CHAPTER 4CREDIT RISK MANAGEMENT
BEFORE YOU GET INTO THE DIFFERENT TYPES OF RISKS IN PERSONAL FINANCE, YOU NEED TO UNDERSTAND WHAT RISK IS AND WHY IT OCCURS IN OUR LIVES.
A risk can be understood as an undesirable event that happens to a person. It causes consequences and damage that are unforeseen in terms of space, time, and severity. That which people intentionally cause to themselves, what they can predict in terms of space and time, is not a risk.
The world we live in is becoming more and more dangerous. There are more and more unprecedented risks every day. For example, the risk of a traffic accident: even though you drive carefully, in the correct lane and at the correct speed, you can still get into an accident due to the carelessness of other drivers. Or the COVID19- pandemic that has caused so much damage to mankind in terms of human life and the economy: no one could have imagined a pandemic that could defeat the advanced medical system of humans in a such a comprehensive and profound manner.
In terms of risk classification, risk can be divided into many different types based on classification criteria. For example, by origin, there are natural disaster risks, political risks, and economic risks. Societal risk includes risk in industry, banking, and education.
In terms of risk assessment, there are two commonly used criteria:
FREQUENCY OF RISK OCCURRENCE
This is the number of times a risk is likely to occur in a given time period, or the average time interval between occurrences of a risk. For example, the number of traffic accidents with loss of life in Ho Chi Minh City in a month, or the time period of a severe flood causing great loss in the Central region, compared with the annual average loss.
SEVERITY OF THE RISK
The extent or value of the damage caused by the risk. It can be spiritual, material loss, or more serious, human health and life. Subjects affected by different risks suffer from different damage.
So, what needs to be done to identify, analyze, and handle risks? That is the duty of risk management. The aim of risk management is to help eliminate or outline strategy against risks that may hinder the achievement of goals.
KEY STEPS IN RISK MANAGEMENT INCLUDE
STEP 1
DETERMINE THE SCOPE OF THE RISK
Predict all possible scenarios within a specific scope. For example, to calculate contingent financing for parenting, the risks associated with the cause of short- term and long-term loss of income need to be listed, including parental health and income risks. When taking out a loan, the scope of risk is different, in addition to the risk of income loss. It also includes a sudden increase in interest rates due to the macroeconomic environment or late payment, resulting in additional an penalty.
STEP 2
IDENTIFY THE RISK
Make a list of possible risks based on prior knowledge and experience, then list them by frequency and impact level.
STEP 3
ANALYZE AND ASSESS THE RISK
Once specific types of risks are identified, each cause needs to be reviewed and analyzed by risk category, probability of occurrence, and associated damages to better understand how it can affect plans and goals.
STEP 4
MAKE A PLAN FOR RISK PREVENTION AND CONTROL
The impact of different risks and scenarios is estimated in case they occur, including how to reduce frequency and severity of risks, prevent recurrence, and make response plans.
STEP 5
IMPLEMENT AND MONITOR THE RISK MANAGEMENT PLAN
Perform the set plan and monitor the implementation progress to ensure compliance with the plan as well as make timely adjustments when risks occur. For example, if someone decides to buy life insurance to protect their family from major life events, they must look for information, then choose and proceed to sign an insurance policy within the planned time in order to prepare for the events before it is too late.
STEP 6
PERIODICALLY REVIEW THE RISK MANAGEMENT PLAN
Risk management is an ongoing and constant process, even when risks have been identified and minimized. Once the risks have been considered, the response plan should be reviewed, adjusted, and updated on an annual basis.
A good and timely risk management plan brings many practical benefits. First, risk management allows the possible risks to avoid unnecessary damage to be understood and provides more time for a response plan to be made before the risk occurs. Plus, a good risk management plan also helps increase profits and minimize losses in investment and asset accumulation. Risk management offers a comprehensive view from which to identify and eliminate unnecessary costs. Finally, risk management gives peace of mind, so life can be enjoyed and one can be ready to respond to life’s events.