Loan Default Risk

Introduction to the Project

The fundamental objective of commercial and consumer lending is to make profitable loans with minimal risk. In order to do so, management targets specific industries or market in which lending offers have reasonable risk but good return. A loan volume and credit quality must be balanced with the bank's liquidity requirement, capital constraints, and rate of return objective. When a bank finds some loans that carry risk of not paying out as planned, those credits are called classified loans and advances. If the bank has high level of classified loan in the market, the management will face a difficult situation in order to do bridge between risk and return of that loan.

The quality of a bank’s loan portfolio and the soundness of its lending policies are the areas where Bangladesh bank and landing financial institutions look closely. It is a good option to examine borrower proposal. In this paper we use ‘small loan default risk’ to refer to an amount of money that loaned to consumer by a financial institution (bank) and which must be repaid, with interest, in installments (usually at a regular interval).we focus chiefly on methods for classifying an applicant for credit into classes according to their likely repayment behavior. That is ‘default’ or ‘regular’ with repayment, but we shall also briefly consider other associated problems in the case of small business credit risk. The probability that an applicant will default must be estimated from information about the applicant provided at the time of the application, and the estimate will serve as the basis for an accept or reject decision. Accurate classification is of benefit both to the creditor (in terms of increased profit or reduced loss) and to the applicant (avoiding over commitment). The way this risk can be measured is called ‘Discriminant Analysis’.

Discriminant function analysis is to predict group membership based on a linear combination of the interval variables. The...