Introduction
Credit control is one of the most important financial management strategies, assuring any business's stability and success. It helps lenders regulate and monitor the granting of credit so that the risks of default and loss do not materialise. Whether it's managing business receivables or evaluating eligibility for a personal loan, effective credit control plays a crucial role in minimising financial risk.
In this blog, we will delve into what is credit control, how it works, its importance and the methods employed by organisations of all sizes.
What is Credit Control?
Whether you are a bank providing complete mortgage solutions or an NBFC offering short-term personal loans, effective risk management is crucial. This is exactly where credit control comes into the picture. But what do you mean by credit control, you’d ask. To put it simply, it is a critical business strategy of managing and monitoring a company’s financial transactions and regulations associated with extending credit to borrowers. This includes assessing the creditworthiness of borrowers, establishing credit limits, monitoring repayments and addressing risks. It is ultimately about responsible lending and protecting from financial losses, in other words.
Who Uses Credit Control?
Credit control techniques are primarily used by banks & financial institutions, manufacturers, retailers, and lenders who are in the business of extending credit to customers. It aids in scrupulous monitoring of a company’s credit transactions to alleviate potential losses and ensure complete financial stability.
How does Credit Control Work?
Credit control is a methodical way to manage the risk within your company’s credit commitments by making sure that all the borrowers adhere to paying their debts in a timely manner. The procedure commences with the analysis of the customer´s credit record, his liability or payment delinquency record. Upon verifying the borrower’s credit, you can set credit terms to prevent any miscommunication. You should also have definitive methods of credit control in place, including ongoing monitoring, effective communication, and recovery actions. This can help minimise your financial risks, build trust and prevent disputes.
Types of Credit Control
Once you know what is credit control, it is crucial to know its different types. The methods of credit control can be quantitative or qualitative.
Quantitative Methods
Quantitative measures focus on regulating credit flow. These include:
1. Bank Rate Policies: The role of the RBI in control of credit is significant. It increases the bank rate policy at which loan is provided to lending institutions, thereby controlling credit and inflation.
2. Cash Reserve Ratio: The Reserve Bank of India makes it mandatory for commercial banks to maintain a cash reserve, controlling the amount of funds given as loans.
3. Open Market Operations: The RBI also regulates the buying and selling of government securities to control the money supply, which may affect credit availability and interest rates.
Qualitative Methods
Qualitative credit control techniques influence the quality of credit. The methods typically include:
1. Credit Rationing: The Reserve Bank of India establishes a maximum loan limit that lenders can provide to different sectors. This way, credit is rationed to increase cash flow to specific sectors and limit it in undesirable sectors.
2. Moral Persuasion: In this practice, the RBI advises or persuades financial institutions to limit their credit lending to maintain price stability.
3. Margin Requirements: The margin refers to the difference the lender should maintain between the value of collateral and the value of the loan approved.
4. Consumer Credit Regulation: This is a measure to limit the credit amount given to consumers, helping mitigate the risks of market fluctuations for certain products.
5. Publicity: Various reports are published by the RBI to educate financial institutions, so they can fund desired sectors and help achieve monetary policy goals.
6. Direct Action: When a financial institution does not follow RBI’s policies, it can lead to direct action in case other methods of credit control do not apply.
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Importance of Credit Control
The significance of having effective credit control measures is beyond just maximising profits for your organisation. Learn why it is crucial for both banking and non-banking institutions to have a definitive credit control strategy.
Manage Your Risks Better
In the absence of a proven credit control system, lending institutions tend to incur hefty financial losses when a borrower with a bad credit score defaults on a loan. This happens due to a lack of risk assessment as the lender fails to evaluate the borrower’s creditworthiness before providing a loan.
Maintain a Steady Cash Flow
Large-scale payment defaults by borrowers can negatively hurt the cash flow of your business because the profit is earned from the interest on loans. With a credit control strategy in place, you can ensure timely repayments that can help maintain a steady cash flow.
Steps of Credit Control Process
Setting up a credit control process for your organisation requires meticulous planning and execution. The important steps include:
Gather accurate personal and credit details of the borrowers. This should include their contact number, credit score, email address, etc.
Establish a strategy to assess the eligibility and risks of each borrower based on their overall profile, credit score and repayment history.
Set a suitable credit limit based on each borrower’s creditworthiness. This can help mitigate your risk exposure.
