What if we talk about risks

A risk can be defined as the probability of an undesirable event occurring and having a negative impact on a given situation. In the context of financing, this means the possibility that something unfortunate happens and prevents you from repaying your loan, or that it costs you more than expected.

Risks associated with financing for individuals
When you borrow money as an individual, several risks may arise:

1. Insolvency risk (or default risk)
This is the most significant risk. It means you can no longer repay your loan installments. This can happen for various reasons:

– Job loss: If your income drastically decreases, it becomes difficult to meet your repayments.
– Illness or accident: An inability to work or unexpected medical expenses can unbalance your budget.
– Change in family situation: A divorce or separation may result in a decrease in household income.
– Over-indebtedness: If you have accumulated too many different loans, the total of all monthly payments can become unsustainable.

The consequences can be severe: banking bans (prohibition from obtaining new credits), asset seizure (house, car), legal proceedings.

2. Interest rate risk
This risk mainly concerns variable-rate loans.

– Interest rate increase: If interest rates rise, the amount of your monthly payments may increase, making repayment more difficult. For example, if you have a variable-rate mortgage, an increase in the European Central Bank’s key rates could increase the cost of your credit.

With a fixed-rate loan, this risk is eliminated because your monthly payments remain the same throughout the loan term.

3. Liquidity risk
Less common for individuals, but it can occur.

– Urgent need for money: If you have an unforeseen expense and all your savings are tied up in illiquid investments (e.g., real estate investment difficult to sell quickly), you may be forced to borrow again urgently, potentially under less advantageous conditions.

4. Market risk (speculative)
This risk is more related to investments funded by a loan, rather than the loan itself.

– Decrease in investment value: If you borrow to invest in stocks or real estate, and the value of that investment decreases, you could end up with a debt larger than the value of what you purchased.

5. Moral hazard and moral risk
This is not a direct financial risk, but it can have consequences.

– Reckless behavior: If you feel « protected » by insurance or a guarantee, you might be tempted to take more risks than you would normally, which can lead to difficulties. For example, if you know your insurance will cover your repayments in case of job loss, you might be less motivated to actively seek new employment.

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Risks associated with financing for businesses
Businesses, whether small or large, face similar and other more specific risks when seeking financing.

1. Insolvency risk (or default risk)
As with individuals, this is the main risk. The business can no longer meet its debts. The causes can be multiple:

– Revenue drop: A decrease in sales can reduce the business’s ability to generate profits and repay its debts.
– Cost increase: An increase in raw material prices, salaries, or energy can strain profitability.
– Poor management: Ineffective management of inventory, client receivables, or expenses can lead to cash flow problems.
– Increased competition: The arrival of new competitors or disruptive innovation can affect the business’s market position.
– Economic crisis: A recession can reduce overall demand and impact the company’s activity.

The consequences are severe: bankruptcy filing, judicial liquidation, job loss, deteriorated brand image for the leaders and the business.

2. Interest rate risk
Interest rate increase: Similar to individuals, a rise in interest rates on a variable-rate loan can increase the company’s financial charges, reducing its profitability.

3. Liquidity risk
This risk is crucial for businesses.

– Cash flow shortage: The business may be profitable on paper but not have enough cash available to pay suppliers, employees, or short-term debts. This can be due to excessively long client payment terms, accumulating inventory, or excessive investment that ties up funds.

– Difficulty obtaining new financing: In difficult times, banks may be more reluctant to lend, worsening liquidity problems.

4. Market risk (or economic risk)
This risk is related to the environment in which the company operates.

– Change in demand: Consumer tastes evolve, and technologies change, making the company’s products or services obsolete.
– Fluctuations in raw material prices: For a manufacturing company, a sharp increase in input prices can erode its margins.
– Currency volatility: For companies that import or export, exchange rate variations can impact their costs or revenues.

5. Operational risk
This is the risk that errors or unforeseen internal events affect the company’s ability to generate revenue or manage its costs.

– Technical failures: A major IT outage, a production problem.
– Human errors: A management mistake, internal fraud.
– Natural disasters: Fire, flood damaging premises or equipment.
– Supply chain issues: Disruption of supply from a key supplier.

6. Reputational risk
– Bad publicity: A scandal, a recall of defective products, or questionable practices can severely damage the company’s image and drive away customers and investors.

7. Regulatory and legal risk
– Change in legislation: New laws or regulations can impose additional costs on the business (stricter environmental standards, new taxes).
– Litigation: A lawsuit from a client, employee, or competitor can lead to significant costs and harm the reputation.

Understanding these risks is the first step to managing them effectively. Whether you are an individual or a business, good financial planning, and precautionary measures (such as a precautionary savings or suitable insurance) are essential to minimize the negative impact of these risks.