Impaired Credit

Definition

Credit deterioration typically refers to a situation where an individual, company, or other entity is considered to have poor credit. For individuals, this is usually reflected in a lower credit score; for companies and other entities, it manifests as a lower credit rating. Borrowers experiencing credit deterioration will find it harder to obtain loans and usually have to pay higher interest rates. Credit deterioration can be a temporary, fixable state or a warning sign of impending larger financial troubles.

Origin

The concept of credit ratings and scores originated in the early 20th century. As financial markets developed, credit rating agencies like Moody's and Standard & Poor's began providing credit ratings for corporate and government bonds. Over time, personal credit scoring systems were also introduced to help banks and other financial institutions assess the credit risk of individual borrowers.

Categories and Features

Credit deterioration can be categorized into personal credit deterioration and corporate credit deterioration. Personal credit deterioration is often caused by factors such as failing to repay debts on time, over-borrowing, or bankruptcy. Corporate credit deterioration may result from poor financial statements, increased market competition, or poor management. Key features of credit deterioration include a drop in credit scores or ratings, increased borrowing costs, and restricted access to financing.

Case Studies

A typical case is during the 2008 financial crisis when many large financial institutions like Lehman Brothers saw their credit ratings rapidly decline, ultimately leading to bankruptcy. Another example is the 2015 Greek debt crisis, during which Greece's national credit rating was downgraded multiple times, significantly increasing its borrowing costs.

Common Issues

Common issues investors face when dealing with credit deterioration include how to assess credit risk, how to manage credit risk within a portfolio, and how to identify early signs of credit deterioration. A common misconception is that credit deterioration is always irreversible; in fact, credit status can be restored by improving financial conditions and credit behavior.