Credit Management as an Essential Component of FM

8/9/2019 Credit Management as an Essential Component of FM

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Credit Management as an Essential Component of

Financial Management

The term credit management may be broadly distinguished into twoidea or concepts. The first one mainly means the business owners

implementing credit management policies to receive the financial

obligations on time and avoiding bad debts. The second one mainly

means that if you are an American who is concerned about paying his

obligations on timely basis and thus meanings definitely deal with debt

management solutions the parties either being the creditors

themselves or debtors.

How Can A Debtor Save On His Credit Score?

Credit score plays a very important role is anyones life as a good credit

score opens great financial avenues for your future. With a good credit

rating you may be extended help for loans and credits. And thinking of

the poor side with a poor credit rating you will always face a problem

availing a loan. Thus you must pay your bills on time. You must pay off

your creditors before the due date. Pay off your credit card obligations.

All these things will help out to save your interest and late fees, which is

very high. You can save a lot of you money. You should not be running

away from your creditors. You will have to coordinate with them and

see how cooperatively they are. They all have specific debt

management plans that can benefit you. Dont run away from them or

else you will be landed up in a bigger trouble.


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How Can Credit Management Solutions Help The Creditor or The

Business Owner?

You are a company or run a business. You can avail benefit of these

services to get your payments on timely basis. It will generate a cash

flow on the regular basis by efficient management and collection of

current and overdue credits extended. It maintains good client-business

relationship. Of course for these services credit management

companies charge come fees. But it is truly worth it. It also helps to

verify the clients good will and credit standing before giving any credit

to them. By abiding by credit management policies specifically designed

for the company these companies check the credit worthiness of your

prospective client and saving a lot of your time and energy.

It Can Help You To Get Back On The Financial Track

These services are extended to the individuals who find it difficult to

pay off their debts on time. For these people they design special credit

management strategies. These companies negotiate with your creditors

and come up with ways that can be feasible to save on your credit score

and also bring you back on the financial track. It can apply to consumer

loans, credit cards, personal loans, outstanding medical bills, auto loans

etc. in all these cases, the company negotiates with the creditor on

behalf of the borrower who is in financial trouble. By doing so it enables

the creditors to accept the fraction of the obligation amount and thus

save money for the borrower and thus making him capable to stand upefficiently again. A positive relationship exists between risk and profits.

So both risk and profit objectives should be balanced. Profit

maximization does not take into account the social considerations.


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The objective of financial management is the same as the objective of a

company which is to earn profit. But profit maximization alone cannot

be the sole objective of a company. It is a limited objective. It profits

are given undue importance then problems may arise as discussedbelow. The profit is vague and it involves much more contradictions.

Profit maximization must be attempted with a realization of risks

involved.

1) Financial Management is sources of Profit Maximization.

The term credit management may be broadly distinguished into two

ideas or concepts. The first one mainly means the business ownersimplementing credit management policies to receive the financial



obligations on timely basis and thus being on the financial track

avoiding low credit ratings. However these two meanings definitely

deal with debt management solutions the parties either being the

creditors themselves or debtors.

2) Financial Management is sources of Wealth Maximization.

The capitalization rate reflects the liking of the investors for the

company. Methods of financial management: in the field of financial

there are multiple methods to procure funds. Funds may be obtained

from long term sources as well as from short term sources. Long term

funds may be procured by owners that are shareholders, lenders by

issuing debentures, from financial institutions, banks and the general

public at large. Short term funds may be availed from commercial

banks, public deposits, etc.


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Financial leverage or trading on equity is an important method by

which a financial manager may increase the return to common

shareholders.

It is commonly understood that the objectives of a firm is to maximize

value and wealth. The value of a firm is represented by the market

price of the companys stock. The market price of a firms stock

represents the assessment of al market price of all market participants

as to what the value of the particular firm is. It takes in to account

present and prospective future earnings per share, the timing and risk

of these earning, the divided policy of the firm and many other factors

that bear upon the market price of the stock. Market price acts as the

performance index or report card of the firms progress and potential.

