Risk is an inherent part of survival, even for businesses. Every company encounters some level of risk on a daily basis, especially those that offer lending services to their clients. The methods in which a lending company assesses and navigates various types of risk can have a direct impact on its overall success or failure.
Since risk is such an integral part of lending, lenders must develop strategic, effective tactics for risk mitigation to help increase their chances of successful loan origination and management.
The Five Main Types of Risk
In general, there are five defined types of risk that business leaders or managers can encounter:
Every business has certain standards, rules, and regulations to abide by to protect itself, its employees, and the people it serves. A business risks losing customers, damaging its reputation, or receiving penalties if it does not comply with these protections established either by its leaders or by industry, state or federal officials.
Legal risk falls under the umbrella of compliance risk and arises when the business breaks any governmental laws in place. Falling out of compliance legally with state or federal agencies can expose the business to expensive fines, lawsuits, and even a total shutdown.
If a business does not maintain a well-regulated or well-monitored operation on a daily basis, it can risk experiencing negative consequences, such as overspending, under-performing, and other factors that lead to profit loss or bankruptcy.
There are one thousand and one ways a business can harm its reputation with customers and other members of the public. Bad business dealings, dishonest policies, poor service, and so much more can cause a business to risk losing trust among customers, potential customers, and shareholders. By risking its reputation, a business could also experience significant profit loss or bankruptcy.
Similar to operational risk, a company that runs on a bad business strategy or no strategy at all risks profit loss, negative PR, compliance issues, and more.
Risk Mitigation Strategies
Just as there are various types of risk your lending company can experience, there are several methods you can enact to mitigate the likelihood of experiencing risk. Four of the most overarching risk mitigation strategies include:
While acceptance is first in the list of mitigation strategies, it should not be the first strategy you consider in assessing and navigating through risk. Acceptance should be the strategy you land on when you have assessed all the likely outcomes and decide that the positives outweigh the negatives. Whether the likelihood of experiencing risk is small or the effects of the risk would lead to minimal damages, sometimes moving forward is worth it for the resulting rewards.
You cannot experience the negative results of risk if you avoid it altogether, right? Risk avoidance prevents you from compromising your operations, profits, legal standings, or other important elements of your business. Risk avoidance in lending can mean denying a borrower with a low credit score, high debt-to-income ratio, or too low of income. In such instances, the lender will avoid the high probability of the borrower defaulting on the loan by not approving the loan in the first place.
Reduction is the process of lowering the likelihood of experiencing risk or minimizing the resulting damages of the risk. In lending, this could mean requiring collateral, increasing your company’s communication with borrowers, offering borrowers multiple ways to pay each billing cycle, and more.
Transference is a mitigation strategy where a business can transfer the risk to a willing second or third party. The most common transference arrangement type is insurance, where a policyholder agrees to pay the insurance company to step in and take care of the financial damages should the company encounter the negative effects covered by the policy.
How Quality Loan Origination Software Benefits Risk Mitigation
Lenders must have strong, robust software that can help them successfully strategize against any level of risk. Whether the best course of action requires a lender to reduce, avoid, or safely accept risk, their LOS software should have mitigation capabilities built into the loan origination and loan management process to properly guide the lender as they navigate through the risk.
Quality LOS Helps Evaluate the Borrower
With the right loan origination software, the lender can easily evaluate crucial factors like the borrower’s:
- Borrowing history
- Cash flow
- Credit score
- Debt-to-income ratio
If the evaluation shows that the applicant would be a high-risk borrower, the lender can (and likely will) deny the application as a form of risk avoidance.
Quality LOS Helps Reduce Defaulting Borrowers
There are many reasons a borrower may become delinquent or ultimately default on their loan, and even low-risk borrowers can reach a stage of delinquency or default. However, lenders can help reduce the likelihood of a loan going sideways by using an LOS that provides:
- Customer Relationship Management capabilities
- Electronic payment acceptance in real time
- Recency and contractual delinquency tracking
- Routine correspondence capabilities
- Routine payment reminders via text or email
absVision is advanced lending software that offers exceptional risk mitigation capabilities throughout the loan origination and loan management process. Learn about all the benefits of absVision by speaking with an ABS expert today: 800-727-7534
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