Credit Management in India

Managing is a vital aspect of any banking operation, especially in a country like India, where bad debts are a common occurrence. The success of a bank largely relies on its credit management practices. Banks in India play a significant role in the country’s economic development by bridging the gap between lenders and borrowers. Therefore sustainable functioning of banks is crucial for the Indian economy. In this post, we will dive into the nitty-gritty of credit management in India. We will shed light on the different stages involved in credit management and explore the methods to deal with bad debts, which have plagued the banking sector in India for a long time.

1. Importance of Credit Management in India

Credit management is of utmost importance in India, especially when it comes to the commercial banking industry. It acts as a crucial deciding factor in determining the success of any bank and the sustainable functioning of the Indian economy. Banks play a major role in bridging the gap between the lenders and borrowers, and good credit management practices ensure that banks can offer promised returns to their depositors while also earning additional borrowers’ returns.

“Good credit management can make the difference between a company surviving, thriving, or going bankrupt,” says TreviPay, a branded payment method built for business commerce. Credit management not only involves the processes of approving customers for onboarding, extending payment terms, setting credit and payments policy, issuing credit or financing, and monitoring business cash flow, but it also includes assessing and approving new clients, balancing the need to attract customers with the need to avoid risk, and setting payment terms that balance the benefits of longer terms against cash flow issues and risks.

A sound credit management strategy involves analyzing a borrower’s financials and conducting background checks. As Angel One explains, “A bank should examine the borrower’s profile from all possible angles and conduct background checks on the information provided by him.” The collateral valuation process is also essential for credit management in India, as it ensures that the collateral provided by the borrower is sufficient for the amount being borrowed. Additionally, monitoring loan accounts ensures that the borrower services the principal and interest on time and allows for prompt action in case of delayed repayments.

Good credit management practices also result in timely payments of accounts receivable, ensuring a healthy cash flow for both businesses and banks. This is critical for the Indian economy, which is known for higher bad debts. As such, credit management practices must be followed diligently to curb the issues of bad debts in commercial banks in India. 

2. Steps of Credit Management in Commercial Banks

Credit is a vital process that plays a crucial role in determining the success of any commercial bank. In India, where bad debts are unfortunately common, banks have to be extra cautious when offering loans to their borrowers. The process of credit management involves several steps that banks need to follow to ensure the soundness of their credit policies. The steps involved in credit management are:

– Get to know your borrower completely. Conduct background checks on the information provided by them.

– Analyze all the documents submitted by the borrower. Verify ID proofs, bank account statements, and credit score information from registered credit bureaus in India.

– Analyze the borrower’s financials to assess their cash flows and repayment capacity. Compute financial ratios to arrive at the borrower’s financial stability.

– Take collateral from the borrower for big-ticket loans. Conduct a background check of the collateral to ensure its valuation.

– Monitor the loan account to track whether the borrower is servicing the principal and interest on time or not.

– Regularly conduct a valuation of collateral as its value changes over time.

It is important to note that credit management is a continuous process and not a one-time task. The above steps need to be followed for each loan that a bank approves to ensure its credit policies are sound. By following these steps, commercial banks can ensure that they avoid bad debts and minimize any credit-related issues that may arise. As Winston Churchill once said, “However beautiful the strategy, you should occasionally look at the results.”

Overall, credit management is a complex and ongoing process that plays a critical role in ensuring banking industry related to credit policies are effective, efficient, and sustainable. 

3. Role of Loan Management in Indian Economy

Loan plays a vital role in the Indian economy. It involves the efficient handling of loans in a way that ensures timely disbursement, enhanced customer experience, and provisions for quick recovery of loans in case of default. The loan management industry in India is witnessing a profound transformation in recent years and, as a result, is shaping the trends and growth of the Indian economy.

According to a recent article published in the Asian Journal of Economics and Banking, loan management systems have been shifting towards digitization with the advent of new and emerging technologies such as machine learning, artificial intelligence, and blockchain. This transformation has led to increased efficiency, faster loan servicing time, and improved loan application to disbursal processes.

Banks in India are adopting new technologies and omnichannel services to deliver faster and convenient loan servicing experience to customers. With self-serving portals, customers can now communicate with lending institutions through their preferred mediums, be it text or mobile app. As more and more customers prefer digital-first platforms, this trend is set to shape the lending landscape in India by 2022.

Despite the transformation and adoption of new technologies, there is still a need to address credit risk in the industry. According to the same article, non-performing loans (NPLs) are a critical indicator of credit risk burden. Banks need to adhere to regulatory norms, conduct proper credit screening and monitoring to avoid the accumulation of NPLs.

In conclusion, the role of loan management in the Indian economy is evolving, presenting both challenges and opportunities for banks in the country. Adopting new technologies and processes, such as digitization, machine learning, and artificial intelligence, can improve efficiency and customer experience in the loan management industry. Proper credit risk management is also crucial to ensure the stability and growth of the Indian economy. As the loan management industry continues to evolve, it will undoubtedly shape the trends and growth of the Indian economy for years to come. 

4. Analysis of Borrower’s Financials for Credit Management

When comes to credit management, analyzing the borrower’s financials is a crucial step for banks in India. This involves looking at a variety of factors, such as the borrower’s income, debts, assets, and credit history. By analyzing these factors, lenders can better assess the borrower’s ability to repay the loan.

One important aspect of analyzing borrower’s financials is assessing their debt-to-income ratio. This ratio compares the borrower’s monthly debt payments to their monthly income, giving lenders an idea of how much money the borrower has left over each month to put towards loan payments. A high debt-to-income ratio may indicate that the borrower is already overextended and may struggle to make loan payments.

Another crucial factor to consider is the borrower’s credit history. By checking the borrower’s credit report, lenders can see how they have managed credit in the past. A poor credit history, with missed payments or defaulting on loans, may indicate that the borrower is a risky candidate for a loan.

It’s also important to look at the borrower’s assets in relation to the loan amount. Lenders may require collateral to secure the loan, and analyzing the value of the collateral is a key part of the credit management process. Collateral can include property, equipment, or even accounts receivable.

Overall, analyzing the borrower’s financials is an essential step in credit management in India. As one article notes, “Credit granting is not only the primary job but also the main source of income. The quality of credit granting concerns not just the reclaims of creditor’s rights; it also affects the successful running of banks.” By carefully assessing the borrower’s financials, lenders can make sound decisions that benefit both themselves and the borrower.

5. Collateral Valuation in Credit Management

Coll valuation is an essential element of credit management. By determining the value of assets pledged as collateral, lenders can reduce the risk of defaults and improve the chances of recovering the principal and interest in case of borrower’s failure to repay the loan. There are different methodologies used for valuing real estate, such as the sales comparison approach, income capitalization approach, and cost approach. According to Finance Training Course, “Collateral valuation is a key component of credit risk management course, which focuses on collection policies for timely payments of accounts receivables.”

In the evaluation of credit risk, the 5 Cs of credit play an important role in determining the strength of a borrowing request. The 5 Cs are character, capacity, capital, collateral, and conditions. Collateral is one of the key elements considered by lenders since it provides a source of security for the lender. As described by the Overview Credit Risk Framework, “Collateral is when an asset is pledged to a lender as security against credit exposure.”

It’s important to note that collateral is not always necessary or sufficient for granting credit. The value of collateral should be appropriate to the risk involved in lending, and the borrower’s character and capacity should also be considered to ensure the soundness of the overall borrowing request. As explained by the Finance Training Course, “Collateral management is a process that involves the creation, perfection, and enforcement of security interest in collateral. After full repayment, security interest is terminated.”

In summary, collateral valuation is an essential aspect of credit management in India. Lenders use different methodologies for valuing real estate and other assets pledged as collateral to reduce the risk of defaults. The 5 Cs of credit, including collateral, also play a critical role in evaluating the strength of a borrowing request. Lenders should consider a borrower’s overall creditworthiness, character, and capacity before relying solely on collateral for security.

6. Monitoring Loan Accounts for Sound Credit Management

Monitoring loan accounts is a crucial aspect of credit management in India. It ensures that banks can identify potential risks and take timely action to mitigate them. Effective monitoring helps banks to maintain the quality of their loan portfolio and enhance their creditworthiness. In this section, we will discuss some of the key aspects of monitoring loan accounts for sound credit management.

One of the key elements of monitoring loan accounts is keeping track of the borrower’s repayment behavior. Banks should track the payment history of borrowers and take corrective action in case of any delinquency. This could include sending reminders, renegotiating the loan terms, or even initiating legal action if necessary.

Another important aspect is analyzing the borrower’s financial statements and creditworthiness on an ongoing basis. This will help banks to assess whether the borrower’s financial position has changed significantly, and adjust their lending policies accordingly.

Collateral valuation is also an essential part of monitoring loan accounts. Banks should ensure that the collateral pledged by the borrower is adequate and that its value is reviewed periodically. This helps to safeguard the bank’s interests in case of default by the borrower.

Sudhir Joshi, Head of Risk Management at HDFC Bank, emphasizes the need for a comprehensive monitoring framework. “Effective monitoring should be an ongoing process, and banks should use a combination of quantitative and qualitative measures to analyze the performance of their loan portfolio. This will help them to identify early warning signals and take proactive measures to mitigate risks.”

To summarize, monitoring loan accounts is a critical component of credit management in India. It helps banks maintain the quality of their loan portfolio, identify potential risks, and take timely action to mitigate them. By adopting a comprehensive monitoring framework, banks can enhance their creditworthiness and strengthen their position in the market. 

7. Valuation of Collateral as Good Credit Management Practice

Val of collateral is an essential part of credit management, especially in cases where creditors want to mitigate risks associated with loan defaults. Collateral usually serves as a backup security for the creditor to recover funds in the event of a loan default. In India, among the various credit management practices, the valuation of collateral occupies a significant position.

