Corporate Credit Risk Management

 Credit risk generally means the potential loss of finance of a company when the commercial borrower fails to pay the credit on time for any kind of debt. Thus, every corporate sector dealing with commercial lending must practice credit risk management to mitigate the loss by understanding the bank’s capital and loan loss reserves. The importance of improving credit risk management has increased over the years to enhance earning. In order to manage the credit risk properly, you must analyze the benefits and risk factors as well as take credit decisions and monitor the current borrowers. Let’s get to know how to practice credit risk more efficiently to make your business more successful. 

• The KYC process and customer onboarding

Knowing the customers is essential for every lending business as it’s the first step to succeed in the credit process. The customer information and your relationship with customers would play a critical role in establishing you as a well-regarded financial service provider. As a reliable financial consultant, you must discuss your customers’ needs and future plans about their company and industry. Know about your clients’ company products and services, their customers, suppliers, facilities, etc. It would help evaluate the criteria to carry out the company’s business strategies. 

• Analyze financial and non-financial risks

Analyzing risk quantification involves estimating the probability of default, loss given default, and risk-adjusted return on capital. The borrowing company might publish unrealistic forecasts according to their sales and growth. This can have a negative impact on the lender’s margin. Thus, rather than using a manual process, utilize an automation process to analyze the company’s base data and evaluate soft factors. Moreover, analyze any risks that areassociated with the industry, business, and management of the company to evaluate whether the company’s balance sheet has enough capital to support credit risks or not.

• Understand the risks associated with commercial lending

There might be many risks associated with establishing a banking relationship with your customers. Thus, as a credit lender, you must know how the requested fund would be used and how the borrower would repay it. Moreover, you should identify, categorize, and prioritize the credit risks associated with the borrower as well as examine the quality and sustainability of the company’s financial performance. 

• Crediting the deal

In order to give credit approval, as a valued financial creditor, first, you should structure the deal by studying the nature of the business, the company’s economic conditions, and competencies or deficiencies in credit risk management. The loan structure is essential to the customer, and he/she should clearly understand within what boundaries the deal can operate. Also, determine the appropriate pricing for the deal, so the company can compensate the lender adequately. After closing the deal, you must monitor it regularly. If the borrowers pay their installments timely, it’s good. However, if they are delaying, it can cause potential loss. Thus, it’s essential to monitor the borrower’s development. 

 

Today’s commercial lending businesses can no longer rely on standard tools to manage corporate credit risks. Customers’ requirements with financing are getting more and more complex, and they also demand faster decisions with credit financing. Due to the integration of AI and ML, now credit risk management can be processed fully or automated partially. This can positively support various financial service providers, financial analysts, and stakeholders with every aspect of the lending business.

Author: Yanhong OU

Date:16.10.2021

Reference:

Sas.com. 2021. Credit risk management: What it is and why it matters. [online] Available at: <https://www.sas.com/en_in/insights/risk-management/credit-risk-management.html> [Accessed 11 October 2021].

Carter, M., 2021. 7 Ways to manage credit risk and safeguard your global trade growth - Trade Ready. [online] Trade Ready. Available at: <https://www.tradeready.ca/2014/trade-takeaways/7-ways-manage-credit-risks-safeguard-global-trade-growth/> [Accessed 11 October 2021].

 

The Global Treasurer. 2021. Credit risk management principles, tools and techniques - The Global Treasurer. [online] Available at: <https://www.theglobaltreasurer.com/2019/02/07/credit-risk-management-principles-tools-and-techniques/> [Accessed 17 October 2021].

 

2021. Credit Risk Management Plan Best Practices | Euler Hermes USA. [online] Available at: <https://www.eulerhermes.com/en_US/insights/credit-risk-management-best-practices.html> [Accessed 14 October 2021].

 

 

Case study of Enterprise Credit Risk Management

As mentioned in the Basel Accord, the objective of credit risk management is to maintain credit risk within the safety boundary through dynamic assessment, real-time monitoring and outcome feedback, so as to obtain the highest risk-adjusted returns. Small and Medium Enterprises (Sme) credit risk management mainly includes the following aspects:

When economic subjects face credit risk in business operation, enterprises should develop targeted measures to ensure effective control and reduction of risk probability in view of possible hazards and losses caused by credit risks. Secondly, it is necessary to control the credit risk, and the choice of control method should match the economic loss that the credit risk may cause, which can effectively monitor every aspects of credit risk management. Finally, feedback of opinions and results should be carried out in time to adjust the original method in time. 

