Credit Risk in E-Banking

Credit risk is the risk to earning and eventually capital, arising from a borrower’s failure to meet the terms of a credit contract with the bank or otherwise to perform as agreed. It is found in all activities where success depends on counterparty, issuer, or borrower performance. It arises any time bank findings are extended, committed, invested, or otherwise exposed through actual or implied contractual agreements, whether on or off the bank’s balance sheet.

Internet banking provides the opportunity for banks to expand their geographic range. Customers can reach a given institution from literally anywhere in the world. In dealing with customers over the Internet, absent of any personal contact, it is challenging for institutions to verify the bona fide of their customers, which is an important element in making sound credit decisions. Verifying collateral and perfecting security agreements can also be challenging with out-of-area borrowers.

Unless properly managed, Internet banking could lead to a concentration in out-of-area credits. Moreover, the question of which state’s or country’s laws control an Internet relationship is still very much at an infancy stage of development

Generally, a financial institution’s credit risk is not increased by the mere fact that a loan is originated through an e-banking channel. When originating and approving loans electronically, additional precautions should be considered. These precautions include the assurence of  management information systems effectiveness to track the performance of portfolios originated through e-banking channels. In finance, a portfolio is a collection of investments held by an institution or a private individual. Holding a portfolio is part of an investment and risk-limiting strategy called diversification. By owning several assets, certain types of risk (in particular specific risk) can be reduced. The assets in the portfolio could include stocks, bonds, options, warrants, gold certificates, real estate, futures contracts, production facilities, or any other item that is expected to retain its value

The following aspects of on-line loan origination and approval tend to make risk management of the lending process more challenging. If not properly managed, these
aspects can significantly increase credit risk.

  • Verifying the customer’s identity for on-line credit applications and executing an enforceable contract
  • Monitoring and controlling the growth, pricing, underwriting standards, and ongoing credit quality of loans originated through e-banking channels
  • Monitoring and oversight of third-parties doing business as agents or on behalf of the financial institution (for example, an Internet loan origination site or electronic payments processor).
  • Collecting loans from individuals over a potentially wider geographic area.
  • Monitoring any increased volume of, and possible concentration in, out-of-area lending.