4 Best Techniques for Managing Credit Risk in Your Small Business Lending
A small business necessarily has a high inherent credit risk due to low credit score, limited business history, insufficient cash flow, and several other reasons. And economic and employment uncertainty right now due to the pandemic only makes this risk prudent to review the steps your financial institution is taking to mitigate that risk.
Credit risk refers to the probability that a borrower fails to make repayments (principal + interest) on time. And credit risk management is the process of ensuring that your small business borrowers’ financial health is determined to mitigate the risks associated with late or non-payments — a process that has been a big challenge for small business lenders.
Here are a few best techniques for managing credit risk in your small business lending.
Know Your Customers
Knowing your customers or borrowers and understanding their unique financial needs is essential because it is the foundation for all succeeding steps in the credit risk management process. It’s important to pay attention and listen to what they’re saying and use that information to establish what demands they are looking to address through your financial institutions. The information you collect and the relationship you establish are vital to gain a competitive edge and position yourself as a trusted financial expert.
One of the best ways to identify and meet your customers’ needs, tastes, and preferences is through face-to-face conversation to discuss the customers’ goals and objectives, and future plans. Besides, gathering a borrower’s financial data from multiple sources is yet another great way to know your customers better. You can integrate with your borrowers’ multiple financial systems such as financial, accounting, banking, cash flow, and others, to see deep critical insights into a borrower’s health. Today, some innovative FinTechs provide financial data APIs that help lenders to access, analyze and use the most robust and real-time financial data of their borrowers and ultimately determine creditworthiness and manage credit risk.
Leverage Cash Flow Predictive Data
Don’t rely only on 5Cs and FICO scores to determine your potential customer’s creditworthiness. Most small business lenders still consider historical data points such as credit score, annual revenue, business history, and collateral, to assess the ability of a borrower to repay the loan. But these old-school credit scoring methods are not enough to make better lending decisions and reduce credit risk.
With cash flow predictive data, you can accurately predict the financial future of a small business, faster. You can visualize how money is moving in and out of a business and how much cash flow a business is expected to generate in the future. Moreover, cash flow predictive data helps lenders to determine the creditworthiness of business owners who have no or limited credit history. Cash flow predictive data allows you to get the full picture of a business’s past, present, and future finances. It helps you visualize where a business is standing in terms of financing, how well it’s managing existing repayments, and how much new financing it can afford. Eventually, it helps you to make better lending decisions, provide easy and fast loans and mitigate credit risk.
Price the Loans Appropriately
When you become more data-driven and have the most accurate, real-time, and precise information about your borrowers, you can price a small business loan appropriately. You can set high interest rates, lower amounts, and short repayment terms for high-risk borrowers and vice-versa.
When you have a better view of your borrowers’ past, present, and future financial health and when you have a better handle on borrowers’ likelihood to repay through predictive analytics, modeling, and actionable intelligence, you can offer your borrowers a competitive deal and optimize ROI on your small business loans with a low risk of default to back that up.
Monitor the Relationship
In today’s small business lending environment, the quality of products and services is an increasingly important factor in nurturing positive customer trust and loyalty. You need to improve customer experience and monitor the relationship to retain your potential customers, boost revenue and take your organization forward. You need to continue listening to your customers/borrowers as their needs change over time.
Loan repayments should be your priority, but maybe your borrower is not feeling well and their business has been closed temporarily. To build and maintain a strong relationship with your borrower, you must continuously monitor it and look for any potential risks.
So these are some of the best tips for managing credit risk in small business lending. If you’re a small business lender, you must follow these tips to know your borrowers’ business better, satisfy their needs, determine creditworthiness, mitigate credit risk, and ultimately make smarter lending decisions.
Sources:
4 Best Practices for Managing Credit Risk | Shire
Credit risk management: What it is and why it matters | SAS
Credit risk management principles, tools and techniques — The Global Treasurer