The importance of credit risk management

Thursday November 7 2019



Kelvin Mkwawa

Kelvin Mkwawa 

Credit risk refers to the probability of loss due to a borrower’s failure to make repayments of any type of credit, and credit risk management is the practice of mitigating the probability of loan loss due to borrower’s failure to make loan payments at any given time.

The importance of credit risk management for banks is tremendous. For the last two years or so, the banking industry has been facing Non-performance loans (NPLs) problem due to weak credit risk management processes and lack of effective controls in place.

As a result, it put the credit risk management into the Bank of Tanzania (BOT) spotlight and they began to demand more transparency from the banks and want to know that banks have a thorough knowledge of their customers and their associated credit risks.

Loans make up the biggest risk for any bank and because of that, the banking industry has been focusing more attention than ever on credit management which highlights its importance to the banks.

The credit risk management is one of the core processes for banks hence the ability to manage its process is essential for their success.

Banks are constantly faced with risks all the time; risks are always associated with banking activities and taking risks is very common in banking. To ensure their healthy financial status, banks must balance their risks daily by having a formal credit risk management practice in place.

Advertisement

In today’s article, I will discuss the importance of credit risk management in banks.

Credit risk management practices differ from bank to bank based on the type and complexity of the credit activities taken by the banks.

Some of the best practices in credit risk management are the consolidation of customer’s data, active portfolio management, centralized decision-making process, and efficient tools for risk exposures.

Even though the credit risk management practices are different from banks to banks, there are four pillars the banks should rest on: a suitable credit risk environment, appropriate credit administration and monitoring processes, sufficient credit risk controls, and clear credit criteria of the bank’s target.

Managing credit risks is the main focus of any banking operations these days as fraudsters and unethical customers have sophisticated methods to deceive the banks. Because of this, the effective management of credit risk has become a critical component and the banks need to monitor, control, and measure its credit risk practices more often to ensure their long term success.

Mitigating risks is one of the components of managing risks and there are three main strategies banks can consider: eliminate/avoid risk completely, transfer risk to third parties, and actively managing risk.

There are so many benefits to banks for having proper credit risk management, including, lowering the capital that is locked with the debtors hence increasing the ability to manage cash flow more efficient, reducing the possibility of getting into bad debts, improved bottom line (profits), enhanced customer management processes, and increased accountability within the institution.

In conclusion, we have seen that credit management is an important aspect of financial management for all banks.

The proper management of credit will enhance the bank’s profitability, hence increasing the wealth of the shareholder and ensure that the bank generates sufficient positive credit from its operations to continually fund the deposit and lending activities.

Therefore, the efficient management of credit will solve problems and save time.

Also, we have seen that credit risk management practices differ from bank to bank but all base their practices on four pillars: a suitable credit risk environment, appropriate credit administration and monitoring processes, sufficient credit risk controls, and clear credit criteria of the bank’s target.

Lastly, to ensure the positive growth of the bank, credit risk management must play a role in managing the risks.

Mr Mkwawa is a seasoned banker.

Advertisement