How can you make your collateral management scalable for changing credit risk?

👌 collateral management plays a pivotal role in mitigating credit risk. As a Chief Risk Officer (CRO), I've witnessed the transformative impact of effective collateral management strategies in safeguarding financial institutions. 👉 The cornerstone of scalable collateral management lies in accurately assessing current and future collateral requirements. This comprehensive assessment involves identifying the types, amounts, and sources of collateral that can be utilized or mandated for various transactions and scenarios. Additionally, it entails evaluating the costs, benefits, and associated risks of employing different collateral types, such as cash, securities.

With my 18yrs experience as a creditrisk manager, the type of collateral should be critically considered as at the time of initiating or booking the loan. For loans to be secured with cash, shares of blue-chip companies or bank guarantee, there must be a reasonable margin between the loan and the value of collateral to take care of all the costs of credit . For collateral such as mortgages, debentures etc, the Open Market Value OMV, the Forced Sale Value FSV and the Investment Value IV must be well calculated to put the bank at a vantage position at all times. For other assets being managed by TRUSTEES companies in the event of Consortium lending, your bank must not be put in an inferior position when underwriting the credit approval.

Ensuring scalability in collateral management for changing credit risk involves a proactive assessment of collateral needs. Regularly review and adapt collateral requirements based on evolving credit risk profiles, allowing for flexibility. Implement robust monitoring mechanisms to promptly identify shifts in risk, enabling timely adjustments to collateral management strategies. Establish clear communication channels with stakeholders to gather insights and feedback on changing market conditions. Leverage advanced analytics and modeling techniques to enhance the accuracy of credit risk assessments and collateral valuations.

Proper structure is key, meaning each credit facility issued should align with its underlying intent. A depreciating asset (equipment) requires amortization that coincides with useful life (ability to generate revenue). A revolver (working capital line of credit) should have advance rates that monitor AR terms, minding risks such as concentration, cross aging, and obsolescence. Lines that support inventory or WIP need careful consideration based on commodity costs or value of unfinished goods on a secondary market (often limited or excluded from a conventional WC LOC) where terms can be negotiated with key suppliers. Bulk inventory for international expansion can leverage SBA export finance, and USDA B&I is also great for risk mitigation.

The first step to making your collateral management scalable is to assess your current and future collateral needs. You need to identify the types, amounts, and sources of collateral that you can use or require for different transactions and scenarios. You also need to evaluate the costs, benefits, and risks of using different collateral types, such as cash, securities, or commodities. For example, cash collateral may be more liquid and flexible, but it may also incur higher interest charges and opportunity costs. Securities collateral may offer higher returns and lower haircuts, but it may also face higher price volatility and liquidity risk.

Automation is a game-changer for collateral management. It has the potential to revolutionize the way we manage credit risk and optimize capital. However, it's crucial to approach automation with a strategic mindset, carefully considering the potential impact on people and processes. By implementing automation thoughtfully and responsibly, we can reap the rewards of efficiency, accuracy, and control, while mitigating the risks associated with technological change. 📌 According to a recent survey by the Risk Management Association (RMA): 👉 80%of financial institutions are investing in collateral automation solutions. 👉 75% of institutions have realized a significant reduction in operational costs through automation.

Through today's technology and automation there are several great ERP options available, many with features customizable to various industrial sectors. These systems, when installed with the proper internal policy and procedures, can produce a slew of insightful data that is helpful to the company's management team, their bank, and other professional services providers. The key then becomes measuring the metrics that matter most and align with the corporate objectives to avoid "analysis paralysis" which can become a byproduct of leveraging too much data which is irrelevant to the stated goals for the individual company/client.

This coincides well with a corporations options ability to manage Working Capital expense, where CXOs should give consideration to reducing the cost of interest expense by negotiating progress payments into new RFQ/RFP. Since interest rates had been low for a long period of time, many companies did not think about how to minimize carrying costs at the front end of their bid process for several years. With today's increased interest rates, progress billing will cut interest expense while also helping to manage risk through quicker collection of AR through adoption of proper accounting as it is prudent for large jobs within various industries. Quality Lenders and CPAs can help CXOs structure BBCs to keep everyone focused on proper KPIs.

Besides automation of collateral management, alignment with organizational objectives and selection of appropriate collateral, right mix of collateral is also required that shouldn't breach regulatory requirement. On top of that, credit personnel responsible for collateral selection and negotiation with clients must also think from the point of view of bank and must not only consider the comfort of customer in providing right kind of collateral.