Risk managers play a crucial role in every financial institution, whether a small community bank or a large fintech. Their strategies, processes, and intelligence help mitigate potential losses or ensure financial stability across the loan portfolio. Risk managers at large fintechs are equipped with advanced risk assessment software to predict potential losses early.
But in small community banks led by traditional loan decisioning systems, risk mitigation processes rely on manual, labor-intensive efforts. This not only causes errors and miscalculations but also delays anomaly detection, reducing the buffer time to take adequate actions.
Risk managers at small community banks should be more vigilant today, as their limited resources, capital, and scale increase their vulnerability to external conditions more than those of large fintechs. A major influential external factor is the interest rate and even a minor increase in it can significantly reduce a small bank's net margins.
Initially, there was optimism that interest rates would begin to decline in 2023, 2024, or early in 2025. However, this has not come to fruition. The US Bank reports that the Federal Reserve is expected to maintain a steady interest rate range of 4.25-4.5% for 2025. Under tariff uncertainty, investors expect two rate cuts of 0.25% each by the end of 2025. This means that financial institutions will need to explore innovative methods for achieving higher profitability and mitigating risk, as interest rates are expected to remain higher for longer.
Understanding Higher for Longer in Lending
What is Higher for Longer and its Economic Impact?
The phrase "higher for longer" refers to the scenario where elevated interest rates persist beyond the initial expectations. As of June 2025, the Federal Reserve has maintained a 4.33% interest rate for federal funds. Whether there is a rate cut or not, or even two to five rate cuts, we don’t expect to return to an era of extremely low interest rates in the foreseeable future. Risk managers must prepare for the potential reality that higher interest rates could be here to stay.
The impact of high interest rates or prolonged high interest rates on the economy is substantial. When the interest rate is high, consumer spending and business investment will be reduced as borrowing money becomes expensive. This may reduce the pace of economic activity as customers and companies become more conservative in their spending.
High interest rates make low-ticket small business lending (less than $100,000) a low-priority and high-risk transaction. Small community banks often struggle to make accurate risk predictions or effectively implement risk mitigation tactics using traditional lending methods. Since small businesses exhibit local economic vulnerabilities, higher interest rates will make debt repayment more costly, resulting in tighter budgets and reduced financial flexibility.
Effect on Banks and Small-Sized Businesses
Issues faced by small community banks
To small community banks, the increase in the interest rate implies an expansion in the costs of funds. If expenditures exceed the borrowers' capacity, this might strain the banks' profit margins. The resultant effect of this situation is an interest margin squeeze, in which the net interest margin decreases as the interest charged on loans and interest paid on deposits diverge.
In this aspect, small community banks are at a critical juncture in balancing profitability and competition in their lending products. Conventional risk assessment and workflow segmentation might be unsatisfactory to the contemporary requirements of the lending business to maintain profitability.
Issues faced by small businesses
Conversely, the cost of borrowing is higher for small businesses, resulting in cash strains and preventing them from investing in growth opportunities. In most small businesses, the cost of credit may become so high that expansion plans are halted, and hiring slows down in different functions.
In some worst-case scenarios, an increase in the cost of credit can make daily activities extremely difficult to manage. This has also increased the interest costs of small businesses that use variable-rate loans, making financial planning more difficult.
The Solution Lies in the Capabilities of a Risk Assessment Software
Financial institutions can uncover critical areas of improvement by understanding the role of risk assessment software in lending. Artificial intelligence has become essential for gaining real-time visibility into borrower profiles through the use of alternative data. Enterprise risk management software unlocks the following advantages almost instantly after implementation:
1. Recognizing Patterns and Operational Risks
Using machine learning, AI-based risk assessment software can detect cash flow and past repayment patterns. It can precisely forecast the local economic vulnerabilities of a small business without conducting on-site demographic analysis. These metrics enable underwriting teams to objectively verify a borrower’s eligibility.
2. Adaptive Real-Time Risk Data
AI-based risk assessment software continuously monitors and manages loan portfolios to prevent oversight misses. Through continuous monitoring, it adapts the reports, keeping the risk analysis responsive to changing external conditions, such as declining sales or local market disruptions.
3. Automating Underwriting and Pre-Screening
Financial institutions can set clear eligibility criteria configured to their unique credit policies using risk management software. This capability filters out the ineligible loan applications even before they reach an underwriter. Risk managers can customize the underwriting dashboard and create custom borrower segregation modules. It helps automate pre-screening and minimizes redundant workload on underwriters.
4. Fraud Detection at Scale
Risk assessment software solutions can easily scale to the size of your organization, investment capital, geographical market, and loan portfolio. Being run on the cloud, these software solutions strengthen cybersecurity measures while enabling fast processing times. Maximum data integrity is ensured to prevent fraud and comply with US data security laws.
AI-based risk management software goes beyond supporting the risk assessment process to offer:
- Automated data collection, management, and interpretation.
- Personalized 24/7 communication with each borrower.
- Instant escalation to human experts for timely incident management
- Automated compliance management, logging, and monitoring as per the latest regulatory requirements
- Guided loan application filling, real-time notifications, and instant query resolution.
5-Step Strategy for Risk Managers: Navigating Higher for Longer with Risk Assessment Software
The past two generations of bankers and risk managers have operated in a predominantly low-interest-rate environment in the lending industry. The shift to a sustained period of higher interest rates necessitates a strategic reassessment of risk management processes. Risk managers must examine and optimize minute aspects of risk management quickly to identify revenue-boosting and profit-diminishing trends.