Prices in the share markets are affected by many factors like general

economic outlook. Outlook of the particular company, technical factors

and even mass psychology. Normally this value is a function of two

factors: the anticipated rate of earnings per share of the company the

capitalization rate. Similarly, for the evaluation of a firms performancethere are different methods. Ratio analysis is a common technique to

evaluate different aspects of a firm. An investor takes in to account

various ratios to know whether investment in a particular company will

be profitable or not. These ratios enable him to judge the profitability,

solvency, liquidity and growth aspect of the firm.

The likely rate of earnings per share depends upon the assessment ofhow profitable a company may be in the future. At the time of

evaluating capital expenditure projects methods like average rate of

return, pay back, internal rate of returns, net present value and

profitability index are used.


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A firm can increase its profitability without adversely affecting its

liquidity by an efficient utilization of the current resources at the

disposal of the firm. A firm can increase its profitability without

negatively affecting its liquidity by efficient management of workingcapital.1. while financial institutions have faced difficulties over the

years for a multitude of reasons, the major cause of serious banking

problems continues to be directly related to lax credit standards for

borrowers and counterparties, poor portfolio risk management, or a

lack of attention to changes in economic or other circumstances that

can lead to a deterioration in the credit standing of a banks

counterparties. This experience is common in both G-10 and non G-10countries.

2. Credit risk is most simply defined as the potential that a bank

borrower or counterparty will fail to meet its obligations n accordance

with agreed terms. The goal of credit risk management is to maximize a

banks risk-adjusted rate of return by maintaining credit risk exposure

within acceptable parameters. Banks need to manage the credit riskinherent in the entire portfolio as well as the risk in individual credits or

transactions. Banks should also consider the relationships between

credit risk and other risks. The effective management of credit risk is a

critical component of a comprehensive approach to risk management

and essential to the long-term success of any banking organization.

3. For most banks, loans are the largest and most obvious source of

credit risk;

However, other sources of credit risk exist throughout the activities of a

bank, including in the banking book and in the trading book, and both

on and off the balance sheet.


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Banks are increasingly facing credit risk (or counterparty risk) in various

financial instruments other than loans, including acceptances,

interbank transactions, trade financing, foreign exchange transactions,

financial futures, swaps, bonds, equities, options, and in the extensionsof commitments and guarantees and the settlement of transactions.

4. Since exposure to credit risk countries to be the leading source of

problems in banks world-wide, banks and their supervisors should be

able to draw useful lessons from past experiences, banks should now

have a keen awareness of the need to identify, measure, monitor and

control credit risk as well as to determine that they hold adequate

capital against these risks and that they are adequately compensated

for risks incurred. The basel committee is issuing this document in

order to encourage banking supervisors globally to promote sound

practices for managing credit risk. Although the principles contained in

this paper are most clearly applicable to the business of lending, they

should be applied to all activities where credit risk is present.

5. The sound practices set out in this document specifically address thefollowing areas:

i. Establishing an appropriate credit risk environment.

ii. Operating under a sound credit-granting process.

iii. Maintaining an appropriate credit administration, measurement and

monitoring process andiv. Ensuring adequate controls over credit risk.

Although specific credit risk management practices may differ among

banks depending upon the nature and complexity of their credit


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activities, a comprehensive credit risk management program will

address these four areas. These practices should also be applied in

conjunction with sound practices related to the assessment of asset

quality, the adequacy of provisions and reserves and the disclosure ofcredit risk, all of which have been addressed in other recent Basel

Committee documents.

6. While the exact approach chosen by individual supervisors will

depend on a host of factors, including their non-site and off-side

supervisory techniques and the degree to which external auditors are

also used in the supervisory function, all members of the Basel

Committee agree that the principles set out in this paper should be

used in evaluating banks credit risk management system. Supervisory

expectations for the credit risk management approach used by

individual bank should be commensurate with the scope and

sophistication of the banks activities. For smaller or less sophisticated

banks, supervisors need to determine that the credit risk management

approach used in sufficient for their activities and that they haveinstalled sufficient risk-return discipline in their credit risk management

processes.

7. The committee stipulates in Sections II through VI of the paper,

principles for banking supervisory authorities to apply in assessing

banks credit risk management systems. In addition, the appendix

provides an overview of credit problems commonly seen by

supervisors.

