Evaluate the risk exposure to commercial bank whilst they endeavour to maximize their revenues within profitable lending.
It is the most common risk experienced by banks in lending. It occurs when customers are unable to meet their obligations, fall due and causes the bank to suffer a loss. Different bank transactions that cause the credit risk may result from the lending made to the governments, individuals, and companies. Second, it may result from lending money in exchange for security bonds. Commercial banks also exchange lending with shares, swaps, trade finance transactions, and other items. The probability of risk increased due to the different items that may cause the credit risk. The risk increase in the event, the bank fails to evaluate the customer credit worthiness. It is more probable to lose a huge sum of money when commercial banks offer huge loans to customers without proper credit rating.
The risk results from market rate fluctuations. Normally, the banks allow customers to deposit money in the bank at a certain rate. Subsequently, banks give out the money in the form of loans at a rate higher than the one paid to depositors. Commercial banks risk a loss when the government control lowers the lending interest rates. If the lending interest’s rates decrease below the interest rate provided to depositor’s commercial banks may experience difficulties paying back the money to the depositors. The probability and the severity of loss increase when the government exercises serious controls in the monetary market. The interest rate risk affects the currents earnings of a firm and the present value of the future cash flows due to changes in the interest factor value.
The depositors in a bank may withdraw their deposits from the bank any time as long as they do not violate the terms agreed. At the same time, the bank may offer huge sums of loan against few deposits made by customers. In case the customers decide withdraw their deposits, the funds will be unavailable.