This review ensures the lender the risk on the capacity of a borrower to pay. With careful planning and thorough credit risk management review, this allows a financial institution or lender to grant personal loans to individuals, businesses and corporations who have the capacity to pay.
As the name suggests, this is a review of the risk of credit being paid.
There are four essential ways to manage credit risk:
- Avoiding Risk – is a way of risk management where a lender denies an applicant to be granted with a loan. This is usually applied to a person who has high credit risk like borrowers who have already defaulted in payments of their previous loan. It is essential that a good credit risk management team evaluate these people who may bring lost sales.
- Controlling Risk – this is a form of risk management where a set of controls or rules are established to allow reduction of high risk borrowers get approved with a loan. Controlling risk is the most common risk management that a financial institution may apply when granting a loan to a borrower.
- Accepting Risk – This is an open type of risk that may be applied by a lender especially if the lender is aggressive in increasing its clients. Accepting risk is open to high risk borrowers which has a high probability of defaulting payment. When a lender applies this type of risk, it is possible that the lender may apply collateral and high interest rates on the approved loan.
- Transferring Risk – This form of risk pushes the risk of default to a third party such as a guarantor. When the borrower makes a default payment in the loan, the guarantor becomes liable for shouldering the loan. In these cases, a guarantor is usually a person who knows the borrower and is willing to shoulder the risk of paying in case of default by the borrower.
The risk management type that a lender may use depends on the goal they have when it comes to building their clients. A controlling risk type of management may be used by a lender with a goal of gaining low risk clients despite being few. Accepting risk on the other hand may be a way of lenders to gain volume of clients rather than quality.