Default is when you give somebody money as they alone and they fail to repay it so they default on that obligation and we’re going to be looking at that as our main form of credit risk so credit risk in this regard has got to two dimensions that I want to but so not talking about counterparty risk we’re talking about default and the two dimensions or the two components is the probability of the default happening and the amount of the loss because of the default so amount of loss what’s nice about these two components is that you can multiply them together and you can get some sort of expected loss and that’s quite cool because you can use this to compare to two loans

one loan it’s got a high probability but just a small loss another one’s got a low probability but a big loss you can combine them together in order to compare one thing I do find quite interesting when it comes to say credit risk is what we sometimes do is if someone has a high probability of defaulting this we see specifically in unsecured lending what they tend to do is they tend to charge these people a higher interest so there’s a high probability that you’re going to default the financial intermediary will charge you a higher interest the interesting thing though by charging a higher interest is the higher interest you charge the more you’re going to increase the probability of default think about it if you only have to pay 10% back that’s much easier to repay and say 20 percent and therefore there will be that high probability so maybe by charging higher interest rates you are causing more people to default which therefore causes you to charge even higher interest rates which causes even more defaults and we saw something like this happen in South Africa recently

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