One of the major sources of income for commercial banks in Malaysia and the rest of the world are interests got from the credit given to borrowers. As much as credit brings a lot of revenue to financial institutions, may also turn out to be the major source of loss. To mitigate credit-related losses, commercial banks need to have a reliable credit risk management strategy.
What is credit risk management?
The uncertainty of whether the borrower fulfills all the conditions given to them while borrowing money is what we call credit risk. Credit risk management is the process of identifying, analyzing, and measuring all the risk factors that may result from borrowing out money and also finding ways of eliminating or reducing these risks.
Credit risk assessment
On the other hand, credit risk assessment refers to the process of determining the borrower’s ability to repay the credit given to them. The five major factors (5Cs) used to determine the borrower’s ability to repay include the following;
- Credit history
- Capacity to repay
- Capital
- Loan conditions
- Collateral security
Types of credit Risks
There are three types of credit risks that commercial banks in Malaysia have to always pay attention to before giving out loans. These include;
- Credit default risk. This type of risk arises when the borrower defaults repayment of the loan or fails to pay 90days past the due date of credit payment
- Concentration risk. This is the type of risk that arises when a single or group of borrowers default to pay back huge sums of money that could affect the major bank operations
- Country risk. This is the risk posed when a country that a commercial bank might have lent money pauses the payment of all its debts
Mitigation of Risks
Credit risk can be reduced or eliminated through the following ways
- Diversification of the clients the bank borrows money
- Commercial banks can choose to insure their loans with any of the many insurance companies in Malaysia
- Charging more rates for borrowers who make payments past the due dates.
Who needs credit risk analysis?
Every organization that does any form of borrowing out money needs to do a credit risk analysis. In Malaysia, organizations that need to do credit analysis include; the commercial banks, Central Bank of Malaysia, financial institutions, and NBFCs.
Debt collection in Malaysia
If you are analyzing credit-risk in Malaysia, one of the things you shouldn’t forget looking at are the debt collection procedures and how to manage bad debts. Here is how effective debt management is done;
- Ensure you have proper documentation of all the credit details
- Find appropriate ways of constantly reminding your debtors to pay up
- Sit down with the debtors and come up with the best solutions on how to go about payment of the debt
- Have a debt management budget to aid all debt collection operations
Conclusion
All financial institutions that borrow out money have to do some form of credit risk management to avoid losses that may arise due to bad debtors. Credit risk is determined by calculating the debt to income ratio of the borrowers. If the borrower has a debt to income ratio of less than 35%, then the risk of borrowing to them is considered to be minimal. For more information about credit risk management in Malaysia, check out credit scan Malaysia