8. A further particular instance of credit risk relates to the process of

settling financial transactions. If one side of a transaction is settled but

the other fails, a loss may be incurred that is equal to the principal


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amount of the transaction. Even is one party is simply late in settling,

than the other party may incur a loss relating to missed investment

opportunities. Settlement risk (i.e. the risk that the completion or

settlement of a financial transaction will fail to take place as expected)thus includes elements of liquidity, market, operational and

reputational risk as well as credit risk. The level of risk is determined by

the particular arrangements for settlement. Factors in such

arrangement that have a bearing on credit risk include: the timing of

the exchange of value; payment/settlement finality and the role of

intermediaries and clearing houses. The active management of credit

risk has risen to the top of the agenda of most financial institutions inthe last couple of years and for good reason. Despite high-profile fears

about the risks of electronic banking, or losses from derivative

positions, inadequate credit risk management is still the biggest source

of serious banking problems according to the Basle Committee the

international banking supervisory body.

The new capital Accord, likely to be agreed within the next year, willgive larger institutions major incentives to reduce their regulatory

capital and save money by improving their credit management

practices. Meanwhile, greater industry competition, industry

consolidation and new technology are adding to the pressure to

improve credit risk management throughout the financial industry. The

current emphasis on shareholder value and risk-adjusted return on

capital is directing investment towards business lines that manage theirrisks more effectively including all types of credit risk. Traditionally,

credit risk refers to the risk that a borrower of counterparty will fail to

meet its obligations. Lending from credit cards to corporate loans is the

largest and most obvious source of credit risk.


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But credit risk in some guise exists throughout bank activities, both on

and off the balance sheet from acceptances, interbank transmissions,

trade financing and derivatives trading to guarantees and settlement.

As you can see by passing your cursor over each point in the circle

below, its not just banks that are subject to credit risk. Fund managers

and investors are directly exposed to credit risk in their fixed-income

investments. Insurance companies are exposed to it through their

credit investment and credit guarantees. Companies are exposed to the

risk that trading partners, distributors or suppliers may default or fail tolive up to critical obligations.


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The advances in measuring and managing credit risk mean that a

passive absorption of credit risk by these companies is the way of the

past. Leading institutions now regularly isolate and package portions of

their credit risk by means of new tools credit derivatives andsecuritizations and pass it to the financial markets. These transactions,

often hybrids of the first generation credit default or total return

swaps that appeared in the mid-1990s are thawing out the credit risk

that lies frozen in bank portfolios and channeling it to investors as our

first Expert Witness testifies.


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The scroll-over Credit Cycle diagram, above, helps make clear how

interlinked all these changes are. An unholy alliance of factors set the

Cycle in motion in the early 1990s: new credit modeling technology,

investor demand, bank marketing, the needs of risk managers and thepower of diversification and attempts to arbitrage regulatory rules on

capital charges.

But the end result is that credit is developing as an asset class for

investors and as a means of diversification for banks and an increasing

range of financial institutions including insurers as our next Expert

Witness explains.

As it matures, the supply side of the credit risk cycle is increasingly

driven by attempts to maximize the risk adjusted rate of return on

credit risk in each institution, while at the same time transferring away

any life-threatening concentrations and correlations of credit risk. Here,

two measures of credit loss expected loss and unexpected loss are the

key to banks attempts to anticipate their future risk exposures.

Expected loss is the average anticipated loss rate on a portfolio in one

year, based on historic loss experience; unexpected loss is the

anticipated variation in that loss rate. By understanding better its

unexpected loss rate at portfolio level in particular, the influence of

correlation on its risk exposures a typical institution might expected to

reduce the economic capital consumed by its credit portfolio by 25-

30%. As the paper below makes clear, banks can achieve these savingseven when using quite simple optimization techniques.

And while banks improve the way they identify, measure, monitor and

control their credit risk, they are also developing techniques and


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systems that track the relationship between credit risk and other risks,

such as market risk to enable full enterprise wide risk management.

The first step is to know your credit risks.

The first step in the credit risk management process is for an institution

to identify the risky credit in its portfolio of loans, dealer or

transactions. Banks, for example, achieve this by assigning a credit

score or rating to each individual borrower, so the bank can begin to

understand its credit risks and assess how best to manage them.

