What is risk mitigation in credit decisions?

• A. It increases the expected loss from defaults.
• B. It is the process of reducing potential losses from credit defaults.
• C. It eliminates all credit risk.
• D. It only applies to collateralized loans.

Answer: (B)

Risk mitigation in credit decisions is about reducing potential losses if a borrower defaults. It focuses on structuring loans and managing exposures in ways that limit how much a lender can lose, even when a borrower can’t meet obligations. This includes using protections like collateral or guarantees, setting covenants or limits, diversifying the loan portfolio, and pricing to reflect the residual risk. The goal isn’t to eliminate all risk (that’s impossible) and it isn’t only about collateralized loans; many techniques work for unsecured or partially secured credits as well.

So, the best answer describes risk mitigation as the process of reducing potential losses from credit defaults. The other options describe outcomes that don’t fit this concept: increasing expected loss would defeat the purpose, eliminating all risk is unrealistic, and limiting the concept to collateralized loans ignores many risk-reducing methods applied across different loan types.