The approach of Savings and Credit Cooperative Organisation (SACCO) to Credit Risk

Credit business is the most important asset business of commercial banks, which can recover principal and interest through lending and make profits after deducting costs. Therefore, credit is the main profit means of commercial banks. Similarly, SACCO was established to improve financing efficiency for low-income groups and small and medium-sized businesses. According to Kariuki, SACCOs' main goal is to provide owners with savings and credit in an efficient way. Bhattarai added, the total revenue of the institution is generated by making loans to customers and earning interest. It can be said that the total revenue is closely related to customer credit risk.

Sacco's credit line had no collateral requirements, so there were numerous payment defaults. Markowitz's (1952) MPT notes that portfolio diversification changes this dilemma. SACCOs identifies the credit risk of loan applicants based on this element of investment portfolio. If the client's credit is not up to standard, then they cannot become partners, through strict entry to reduce the risk of credit sales. SACCOs evaluates customers' credit ratings in a scientific way, which reflects the dynamic assessment process of enterprise credit risk management.

A case study of MF Global

MF Global is the world's largest futures trader and one of the 100 largest listed companies in the UK. Due to its holdings of us $6.3 billion of European sovereign bonds, MF Global was downgraded by several rating agencies after its financial statements were released on October 25, 2011, resulting in stock price declines and financing difficulties. The Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC) demanded that MF Global sell its brokerage business to protect its clients. In the sale of its brokerage business, MF Global was found to have misappropriated nearly $600m of client money for its own business and lost money because of poor operating decisions. In light of this, the SEC and the CFTC demanded immediate bankruptcy of MF Global.

Through real-time monitoring, the SEC and CFTC were in control of the operating conditions of MF Global, so as to prevent MF from defaulting on its debts due to poor business conditions. When things went wrong, the SEC and CFTC required MF to take immediate steps (eg: selling businesses and filing for bankruptcy) to mitigate risks and losses. This process reflects the real-time monitoring phase of credit risk management.

 

Author: Cuiwen HUANG

Date: 13.10.2021

 

Reference:

Hilary, T. (2012) The Collapse of MF Global: What Happened and Lessons Learned, Available at: https://ssrn.com/abstract=2603511 (Accessed: 13th October 2021).

Josiah, A. and Stephen O. (2021) ‘Credit Risk Management and Efficiency of Savings and Credit Cooperative Societies’, Journal of Applied Finance & Banking, 11(1), pp. 99-120.

Paul, E.P. (2013) ‘Behind the Collapse of MF Global’, Journal of Agricultural & Applied Economics Association, 28(2), pp. 1-5.

 

Credit Risk of SME

As is known to all, small and medium-sized enterprises (SMEs) are the basic force for promoting employment and stabilizing society, the backbone of economic growth and innovation, and the largest and most dynamic group in the market economy.The previous literature suggests that SMEs play an important role in an economy’s growth(Kang Li et al.,2019).Many large enterprises are from small and medium-sized enterprises, which inject a steady stream of vitality into the booming market.This blog explores the research progress and lending techniques of sme credit risk.

Through a detailed analysis of the literature, it can be found that in recent years, the research content of SME credit risk mainly includes three aspects: the research of SME credit risk based on financial index system, supply chain finance and enterprise big data.

1. Research on credit risk of SMEs based on financial index system.

The traditional credit risk index is mainly financial index, and the credit risk model based on financial index is widely used in the risk assessment and early warning of small and medium-sized enterprises.

2. Research on credit risk of SMEs based on supply chain finance model.

Supply chain finance is a kind of self-compensatory trade financing credit mode, which plays an important role in improving the financing environment of small, medium and micro enterprises. In recent years, it has received extensive attention from the industry and academia, and more and more literatures on credit risk research of small and medium enterprises based on supply chain finance mode have been published.

3. Research on credit risk of SMEs based on enterprise big data.

In addition to corporate financial data, corporate big data also includes all non-financial data that directly or indirectly reflect corporate operations, such as corporate shareholder background, corporate management information, and associated network media.With the development of big data technology, more and more scholars begin to pay attention to the research on credit risk of smes based on enterprise big data.

