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A company’s credit policy is a way to establish controls and regulations to guide the organization on how to measure, monitor and control credit risk. All types of businesses can benefit from having an established credit policy with defined limits approved by management to allow for rapid and efficient credit assessment on customers, counterparties, vendors and the like. Ad hoc credit systems are costly in time and expense and raise unintended financial risk to the firm.

In an ideal environment, the Board of Directors should establish a risk committee to review existing Credit Policy (CP) to determine its appropriateness for the organization’s appetite for risk. Further, senior executives from the Chief Executive Officer through the VP and Director levels representing the major disciplines in an organization should be involved in crafting a Corporate Credit Policy Statement. Their collective involvement should design and authorize the requirements for credit risk assessment and permissible credit risk tolerance ranges used in assigning unsecured credit limits for customers and counterparties.

Management must determine what level credit risk is acceptable for its corporate credit policy. This can be done by ascertaining what enterprise risk type best fits their strategic objective. Generally, companies fall into four major enterprise risk types:

1. Risk Avoidance – conservative credit policy
2. Risk Mitigation – moderate credit policy
3. Risk Retention – aggressive credit policy
4. Risk Transfer – to transfer credit to another entity

Enterprise risk types and thresholds are important to make certain the company’s credit policy is aligned with the intentions of senior management.

Further, senior management has the responsibility to create a well-defined CP with the guiding principles utilized for credit risk research and analysis while establishing permissible credit risk tolerance ranges that clearly define limits and controls.

Part of the process of crafting an appropriate CP has to do with the cost of implementing a specific CP over another.

To glean enough insight into what strategy works best requires an evaluation of the various information technologies currently being used, what upgrades are possible, the cost structure of the various credit services being purchased, the personnel required to carry out each strategy and most of all what is the expected credit loss ratio.

Senior executives must be adept at creating and handling good organizational policy for a variety of reasons and disciplines.

Those executives who spend a minimum amount of time defining their company’s credit policy and evaluating the effectiveness of the tools their credit risk managers use can expect improvements in corporate performance by reducing costs, mitigating losses and creating an effective and disciplined process.

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Credit Policy Institute

The Credit Policy Institute is a creation of Strategic Risk Management Partners
(www. srmpartners.biz ) which is a firm whose staff is devoted to creating the guiding principles on Credit Policy making for large and small companies who can benefit from a disciplined judgment process. These guiding principles are for all senior executives and Boards of Directors who aspire to improve corporate performance and more specifically the approach utilized in credit risk assessment and determining acceptable risk tolerances and how they can be managed, monitored, controlled and regulated within their organization.

Credit Policy Institute features a 12 part series on the components necessary to build and implement a sound credit policy.
How to Build a Credit Policy – Series
Series 1 – Credit Policy – The Preface
Series 2 – Overcoming the corporate culture and mindset for an in-house Corporate Credit Policy
Series 3 – Corporate Credit Policy Statement Preamble
Series 4 – Strategic Relationships of the Corporation
Series 5 – Identifying corporate structure
Series 6 – Creating Corporate Risk Model Identifiers
Series 7 – Predictive Credit Scoring Model
Series 8 – Scorecard output and Corp sign-off requirements
Series 9 – Pass, Fail and limited unsecured credit lines
Series 10 – Comprehensive Tracking System
Series 11 – Sample Corporate Credit Policy
Series 12 – List of companies for Credit Scoring Software

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