The first question you must ask is, “What is Credit Risk Management?” It is when an investor’s risk of loss incurred when a borrower fails to make payments on the specified time. In other words, the borrower has “defaulted”. In professional terms this is known as a credit risk and is taken by the investor. There can be credit risk management problems in banks or other business organizations.
Three Components of Credit Risk Management
There are three components of credit risk management, these are:
a) Omission by board members and senior managers
b) Inconsistent organizational Structure
c) Inadequate systems for risk control.
Credit risk management arises due to failure in best practices which lead to the above mentioned components.
Administrative System for Credit Management
The best practices involved in administration of credit management include:
Measuring the Credit Risk
This is an essential best practice and comprises of a number of qualitative and quantitative techniques. Measuring credit risk involves analyzing business risk, internal risk rating, and the design of the operational rating system and architecture of the internal rating system.
Review of Credit Risk
The credit risk incurred by the financial institution must be reviewed every year. This helps in improving best practices by providing information on financial statuses of obligators.
Delegation of Authority
It is a required best practice for banks to establish responsibility for credit sanctions. There are protocols and processes to maintain leading standards. Therefore there have to be clear delegations of authority to minimize credit risk. Additionally, the delegated authorities must also be reviewed regularly.
Managing problems with credits