According to Investopedia, “collateral is any asset that a lender accepts as security for extending credit.” The value of the collateral is dependent on market conditions such as the supply and demand for assets, and the liquidity of the market. Therefore, proper assessment of the collateral value is crucial for effective credit management. However, the value of the collateral may fluctuate, and it’s not always a foolproof measure.

“Valuation of collateral is important since banks lend to their customers based on the overall risk position of the customer, including collateral,” said the authors of the research paper published in PMC. Valuation of the collateral aids the banks in determining the maximum amount of credit acceptable based on the market value of the collateral offered.

The article also suggested that revaluating collateral periodically could be a good credit risk management practice. This would enable the creditor to keep track of the collateral’s value and manage credit risks better.

In conclusion, valuation of collateral is a critical practice for credit management in India. It helps in mitigating the risks of loan defaults and enabling banks to offer loans based on the collateral’s value. Additionally, periodic revaluation and assessment of the collateral remain an essential part of an effective credit management system. 

8. Collection Policies for Timely Payment of Accounts Receivable

Collection policies are an essential aspect of credit management and aim to ensure timely payment of accounts receivable. It involves a series of steps that companies follow to collect payments from their customers. Collection policies vary by company, and the steps taken may depend on the approach followed by the firm. An example of the usual protocol involves initiating a friendly phone call to make sure payment is made on time. If a payment is late, a firm phone call is made, followed by a threatening letter, and ultimately, handing over the client to a collection agency.

Companies may provide leeway to long-standing or trusted customers, deviating from their collection policy. Nevertheless, it is essential to have a collection policy in place to maintain a healthy cash flow. A robust collection policy can help companies detect payment collection issues, ensure timely processing of payments, and decrease credit risk.

Therefore, it is crucial to manage accounts receivable aging reports effectively, as they can yield real-time insights into the health of the company’s finances. As the report divides outstanding bills into age-based categories, it assists companies in determining which customers need to be followed up with and in danger of not paying their invoices on time.

“Keeping the reports up to date provides businesses with a comprehensive view of their financial standing and helps them manage their cash flow more effectively,” says a financial expert. By addressing issues related to inconsistent data entry, incorrect reporting, and difficulty in reconciling payments made by customers, companies can increase their cash flow and maintain proper financial operations. It also enables management to make data-driven decisions that improve the company’s overall financial health. 

9. Sources and Uses of Funds for Banks in India

In India, banks rely on a variety of sources to fund their operations and lending activities. Some of these sources include internal resources such as retained earnings, while others rely on external investments or borrowing. One source of funding for banks is the Reserve Bank of India’s Liquidity Adjustment Facility (LAF), which allows banks to borrow overnight funds at the central bank’s main lending rate, currently at 7.75 percent. However, the ability to continuously tap these funds lowers the need for banks to raise cash in markets, which has hindered the development of a proper money-market yield curve. As a result, the RBI is implementing measures to encourage the use of new term repos, which would help create a smooth yield curve and price risk across various maturities.

Aside from the LAF, banks can also raise funds from other central bank facilities and through short-term loans, overdrafts, and other forms of borrowing. When it comes to external sources of funding, banks can issue new share offerings, obtain government assistance, or receive venture capital investments. Each of these sources has its own advantages and disadvantages, and banks must carefully consider which options are the best fit for their specific needs. Bank borrowing is another common form of funding and can be costly depending on interest rates and fees. As one expert suggests, “banks are not very actively mobilising deposits,” so finding appropriate sources of funds is crucial for their continued success. 

10. Functions of Banking Industry Related to Credit Policies

The industry plays a crucial role in credit management policies in India. Here are ten functions related to credit policies that banks undertake:

1. Assessing creditworthiness: Banks evaluate the creditworthiness of borrowers before approving loans using various factors like credit score, income, and past payment history.

2. Setting interest rates: Banks decide the interest rates of their loans based on the creditworthiness of the borrower and the current market conditions.

3. Developing loan products: Banks develop customized loan products like personal loans, home loans, and business loans that cater to the varying needs of borrowers.

4. Creating loan agreements: Banks draft loan agreements that outline the terms and conditions of the loan, including repayment schedules and collateral requirements.

5. Providing overdraft facilities: Banks offer overdraft facilities to help borrowers manage short-term financial needs by allowing them to withdraw more than what they have in their accounts.

6. Monitoring repayments: Banks keep a strict check on timely repayments, follow-up with borrowers, and initiate legal action against defaulters.

7. Debt recovery: Banks help in debt recovery by repossessing collateral assets and liquidating them to recover outstanding payments.

8. Risk management: Banks manage risks related to credit policies by maintaining adequate reserves, diversifying loan portfolios, and tracking market trends.

9. Regulatory compliance: Banks adhere to regulatory guidelines set by the Reserve Bank of India (RBI) to ensure that their credit policies are in line with government policies.

10. Educating customers: Banks educate customers about credit policies, loan management, and financial planning through workshops, seminars, and online resources.

As stated by the study mentioned earlier, improving managerial efficiency, proper credit screening and monitoring, and regulatory compliance can enhance the credit quality of Indian banks. Credit policies and their implementation are pivotal for ensuring a stable and thriving banking system in India.