Best Credit Risk Management Strategies for Financial Institutions
Implementing a credit risk management strategy can help lenders in a variety of ways. Lenders can use credit risk analysis to boost financial security, determine a borrower’s creditworthiness at any particular time, provide customized loan products that borrowers can handle to build their credit, and more.
Are you concerned about managing your financial institution’s credit risk? Is your financial institution following best credit risk management practices? If you’re interested in improving credit risk management as a lender, this article is for you.
Keep reading while we’re sharing some of the best procedures and techniques to improve your financial institutions’ credit risk management.
What is Credit Risk?
When a borrower applies for a loan, the lender must determine their creditworthiness to pay back the borrowed amount. From credit score to annual revenue, business history, borrowing and payment history, and current financial situation, lenders look at the past and current financial data to determine how likely a borrower is to maintain a new loan. In addition, lenders also consider future cash flow position, loan amount, and repayment terms when deciding whether to approve a loan.
Combined, these factors help lenders understand if a borrower can meet its debt obligation in the given time period. Basically, credit risk is the process of understanding the risk level of a loan. It is the probability that the lender will not receive the loan payments required to service the loan extended to a borrower.
Importance of Credit Risk Management
Lending risks are inevitable yet mitigated. Traditional banks and private lenders are constantly leveraging financial technology to reduce the risk associated with lending. If a borrower misses a monthly payment or defaults on a loan, the lender at a loss.
Even if the loan is backed by some collateral, the time, efforts, and money spent to sell the assets to recoup the losses still leave the financial organizations with a negative return. That’s why it’s super important for lenders to thoroughly assess each borrower’s credit risk.
Best Credit Risk Management Techniques and Methods
Know Your Customers
Knowing your customer is essential since it is the foundation for all succeeding steps in the loan process. To mitigate your credit risk, you must operate on accurate and timely information. The information you collect and the relationship you establish are important in establishing yourself as a trusted lender. Gathering the right information and making good relationships will help lenders protectively identify issues that may prevent them from managing credit risk effectively.
Here are the types of information lenders must gather about their borrowers:
● Products and services
● Customer suppliers
● Company ownership and history
● Nature of business and industry
● Business plan
● The impact of economic condition
Before offering the loan, try to understand how economic and industry factors can influence your borrowers’ business. Find out the company’s reputation and how it operates within its industry. Also, evaluate the company’s management and business strategy. Once you have all the information at your disposal, you can choose the right loan for the right candidate.
Know Why Your Borrowers Need Money
The next step in mitigating credit risk is to understand the numbers. Lenders must know how their borrowers are going to use the funds and how they are anticipated to be repaid. To understand the numbers, lenders must have a great understanding of the historical, present, and projected financial performance of a company or borrower. Performing a borrower’s financial analysis helps lenders understand why a company or business borrows money and provides them with insights into the borrowers’ ability to repay.
Here are some of the essential analysis lenders can perform to understand their borrowers’ numbers:
● Balance sheet quality analysis
● Income statement quality analysis
● Cash flow statement analysis
● Analyzing cash flow drivers such as profitability ratios and turnover ratios
● Developing projections
● Personal and business financial statements
Use Financial Data Sharing APIs
In the present lending scenario, leveraging financial data sharing APIs is one of the best solutions for credit risk management. When financial institutions have access to the most robust, real-time, and accurate data of the borrower and internal resources, they can make lending less complicated and reduce risk with lending.
There are many fintech companies that are creating ground-breaking financial APIs for lenders to help them power their business to grow and thrive. Financial APIs bring them full, dynamic, and real-time access to extensive past, present and predictive financial, accounting, banking and cash flow data supported by numerous data attributes so they can better determine their borrowers’ creditworthiness, make informed lending decisions and ultimately reduce loan risks.
With single API integration, lenders can normalize data from a variety of leading accounting software and banking providers. Lenders can look into a borrowers’ current and future financial health and determine the ability of a company to repay the principal and interest amount. Today, lending API providers can transform raw data into a clean and usable form using artificial intelligence and machine learning to take more intelligent actions that reduce credit risk and provide a competitive edge to lenders.