Understanding risk will help in managing it

Financial risk is now a household topic. Once discussed mainly in corporate circles, this topic has recently dominated the agenda of political leaders, commercial entities, schools and colleges, and dinner tables across the world. For banks, credit risk is by far, the main cause of concern and uncertainty in present times, one of the root causes being the lack of information and transparency of existing and prospective borrowers. Banks are today adopting a more cautious approach to lending, with many having curtailed lending activities altogether. In the long run, this could lose them significant revenue generating opportunities. Now more than ever, banks need to have a clear understanding of the risks they are willing to take – only those risks that can be identified and measured can be managed and controlled. A bank's risk management should involve proactive measures to counter future uncertainties and allow banks to improve profitability. The current financial turmoil that has shaken the financial industry has caused banks to realise that they need to revisit and revise their policies, procedures, business models and risk management strategies, while still continuing to perform their core business activity of lending. Banks are striving to improve their profitability and reduce their losses, while adapting their risk management framework to the current situation. A recent survey of senior risk managers conducted by Interactive Consultants and initiated by Emcredit showed that the solution to many of the lending risk challenges lies in the preliminary stages of credit granting: risk profiling. The consensus was that accurately assessing and measuring a customer's financial background and creditworthiness is a leading method to minimise risk and improve profitability. Credit bureaus are central to such activities. Credit bureaus play a vital role in that they enable banks to accurately assess the risk of repayment associated with potential borrowers. They help improve the quality of lending by supporting banks to make more informed lending decisions in line with their risk appetite. In the recent survey, respondents highlighted that in order for financial institutions to develop an effective risk appetite, they require access to accurate and comprehensive credit information. The survey showed that 54 per cent of the respondents believed that financial institutions should adopt more innovative strategies to attract and retain customers. Industry experts say that one such measure at the disposal of banks is risk premium pricing. This means that information on customers' credit worthiness can help lenders tailor credit terms, and products based on the customer's credit standing. Instead of a blanket approach to offering the same rate of interest and product features for all borrowers, banks can price rates in accordance with the customer's risk profile. In the survey, a significant number of respondents agreed that for financial institutions to rid themselves of excess exposure to toxic assets is to adopt better quality lending, underlining the importance for more accurate measures to risk profiling. Additionally, 39 per cent recognised the significance of credit information in helping banks monitor their existing loan portfolio to facilitate early intervention or better management and recovery of overdue loan payments. Further, according to our survey, 95 per cent of the respondents stated that having access to credit information would allow their organisations to service new market segments such as unskilled labour, self-employed individuals and others who are often ignored due to the lack of sufficient and reliable information on them. When it comes to cost management, 61 per cent of respondents said processing a typical consumer loan application takes a minimum of 48 hours. With effective credit information, banks can enhance their competitive advantage through quicker lending decisions. Another interesting point highlighted by respondents was the importance of cultural aspects, such as the customer's reputation in the risk evaluation process. Reputation is a key component or risk management because it is a reflection of how individuals have typically behaved in the past, which is often a strong indicator of future behaviour. The positive and negative information contained in a credit report creates "reputational collateral". According to the survey, respondents felt that reputation is the second most important cultural aspect when assessing risk. Worldwide, there is a greater emphasis on the creation of knowledge economies. When empowered with actionable insights, banks, commercial entities and governments can take more sure-footed steps in achieving their goals. - The writer is the Chief Business Officer at Emcredit. The views expressed here are his own Keep up with the latest business news from the region with the daily Emirates Business 24|7 newsletter. To subscribe to the newsletter, please clic