There are many risks associated with bank loans, for the bank and lenders. Detailed risk analysis requires understanding its meaning. Risk is the probability of certain results or the uncertainty about them, especially an existing negative threat attempting a monetary objective. The risk in bank loans can be: credit, non-payment on time or at all, interest rate, decrease in loan interest rates and the bank does not earn enough and the liquidity risk, that is Deposits are quickly withdrawn from the bank, leaving it short of immediate cash.
Risk and return
Much of the economy can be characterized by an exchange between risk and return. There are risks associated with all actions. “Risk” means the possibility that your investment, time, effort or money will be lost instead of being used productively. You run the risk of dropping your ice cream cone every time you have one in your hand, you’ll want to think about it that way. In general, the greater the potential for return, the more risk there could be; Economists call this an inverse relationship. For example, it is relatively easy to obtain fair compensation on a Treasury bill, although the rate will be less than 5% per year. Treasury bills are reliable, but not very profitable. But nevertheless, The stock market is a high-risk vehicle that can generate higher remuneration (around 11% per year is considered the nominal historical return of the stock market) or result in loss. Different investments are going to be good for different people, but with most investments, the two things that will be analyzed are the risks associated with the investment and its potential return.
Bank risk and loans
The point of taking risks in the first place is to get an opportunity for greater profitability and when banks make loans, they are undertaking various types of risk, hoping to have a return. Theoretically, at least, banks earn money when they combine small savings deposits of the people and they gather those funds in loans, which they lend to solvent borrowers, who pay again more interest than the bank pays to the depositors, generating a profit for the bank. When a bank makes a loan, however, there are several ways in which the profit model can turn against it.
When a banker makes a loan, he is taking the risk that the borrower pays the loan (credit risk), and also that the borrowed funds will not be necessary to pay the withdrawals or to take care of regular banking business, thus avoiding the runs banking (liquidity risk). In addition, the banker is assuming the “interest rate risk”, which is more subtle, but present. Interest risk represents the possibility that the bank has somehow valued its loans and interest rates incorrectly, either the bank’s fault or the ever-changing market’s fault. If it turns out that loan payments are not high enough to cover deposit costs (or if the bank’s profit on loans is less than deposit losses).
Depositors have their own series of risks. Most significant, is your concern about credit risk; If the bank goes bankrupt, the depositor wonders if he can recover the money he deposited. However, depositors do not really have a number of risks comparable to that of bankers, because the safeguards are in place. It is likely that most banks refuse to return deposits to their depositors and the FDIC insures bank deposits up to a fixed amount, so this risk is relatively low. Other risks that depositors may have (such as the risk that banks will not pay interest or high enough interest rates) are incidentally compared to the return of their deposits.
The risks are relative to each person, so it is not surprising that the borrower has his own set of risks that concern him. First of all, he has a loan for a reason and if he borrowed, logically, he borrowed so that the remuneration of the investment in which the loan will be used is higher than the cost of the loan, anticipating in the long term. This means that the borrower has a risk: that the return on investment is very low and the loan costs too high so that his effort will be a financial failure. This is a form of interest risk. The borrower faces other risks (credit risk associated with the investment, for example), but these other forms of risk are reflected on the investment, not on the loan. The biggest risk for a borrower.