Banks reduce credit risk by screening loan candidates, requiring collateral for a loan, performing a credit risk inspection, and by diversification of risks. Banks can considerably minimize their credit risk by loaning to their clients since they have more details about them as compared to other competitors, which lessens unfavourable selection. Checking and savings accounts can unveil how well the customer manage their wealth, basic income, monthly expenditures, and the measure of their reserves to hold them over financial difficulties. Banks will likewise verify incomes and employment history, and get credit reports and credit scores from credit reporting agencies.Collateral for a loan significantly reduces credit risk not just becauseborrower has a greater motivation to repay the loan, but also because the collateral can be sold to repay the obligation if there is an occurrence of adefault.
Diversification can also reduce credit risk by producing loans to organizations in diverse industries or to borrowers in various locations. However, the key to reducing loan losses and ensuring that capital reserves appropriately reflect the risk profile – is to execute an integrated, quantitative credit risk strategy. This strategy should get banks up and run quickly with simple portfolio measures.An effective credit risk strategy should: Include a sound credit risk policy that prevents operating losses. Be clearly comprehended by credit organization.
Have the implementation involving senior management as part of credit procedure and policies. Act as a key risk control with segregation of duties according to credit function responsibilities.