Lending Report

Lending Report

1. Introduction

As there has been an economic downturn, the economy faces a lower rate of growth and may move into a recession. As a result of the downturn, there is a decrease in the demand for borrowings, which usually reduce the interest rates. Therefore, the bank is facing great risks associated with lending.

2. Bank risks

Overall, there are three types of risks taken by the bank, that is, the liquidity risk, interest rate risk and credit risk.

2.1 The liquidity risk

The liquidity risk could arise where a large amount of deposits will be withdrawn within a short period, and as a result, the bank may be unable to pay on demand, especially in an economic downturn. As the interest rate is lower, customers are more likely to withdraw funds from their accounts.

2.2 The interest rate risk

The bank pays interest on deposits and borrowings (liabilities) and receives interest from loans and securities (assets). The bank would take the interest rate risk when the interest rate paid on its liabilities is higher than the rate earned on its assets, that is, the net interest income is negative. When the economy becomes weaker, the uncertainty of interest rate is increasing. Therefore, the bank should manage the interest rate more carefully.

2.3 The credit risk

The credit risk occurs when a borrower cannot repay the loan on time or at all.

In an economic downturn, individuals or firms are willing to borrow from the bank because of a lower interest rate. However, as the deteriorating economic conditions, it will be harder for a borrower to repay those funds. The risk of bad loans would be increased.

3. Lender-borrower agency relationships

As is mentioned above, as a result of the economic downturn, there is a credit risk that the borrower would not repay the money. In this instance, the lender/bank is the principal and the borrower is agent. When the borrower is a company, managers would be the