CREDIT RISK MANAGEMENT || TRAIN ANIL MAURYA

Objective of the E - BOOK || TRAI ANIL MAURYA 

To minimise the credit risk
Key Learnings from the Video

1. What is Credit Risk?

When your debtor defaults in repayment of the principal amount of loan and interest, it is known as "Credit risk."

For example:

You gave Rs.10, 000 as a loan to some person at 10% interest.
If he defaults Rs.10, 000 (principal amount) and Rs.1000 (interest), then he will face a credit risk of Rs.11, 000.
2. Credit Risk- Factors

Poor cash flows: If the debtor has poor cash flows, he may not be able to repay your loan.
Rising interest rates: Borrowers may default due to the rise of interest rates of the loan.
For example:

A person borrowed a certain amount at an interest rate of 9% but now it has risen to 12%.
He might be unable to repay the loan and interest amount in this situation due to the increased interest burden.
Failure of business/profession: There are chances that the amount borrowed is invested in a business/profession which fails. So, he might not be able to repay the amount.
Change in market conditions: Market conditions might change due to which the borrower might not be able to repay the loan amount.
Willingness: Some people intentionally don't want to repay the loan amount. There are many cases wherein borrowers have raised loans and move to another country, even when they could easily repay the loan.
Interest rate: Banks offer low interest rates to people who have high creditworthiness whereas they offer high interest rates to people who have low creditworthiness.
If you have a strong cash flow with a strong will to repay the loan and there are no earlier defaults in your profile, banks will give you the loan at a low interest rate.
If you are a small startup with no strong cash flows, NBFC’s will charge 15-24% interest rate annually whereas they will charge 8-9% annual interest rate from big business houses such as Reliance.
3. Steps to reduce credit risk

(1) Check new customer’s credit records:

You should thoroughly check the credit record of your new customer with the help of:

CIBIL: CIBIL score of more than 650 shows low credit risk by a person. It shows the person has never defaulted loans and paid installments on time.
Previous creditor’s investigation: You can do a background check of your borrower with someone who in the past may have dealt with this particular borrower.
Credit reporting agency: You can take the help of a credit rating agency if you are giving a large amount on loan.
Financial statements: You can check the financial statements of the borrower for credit analysis.
(2) Paperwork- Sign credit application: You should complete all the necessary paperwork and take a signed credit application from the borrower. He has to fill the following details in this application:

Contact information
Company’s name
Company's director's name
Business profile
Personal guarantee
Banking details
References
(3) Establish credit limits: You should set limits for providing loan based on:

Credit agency reports
Bank transaction reports
Financial statements such as balance sheet, P&L account, and cash flow
(4) Clear credit terms: You should mention the terms while providing a loan to the borrower.

(5) Credit risk insurance: If the borrower defaults in repayment of loan, the insurance agency will pay you the amount. So, you should do credit risk insurance.

(6) Factoring services: You can discount your bill of exchange with the bank.

For example:

You have a bill receivable worth Rs.1,00,000 from Cadbury company.
You can discount this bill with the bank for Rs.95,000 and at the maturity time, the bank can collect the amount from the company.
(7) Overdue accounts: You should use an aging report for overdue accounts.

For example:

If there is a delay by 1 day, you can send an e-mail reminder.
If there is a delay by 1 week, you can give a friendly call.
If there is a delay by 15-30 days, you can send a strong e-mail to the borrower with all the necessary attachments and also send a demand letter with registered post.
If there is a delay by 60 days, you can send a legal notice.
(8) Due diligence: While giving a loan/credit to a company, you should check:

Profits
Net worth
Shareholder funds
Working capital
Relations with suppliers
Defaults
Relations with bankers
(9) Early payment discount: You can give cash discounts to the credits for early payment.

Thus, you should follow all these steps to minimise the credit risk in your business.  

Key Outcomes of the Video

Use an aging report for dealing with overdue accounts
Check the financial statements of the borrower for credit analysis
Take the help of a credit rating agency while giving a large amount of loan


CREDIT GOES TO BADA BUSINESS 

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