Credit risk is one of the biggest — if not the biggest — risks for financial institutions. When you lend money or extend credit, and the borrowers fail to meet their contractual obligations, it can get expensive quickly. And when your portfolio gets out of compliance with your lending policies or regulatory compliance, it becomes a big problem.
While you cannot fully protect yourself against all credit risk, there are ways to lower your exposure.
Let’s examine the most common causes of credit risk for financial institutions, along with how credit risk platform solutions can help lower your risk and maximize your profitability.
Common Causes of Credit Risk for Financial Institutions
Effective credit risk management protects against potential losses and helps maintain financial stability. Banks and other financial lenders must constantly balance risk against potential gains or losses. Some of the most common causes of credit risk that can undermine your position include:
- Default Risk. If a borrower defaults, it can lead to significant losses.
- Borrower-Specific Factors: Creditworthiness, financial performance, and industry play a significant role in determining credit risk.
- Industry Sector: The industry in which a borrower operates can impact credit risk. Some industries are inherently riskier than others.
- Macroeconomic Factors: Economic conditions, such as inflation and interest rates, can affect credit risk.
- Regulatory Environment: Changes in regulations can impact credit risk.
Benefits of Credit Risk Platform Solutions
Exposure to credit risk continues to be one of the leading sources of problems for financial institutions globally. Managing these risks requires credit risk platform solutions to make decisions driven by data.
Accurate Credit Risk Evaluation
One of the most common causes of credit risk is ineffective analysis of customer or client creditworthiness. While your proforma may change over time as your risk tolerance varies, you need an objective way to score and evaluate borrows to make better credit decisions.
Credit risk platforms can weigh hundreds of data points and use predictive analytics to forecast potential delinquency risks.
Improved Efficiency
Today’s credit risk software can automate that time-consuming and labor-intensive process of manually underwriting loans and extending credit. This provides more rapid decision-making and increases efficiency in processing more applications in less time.
This can lead to expedited loan origination cycles and reduced operating costs while always staying within your required thresholds for go/no-go decisions on credit.
Ongoing Portfolio Management
Just as making credit decisions while onboarding a new client or customer is important, keeping track of your overall portfolio is critical to mitigate risk. The right credit risk platforms can provide data and dashboards to track lending performance, exposure levels, and concentrations to identify risk factors.
This provides the information you need to make data-driven decisions. Stress testing can forecast implications along with what-if scenarios to examine the impact of various economic conditions.
Regulatory Compliance
A Deloitte study shows that regulatory compliance spending has increased by more than 60% over the past few years. As new regulations hit the books and an increased focus on enforcing existing compliance mandates, staying on top of everything can be a challenge. However, failing to do so can cause cascading problems, including fines and penalties, damage to reputation, and costly lawsuits.
Credit risk engines can ensure that processes are standardized and comply with the latest rules and regulations — both internal and external.
Improved Customer Experience
By accelerating your decision-making, you can provide a better customer experience (CX), eliminating the long delays of years past. In many cases, you can get near-instant credit decisions. In decisions, you can show the specific factors that led to the decision.
CX is a significant factor in every business, but it is especially important for financial institutions. A study by Qualtrics shows that financial institutions that can improve customer experience scores by 10% stand to gain as much as a 27.5% growth rate.
Better Margins
Ultimately, better credit risk management helps to improve profitability. Precise underwriting can help you stay true to your portfolio credit risk goals and lower exposure to delinquencies and charge-offs.
Besides decreases in loan impairment, you can also leverage software to increase activity, boosting lending volume capacity. This helps originate higher-quality assists and maximize portfolio yields.
Command Credit provides a suite of credit risk platform solutions to help you manage your exposure. With business and consumer credit data, fraud detection and prevention, background investigation, and robust marketing tools, Command Credit can build a custom solution for you that provides the critical data you need and integrates with your tech stack and workflow.
Contact the Command Credit team today to discuss your needs and see how our solutions can help lower your credit risk while maximizing profits.