Credit management in simple words is the process of monitoring and collecting payments from the borrowers. A specialized credit management system eases the amount of capital tied up with debtors.
The principles of credit management revolve mainly around the concepts of safety, Liquidity, Diversity, and Profitability. The banks all over the world examine following details with care before acceding to a loan request.
Safety means that the borrower must be in a position to repay the loan and interest at regular interval as per sanction terms. The repayment of the loan relies on the nature of security and the potential of the borrower to repay the loan. The prime security can be hypothecation/pledge of stock, book debts or other assets created out of bank finance. Bank may insist for a charge on immovable property as a collateral security in addition to prime security and a third party guarantee (which is also treated as security to bank finance). The main concern is that security available to the bank should be good enough to fall back upon in the event of adverse circumstances. The value of security accepted should be steady and easy to ascertain. All precaution to be taken while accepting the immovable property as security that the security offered has a clear marketable title. It is also inevitable to ascertain and confirm through legal opinion from an experienced advocate so that bank could easily take possession of such security with very little expenses and dispose-off the same to recover its dues when the account goes bad.
Liquidity plays a paramount role when a bank lends the money. Generally banks give money for short duration of time. This is because banks are dealing with depositors’ money. This money can be withdrawn by the depositor at any point of time. Therefore, banks should ensure that it has sufficient funds to satisfy both maturing short-term liabilities and sudden withdrawal of demand deposits or time deposits before maturity. Hence, it is very important to have good credit management practices for efficient cash flow.
Commercial bank should abide by the principle of diversity while lending. It should never allow all its funds to flow to a specific sector or type of advances. Concentration on specific industrial or service sectors can indeed become a major problem to the banks when that business is passing through bad times with wide-spread sickness.
Last but not the least; profitability is another important objective of the credit management. A bank should only invest (lend) if it earns sufficient profits from it. Thus, it should, invest in such assets(loans and advances) that have a fair and stable return on the funds invested.