Credit policy

A firms credit policy is the set of principles on the basis of which it determines who it will
lend money to or gives credit (the ability to pay for goods or services at a later date).
A credit policy formalizes lending guidelines that employees follow to conduct bank
business. It identifies preferred loan qualities and establishes procedures for granting,
documenting and reviewing loans.
The managements credit philosophy determines how much risk the bank will take and in
what form. Here we need to know a very important concept that is called a banks credit
culture. This refers to the fundamental principles that drive lending activities and how
management analysis risk. This lending philosophy would differ from bank to bank.
However there are three loan credit cultures namely: value driven, current-profit driven and
market share driven.
In economics, credit policy is government policy at a particular time on how easy or difficult
it should be for people and businesses to borrow money and how much it will cost. This is
done through change in interest rates.
Credit policy varies from firm to firm and is based on the particular business, cash flow
circumstances, industry standards, current economic conditions and the degree of risk
involved. It also has impact on performance, as a relaxed credit policy boosts sales but also
increases defaults and bad debts whereas a conservative credit policy may restrict sales but
will also minimize defaults.
Credit risk
Credit risk is the potential for loss due to the failure of a counterparty to meet its obligations
to pay the Group in accordance with agreed terms. Credit exposures may arise from both the
banking and trading books.
Credit risk is managed through a framework that sets out policies and procedures covering
the measurement and management of credit risk. There is a clear segregation of duties
between transaction originators in the businesses and approvers in the Risk function. All
credit exposure limits are approved within a defined credit approval authority framework.

Types of credit risks

Credit default risk

The risk of loss arising from a debtor being unlikely to pay its loan obligations in full or the
debtor is more than 90 days past due on any material credit obligation; default risk may
impact all credit-sensitive transactions, including loans, securities and derivatives.
Concentration Risk
The risk associated with any single exposure or group of exposures with the potential to
produce large enough losses to threaten a bank's core operations. It may arise in the form of
single name concentration or industry concentration.
Country risk
The risk of loss arising from a sovereign state freezing foreign currency payments
(transfer/conversion risk) or when it defaults on its obligations (sovereign risk); this type of
risk is prominently associated with the country's macroeconomic performance and its
political stability.
Credit Risk mitigation
Potential credit losses from any given account, customer or portfolio are mitigated using a
range of tools such as collateral, netting agreements, credit insurance, credit derivatives and
other guarantees. The reliance that can be placed on these mitigants is carefully assessed in
light of issues such as legal certainty and enforceability, market valuation correlation and
counterparty risk of the guarantor.
Risk mitigation policies determine the eligibility of collateral typesWhere appropriate, credit
derivatives are used to reduce credit risks in the portfolio. Due to their potential impact on
income volatility, such derivatives are used in a controlled manner with reference to their
expected volatility.

Assessing credit risk

Significant resources and sophisticated programs are used to analyze and manage risk. Some
companies run a credit risk department whose job is to assess the financial health of their
customers, and extend credit (or not) accordingly. They may use in house programs to advise
on avoiding, reducing and transferring risk. They also use third party provided intelligence.
Benefits of credit policy

Maximization of incomes of long-term or short-term credit operations within the

limits of the established risks and the current legislation.

Introduction of a complex control system by risks of the Bank, directed on decrease

and a diversification of risks.

Efficient control maintenance of credit process of Bank.
The direction of credits in priority and least risky branches of economy.
Maintenance of steady growth of profitableness of credit operations by means of

development of new bank products and service improvement of quality.

Increases of a rating of steady Bank in economic, social and ecological aspects.

Features of credit policy

Credit policy should be in line with the prudential regulations issued by the State Bank

of Pakistan.
Credit should be self liquidated that is it should be supported by future cash flows.
Credit policy should encompass that credit is structured to meet customers need.
Bankers evaluate the projected cash flows of the prospective borrower before disbursing

the loans.
The credit policy must be diversified with respect to industries/business and regions.
Credit policy must ensure that request from defaulter of other banks are not entertain.
The credit must be within banks target market and within risk assets acceptance criteria.
The credit policy must clearly explain the basic principles governing the disbursement of

finance/ credit.
It lays down a broader framework and helps the banks to carry on its activities over a

long period of time.

The bank is able to take care of the competitive environment and is also able to safe

guard against future challenges.

It also provides encouragement to field officers to discharge their duties within the frame
work