Even if you're not in the banking industry, understanding the objectives of credit risk management helps you as a consumer. Lenders face credit risk management with every loan they consider. Banks must create a delicate balance between strict credit risk policies and customer satisfaction. Conservative credit risk management policies, fast loan decisions and reasonable loan pricing achieve this balance of protecting loan portfolios while keeping bank customers satisfied with the institution.
All lenders must reduce their risk of loan loss. Credit risk management is the most difficult potential loan loss to prevent. Borrowers with consistently poor credit reports or excellent credit scores allow lenders to make easier approval and rejection decisions. However, prospective borrowers with a mix of on-time payments and late payments create credit risk management challenges for lenders.
Lenders design lending pricing, policies and procedures for employees to achieve credit-risk objectives. Based on borrower credit scores, procedures advise bank employees how to process and price loan applications to reduce credit risks. Banks often instruct lending staff to approve or reject applicants based on their credit scores. For example, lender procedures may give loan officers permission to approve loans at higher than market interest rates for borrowers with credit problems that increase loan risk.
Credit Risk and Customer Satisfaction
Balancing credit risk and superior customer service often requires approving applications while changing loan terms, such as increasing down payments or interest rates, to manage risk and increase loan security. Since banks do not want to appear to be restrictive, increasing interest rates or down payments can achieve credit risk management objectives, while maintaining customer satisfaction. Balancing credit risk objectives and customer loan approvals, adjusted for increased risk, can achieve reasonable risk and customer satisfaction.
Lenders have a fiduciary responsibility to stockholders (banks) and members (credit unions) to make the safest operational, financial and risk decisions at all times. Conservative credit risk management is critical to exercising appropriate fiduciary responsibility. Adhering to conservative credit risk policies better protects loan portfolios and satisfies stockholders, management and customers, while proving to federal or state regulators that the lender is exercising effective fiduciary responsibility.
Credit Risk Equals Financial Risk
Just as banks must avoid financial risk with their investments and cash security measures, they must establish credit risk policies that minimize loan losses. Credit risk can impact both the lending and the financial areas of banks and credit unions. Loan losses occur at every bank; however, mismanaged credit risk can lead to excessive loan problems, inevitably damaging the financial condition of financial institutions. Properly managing credit risk, along with improving the earnings of the loan portfolio, can prevent excessive financial damage.