1. Accepting Margin Compression
Given that passing the entire increase in interest costs to borrowers is not always feasible, lenders must accept some degree of net interest margin compression. This means absorbing a portion of the increased lending costs, which requires reevaluating pricing strategies and cost structures. Loan officers must explore alternative ways to boost profitability in the face of high interest rates.
Automated credit analytics capabilities of risk management software help uncover and act upon such situations early. Financial institutions can reduce loan conversions into non-paying assets by detecting potential defaulters early and providing flexible repayment methods, extending repayment timelines, or modifying pricing structures. On the other hand, risk assessment software helps underwriting teams offer competitive pricing to healthier risk profiles while assisting them to mitigate risks when lending to new businesses.
2. Optimizing Operational Efficiency
To mitigate the increased cost of lending, banks will need to explore ways to reduce their operating costs, particularly in risk scoring, loan origination, and underwriting. Risk managers can streamline these processes by embracing AI-automated risk assessment software. This will help remove data silos, increase efficiency, and minimize the impact manual workloads have on your financial institution.
Automated underwriting, real-time data analytics, and AI-driven decision-making metrics can significantly reduce processing time and support informed decisions. They also reduce the costs of operations, regulatory compliance, logging, and operational agility, as well as errors caused by manual data entry.
3. Profitably Using AI-Powered Credit Analytics
The more advanced the data analytics, the more insight you can have into the borrower and credit risk, which can enable better decisions when making loans. Risk data analysis through AI algorithms can easily forecast trends and patterns. Banks are in a position to utilize improved predictive defaults and manage risks across their loan portfolios. Such an active risk management process can help mitigate potential losses and enhance the overall stability of the lending portfolio.
The AI-driven loan decisioning system enables the underwriting team to create customized risk assessment templates tailored to the financial institution's specific credit policies.
4. Strengthening Customer Relationships
Strong customer relationships are significant in a world of high interest rates. Small community banks and credit unions should focus on value-added services and personalized financial advice through user-friendly risk management solutions. They must leverage GenAI’s conversational abilities to assist small businesses in overcoming the challenge of increased borrowing costs. It includes the provision of flexible loan terms and cost management suggestions and tools to facilitate financial planning and forecasting.
With a single risk and loan decisioning system, your customer relationship management teams can conduct informational webinars, provide self-service dashboards, and send urgent notifications in real-time. The contemporary borrower is more than eager to get the loan. They require a smooth, hassle-free experience. With risk assessment tools, your financial institution will be able to eliminate time-consuming operations and advise its borrowers based on the loan product that best suits their needs.
5. Loan Portfolio diversification
Due to their small size, community banks and credit unions should diversify their loan portfolios to mitigate risk and reduce their reliance on any single market segment. A diversified portfolio will also serve as a shield against unfavorable economic variables, providing the bank with greater resilience.
A risk management program can provide realistic data on risk to new sectors or geographical areas that may be less susceptible to higher interest rates. With proactive risk mitigation, the financial institution's stakeholders will be able to make sound decisions concerning the expansion of the business and diversification of the loan portfolio.
Acquire the Essentials to Navigate Higher for Longer Seamlessly
As we navigate the possibility of higher interest rates persisting for a longer period, banks and small businesses need to adapt their strategies accordingly. By embracing technology, enhancing risk management practices, and cultivating strong customer relationships, financial institutions can mitigate the challenges and capitalize on the opportunities presented by this new interest rate environment. The ability to adapt and innovate will be key to thriving in a landscape where higher interest rates are the new norm.
Ready to scale your financial institution through high-interest periods?
Schedule a free Biz2X risk assessment software demo, customizable to your unique policies.
FAQs about Risk Assessment Software
1. What is risk assessment software? Why do small banks need it?
Risk assessment software analyzes vast amounts of data to generate conventional and alternative credit scoring reports. It continuously monitors the loan portfolio and provides the latest updates in real-time. For small banks, this capability is crucial in reducing risks when lending to small businesses that lack historical data to demonstrate their credibility.
2. What are the four types of risk assessments?
The four types of risks associated with lending are credit risk, market risk, operational risk, and liquidity risk. Risk assessment software like the one offered by Biz2X helps risk managers improve efficiency in detecting patterns associated with these risks to provide an early prevention buffer. This buffer helps risk managers significantly reduce the overall risk exposure and improve profitability.
3. How do I choose the right risk assessment software?
The ideal risk assessment software will possess all the latest capabilities needed to fulfill modern borrower expectations. They include artificial intelligence, machine learning, cloud-first infrastructure, no-code configuration, and customizable dashboards.
4. Can risk assessment software integrate with existing business systems?
The right risk assessment software will come with seamless integration functionality with all relevant technologies and platforms. Biz2X risk assessment software is connected to an established network of integration and service partners, ensuring maximum integration readiness with your existing business systems. It includes bank accounting systems, credit bureaus, third-party services, and other enterprise software.
5. How do I request a demo of the Biz2X risk assessment software?
Biz2X provides a free demo service to financial institutions. This helps them understand the potential ROI of implementing Biz2X risk assessment software while getting a glimpse of its industry-best capabilities. To schedule your free customized demo, click here.