Some assets are easier to assign a credit score than others. The most

developed credit scoring techniques are for consumer loans, such as

credit cards and auto loans. As early as the 1980s, credit bureaus

focused on information such as credit delinquency and debt burden to

assess credit quality. A bureau score that captures almost all the

measurable risk inherent in a consumer relationship can be purchased

readily and cheaply from a credit bureau such as Equifax or Experience.

Credit provides also use information supplied in credit applications,

such as income and whether the individual owns or rents his home.

Automated scoring techniques provide a three digit number derived by

computer algorithm from the individuals credit report, which is

compared with patterns in thousands of past credit reports.

Bureau scores are also applicable to some small business- possibly

those up to $ 1 million in asset size, as many startup companies are

considered to share the credit characteristics of their founders. But

there are also many proprietary and industry standard approaches to

credit scoring in the small business sector.


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Increasingly, consumer and small business credit scores are augmented

by data mining technology that helps institutions analyze the reward

part of the risk/reward equation for example; a consumer segment

analysis might rank customers in terms of their propensity to carry arevolving balance. This is important because a customers profitability is

not only decided by the chance that they will default, but also by the

likelihood that they will take up bank offerings. Marginally risky

customers are not always loss makers. One reason for this is the

problem of data. Information exists on hundreds of thousands of bad

credit card debts and millions of goods ones. In contrast studies on

commercial default models rely on relatively tiny numbers of defaultingcompanies, partly because the universe of potential defaulters is

smaller, but partly because reliable data is difficult to obtain and filter.

Outside the US, the data problem extends even to the largest

companies. This is partly because public credit ratings have been

applied to major US companies for years Moodys default database

holds information on 1,975 public US and Canadian companies thathave defaulted since 1980. By comparison, only 14 holders of long term

local currency rating have defaulted in Europe since standard & Poors

began rating corporations there in 1975. All but two of these defaulted

in the last two years.

Because of a serve leak of publicity available European data on credit

losses, data on recovery rates of US corporate bonds the amount that

is likely to be recovered by a creditor if a company defaults, are used to

infer European recovery rates. But there is no standard or accurate,

methodology to do this. The data problem makes it more difficult to

apply statistical approaches, and so more subjective methods have to

be called upon.


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These includes business report scores available for a small fee to

suppliers and purchasers of trade credit, based on liens, court actions,

creditor petitions and company age and size.

Credit scoring for such middle market companies relies on how an

individual bank interprets various financial ratios derived from a

borrowers financial statement and other data such as industry sector.

While the approaches are increasingly sophisticated, they are not

standardized and are difficult to compare and back-test against data.

The Credit Cycle we identified earlier looks set to change this. Banks are

recording that without standard ways to assess the credit risk in theirportfolios, it will be difficult to convince both regulators and credit

investors that loan and other credit-linked middle market portfolios

represent a specific level of risk. Meanwhile, major credit rating

companies have begun to promote modeling approaches for middle

market credits that weight the various financial ratios in a manner that

is standard and which can be more easily tested against the limited

historical data that is available.

Public credit ratings are not the only way to assess the credit risk posed

by larger companies. The most commonly used quantitative method is

based on principles expounded by the well-known academic and

researcher Robert Merton. These Merton Models consider the

companys equity as a call option on the value of the firms assets, in

which the strike price of the option is related to the liabilities of thefirm. The equity value and its volatility, together with the level of

liabilities, provide information that allows the credit modeler to

estimate the default probability of the quoted company.


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Traditionally, once credits have been measured or scored, a bank would

decide to accept or reject the implied credit risk of the transaction. But

the new credit risk modeling, pricing and transferring tools mean that

banks can now actively manage their loan portfolios to ensure anefficient risk/reward ratio and sufficient diversification of loans much

as they would an investment portfolio.

The Role of the Rating Agency

Credit rating are vital to the credit industry because they offer

consistent and publicly available credit scores, produced by

independent agencies, for either he credit worthiness of a major entityor for a particular debt security or other financial obligation.

Ratings helps to determine how much companies and government

must pay for credit but they are also about to take on a new role in the

banking system under the Basle Committees revised Capital Accord.

Within a year or two, they are likely to become one part of the process

that sets the amount of regulatory capital banks must put aside against

credit losses. However, the banking industry successfully argued against

the regulators plans to make rating agencies the cornerstone of the

regulatory capital calculation. Their argument was partly inspired by the

fact that there are only two big agencies on the world stage the banks

and the financial systems might have become dangerously dependent

on these agencies.

