This article covers all you need to know about credit management, it’s objective, policy and need to have a good credit management in an organization or industry.
When you hear credit, it simply means different things to different people depending on the field of application.
To a banker and generally to a lender, credit is a loan of money given to a borrower on an agreed credit terms.
Credit as a loan of money can be given on short, medium and long term basis.
This simple definition will be used in defining what credit management is all about.
Management on the other hand is a function which includes planning, organising, controlling, staffing, directing, setting objectives and decision making.
Of all these, it’s functions of planning, controlling and decision making are applied in the credit management.
The planning function is the process of deciding what the organization objectives should be, and what members should do to attain them.
While controlling involves insuring that the organisation is actually attaining it’s objectives.
Decision making is making choice between other alternatives. All these are relevant and applicable in credit management.
What is credit management
Credit management may be defined as the maximization of the value of an organisation by achieving a trade off between liquidity and profitability.
The bank dual objective of profitability and liquidity can only be realized if the loan portfolio is efficiently and effectively managed.
The profitability objective is the maximization of profit which satisfies the desires of those who invest in the organisation, while the liquidity objective provides for continuous liquidity which satisfies the depositor.
The liquidity objective is as important as the profitability objective because the depositors continuous patronage and confidence in a bank is the basis for achieving profit maximization objective.
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The consequence of this is that bank loan (credit) portfolio must be effectively and efficiently managed to ensure realization of the corporate objective.
Objectives of Credit Management
The main objectives of credit management especially to a banking institution include;
1. To obtain optimum liquidity.
2. To maximize profit.
3. To control the cost of managing credit so as to keep it at a minimum.
4. To keep the credit portfolio at an optimum level.
Need for Credit Management
According to Pandy, granting of credits and it’s management involves costs.
To maximize the value of the firm (bank), these costs must be controlled and they should remain within acceptable limit.
These costs include the credit administration expenses, bad debt losses and opportunity costs of thr fund tied in receivables (loan).
Beside, these costs are absence of credit management will lead to low profit arising from increasing bad debts.
It will also lead to increase in credit interest risk, distortion in production activities in the economy as well as the failure of lending to perform it’s functions of creating.
New investment, employment, providing income, generating savings and improving the standard of living of the people.
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The need for credit management therefore arose as a result of the need to regulate and control these costs so as to keep them at the bearest minimum since they cannot be totally eliminated.
Credit Policy
Extension of credit involves fund which have opportunity cost in themselves.
The objective of credit management cannot be achieved without investment in loan portfolio.
Because of this, a trade off should be established between costs and benefits to bring investors and debtors at an optimum level.
To achieve this, a dynamic credit policy and management must be put in place to help in optimizing the loan portfolio at a minimal cost.
Credit policy is defined as those decision variables that influence the amount of credit.
You can also say that credit policy is a policy involving a trade off between the profits on sales that give rise to receivables (debtor) on the hand and the cost of carrying these receivables plus bad debts losses on the other.
The primary purpose of a written credit policy is to provide a framework of standards and point of reference within which individual lending personnel can operate independently and with relatively uniformity and flexibility while making their individual decisions within their respective delegated authority.
The absence of this clean cut guideline may lead to diversities in the application of credit policies by the credit officers or the concentration of all decision making in respect of approval of credit in the hands of one or two persons at the top.
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In addition, well conceived lending policies and careful lending practices are essential to facilitate the credit creating function and minimize risk in lending.
A carefully articulated lending portfolio are in line with the objectives and aspiration of the credit management of a bank.
In formulating a lending policy, a number of areas which have direct bearing on credit creation must be considered.
Some of the these areas includes the following;
- Business scope
- Marketing strategy
- Liquidity
- Credit portfolio composition
- Authorization levels and limits
- Documentation
- Repayment
- Interest rates
- Security and collateral
- Bad and doubtful debts
- Operational risk
- Control
Some explanation or the terms are as follows;
Business Scope: The credit policy must define the scope of the business activities that the bank must undertake and extend the manner it can participate.
Market Strategy: The bank’s stance in seeking after and developing new commitment customers.
Liquidity: Apart from maintaining the statutory liquidity ratio, a bank must retain in liquid, or readily realisable form.
Also with sufficient funds to meet an abnormal or unforseen demand by depositors.
Authorization levels and limits: Establishment of the various credit management levels, in a hierarchical order with their respective authorization limits.
This should be in line with the discretionary powers of the various officers.
Repayment: This is the bank loan repayment philosophy. Generally, banks are not willing to commit their funds to long term financial needs, even to the productive sector of the economy.
Though in recent times, there has been a shift from the traditional trend of bank repayment in credit management.
Interest Rate: The gross profit margin of the banks used to be predetermined by the monetary authority who prescribed the interest rates payable on deposit and the rates chargeable on loan and advances.
Now that the rates have been led to the market forces, it is imperative that banks policy on interest rates is such as would enable it to compete favorably within the industry.
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Such policy must in addition ensure a reasonable contribution margin.
Security/Collateral:
Clarification as to the types of securities or collateral acceptable to the bank and their relative safety margins and perfection procedures must also be sort out.
This is what credit management and it’s objectives is all about, and i hope that this article helped you in understanding how to manage credit in a firm and organization.