Lending institutions are exposed to a myriad of risks from loan activities when they act as an intermediary for a third party. To minimise credit risk, lending institutions take some mandatory steps to monitor risk at regular intervals, to minimise the financial loss incurred by a bank in case a customer or any financial institution defaults on their loan. This is where auditing credit risk management comes in.
Auditing credit risk?
The three basic principles of lending are profitability, safety, and liquidity of advance. The internal auditors at any lending institution base their loan inspections on these three principles, which are translated as a process of verification of loan accounts as a preliminary check, loan disbursement, and post-disbursement inspection.
Auditing Credit Risk Management
Lending institutions are exposed to a myriad of risks from loan activities when they act as an intermediary for a third party. To minimise credit risk, lending institutions take some mandatory steps to monitor risk at regular intervals, to prevent any financial loss incurred by a bank in case a customer defaults on their loan. This is where auditing credit risk management comes in.
Internal audit of credit risk management is aimed to identify, analyse, document, and report any credit risk irregularities and non-compliance that could lead to ineffective credit risk mitigation in any lending institution.
The auditors employ various analytical methods to examine and assess credit risk data, and to find any discrepancies in the projected and operational finances of the lending institution. It is imperative for an effective credit risk management audit that all the financial findings and information is updated, correct and relevant to the auditing process.
An audit report is then presented that summarises the entire credit risk auditing process, backed by data and adequate evidence, and the problems identified. The audit report also presents a list of recommendations and corrective measures that the banks can take next to overcome credit risk management issues.
The main purpose of a credit risk management audit is to come up with a comprehensive solution to all of a lending institution’s credit woes and to ensure that the institution is financially viable and thriving.
The Credit Risk Auditing Process:
Auditing credit risk in any financial institution is a cyclical process, and it must be regularly carried out in order for it to be effective in mitigating and managing credit risk. The credit risk management auditing process can be described as following
Identification of stakeholders, and delegation of roles and permissions within the financial institution
Conducting regular reviews of customers, and setting up processes to remind them of upcoming deadlines
Reviewing risk analysis processes in place, and tuning them regularly to keep up with changing finances
Monitoring assets associated with high risks to categorise them for retiring or patching
Auditing Credit Risk Management - Best Practices:
The nature of credit risk cannot be predicted with absolute certainty, as there are a number of internal and external factors at play that declare a credit risk as low or high. Therefore, a dynamic and agile credit risk audit policy must be devised to overcome any unforeseen circumstances.
The credit risk auditing system must adhere to all local and international credit laws and regulations.
The credit risk audit process must be conducted timely and regularly to manage risk continuously. The loan assessment, client knowledge, asset assessment and calculating losses on a bad loan must be analysed regularly to mitigate any credit loss.
A strong organisational structure is crucial for all internal stakeholders to keep up with credit risk. All internal regulations, areas of operation, and responsibilities must be clearly chalked out to avoid any miscommunication and to ensure that the credit risk management processes are carried out smoothly.
As risk is identified and brought to light, a framework must be in place that is consistent with the regulations and objectives of the bank, that provides credit risk management professionals with detailed guidance on how to implement the risk mitigation strategies. This way, credit risk can be controlled and limited.
A stress test must be conducted regularly in a lending institution to assess their level of exposure to credit risk. A stress test takes into account all possible factors that can affect the loan portfolios of customers, and the financial viability of the bank in the long run.
Credit risk management professionals must be imparted with the latest credit risk auditing techniques and analytical tools to come up with credit risk mitigation strategies and practices more efficiently.
Regular reviews of credit limits must be carried out to paint a complete picture of the risk profile of a borrower. The credit limit review takes into account the borrowing history of the customer, their source of repayment, the creditworthiness of the customer, and their history of repayment. The terms and conditions of the loan and the relevance of the collateral are taken into consideration as well.
As the bank takes into consideration all these important factors to audit credit risk, a comprehensive auditing report is presented with the findings to point out any issues and offer solutions.
An effective credit risk audit gives rise to many questions and points out any issues in the credit risk management system. It requires consistent tracking and monitoring to provide actionable insights and practical strategies that banks can incorporate in their credit risk management practices to increase efficacy.