Banks and credit unions want and need to bring in more loans, and they must be able to say ‘yes’ to as many leads as possible. But things don’t always work out between lenders and borrowers, and the loan ends up defaulting. While these cases can’t be prevented entirely, there are steps banks and credit unions can take to mitigate credit risk.
A borrower defaulting on loans usually happens for two major reasons, according to an article from Market Realist: inadequate income and business failure. A borrower’s sudden loss of their business or income is often out of their control, so a lender may find that while they can make their payments on time initially, an unexpected change of their financial situation can leave them unable to pay. Other times, a borrower will simply not comply with the terms of the loan, even if they have the means to pay it back. Of course, during the lending process, provisions are put in the contract, but there are other steps financial institutions can take to keep the risk of default to a minimum.
In an article from Investopedia, they note traditional five Cs of credit used to gauge creditworthiness of potential borrowers: character, capacity, capital, collateral and conditions. As a lender, first check if the applicant has a good credit history, what their debt-to-income ratio is, and of course, how much money they actually have. From there, consider the collateral, for example, the year, make and model of the vehicle for a car loan. Having a proper system in place that can help banks and credit unions evaluate borrowers’ creditworthiness is essential, and Open Lending can help. Back in May of 2020, the NCUA signed on to an interagency policy statement on allowances for credit losses, according to an article from NAFCU. Some of the goals the statement listed for an effective credit risk review system include:
1. Adjusting risk ratings for loans with clear credit weaknesses
2. Making sure loans credit weaknesses, both potential and actual, are identified
3. Reviewing for potential problem areas in the portfolio and trends that affect the portfolio’s quality
4. Providing management with an assessment of the portfolio
With every loan comes the potential for risk, but fully understanding the risks involved will allow your bank or credit union to make the most of its portfolio. We at Open Lending can help your financial institution mitigate credit risk with our data-driven analytics, so you can increase your auto loan volumes safely without adding substantial risk. Contact Open Lending today so we can help your bank or credit union say ‘yes’ to more loans.