Tuesday, November 20, 2012

The Evolution Of Mortgage Lending

While credit ratings are important for assessing the creditworthiness for both banks and individuals, they are often not enough to minimize the risk inherent in lending. Credit risk management has evolved to a point where it’s now possible for a sophisticated software program to assess the risk of taking on debt, investing in businesses, and carrying long-term debts for investment purposes. This type of analysis is especially useful for banks since banks rely on investment income from loan activity.

Lending software, and loan portfolio management after the loan has been issued, can analyze all of the interest rates in the market place, assess the risk of default in a loan portfolio, and help banks and other financial institutions make intelligent decisions about long-term portfolio allocation.
It’s not enough to shake hands with clients and trust that their business is viable. Loans are often sold, resold, and packaged with other investments to form complex investment products. These derivatives sometimes require constant monitoring so that financial institutions don’t expose themselves to undue risks. The unfortunate truth is that lax credit standards for borrowers and counterparties is still the biggest hurdle for many institutions. While the primary issue for banks is credit default, banks (and other financial institutions) also face risks associated with trading. So, even if a bank isn’t making loans directly to the marketplace, it still faces potential credit risk from investments in other banks’ loan activity.

One reason that software is becoming more important in managing credit risk is the sheer size of the market. The global credit market is incredibly complex. Financial institutions are forced to pay attention to many different economies, markets, and foreign as well as domestic regulations. While credit risk management software won’t solve every problem, it will help mitigate the risk of portfolio turnover (i.e. defaults) while providing key information and metrics necessary for financial institutions to better diversify their holdings.

There are essentially two steps that financial institutions need to take to shore up their portfolio:
1) Assess their current exposure to high risk loans and;
2) Hire a company that can provide comprehensive analysis and software package to better manage credit risks.

While it’s possible for a bank to build an in-house custom solution, it’s unnecessary. Entire firms already exist to assess and manage credit risks. An outside firm can provide the needed objectivity, stress-testing, and in-depth data analysis that a bank needs. Like a good friend who’s willing to tell someone “inconvenient truths,” an independent firm can keep a bank honest and improve long-term portfolio performance.

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