less than the full credit extended to the borrower, because the lender usually receives at least part of the full amount of the loan it had extended. Another category of credit risk is delivery risk, which is the risk that a party in a funds transaction fulfills its agreement but that the other party fails entirely to do so. In the case of a loan, the lender in this transaction loses the entire value of the transfer.

No comments: