Credit groups can deal with inadequacies

The recent collapse of Chase Bank, Imperial Bank and Nakumatt supermarket chain requires a closer look at credit management policies in the commercial sector.

It calls for questions as to how the sector operates. Is there need for more credit information? What are the advantages of receiving such information and how can it ultimately minimise credit risk, thus boosting a firm’s performance?

Credit risk can be defined as the probability of financial loss resulting from a debtor’s failure to meet his obligations on any type of debt. Credit policies are recognised as an effective antidote for risk, spelling out credit terms, limits, know-your-customer processes, supporting documentation, and any other requirements.

Formulation and enforcement of credit policies reflect a more forward-looking view of credit risk which may enhance an institution’s risk management framework and contribute positively to its long-term success. In addition to this, proper credit management, if assessed by an independent body, can enhance confidence in the firm’s prospects.

Credit risk management is the practice of improving a company's sales and profits by keeping both credit risk and payment delinquencies within acceptable limits. In order to mitigate losses one needs to find the right balance in the risk-reward relationship between sales and bad-debt losses.

Unfortunately, due to the poor payment practices in the Kenyan market it is difficult to adequately and effectively plan cash flows. Furthermore, it becomes an expense as some companies incur further collection costs to recover outstanding debts.

In many developed economies several tools are used to assess and collect outstanding debt. One of these methods is credit groups that enable members to anonymously contribute receivables and payables information to create an accurate assessment of their businesses and their customers.

By applying to join industry credit groups one can submit data on common customers and create a clear credit profile based on aggregated information from industry players.

A good example in the case of Nakumatt. Had the supermarket chain’s suppliers belonged to an industry credit group administered by an independent trade bureau and provided debtor information on Nakumatt, they would have an accurate view of Nakumatt’s ability to repay debt and likely saved themselves significant losses. This information is valuable to not only current players but to potential investors in businesses.

READ: Audit reveals Nakumatt suffered Sh18bn fraud

This will address several challenges that currently face successful risk management in Kenya today. For starters, inefficient data management limits ability to access the right data whenever it is needed causing delays in decision making. Credit groups coupled with the right technology mean that accurate information is only a click away.

Secondly, lack of credit management frameworks in companies remains a big disadvantage. This is because without it, companies cannot generate complex, meaningful risk measures and get a clear picture of groupwide risk.

Not only that, if the information is kept internally it is difficult to gauge your performance against industry peers. Constantly changing credit policies is a problem as credit analysts cannot change model parameters as easily, which results in duplication of effort and negatively affects the efficiency ratio.

This is easily fixed through credit groups. Finally, insufficient risk tools for financial institutions affect the ability of managers to identify portfolio concentrations or re-grade portfolios often enough to effectively manage risk.

Managing risk in any firm is easier if a number of controls are put in place. The easiest method is simply evading risk by declining requests to extend credit facility to flagged accounts. If accounts are flagged, how does this information ensure that you are repaid?

By sharing information within a credit group, the accounts are flagged across the sector and the client has less access to credit from other firms. Firms also benefit as this database of debtors is disseminated through credit reports generated by industrywide information.

Governing risk involves developing a comprehensive strategy that will mitigate credit risk in the company.

Clear controls and procedures on whom to extend credit to using all sources to assess a potential customer and what remedies to employ when a customer fails to pay are important in governing credit risk.

Very few companies accept doing business with customers identified as high risk. These tend to be companies trying to gain market share, companies with high profit margins or those with adequate reserves for the bad debt losses that are almost certain to accompany this policy.

Finally, one can transfer risk by working with debt factoring companies willing to purchase receivables and ease cash flow.

In conclusion, credit risk management is a dynamic process that requires the use of meaningful reporting within a strong governance structure.

An effective credit program provides directors and senior management with critical information to identify and proactively respond to emerging risks and support strategic decisions. Sharing and pooling credit information significantly reduces risk by increasing client and firm assessment abilities.

Credit management, has a public face accessible by banks, employers, insurers, property managers and many other organizations. This public reputation is summed up in form of a days beyond terms report, which is based on credit history. This report makes it easier to gauge the likelihood of repaying on time. It also provides potential suppliers confidence in extending credit to firms and potential creditors such as banks confidence in extending financing.

Najma Dadar, Managing Director, Veri-Credit.