Continuously monitor borrower repayments to ensure minimum defaults. Keep a track of upcoming EMIs and missed repayments, if any.
Factors Affecting Credit Control
Discussed here are some important factors you should consider when implementing a credit control strategy:
1. The Borrower’s Credit Profile: Having a clear insight into the borrower’s creditworthiness and repayment habits can help establish a fool-proof credit control strategy and set the right limit for them.
2. Risk Appetite: A vital factor to consider is the risk you can afford to take as a lender when extending credit to borrowers.
3. Regulatory Requirements: Make sure your lending institution or non-banking organisation complies with all the RBI’s regulatory requirements.
4. Other Factors: Various other factors that may affect your credit control strategy are market competition, economic conditions, inflation, interest rates, industry-specific risks, etc.
How and When to Write a Credit Control Letter?
Despite having effective credit control techniques in place, some borrowers never seem to honour their repayment obligations. In such cases, a credit control letter can help you collect late EMIs, especially when you know how to write one. Here are some tips for you:
Send the first credit control letter as a gentle reminder that one week has passed after the EMI due date. It should include a few lines requesting him/her to repay within the week.
If the EMI still remains unpaid, send another letter one week after the first one. This time, use firmer language to request repayment within a specific date and along with the invoice.
If the borrower doesn’t pay even after one month of the original due date, you may seek third-party assistance in the form of a debt collection agency or your trade credit insurer. You must communicate your intentions to the borrower via post and email, but it should not be in the form of threats. The letter is a part of your credit control practice and should focus on persuading the borrowers to fulfil their payment obligations.
When to Consider Outsourced Credit Control?
Outsourcing the credit control process is gaining immense popularity because it helps free up your valuable time and money in monitoring & managing payments, while safeguarding your cash flow.
Example - Trade credit insurance can cover your receivables against sudden political and commercial risks, such as changes in EXIM regulations, customer bankruptcy, etc. It is a complete solution that also includes vetting borrowers, collecting debts and compensating you in case of defaults.
Outsourced credit control is also crucial if you are dealing with late-paying customers who are different in their ethnicities, languages and time zones. In such cases, the risk insurer uses local representatives who share the same cultural background and language as your client. This can help minimise misunderstandings and ensure an efficient credit control process.
What is the Difference Between Credit Control and Credit Management?
They may sound similar, but are different in the following way:
Credit Control
Credit Controlis the first, and most crucial step, in ensuring you are extending credit to customers who agree to your conditions and can meet their repayment obligations as per terms & conditions.
Credit Management
Credit Managementis the next step that involves monitoring, record-keeping and reporting late payments and defaults. The more efficient your credit control is, the stronger your credit management is likely to be.
Conclusion
With key pillars of diligent credit assessment, transparent terms of borrowing, consistent monitoring of loan repayment, and best collection practices, any lending institution will be able to develop credit control strategies that cannot be ignored. This fosters responsible and regulated borrowing practices to help maintain the tightrope of increasing sales by providing credit to more users and minimising the risk of failure to pay.
Frequently Asked Questions (FAQs)
Q.1. What is credit control risk, and why does it matter?
It is the potential risk that an organisation faces when extending credit to a borrower. The risk may be in the form of late payments, defaults, non-payment, or the borrower’s inability to meet their payment obligations. Having effective measures to control these risks can help mitigate your financial losses.
Q.2. Who uses credit control?
Here is an overview of who should use credit control:
Banks and financial institutions to stay financially viable and minimise loan defaults.
Lenders & creditors to manage repayment risks and reduce financial losses.
Manufacturers & retailers to ensure they get paid on time by customers.
Q.3. What are the stages in the credit control cycle?
The stages of a credit control cycle include evaluating the borrower’s creditworthiness before extending them credit, following up for payments, and monitoring their repayments.
Q.4. What does a credit controller do?
The key role of a credit controller is to assess the creditworthiness of the borrower, set credit limits, and manage accounts receivable to ensure timely repayments and reduce bad debts.
Q.5. What are the benefits of implementing a credit control policy?
Learn why is credit control important:
It helps prevent financial losses by identifying responsible borrowers.
Promotes financial responsibility among borrowers to ensure timely payments and reduce bad debts.
Ensures lenders and organisations with steady cash flow and increased profitability.
