Credit Risk Management
Credit risk management in a financial institution refers to the strategic processes for identifying and treating risks posed by consumers who borrow from the bank. Managing credit risk is not only essential for the financial gains of the bank or credit union, but government and regulatory agencies now require greater transparency in the credit risk management of each financial institution.
Credit risk relates to the probability that a company or individual can manage their debt in a way that maintains or improves their current financial position. The customers who borrow from a bank or credit union each have specific credit risk. Banks must have impeccable creditworthiness to continue in their business and thrive.
Yet, the bank’s credit risk goes beyond an individual loan. It can relate to the bank’s portfolio. The bank must assess concentration risk, which happens if the bank is overcommitted in a specific category or a certain type of loan. Credit risk may involve financial instruments other than loans and balance sheet instruments, as well. It needs to determine its credit risk appetite and establish guidelines for approving loans.
Accurate credit risk assessment gives banks the information they need to maintain the right level of capital reserves. Once the risks are assessed, the bank managers can develop strategies for avoiding, reducing, transferring, or accepting them.
Aspects of credit risk to consider include the financial conditions the bank, credit union, business, or individual is working under, its financial performance, legal issues that could affect financials, and recent acquisitions. Vendors need to be thoroughly vetted, as well, to ensure their credit risk does not adversely affect the bank.
Credit risk management relies on data from many sources. That data needs to be managed efficiently so that it can be used to calculate and make decisions about the risk. The bank needs to have standard procedures for handling credit risks throughout its organization.
Credit risk management software can help with these tasks. The software can also help the bank avoid doing the same calculations over and over as new details come into play. With credit risk management software it is also easier to identify portfolios that contain greater credit risks. Reporting is much simpler, giving risk managers more time and information to make critical decisions.