Risk management and control constitute the basic core of banking activity. This has always been the case, but recently new regulations have been introduced to avoid the repetition of new financial crises.
The basis of the banking business lies in stable and direct relationships with customers. A recurring, well-managed business model based on long-term customer relationships fosters profitability for financial institutions and provides businesspersons with value, services and products tailored to their needs.
In this context, clients should be aware that risk management policies must be approved by the banks’ boards of directors, developing methodologies, procedures and criteria for granting transactions.
The granting criteria must be linked to the borrower’s payment capacity to comply, in a timely manner, with the total financial obligations undertaken. Such ability to pay will be assessed based on the funds or net cash flows from their businesses or usual sources of income, without depending on guarantors, sureties or assets provided as collateral. These should always be considered when evaluating the granting of the transaction as a second and exceptional way of recovery when the first has failed.
In this sense, granting procedures must require in each transaction the identification and quantification of the sources of generation of ordinary funds of each borrower, which will serve as the first and fundamental way of transactions recovery. For these purposes, the established procedures will include minimum documentation requirements.
Banks must prudently manage risk as this is the essence of their business, not accepting disproportionate levels of indebtedness from their clients and adequately assessing every risk incurred when granting a transaction and that may already arise upon delivery of the suitable documentation, when carrying out the analysis of the transaction, upon the correct formalization of the contracts and collateral provided and during the monitoring of the transaction and the client. Monitoring that involves consulting and periodically checking the problems that may occur, such as delays in payment commitments with the institution, negative records in external sources, adverse variations in the value of the collateral, etc. Also, keeping the client informed through periodic reports is required.
A suitable risk management is at the heart of the banking sector activity and, in a first and fundamental instance, must be based on knowledge of the client.
Central banks require credit institutions to use the utmost care and diligence in the rigorous and individualized analysis of the credit risk of transactions not only at the time of its granting, but also continuously during its term.
They also require that every transaction be adequately documented and that the available information be updated with new financial statements and economic information that allow analysing the solvency and payment capacity of clients and guarantors.
In the case of financing to companies and businesses in general, the main source to meet the commitments undertaken (debt and interest) must be the generation of cash flows estimated from the financial statements of the business and from realistic forecasts.
In this sense, the quality of the annual accounts prepared by the companies and the availability of reliable and justified forecasts are of particular relevance.
Regarding the annual accounts, a first element of assessment of the company by financial institutions is precisely the quality and quantity of information provided in the annual report. The use of forecasts is destined to have an increasing importance in customer and transaction analysis.
In all credit transactions, the following points must be clearly identified:
- Purpose of the transaction: Carrying out an investment project, working capital financing, etc.
- Repayment sources: Detail of the resources with which it is expected to meet the capital repayment and interest payment commitments.
- Collateral provided: Specification of the existing collateral in the event that the borrower cannot meet their obligations under normal conditions.
