The 3 Phases of Credit Risk Management
by Michael C. Dennis M.B.A., C.B.F.

The process of credit risk management seems to divide itself conveniently into three distinct phases. The first is the Recognition phase. The next is the Evaluation process. The third is the Risk control plan or program.

Recognition of the existence of an unacceptable credit risk involves information gathering. You might learn of a potential problem based on the customer's payment pattern to your company, or you might hear something at a credit group meeting that alerts you to a problem. You might also discover a problem while updating the credit file as part of your normal credit file maintenance process.

Generally, risk recognition occurs during the information gathering process. Some risks will be self-evident. Other risks will not be as easy to find.

The risk evaluation phase involves an attempt by the credit department to determine the degree or severity of risk. Generally, this includes measuring the level of risk and comparison to the permissible or acceptable level of risk.

The third phase involves implementation of risk mitigation strategies. These typically include reducing or withdrawing the customers open account credit terms; shortening the terms of sale; requiring the pledge of collateral as security; or requiring personal or inter-corporate guarantees.