Why You Need Risk Management in Lending
Responsible fulfillment of contractual obligations by all borrowers is an unfulfilled dream for lenders. Failure to repay a loan does not always depend on the will of the borrower, especially if the loan is taken for a long time. Many external factors can interfere with the usual course of affairs, which can prevent a person from fulfilling all their obligations:
- Job loss;
- Health problems;
- Natural and technogenic disasters;
- Depreciation of assets, etc.
Evidence of the Importance of Risk Management in Lending
Risk management in lending is given paramount importance since many unpaid loans lead not only to the loss of the lender’s capital but also to the loss of the right to remain in this industry. Therefore, banks or other financial organizations create special departments aimed at identifying potentially unfavorable borrowers. The result of their work is impressive, which is proven by the fact that in the United States, more than 1/5 of all loan applicants are refused.
What Variables Does Credit Risk Management Consider?
Some people think that when applying for a loan, a bank or another lender will evaluate only their creditworthiness. However, modern risk calculation technologies go far beyond the simplified scheme for checking potential borrowers. To assess the probability of default by a borrower, a bank needs to:
- Estimate the degree of reliability of a borrower’s income;
- Explore the possibilities of covering the amount of debt at the expense of collateral;
- Assess the business prospects of the company or the sustainability of the organization in which the borrower works;
- Evaluate the situation in the industry in which this business or organization operates.
Only after a full analysis of all factors that may affect the performance or non-performance of loan obligations, the lender can assess all the risks and make a decision on the loan.
Why It’s Important to Do Comprehensive Analysis to Assess Credit Risks
Let’s consider just one of the examples of problematic loans. A bank receives an application for a big loan from a person who receives a solid salary. He has been working at the enterprise for many years and at first glance seems to be a reliable borrower. However, a more detailed analysis may show that his business is in a high-risk area, and there are no other large businesses in his place of residence. For example, this may be the coal industry, which is criticized by environmentalists, an enterprise in which full automation of the production process is being introduced, etc. And although the revealed facts do not make a person less creditworthy, the loan itself becomes more risky for the lender.
Impact of Loan Type on Credit Risk Management
All of the above is most true for major loans, such as mortgages, car loans, large personal loans, etc. When you are dealing with payday loans, such a thorough check is redundant. Since this is a short-term type of loan, it is unlikely that anything serious will happen in a month to the enterprise or industry in which the applicant works. Therefore, numerous lenders, whose offers can be found on the Payday Depot platform, have much softer approaches to checking their borrowers and assessing their creditworthiness.
The more money lenders risk, the more comprehensive the evaluation they are conducting. And even despite all the solidity of the examination, there are some defaults on loans. Now, many of them are hoping that the powerful AI will take into account all factors, make the right decisions, and change the entire lending industry.