In the loan market, there is a serious information asymmetry between banks and enterprises, which is the fundamental reason that SMEs can hardly borrow from banks.Stiglitz & Weiss(1981) commentioned that information asymmetry and its credit risk are the root cause of financing difficulty of small and medium-sized enterprises.In the backdrop of the entrepreneurship, the country launched a series of policies to help small and medium-sized enterprise development, which makes the number of small and medium-sized enterprises increased year by year, the country SMEs have become an important part of the economic structure. However, influenced by internal factors and external environment, small and medium-sized enterprise the management floating is bigger, this leads to the commercial Banks can not accurately assess the credit risk of small and medium-sized enterprises.Business loans is the main source of income of commercial Banks, bank credit management effect greatly affects the stability of China's economic and social development. Therefore, commercial Banks should according to the new economic situation, in a timely manner to solve various problems arising from the loan business, both to help small and medium-sized enterprise financing problems, and promote the rapid development of economy in China.

Author: Yuxuan Shi

Date: 12.10.2021

Reference

Li, Kang; Niskanen, Jyrki and Niskanen, Mervi.(2019)Capital structure and firm performance in European SMEs: Does credit risk make a difference?Managerial Finance,45(5),pp.582-601.

Song, Zhuo-lin, Zhang, Xiao-mei.(2018)Lending technology and credit risk under different types of loans to SMEs: Evidence from China.International Review of Economics and Finance,57,pp.43-69.

Stiglitz and Weiss(1981)Credit rationing in markets with imperfect information.The America Economic Review, 73 (1981), pp. 400-410.

High-tech Enterprise Credit Risk

As we all know, high-tech industry is an indispensable and important economic support for every country or region. While especially in China, the development of high-tech industry is the main driving force of economic restructuring, so how to support the rapid and better development of high-tech industry has become one of the practical problems that need to be solved. However, as the leading part of the national economy, high-tech industry is facing the problem of financing difficulty. This is mainly due to information asymmetry caused by the barrier (Zhang, 2011). According to Guiso(1998)'s research, high-tech companies are more likely to be exposed to credit markets than those engaged in traditional investment projects. And compared with traditional industries, high-tech industry has the characteristics of high risk and large investment, so the uncertainty is relatively high, which deepens the impact of information asymmetry, resulting in financing difficulties from time to time (Zhang et al., 2013). Therefore, in order to solve this problem, it is necessary to speed up the construction of high-tech enterprise credit system. This blog is mainly to discuss the relationship between high-tech enterprises and credit risk and how to establish targeted high-tech enterprises credit risk evaluation index system.

                            Figure 1:  High-tech exports by high-technology group of products in EU
                                                                   Source: Eurostat (htec_trd_group4)

According to Zhang et al. (2013)'s research, taking listed companies in China's high-tech industry as samples, Cox model was used to analyze the factors influencing the credit risk of Chinese high-tech enterprises. The results show that the company's financial status, especially liquidity ratio, receivables turnover, ROE and so on, have a significant impact on the credit risk of high-tech enterprises. In terms of independent innovation capability, the stronger the independent innovation capability, the lower the credit risk of high-tech enterprises. This shows that there is a significant negative correlation between independent innovation capability and credit. This makes us unable to help considering whether other factors, such as region, are related to the credit risk of high-tech enterprises? It also leaves the reader with something to think about.

Generally speaking, enterprise credit evaluation methods include Z score, Logistic regression model, MHDIS model, artificial neural network, fuzzy comprehensive evaluation method, fuzzy integral method and so on (Zhang, 2011). Therefore, introducing the uncertainty measure model into the credit rating of high-tech enterprises can solve the uncertainty of many factors in the credit rating system of high-tech enterprises on the one hand, and carry out quantitative analysis on it on the other hand (Zhang, 2011). And when constructing the credit risk evaluation index system of high-tech enterprises, the factors such as liquidity ratio, receivables turnover rate and independent innovation ability should be considered comprehensively to scientifically evaluate the credit status of high-tech enterprises (Zhang et al., 2013). On the other hand, when commercial banks and other financial institutions make loan decisions for high-tech enterprises, they should distinguish high-tech industries from traditional industries and take independent innovation ability into consideration, so as to facilitate the financing of high-tech enterprises (Zhang et al., 2013).

Establishing an effective evaluation index system for the credit risk of high-tech enterprises is conducive to scientific evaluation of the credit status of high-tech enterprises, reducing the possibility of information asymmetry, and thus reducing the credit risk (Zhang, 2011). From the macro point of view, but also conducive to promote financial resources flow to the technology industry, economic structure adjustment. It is very important to suggest effective risk rating methods not only for the credit risk evaluation index system of high-tech enterprises, but also for any enterprise. Now credit risk has become one of the core subjects of risk management (Aguais, 2001). Only by recognizing the complexity of credit risk can we better measure the risk, and thus manage and optimize the risk and return. This blog is about high-tech companies and credit risk. The credit risk of SMEs will continue in the next blog post. 

