5 Best Practices to Manage Credit Risk in Banking Sector 5 Best Practices to Manage Credit Risk in Banking Sector

5 Best Practices to Manage Credit Risk in Banking Sector

5 Best Practices to Manage Credit Risk in Banking Sector

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Exposure to risks and managing risk effectively

Over the recent years, the financial services sector has encountered challenges for several reasons, but many of those challenges can be linked to bad lending, poor risk management, or the lack of agility in adapting to changing economic scenarios.

Credit risk, in simple terms, is the uncertainty of bad debts, in case a borrower fails to meet his commitments in accordance with the agreed loan terms. The primary aim of credit risk management is to take calculated exposures within defined parameters so that the overall process optimizes the bank’s risk-adjusted rate of return.

Since vulnerability to credit continues to be the prime risk factor for the financial industry worldwide, banks should take special initiatives in strategizing comprehensive measures to identify, monitor, and control the inherent risks in lending as best as they can.

The best practices outlined in this article address the issue of credit risk management in the following areas: (1) Setting up an ideal credit risk environment (2) Formulating a full proof credit-granting process (3) Securing controls over credit risks (4) Intelligent recruitment of human resource, and (5) Incorporation of effective information system.

1) Setting up an Ideal Credit Risk Environment

The bank’s board of directors, in an ideal credit risk environment, should involve and take the responsibility of periodically reviewing the credit risk policies of their bank. The policy, as and when undertaken by the board, should clearly state the bank’s tolerance level for risks, and also the interest rate spread it requires for taking such risks.

The top-level management is then obligated to implement the credit strategy approved by the board for classifying, measuring, monitoring and regulating the credit risk. Such policies should be religiously followed across the organizational line for individual as well as portfolio credits.

Banks should periodically monitor the inherent credit risks in all its products and services. For new launches, it should identify risks in advance and price-them out by ensuring that adequate risk management procedures are initiated before the product is introduced.

2) Formulating a Full Proof Credit Granting Process

It is essential for banks to operate within well-defined credit criteria. These criteria should clearly lay down the bank’s target market, the borrower’s credential requirements, purpose and structure of credit, and the source of repayment.

Financial institutions should set an overall credit limit for all individual borrowers, as well as for connected counterparties, as specified in the credit policy.

Banks should also explicitly define its approval guidelines for new credits, renewal, refinancing, and premature terminations. Deviation in guidelines shouldn’t be entertained without the recommendation of the board.

3) Securing Control Over Credit Risks

Banks must establish a process for continuous review of credit risk management strategies. Results of such assessments should be forwarded directly to the board of directors.

The reviews are intended to provide valuable insights on whether the bank’s credit granting functions are being accurately managed within the defined standards and limits.

Banks must enforce an internal control mechanism to make sure that exceptions of policies, limits, and procedures are communicated to the appropriate authority in time.

There should be a streamlined system in place for early detection of fraudulent activities, and for corrective action on deteriorating credits.

4) Intelligent Recruitment of Human Resource

It is also a responsibility of the management to ensure that sufficient and competent resources are allocated to control and manage the credit risks. Credit managers should –

  • Have a comprehensive perception of the risks associated with the bank’s credit activities.
  • Be capable of understanding relevant factors and conditions which can directly or indirectly affect the credit quality and risk profile of the institution.
  • Immediately report a change in the risk profile or credit portfolio to the concerned authority for consideration.

The bank management should consistently organize credit training programs to equip its personnel with adequate knowledge about the institution’s credit standards and culture.

5) Incorporation of Effective Information System

Banking institutions must have an information system in place to effectively manage the inherent credit risks in its activities.

The information system should enable the bank to:

  • Use analytical techniques to maintain a database for credit research.
  • Report high exposures.
  • Track the status and account performance.
  • Monitor and control limits.

Financial service providers should tally its credit risks with the overall spread of an account relationship. Credits should be priced in such a way that, together with other revenues earned from an account, it would compensate all the associated costs and risks incurred by the institution.

Has your organization embraced these best practices, or may be, is on its way? eKutumb banking technology solutions and services can assist your bank in forming a successful credit risk management strategy.

Author: Kishore Kapoor

Kishore Kapoor an industry veteran of 31 years in global banking technology. A Founder & CEO of eKutumb.com – World’s first marketplace for enterprise software delivery and consulting business by creating value for all of industry stakeholders involved (customers, partners, individuals and investors) through a disruptive and trans-formative approach of doing business.

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5 Best Practices to Manage Credit Risk in Banking Sector
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For any economy in a country banking sector plays import role, read 5 best management practices outlined in this article that address the issues of credit risk.
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eKutumb PTE. LTD.
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Kishore Kapoor Founder & CEO Of eKutumb

Kishore Kapoor an industry veteran of 31 years in global banking technology. A Founder & CEO of eKutumb.com - World’s first marketplace for enterprise software delivery and consulting business by creating value for all of industry stakeholders involved (customers, partners, individuals and investors) through a disruptive and trans-formative approach of doing business. You can connect with Kishore Kapoor on Linkedin and Google Plus