How to Update and Refine Your Company's Credit Risk Analysis

In 2020, the collapse of Wirecard, a German payment processing company, sent shockwaves through the financial industry. Once valued at €24 billion, this fintech giant crumbled under accounting fraud and €1.9 billion in missing funds. Its downfall exposed critical flaws in traditional credit risk assessments. The case highlighted the need for more rigorous due diligence, independent verification, and a deeper understanding of emerging technologies and business models. 

Today, evolving regulations, rapid technological advancements, and increasing global uncertainty demand a new approach to credit risk analysis. Traditional credit models that worked in the past are no longer sufficient. With the global credit risk assessment market projected to reach $16.56 billion by 2030, businesses must embrace more dynamic and sophisticated strategies. 

Thus, to avoid financial losses and keep your company safe, updating and refining your company’s credit risk analysis is a must.  

This article outlines: 

• The essential steps for updating and refining your company's credit risk analysis 
• The costs of inaction 
• How Cedar Rose comes to the rescue 

The Essential Steps for Updating and Refining Your Company’s Credit Risk Analysis

1. Review Your Company’s Credit Risk Framework 

Reviewing your company’s existing credit risk framework, i.e., the comprehensive approach and policies you use to identify, monitor, measure, and control risks associated with extending credit, is an essential first step. 

This is because credit risk assessment has evolved beyond subjective judgment, which relies solely on a borrower's character, capacity, capital, and collateral. Today, credit risk frameworks are dynamic, analyse hundreds of data sources, and consider both financial and non-financial factors to provide a more objective and comprehensive evaluation. 

That's why it's important to ensure you have a robust framework that identifies potential risks by analysing factors like the borrower's financial history and economic conditions. It should also monitor existing risks by tracking credit account performance and measure the level of risk by quantifying potential losses. Finally, it needs to control and mitigate these risks with strategies that reduce the likelihood and impact of credit losses. 

To review your company’s credit risk framework, perform the below: 

• Review existing credit risk models and methodologies to identify gaps for improvement and ensure alignment with regulatory requirements and market conditions. 
• Conduct a thorough analysis of your company’s risk appetite. 
  Cohort analysis, rigorous statistical testing, and back-testing against historical data are vital to validating the predictive accuracy of your credit risk models. 
• Critically examine the relevance, completeness, consistency, and adequacy of the factors used in your rating system to identify risk. 
• Recalibrate credit scores to reflect your company’s specific customer base and establish a feedback mechanism to learn from past credit decisions, especially those that resulted in defaults.
  

Next, regularly review, assess, and update your clients’ risk profiles to ensure they accurately reflect the current risks. Adjust credit scores to reflect your specific customer base. These profiles categorise them based on creditworthiness, financial health, credit history, industry, and economic conditions. Start with re-runs of the initial analysis with updated financials and changes in market and borrower circumstances. Then, validate the profiles by ensuring they align with actual outcomes. Compare predicted risk with actual credit losses. Use stress testing and scenario analysis to simulate adverse conditions and reveal vulnerabilities. Leverage financial ratios, such as liquidity ratios for short-term stability and leverage ratios for debt reliance to gain deeper insights into borrowers’ ability to manage obligations. Last, keep profiles live and actionable by analysing updated financials, watching for market trends, and tracking key metrics like cash flow, profitability, and debt.

Beyond revisiting existing risk profiles, identifying emerging risks or new or evolving threats that may impact credit risk exposure is a must.  

Effective methods include trend analysis, scenario planning, and horizon scanning. Trend analysis examines historical data, such as financial ratios, credit metrics, macroeconomic indicators, and industry trends, to identify patterns that signal potential changes in creditworthiness or risk of default. Scenario planning involves developing simulations to evaluate the impact of events like recessions or sudden interest rate changes on a company’s credit portfolio. Horizon scanning actively monitors the external environment for signals of change, including technological advancements, regulatory updates, industry trends, and geopolitical developments. 

Apart from monitoring clients’ financial health and staying informed on market trends, geopolitical developments, and other factors, cultivating a risk-aware culture is a must. It ensures employees remain vigilant and proactive in detecting and reporting risks. This allows your organisation to swiftly adapt their strategies to mitigate impacts effectively.

4. Leverage Technology for Proactive Risk Assessment  

Finally leverage technology to shift from static, periodic assessments to dynamic, real-time risk management. 

Use data analytics to analyse financial statements, credit reports, and any form of alternative data, be it market data or even social media activity. This uncovers hidden correlations and patterns that signal emerging risks. Next, employ automation technologies to simplify and optimise processes and enable ongoing monitoring of credit accounts. This helps flag unusual activities and triggers alerts for potential defaults. 

Don’t forget to make use of IoT devices for continuous data collection, like tracking goods in supply chain finance to detect disruptions that affect borrowers. Use AI and machine learning to analyse vast datasets, adapt to real-time changes, and provide dynamic, accurate risk assessments. 

Employ Monte Carlo simulations to model a range of outcomes and probabilities, offering deeper insights into potential risks and their impacts. 

The Cost of Inaction  

Failing to update your company’s credit risk analysis leads to considerable risks and missed opportunities. Outdated profiles and traditional credit risk analysis models fail to address the dynamic nature of risk today. They also fail to keep up with the ever-evolving regulations.  

The result is inaccurate assessments that lead to poor lending decisions such as extending credit to financially unstable or unhealthy partners. Overly conservative assessments further lead to missed opportunities like rejecting creditworthy clients and ultimately losing revenue in the long run. This means heightened exposure to financial loss, reputation damage and regulatory penalties.  

How Cedar Rose Comes to the Rescue  

Modernising credit risk analysis is no longer an option. 
It’s a proactive strategy that sets your company on the road to success. 

Cedar Rose equips your company with unparalleled access to a global database of over 472 million companies and millions of shareholders, directors, and ultimate beneficiary owners (UBOs), all accessible through our CRiS Intelligence platform. Our all-in- one risk management platform offers comprehensive, reliable data and streamlined corporate searches and investigations.  

With CRiS Intelligence, you can manage credit risk and assess creditworthiness with ease, leveraging our detailed company credit reports, CR score, Auto Size Indicator, and AI-powered Automated Credit Limit algorithm for enhanced accuracy and efficiency. Backed by our commitment to innovation, precision, and compliance with ISO27001, GDPR, and PDF/UA standards, we provide the dynamic credit risk solutions you need to thrive in today’s fast-evolving complex business environment. 
 
Don’t let outdated credit risk strategies hold you back. 
Speak to our experts now. 

Sources 

1. https://www.gdslink.com/how-to-build-a-credit-risk-management-framework/  
2. https://www.auditboard.com/blog/preparing-for-emerging-risks-with-proactive-strategies/ 
3. https://www.crowe.com/insights/fincrime-in-context/benefits-of-a-technology-enabled-risk-assessment-process  
4. https://fastercapital.com/content/Credit-Analysis--How-to-Perform-a-Credit-Analysis-and-What-to-Look-for.html#Introduction-to-Credit-Analysis  
5. https://fastercapital.com/content/Credit-Analysis--The-Basics-of-Credit-Analysis-and-How-to-Perform-It.html#What-is-Credit-Analysis-and-Why-is-it-Important- 
6. https://fastercapital.com/content/Credit-Risk-Validation--How-to-Validate-and-Verify-Credit-Risk.html#Introduction-to-Credit-Risk-Validation