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Credit Control: What is It, How It Works, Different Methods
Credit control helps lenders manage and regulate the extension of credit. This financial strategy is best to implement when they want to minimise the risk of defaults and financial losses. With effective credit control management, financial institutions can keep track of unpaid debts and retrieve them in time. This blog discusses what credit control is, its types, and the factors that influence its implementation. Read on!
Credit control refers to the process of regulating and managing the extension of credit by financial institutions to borrowers. It aims to balance the need for providing credit to stimulate economic growth while minimising the risk of default and financial instability. Effective credit control involves assessing the creditworthiness of borrowers, setting credit limits, monitoring credit utilisation, and implementing measures to mitigate potential risks.
Here’s how credit control works:
1. Credit Assessment: This involves determining the creditworthiness of borrowers by analysing factors such as their credit history, financial stability, and payment behaviour.
2. Setting Up Credit Terms: Setting clear credit terms, credit limits, and payment terms based on needs and business objectives to avoid misunderstandings and payment delays.
3. Credit Monitoring: Regularly monitoring the accounts of borrowers by tracking outstanding invoices and identifying overdue payments.
4. Credit Control Practices: Implementing strong credit control practices to follow up on overdue payments, including reminders, phone calls, etc.
5. Communication: Effectively communicating with customers to negotiate payment arrangements or settlement agreements for unpaid debts.
6. Recovery Actions: Continuously assessing credit risk and adjusting credit policies and procedures as required to minimise risk exposure and make informed decisions for credit management.
The strategy of credit control is primarily used by financial institutions, retailers, manufacturers, and lenders to manage risks associated with lending credit to borrowers. Additionally, in firms, the risk committee oversees monitoring credit control to mitigate losses and ensure overall financial stability.
The following points highlight the importance of credit control for your lender:
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Credit control methods can be qualitative or quantitative. They aim to regulate the availability and cost of credit in an economy.
Qualitative methods focus on influencing the quality of credit. The methods include the following measures:
A. Credit Rationing: In this method, credit is rationed by limiting the availability of credit to each applicant. RBI sets a maximum limit for loans that lenders can provide to a particular sector. This method is used to divert credit flow to desirable sectors and restrict the flow in undesirable sectors.
B. Margin Requirements: It refers to the difference between the value of loan security offered for a loan (collateral) and the value of the loan granted. This method is adopted for stabilising the economy during inflation or deflation.
C. Moral Persuasion:In this method, RBI may advise, suggest, or persuade lending institutions to cooperate in controlling price stability by limiting credit lending.
D. Method of Publicity: RBI publishes various reports in a public forum to educate and influence lending institutions about the good and bad systems. This helps the lending institutions direct the credit supply in desired sectors and attain monetary policy goals.
E. Regulation of Consumer Credit: Consumers are given limited credit. As a result, the number of EMIs is reduced. Consumer credit is regulated for certain products affected by inflation or deflation.
F. Direct Action: In this method, if the lending institutions do not follow the policy laid by RBI. It only has a recourse to the direct action. This method is usually used to supplement other credit control methods.
Quantitative methods target the quantity of credit. These include the following measures:
A. Bank Rate Policies: It is the rate at which RBI provides loans to lending institutions without any security or collateral. The bank rate policy is increased to control credit and inflation.
B. Open Market Operations: RBI conducts the buying or selling of Government securities in the open market to increase or decrease the money supply, affecting interest rates and credit availability.
C. Cash Reserve Ratio: RBI mandates commercial banks to hold a certain percentage of their deposits as reserves, controlling the amount of funds available for lending.
Outsourcing credit control can help in the following times:
1. When lenders lack the expertise and resources to manage credit control effectively in-house.
2. If the lender must write off bad debts frequently.
3. When lenders find it challenging to send invoices on time and miss sending payment reminders, they can leverage outsourced credit control.
4. In case there is a lack of the standardised process and the latest payment software.
5. Outsourced credit control is excellent when lenders need to manage credit processes and reduce bad debts effectively.
Credit control is an essential strategy of financial management. It ensures responsible lending practices and minimises credit risks. Knowing what credit control is and how it works, financial institutions can use strong credit control measures to balance the need for providing credit and maintaining financial stability. To mitigate risks effectively, financial institutions must adapt their credit control strategies based on dynamic market conditions.
1. What is an example of Credit Control?
An example of credit control is imposing credit card limits. Financial institutions set a maximum limit on cardholders' spending, which helps control the amount of credit extended and manage the risk of excessive debt accumulation.
2. What is Credit Control Risk?
Credit control risk refers to the potential risk faced by financial institutions when extending credit to borrowers. It includes the risk of default, late payments, non-payment, or the inability of borrowers to fulfil their credit obligations.
3. What is the Credit Control Cycle?
The credit-control cycle refers to the process of examining the risk involved with extending credit to a borrower, which also extends to tracking their credit activities to recover the outstanding amount.
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