Although the agencies are independent, they are paid by the

companies they rate rather than by the users of ratings information a

conflict of interest that has to be carefully managed. Rating agencies

have also been criticized for poor risk estimation and for being too slow

to downgrade their existing ratings when problems appear.


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One of the areas that Basle is keen to stress is the importance of setting

and adhering to credit limits. Banks should set limits by customer,

geographic region and industry sector. Excessive credit exposure to one

or more countries, regions or industries is dangerous because of therisk of default contagion between companies in the same region or

industry. Equally important is calculating accurate exposures against

the banks credit limit. For some areas of the banks business, this can

be particularly difficult. In the case of derivative portfolios, in particular,

there may be no clear relation between a contracts value at a

particular point in time and the potential credit exposure embedded in

it, as the button below explains. Once credit limits have been set, twomethods are increasingly being used by banks to mitigate their

exposure and help lower potential credit losses from derivatives:

netting and collateral. Most financial institutions now use bilateral close

out netting agreements to prevent a defaulting counterparty from

stopping payments on contracts with a negative value while demanding

payment on those with positive value.

The use of collateral has also grown dramatically in the last few years,

particularly in the derivatives market, where the amount a firm stands

to lose if counterparty defaults depend on how the market moves over

time.


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Practical Study

The function of commercial banking and application of the fundamental

principles of the depositor bank relationship have remained essentially

the same since about 500 B.C. Bank operation methods and

procedures, on the other hand, have undergone a constant process of

evolution because of economic growth, the mounting volume of

transactions and greater use of banking facilities.

As a result of these contributing factors, methods and practices

necessary to handle the increased volume of detail work have been

developed while another and quicker methods have been adopted inorder to cope with the increased volume, much of which has been

accomplished without unduly increasing the cost of doing business.

During the last twenty years we have experienced a constant transition

from the old to the new from manual to mechanical methods and

procedures from old established practices to current techniques and to

a more scientific approach to the solution of problems brought about

by day to day changes in business practices.

Our Banking System Today:

The banking Business as we know it today is composed of three

separate and distinct principal functions.

1-The acquiring of funds to invest and loan.2-The investing of such funds in loans and bonds.3-The servicing of such funds, such as providing of checking/saving

facilities, and the collection of draft, notes and checks.


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These functions, while differing in detail of operation, follow the same

principles established hundreds of years go by money-lenders and

exchangers.

Bank Definition

Banks are institution that enjoys the public money doing nothing for

the public. According the banking ordinance 1962 sec (6),

Banks mean the acceptance of deposit for the purpose of lending or

the investment of deposit of money from the public repayable on

demand or otherwise withdraw able by cheques, drafts, orders and

otherwise

Banker

Banker includes a body of persons whether incorporated or not who

carry on business of banking.

Allied Bank Ltd

ABL is the first Muslim Bank established on territory that later on

became Pakistan. It was established on December 3, 1942 as

Australasia Bank at Lahore with capital of 0.12 million. At that time the

chairman was Kh. Bashir Baksh. ABLs story was one of the dedication,

commitment to professionalism and adaptation to changing

environmental changes the banks history is divided into many phases.During 25 years of united Pakistan the bank advanced forward in all

areas of its activities. 1970s were a difficult decade for all Banks of

Pakistan. In 1971 East Pakistan was separated and Australasia bank lost

its 50 branches and a lot of capital as well.


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Nevertheless the growth steady, in 1974 all the banks were

nationalized including Australasia Bank.

Objects are as follows;

i. Main objective of Allied Bank is to earn profit.ii. To provide services to their customers and assistance in the

development of commerce and trade.

Allied bank also have another responsibility to give service to their

communities. It watches the growth and development of his

community especially the commerce and business of the area.

Management System

Successful and profitable banking management depends on two

principal factors.

A. The manner in which the functions of banking, that is theacquiring of deposits, the investing or converting such deposits

into earning assets and the servicing of such deposits areperformed.

B.The degree to which officers and employees contribute theirtalents to the progress and welfare of the bank in discharging

duties and responsibilities.

