Every loan carries a risk.
However, one should not forget that it is mutual and applies to both the borrower and the lender. What’s more – the award of funding will depend on its assessment. We explain what credit risk is and how it is shaped.
Lending is one of the most important and most profitable areas of banks’ operations. For this reason, they particularly care about entrusting their funds to reliable clients who will conscientiously pay their debts. However, credit risk is still an important aspect that determines funding. According to the report of the Polish Financial Supervision Authority, summarizing 2018, impaired loans accounted for 6.8% of all liabilities, while risk costs were the lowest in a decade.
Positive estimates are influenced by both economic development and a significant increase in lending. Statistics show that owners of Small and Medium Enterprises (11.4%) and people who decided on consumer loans (10.8%) have the biggest problems with paying their debts. The situation looks much better in the case of housing loans (2.5%). In each case, the bank carefully observes the potential borrower and tries to avoid unnecessary risk, assessing its credibility.
What is credit risk?
Basically, the credit risk taken by banks can be divided into two types: the first of them – active credit risk is associated with a situation in which the borrower will not be able to meet the obligation to repay the debt, together with additional costs, within the deadline specified in the contract. It applies not only to loans, but also to other obligations in which the customer becomes the bank’s debtor, such as a letter of credit or collection.
On the other hand, passive credit risk refers to problems in obtaining the capital necessary to offer credit products. From the client’s point of view, however, active credit risk is much more important, especially since each of us has a significant impact on its formation.
Credit risk assessment
To reduce credit risk, banks introduced extensive assessment tools for potential borrowers. The foundation of this system is the assessment of creditworthiness and customer credibility. Without them, no institution will decide to entrust its money to the applicant. The result of analysts’ activities is determining the creditworthiness, i.e. the amount, which repayment should not cause difficulties with timely payment of receivables.
Of course, each institution uses a different rating system – some banks decide to take higher risks in exchange for increasing lending, others present a more conservative strategy. Each of us, however, has a real impact on shaping creditworthiness, and proper household budget management can help to obtain attractive financing conditions.
Credit scoring, i.e. customer credibility
For the bank, not only what our revenues are, but also other factors, including the history of repayment of existing liabilities. Each borrower must take into account the fact that the institution will check all entries in the systems of the Credit Information Bureau and the Economic Information Bureau. In addition, many different factors are assessed, including family circumstances, careers, use of other banking products, housing status and education.
Each point is assessed accordingly. If the final point value allows the so-called cut-off threshold – the loan will be granted. If it is located close to this limit, bank employees may demand that additional conditions be met to reduce credit risk – e.g. securing liabilities with additional assets or taking out additional insurance. In the case of scoring significantly lower than the ideal borrower’s profile, the application will be rejected.
Credit risk – mutual protection
Although credit risk appears to only apply to the lending financial institution, it actually has a tremendous impact on the customer’s situation. It depends on his assessment whether he receives a loan at all, it can also significantly affect the attractiveness of the presented offer. The principle is very simple: the lower the credit risk, the higher the consumer rating, and therefore the greater the chance that the payment will be carried out in line with the bank’s expectations.
However, the credit risk assessment process should not be demonized. What is the collateral of the lender also favors the borrower’s interests: if we have received a negative decision, it is worth thinking about sorting out home finances or re-analyzing the actual needs. Usually, diligent household budget management and elimination of unnecessary expenses can significantly reduce credit risk and allow you to obtain the expected financing.