Developing A New Credit Risk Management Strategy

07/30/2009 - Finance Changes to a lender's credit risk management strategy have to balance needs in both the current and future credit landscape. Decisions made solely to plug leaks in a lender's credit portfolio could undermine the financial foundation of the company, ultimately weakening its position in the market.

For example, in response to losses from defaults a credit card company raises rates across the board. While this might bring in more money over a few months, this decision could be disastrous. Customers with good credit are likely to move their accounts to other credit providers. Borrowers who have poor credit will complain about the rate increases, but their financial situation precludes them from getting new credit elsewhere. The result is the credit card company's lending portfolio contains a greater ratio of high-risk customers.

Successful Companies Develop Strategic Plans

The latest generation of loan review software gives today's lenders tools unimagined in previous decades. The ability to analyze and categorize the current loan portfolio enhances a lender's ability to create a strong credit risk management strategy. Lenders must develop comprehensive risk management programs that protect themselves without burdening good customers.

A borrower's creditworthiness should be evaluated based on the most recent data available. The FICO score is still a valuable tool, but is based on old data. A borrower's financial situation may have changed significantly since then. Recent charging and payment history should be taken into account, and any significant change in a borrower's habits may be a sign of impending trouble. This doesn't mean closing a suspicious borrower's account, but the lender might think twice before approving a credit limit increase.

Regularly Revisit Your Credit Risk Management Strategy

Recent events have emphasized that the financial world changes, sometimes very quickly. A credit risk management strategy that is effective today could be completely useless in a year or two. Risk management must be an ongoing practice so the lender can reposition as the market changes.

This is especially true for lenders forced to make significant changes in their pricing structures to cover near-term losses. After evaluating the situation, a business might decide it is worth the risk of losing some of their better customers. In this case the policy changes should be reviewed later to see if they are still relevant. As the economy recovers, lenders can't afford to get complacent again.

Financial institutions must acquire the tools needed to survive in today's rapidly changing economy. Old technology can't provide the flexibility and agility needed. Update your credit risk management strategy before it's too late.