Concept and Meaning of Credit Management
In a layman term, the prime function of a bank is to accept deposits and grant loans and advances. The purpose of credit in banks is to earn good profit through and earn good revenue. While granting loans and advances it becomes very important for banks to make sure that they collect the payment form the borrowers in time under agreed credit terms. Here Credit Management plays an important role in ensuring collection of payment from the borrowers.
Credit Management in a very simple language means, Managing debtors and financing debt and it is achieved by collecting payment from the borrowers under the specified agreed terms.
An important function of credit management is credit control and its management. Banks have a specialised credit management system that tries to minimise the capital tied up with the debtors. Good credit management will ensure the efficient flow of cash.
Credit Management plays a very important role in deciding where the bank should invest its funds because one of the main motives of the bank is to earn profit and banks can earn profit only when they invest their capital from where it can earn sufficient profits. Thus investment should be made only when the return is confirmed.
Principles of Credit Management
The principles of credit management include; Character, Currency, Diversity/ Spread, End-Use, Liquidity, Need-based finance, Profitability and Safety.
Character Banks check the character of the customer, individual or companies while giving them the credit. Banks check the previous track record (credit score, punctuality of paying at regular intervals, etc.) of the borrower ?and his capacity and willingness to repay the loan amount within the specified time period agreeing to credit terms as set up.
Currency During cross border lending analyse the trends in currency movement while taking the decision about granting a loan. In the case of drop (depreciation) in the value of the domestic currency, the cross border loan will become very costly and the chances of default in payment will increase. Following the credit management process properly will help in checking this parameter while giving cross border loans to foreign companies, individuals.
Diversity / Spread Banks should be diverse enough while lending. Commercial banks should never advance their funds in a particular sector. If banks happen to concentrate only on a specific sector then it might face serious problems if that particular sector goes through bad times and become a sick unit or fail to revive.??
End-Use Banker should ascertain that money that is lent has been used for the purpose for which the same was granted and banker should also ask for the supporting papers from the borrowers for the same.???
Liquidity When banks lend money liquidity plays a very important role. Banks deal with depositor?s money and that money can be withdrawn by the depositor at any point in time. Therefore banks should make sure that they have enough funds to meet every type of needs of depositors be it the withdrawal of demand deposits or time deposits before time maturity. Hence, such a credit management system should be there which can manage the cash flow efficiently.
Need based finance Credit management process will help the bank to ascertain the need of the borrower and should lend accordingly. In this way, the bank will neither over finance or under finance the borrower.??
Profitability As already mentioned, profit earning is an important objective of commercial banks and good credit management can help in investing the money only at a place where profits can be earned.
Safety Bank also has to see the safety of its funds before lending. Whether the borrower is in the position to repay the loan and interest at regular intervals or not. The prime security can be the pledge of stocks, book debts. And may charge on immovable property as collateral security, and a third party guarantee is also treated as a security. The securities that are available to the bank should be fair enough and the market ?value of the security should be more than the amount that is lent out so that in case of adverse circumstances bank can recover the money from the securities. While accepting the security bank should see that the value of the security is easy to ascertain. Precaution should be taken while accepting the immovable property as security that the security has a good title in the market.
Importance of Credit Management
Banks take risk while lending out money to the borrowers. The borrowers might fail to repay the loan amount and the interest in a specified time period. Credit management is very important but many a times bank can?t assess whether it will get the money back or not because even if the trusted and loyal borrowers who pay their dues on time, the economy can show a drastic shift and things might change and that is where it becomes important to manage the credit in such situations.
Objectives of Credit Management
- To improve and maintain efficient cash flow.
- To settle the outstanding balances.
- To safeguard customer?s interest and reduce risk.
How Credit Management System is set-up?
- To have complete information about bank?s own capital reserve.
- To understand and prospect bank?s overall credit (lending) risk based on its customers.
- To establish a sound credit management process for monitoring efficient cash flow.
- To implement quantitative credit risk solution so as to build an environment with minimal credit risk.
Why Credit Management System is set-up?
- To determine how much credit to give and on what terms.
- To deal with default payers which include non-payers and late payers.
- To monitor and collect payments from borrowers in a specified time period.
- To monitor the credit rating and payment records of the customers.
- To assess the security of payment of the credit, borrowers have to keep with the bank for getting the loan from the bank.
- To prevent any bad debt from arising.
- To improve and maintain customer relations.
- To detect complaints in due time.
Through effective credit management, a bank secures an optimum balance between giving credit to earn and risk from default in a payment like non-payments or late payments. Credit management helps in deciding how much credit should be given to the borrowers and ensure that they comply with credit terms. Banks can also refuse to lend or agree to lend but at a high rate of interest after ascertaining the credit risk that is involved.
Every business has a core department which plays a very crucial role in achieving success. For commercial banks, this core process is Credit Management, with sound credit management success, is guaranteed for banks as it will invest (lend) only where the customers have the capacity and willingness to repay the loan amount in time and ensure to comply with credit terms that are set-up.
Benefits of Credit Management
- Credit management contributes to profit because of efficient cash flow.
- The decrease in the number of non-payments and late payments.
- High liquidity is maintained.
- Helps in building positive image and goodwill of the bank.
Limitations of Poor Credit Management
- Poor credit management may incur financial losses.
- Poor credit management will impact the credibility of the bank.
- Poor credit management can shatter the reputation of the bank.
Sound credit management will help banks to monitor and collect payments from the borrowers within a specified time period. Hence, every bank should have effective credit management to ensure timely payments from the borrowers.