4 Things We Learned from Big Banks About Mitigating Risk

Quickcheck Canada
August 12, 2016

Anybody who is in the lending business, whether they are a small operation or a large company with several stores, can take advice from big banks about lending money to people. Banks that have lent money to people for decades have all sorts of experience when it comes to loaning and collecting money. Obviously, most big banks that offer these types of loans are doing well enough in their endeavors that they can remain afloat. This is why it's a good idea to give heed to healthy lending practices by these banks.

Taking Credit Risk Into Account

One of the most important risks for anyone who is going to lend money to someone is their credit score. If someone is looking to borrow money and has a terrible credit score, then there's a good chance they are not going to pay back the money they are borrowing. If they were unable to make payments on their loans in the past, there's a good chance they are either comfortable with defaulted loans or simply incapable of repaying the money they borrow, even if it looks like they can on paper.

Factoring in Operational Risks

An operational risk is one that comes from within a lending company. Unfortunately, it's common for employees of a lending practice to bend the rules or make exceptions every so often. If the employee of a lending company finds their friend or family member in their office asking for a loan, they may overlook something like a bad credit score and provide the loan anyway. Implementing strict lending practices and monitoring employees closely is one way to reduce operational risks.

Considering Market Risk

Market risks are those that come from the market changing unexpectedly. For example, a lender may provide someone with the money they are asking for based on the current value of their home. If the housing market suddenly plummets during the time a borrower is supposed to pay back their loan, it could be bad for the lender. If someone is unable to repay the loan normally and the only thing a lender can do is collect funds from the home that's being used as collateral, then they might be unable to retrieve all of the cash they provided to the borrower. One way to reduce market risks is by diversifying assets to cover a broad spectrum. A lending company should consider assets other than a borrower's home or vehicle when they are looking for collateral.

Maintaining Liquidity Risk

The final piece of advice from big banks to smaller lending companies is to properly manage liquidity risks. This type of risk is one that lenders need to consider for the company's funds overall. It's never a good idea to spread funding too thin; before issuing out new loans, the previous ones need to be successfully collected. Relying on a borrower to repay loan funds is one thing that has sent several lending companies under. The amount of money projected to be coming in should be at a healthy balance with the amount of loans being issued – while it may be tempting to issue more loans in hopes of higher collections, the risk factor may be too great and should be carefully analyzed.

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