Credit Risk Analysis in Lending

Consumer debt is at an all-time high. According to the Federal Reserve Bank of New York, Americans’ credit card debt totaled more than $900 billion in 2022’s fourth quarter. The staggering amount represents the highest total since tracking began in 1999.

Lenders need a reliable way to determine credit risk amid high debt. Cash flow analysis is one way to do this, as it can provide an accurate picture of a borrower’s finances. Credit risk analysis builds upon this data to help lenders make informed decisions.

Both cash flow and credit risk analysis are integral to lending, but the processes are tedious and time-consuming without automation.

What is Credit Risk Analysis?

Credit risk analysis assesses a borrower’s ability to repay a loan. The analysis helps lenders decide who to advance credit to and what terms and conditions should be offered. Effective credit risk analysis modeling includes several factors, including income and employment verification and financial statements review.

How do you perform a credit risk analysis?

To conduct a credit risk analysis, it’s necessary first to assess cash flow. How much money moves through the borrower’s accounts each month? This step involves verifying income and modeling current and future solvency.

However, cash flow is just one of the factors that lenders need to evaluate. Credit scores, past credit history, and other personal information also must be considered. Completing an in-depth data analysis takes significant time and resources – something many lenders lack.

Not all borrowers have traditional sources of income or sufficient credit histories. This can be challenging to some lenders who underwrite non-traditional sources of income using traditional data points. With cash flow analysis, lenders can underwrite loans to non-traditionally employed borrowers by examining their income sources, including bank statements and tax returns, to determine their ability to repay the loan. By analyzing the borrower’s cash inflows and outflows, lenders can also assess the borrower’s expenses and debts to ensure they have enough cash flow to repay the loan.

That’s where automation can exert a transformative influence. AI tools can determine lender risk in minutes rather than hours. The efficiency allows for increased loan approvals and happier clients.

What are the 5 C’s of Credit Risk Analysis?

Assessing creditworthiness becomes easier when lenders use the five C’s of credit risk analysis as a guide. The five C’s refer to character, capacity, collateral, capital, and conditions.

Character

Character is the factor that evaluates a potential borrower’s trustworthiness in terms of their past financial behavior. It includes credit score history, repayment patterns on existing loans, bankruptcy filings, etc.

Capacity

Capacity assesses whether or not a potential borrower has enough income to afford loan payments and other financial obligations. Capacity asks lenders to examine borrowers’ income, debt-to-income ratio, and job stability.

Collateral

Collateral is an asset pledged to secure the loan. It can include real estate or personal property such as cars, jewelry, artwork, and other valuable items.

Capital

A borrower’s total available capital includes all of their assets, both financial and non-financial.

Conditions

Conditions are externalities that could affect a borrower’s ability to repay the loan, such as economic factors, industry competition, or changes in the local market.

The five C’s provide lenders with a comprehensive view of each borrower.

How does Credit Risk Analysis Impact Lending Decisions?

Analyzing credit risk helps lenders make intelligent decisions with confidence.

High-risk customers are quickly identified, allowing you to reject their applications or formulate terms that minimize the risk. The same analysis also limits bad debts. Lenders can focus on clients who are likely to pay on time.

Credit risk analysis software makes lending more pleasant for everyone involved. Borrowers can trust lenders to make fast, accurate decisions. The speed lets lenders churn through applicants and extend better service with fewer resources. Automation makes the process even faster and more reliable.

Credit Risk Analysis with Ocrolus

Ocrolus is a cloud-based solution that automates risk analysis. The highly reliable and accurate software eliminates hours of human labor and crystallizes lender decisions. With Ocrolus,  lenders can better predict and reduce credit risk significantly.

The AI-driven cash flow analysis engine uses bank statements, and additional relevant data points to build a holistic picture of borrowers’ financial health. The process allows lenders to understand seasonality in cash flow and credit risk, giving them better control of their finances and tightening their financial forecasts.

Credit risk analysis with Ocrolus’ technology also enhances risk-management capabilities by incorporating detailed financial dynamics into risk modeling.

Lenders need a dependable platform. Ocrolus takes the complications from credit risk analysis, giving lenders time to assess debt capacity, measure non-traditional income, and identify trends in cash flow. With automated analysis, lenders can make fast decisions and increase the size of their loan portfolios without increasing staff.

Book your demo with an Ocrolus cash flow analysis expert to learn more about how Ocrolus can improve your lending processes by reducing credit risk.