Loan Risk
Loan risk is one of the key elements to consider when evaluating whether or not to grant a loan. Loan risk is the potential for repayment failure by the borrower. There are several different types of loan risks, such as credit risk, liquidity risk, and market risk.
Credit risk is the chance of a borrower defaulting on the loan. It is the most difficult to quantify and can usually only be measured using subjective methods like assessing the borrower’s credit history or evaluating the borrower’s ability to make payments. The borrower’s credit score, which is typically determined by credit bureaus such as Experian, Equifax and TransUnion, is a good indication of the borrower’s credit risk.
Liquidity risk is the potential for a loan to become illiquid. This can occur when the borrower has difficulty making payments and the lender is unable to recover the loan amount. It is closely associated with credit risk and is typically measured using various liquidity ratios, such as the current ratio and the debt-to-equity ratio.
Market risk is the chance of losses due to a change in market forces, such as changes in economic conditions or interest rates. Loan originators are generally responsible for assessing this risk before concluding a loan agreement.
Regardless of the loan risk factors, a lender should have a system of controls to identify and mitigate these risks. The first step is to ensure lenders assess the borrower’s ability to repay. This can be done by using a comprehensive credit risk assessment, which includes gathering information from borrowers, reviewing the borrower’s credit report, and verifying the borrower’s income and expenses. Lenders should also monitor their loan portfolios for signs of potential trouble, such as delinquent payments, over-leveraging, or excessive risk. Finally, lenders should assess the potential risks from a global perspective by evaluating macroeconomic factors and trends.
In conclusion, loan risk is an important factor to consider when evaluating loan applications. By understanding the different types of loan risks and incorporating a system of controls, lenders can better manage their risk and ensure the success of their loan portfolios.