Credit risk, market risk, operational risk, and financial risk

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Credit risk is the potential loss that the organization will suffer due to a borrower's failure to repay the loan in accordance with contractual obligations. The factors that affect credit risk are often related to the factors that affect market risk, since market conditions can influence the likelihood of a default. Credit risk is particularly important to lenders such as banks.

A bank such as Wells Fargo manages credit risk by having a culture that accepts risk ownership and accountability. A strong competency in identifying problems early is important in risk management, as is the ability to address issues and respond promptly to changes in the market. Risks are undertaken only when the bank understands them, and can tolerate them. In general, risk is avoided or minimized if the bank does not have a competitive advantage by assuming the risk.

One way that Wells Fargo—and banks in general—manage risk is by using the 5 Cs. The 5 Cs are:
Credit history—Wells Fargo considers a customer's payment record and FICO score when determining if a loan should be made.
Capacity—The customer's level of income, employment stability and origination of income are also ways to determine if debt is likely to be repaid. The customer's debt-to-income ratio may be scrutinized for excessively high reliance on debt.
Collateral—A home equity loan uses the customer's home as collateral.
Capital—A customer's savings, investments and other assets, which might be used to repay a loan, are considered.
Conditions—The purpose of the loan will be considered.

Wells Fargo may also adjust prices to account for increased risk. Different consumers have different levels of credit risk associated with them. For example, Wells Fargo may have different interest rates for mortgages depending on the amount the homeowner is borrowing. Similarly, the interest rates charged to borrowers with high FICO scores could be different from the interests rates charged to borrowers with low FICO scores. By computing the expected value of an investment, Wells Fargo can price the risk for a sufficient return.

The company's methods work well with its strategy. In 1996, Wells Fargo was ranked as the ninth largest U.S. bank. According to Forbes, Wells Fargo is now the ...