Credit risk is understood simply as the risk a bank takes while lending out money to borrowers. They might default and fail to pay the dues in time and these results in losses to the bank. Loan portfolio management is very important but most times a bank can’t fully determine if it will retrieve the money back because even if the borrowers have been paying their dues on time, the economy might change and change the way things have always been.
So what do banks do then? They need to manage their credit risks. The aim of credit risk management is to maintain credit risk exposure within proper and acceptable parameters. For this, banks need to manage not only the entire portfolio but also individual credits. A review is vital for any bank’s long term success and future. Loans make up for the biggest risk for any bank or lending institution. A good and reputed credit risk management company should be chosen for this task so that not only is there proper risk management but also good recommendations and correct estimates. A bank’s reputation is at stake with credit risks and this is not taken lightly at all by any of the financial institutions who are serious about their image and of looking at long term effects of the same.
A few principles are important for credit risk management and if followed, the banks will be at ease about the whole risk management process.
• The company chosen for credit risk management review should be reputed and confident of handling such a sensitive task. Not every company is capable of providing the right recommendations and it is the work of highly skilled professionals that should work on an organization as big as a bank.
• Senior management of the financial institution or of the company chosen for the task should be responsible to drive procedures that identify measure and control credit risk.
• All products, activities and services of the banks should be taken into consideration when considering credit risk. The risk of new products and services will be subject to proper risk management procedures before being executed.
• Credits to individuals and companies should not be given without proper screening. There should be a process in place before lending out to anybody or any company.
• Existing borrowers and individual credit conditions should be screened under a proper system.
• Banks should develop internal commercial loan risk rating systems that are in accordance with the institution’s size and activities.
• The credit risk management company should be able to look into future economic concerns and potential changes. A plan should be in place for the same in order to manage everything effectively, both in the present and the future. The estimations given by the company should be close to accurate and only highly reputed and skilled companies can do such a task.
These are just a few of the principles to be kept in mind by a bank and any other lending organization in order to minimize risks and maximize reputation. Credit risk being one of the most vital determinants of a bank’s economic strength should not be neglected in any of the products and activities of the bank, old or new. Hiring a consultancy and a management company that can do the needful with utmost precision and skill is one of the most important things for a financial institution to do. Managing credit risk is itself a risky task because a lot of predictions and recommendations are involved and hence there is no place for a loophole in this process.
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