Business Basic Checking

A great account to hold down the cost of your business checkingaccount. There are no monthly service charges or per check charges

when a $100 minimum balance is maintained plus there is no charge

for deposited items. Only $25 is required to open account.


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Business Now Account

This account enables sole proprietorships, municipalities and some

nonprofits to earn interest on account balances, with a $500 minimum

balance to earn interest and avoid monthly service charge.

Money market Account

With our money market account you can get limited check writing

privileges plus the higher yields of an investment account. This account

offers a tiered interest rate.

Municipal Now

This account is an interest bearing operating account. Collected funds

deposited into this account, in excess of the FDIC insured deposit

balances, will be collateralized with U.S. Government and Agency

Securities.

Credit Management

The term credit management may be broadly distinguished into two

ideas or concepts. The first one mainly means the business owners




obligations on timely basis and thus being on the financial track

avoiding low credit ratings. However, these two meanings definitely

deal with debt management solutions the parties either being the

creditors themselves of debtors.


22/24

How Can A Debtor Save On His Credit Score?

Credit score plays a very important role in anyones life as a good credit

score opens great financial avenues for your future. With a good credit

rating you may be extended help for loans and credits and thinking of

the poor side with a poor credit rating you will always face a problem

availing a loan. Thus you must pay bills on time. You must pay off your

creditors before the due date. Pay off your credit card obligations. All

these things will help out to save your interest and late fees, which is

very high. You can save lot of your money. You should not be running

away from your creditors. You will have to coordinate with them and

see how cooperative they are. They all have specific debt management

plans that can benefit you. Dont run away from them or else you will

be landed up in a bigger trouble.

How Can Credit Management Solutions Help The Creditors or The

Business Owner?

You are a company or run a business. You can avail benefit of these

services to get your payments on timely basis. It will generate a cash

flow on the regular basis by efficient management and collection of

current and overdue credits extended. It maintains good client business

relationship. Of course for these services credit management

companies charge some fees. But it is truly worth it. It also helps to

verify the clients good will and credit standing before giving any credits

to them. By abiding by credit management policies specifically designedfor the company these companies check the credit worthiness of your

prospective client and saving a lot of your time and energy.


23/24

It Can Help You to Get Back On The Financial Track

These services are extended to the individuals who find it difficult to

pay off their debts on time. For these people they design specific credit

management strategies. These companies negotiate with your creditors

and come up with ways that can be feasible to save on your credit score

and also bring you back on the financial track. It can apply to consumer

loans, credit cards, personal loans, outstanding medical bills, auto loans

etc. in all these cases, the company negotiates with the creditor on

behalf of the borrower who is in financial trouble. By doing so it enables

the creditors to accept the fraction of the obligation amount and thus

save money for the borrower and thus make him capable to stand up

efficiently again. A positive relationship exists between risk and profits.

So both risk and profit objectives should be balanced. Profit

maximization fails to take into account the time pattern of returns.

Profit maximization does not take into account the social

considerations. The objective of financial management is the same as

the objective of a company which is to earn profit. But profitmaximization alone cannot be the sole objective of a company. It is a

limited objective. It profits are given under importance then problems

may arise as discussed below. The term profit is vague and it involves

much more contradictions. Profits maximization must be with a

maximization must be attempted with a realization pf risk involves.

1-Financial management is Sources of Profit ManagementThe term credit management may be broadly distinguished into two

ideas or concepts. The first one mainly means the business owners


obligations on time and avoiding bad debts.


24/24

The second one mainly means that if you are an American who is

concerned about paying his obligation on timely basis and thus being

on the financial bank avoiding low credit ratings. However, these two

meanings definitely deal with debt management solutions the partiedeither being the creditors themselves or debtors.

2- Financial ManagementIt source of wealth maximization: the capitalization rate reflects the

liking the investors for the company. Methods of financial

management: in the field of financing there are multiple methods to

produce funds. Funds may be obtained from long term sources as wellas from short term sources. Long term funds may be procured by

owners that are shareholders, lenders by issuing debentures, from

financial institutions banks and the general public at large. Short term

funds may be available from commercial banks, public deposits, etc.

Financial leverage or trading on equity is an important method by

which a finance manager may be increased, the return to common

shareholders.

Credit Management as an Essential Component of FM

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