Borrowers and lenders face each other, so there is always a certain credit risk when entering into a contract. Although this can be weighed and secured as far as possible beforehand, it can never be completely ruled out. Above all, the bank takes the credit risk, because it gives a corresponding sum of money. Only then, if the borrower complies with his payment obligations, the bank earns the lending. If he does not do so, the bank often loses a large part of the money. In the worst case, even everything.
What are the credit risks?
In general, both the bank and the customer take a certain risk when money is involved. The borrower usually bears the interest rate risk. Although interest can be fixed for a specific term, unforeseen changes are still possible, for example if the borrower takes longer than the planned repayment term. The bank is usually subject to the inflation risk, namely when the monetary value drops and the bank does not get back the actual value of the loan amount. Country risk, hedge risk or liquidity risk should also be mentioned here.
Minimize credit risk
Before the bank gives out a loan, it wants to secure as much as possible, even if it never works 100 percent. Even the highest paid job can be lost and even the fittest young man can die accidentally or become unable to repay. Many other risks, however, can be minimized prior to lending. So the bank looks at the personal and economic creditworthiness of the customer. Previous payment obligations, monthly income, expenses and of course the existing collateral. In fact, the bank wants something that can be seized. In a real estate purchase, this is for example the property itself, which is subject to a land charge.
Balance credit risk – personal reasons
Many banks and financial advisers often decide by feel when all other aspects have already been examined. Of course, the bank is under no obligation to spend the money just because the client has a high monthly income and could afford the loan. If the borrower is generally rather wasteful in his lifestyle, the bank can take this as an opportunity to reject the request. People who generate high revenues but have not accumulated any reserves at all therefore still have a certain risk.
Credit risk also for the borrower
Of course, it is also a risk for the borrower to take out a loan. After all, this takes the role of the debtor and possibly owes his bank a correspondingly high sum of money. If the borrower loses his job or loses needed income, it can lead to defaults. Moreover, the borrower runs the risk of losing his property.
In order to be able to assess the credit risk properly, the bank has several individual risk factors together and then decides. If, from the bank’s point of view, the risk is too high, the loan request will be rejected. Then the borrower can try to reduce the credit risk through collateral or guarantees. Of course, refusing the bank does not always mean arbitrariness. In most cases it is better for the customer to refrain from an excessive monthly burden.