by Dave Williams, Managing Director, S&P Capital IQ
Looking at credit risk through a variety of measures provides a more holistic view of credit worthiness than is common in traditional cash management and corporate treasurer practice. Taken together, a combination of measures can not only provide greater perspective on credit risk but also serve as the foundation for pre-emptive monitoring and credit policy frameworks.
Creating a framework view
Indeed, as the creditworthiness of an entity degrades, credit policies typically call for increased monitoring, reductions in exposure to the entity, or potentially triggering risk mitigation strategies such as moving to all cash transactions. Yet to do this many credit management policies rely on a single indicator of credit worthiness such as a traditional credit rating.
However, it is difficult to point to a single indicator that gives a complete and dynamic view of credit risk. Traditional long-term issuer credit ratings take views on creditworthiness that consider the entire business cycle. As such, they may not react to quickly evolving market conditions in a way that ratings implied from the Credit Default Swap (CDS) markets do. On the other hand, such market-derived indicators can be quite volatile. What are also needed are indicators that have market inputs, but that are grounded in the context of longer-term cycles and incorporate the fundamental information that drive a credit score or rating. Indeed, combining several credit indicators, rather than just one, can result in a more accurate and robust credit management scoring framework. If necessary, such a framework may then be represented by a single composite score.
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