Author: Yue PAN

Date: 11.10.2021

Reference:

Aguais, S.D. and Rosen, D., 2001. Enterprise Credit Risk Management.

Guiso, L., 1998. High-tech firms and credit rationing. Journal of Economic Behavior & Organization, 35(1), pp.39-59.

Zhang, M., 2011, May. Application of unascertained measure model in credit evaluation of high-tech enterprise. In 2011 International Conference on Business Management and Electronic Information (Vol. 4, pp. 321-325). IEEE.

Zhang, M., He, Y. and Zhou, Z.F., 2013. Study on the influence factors of high-tech enterprise credit risk: Empirical evidence from China's listed companies. Procedia Computer Science, 17, pp.901-910.

Introduction of Enterprise Credit Risk

1. Introduction

Enterprise credit risk management, also known as enterprise credit management, is a special technology for scientific management of credit sales of enterprises. The most basic goal of setting up credit management departments of enterprises is to avoid risks arising from credit sales and increase the success rate of credit sales (Fraser and Simkins,2010).

In the face of the current market, it is impossible for enterprises to sell only by credit, and only by strengthening the management of sales departments. The management of credit sales in enterprises needs to introduce management methods which are very different from traditional methods, and must break through the tradition of sales management by sales departments, and even need to establish a new department to support credit sales. In other words, the credit sales activities of enterprises should be managed by the newly established credit management department, including coordinating among several relevant departments, introducing credit products and credit management services from outside the enterprises, and technically supporting the sales department. The credit management departments of enterprises use the credit products and professional services provided by the credit management industry to effectively manage the credit sales activities of their enterprises. As a result, the credit risk of enterprises to customers is reduced.

(source:YouTube,2019)

As for the research of enterprise credit risk management system, the research of credit management theory in developed countries has a history of more than 100 years, and has formed a relatively perfect theoretical system including credit evaluation, credit risk transfer, credit monitoring and so on. In most developed countries, such as the United States and Britain, there are credit management research centers, and the state has specially set up credit research funds for the research and development of credit management. And most foreign enterprises have established their own credit risk management departments. However, in some developing countries, the theoretical research on credit management has just started or not yet started, and there are no specialized research institutions and no specialized courses in universities. Only a few scholars are doing some theoretical discussions, which have not yet received corresponding attention.

In the world economic system, about 400 million small and medium-sized enterprises are the main sources of job creation in the world, accounting for more than 95% of the total number of companies and 60%-70% of the employed people (Djemaa, 2018). In addition, some data show that in the past 20 years, American high-tech companies have represented more than $400 billion in M&A transactions, accounting for 20% of all M&A transactions (Irwin et al., 2021). This series of data shows that small and medium-sized enterprises and high-tech enterprises are very important in providing jobs, knowledge innovation, economic development and national income. However, at present, small and medium-sized enterprises and high-tech enterprises are faced with various difficulties that restrict their healthy development, such as financing constraints and lack of credit, which always restrict the healthy development of small and medium-sized enterprises. Among them, the management of credit risk is the most important, which is directly related to the actual interests and future development of enterprises.

Therefore, how to strengthen credit risk management and reduce credit losses caused by poor credit risk management has become a key concern of small and medium-sized enterprises and high-tech enterprises. Finally, it is expected to provide a feasible suggestion for enterprises to prevent and control credit risk, which is also the ultimate goal of this study.

Author: Ziwei SONG 

Date: 10.10.2021

 

 

 

 

Reference：

Djemaa, H. (2018). Islamic financing options for SMEs- role of Islamic banks. Global Journal of Business, Economics and Management: Current Issues, 8(3), pp.109–120.

Fraser, J.R.S. and Simkins, B.J. (2010). Enterprise risk management. Hoboken, N.J.: Wiley.

Irwin, K., Gilstrap, C., Drnevich, P. and Tudor,  C. (2021). From start-up to acquisition: Implications of financial investment trends for small- to medium-sized high-tech enterprises. Journal of Small Business Strategy, 29(2019), pp.22–43.

Vizo Financial. “Introduction to Enterprise Risk Management.” YouTube, 25 Feb. 2019, www.youtube.com/watch?v=PTXexxUckIM. Accessed 25 Apr. 2020.