Modern Credit Risk Management for the CFO of Today

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Finance teams in most companies have realised that they must adopt the technology and tools driving change in modern businesses. Today’s companies need finance leaders who can leverage technology to manage emerging risks.

The main task of modern-day CFOs is to plan for and forecast the future financial performance of their company in a rapidly changing environment. These forecasts cannot be based on traditional tools that primarily relied on past performance as indicators of future growth. A dynamic assessment of the risk environment, such as those associated with geopolitics, global supply chains, climate change, compliance, and technological disruption, is required for future projections of company performance. Day-to-day management of operational risks emanating from processes, personnel, logistics, IT and cybersecurity, and unforeseen disasters is required.

Similarly, credit risks pertaining to large distribution networks, supplier risks associated with complex supply chains, and compliance risks across both distribution and supply chains need to be assessed and monitored on a continuous basis. This poses a significant challenge for traditional, static, risk management tools that rely only on structured data from a few sources.

Fortunately, CFOs have an arsenal of technological tools to handle the complex and dynamic risk management challenges that confront their businesses. Next-gen intelligent risk management platforms leverage structured and unstructured Data, Artificial Intelligence, Machine Learning, Cloud Computing, and Analytics to identify, model, simulate, report, mitigate and monitor risks and prevent fraud. This enables companies to avoid financial losses and grow in a sustainable and compliant manner.

Avoiding Critical Supply Chain Risks

Any risk that threatens the financial health of any business, which is a part of a manufacturing supply chain, constitutes a financial risk to the entire supply chain. There are different types of financial risks, and the exposure to these risks needs to be measured, assessed, and controlled at all points in time.

Some of these risks include:

  1. Non-payment of dues by the customer/ distributor/ dealer, i.e., bad debts
  2. Non-delivery of the promised goods or delivery of inferior-quality goods by the supplier
  3. Delayed deliveries of raw materials, components, etc. that cause cascading delays in the manufacture and supply of the finished product; these delays adversely impact the working capital cycle and result in higher interest and financing costs
  4. Volatility in commodity prices; if commodity prices are not properly hedged, they can cause huge financial risks to businesses
  5. Unhedged foreign exchange exposure
  6. Labour shortages in the supply chain result in delays and higher costs; for example, in the US, labour markets are extremely tight at present, causing wage inflation and worker shortages, leading to knock-on effects on all parts of the supply chain.
  7. Shipping delays caused by shortages in the availability of shipping containers, ships or trucks; this happened during the COVID-19 pandemic, causing freight costs to skyrocket and impacting the viability of various businesses
  8. Problems caused by improper legal contracting between buyers and sellers, especially in international transactions; this causes delays in goods getting cleared from ports and results in very high demurrage costs
  9. Geopolitical issues such as war and conflict can result in trade sanctions; these have a long-term financial impact on supply chains. The Russian invasion of Ukraine is a current example of the havoc that armed conflict can wreak on supply chains.

Data Elements to Examine While Monitoring the Credit Risk, Supplier Risk, and Compliance Risk of B2B Counterparties

  • Compliance Indicators: A company with nothing to hide will usually be statutorily compliant. Therefore, it is a good idea to check specific regulatory filings to verify if these are complete and have been done on a timely basis. Specifically for Indian companies, Goods and Services Tax (GST) and Ministry of Corporate Affairs (MCA) filings can help determine whether the company is current with its statutory filings.
  • Payment Indicators: Monitors the Employee Provident Fund (EPF) data of your counterparties can also provide an early warning signal. Delays in EPF payments could indicate stress on cash flows. EPF returns can also reveal if the number of employees of a company has suddenly reduced (indicating layoffs), which is a sign of financial difficulty.
  • Financial Statements, Working Capital Usage and Ratio Analysis: it is important for companies, banks and financial institutions to analyse the P&L Account, Balance Sheet and Cash Flow statements of their counterparties where available. Working capital usage must also be checked on a periodic basis and key financial ratios must be monitored for signs of stress.
  • External Credit Ratings: Credit Ratings by independent external credit rating agencies are a credible measure of a company’s performance and outlook. Any upgrades or downgrades to credit ratings awarded by accredited external credit rating agencies to the financial instruments (eg, bonds, commercial paper etc), issued by your counterparties is a good alert to the financial health of a counterparty.
  • Litigation Data: It is imperative to monitor the litigation in which your counterparties may be involved. An increase in Section 138 (cheque bouncing) cases, NCLT petitions, Section 420 (cheating), labour court, or consumer court cases indicates the presence of a deeper problem in the company.
  • News and Social Media: It is crucial to check news and social media for any developments related to your counterparties’ risk to ensure that you are not caught off guard. Early news about a positive development will help you develop a new business opportunity with your counterparty while being forewarned about a negative development will help you cut your losses early.

How Rubix ARMS™ and the Early Warning Signal (EWS) Platforms Help Businesses

There are many use cases for Rubix ARMS™ and Rubix EWS platforms. Here are some examples of how they are solving real challenges in business:

Identity Theft and Fraud Prevention: Over the last few years, there has been a significant increase in fraud arising from fraudulent counterparties, provision of fictitious contact information, falsification of address proof, and identity theft. Only an automated solution for identity validation and fraud can nip this problem in the bud. The Rubix ARMS™ platform leverages structured and unstructured data from 120+ data sources to validate the identity of counterparties on-the-fly, thus providing accurate KYC information that helps prevent fraud.

Credit Decisioning: Inefficient methods of credit assessment and monitoring by corporates, banks and financial institutions leads to lower credit deployment to businesses (especially MSMEs), credit defaults, and poor underwriting decisions. The Rubix ARMS™ platform deploys Risk Analytics to generate and assign Risk Scores to counterparties, thus reducing human bias in credit decisions. Portfolio monitoring on the Rubix EWS platform ensures lower default risk on an ongoing basis and optimum credit deployment for business growth.

Supply Chain Risk Management: Excessive reliance on human judgement and relationships may lead to errors in supplier selection. Inadequate monitoring of supplier risk may cause sudden disruptions in the supply chain. The Rubix ARMS™ platform allows you to view Supplier Risk at both the individual supplier and portfolio levels. The Rubix EWS platform helps you to identify potentially weak suppliers so that you can strengthen them or quickly find alternate suppliers.

Third-party Compliance: Statutory and regulatory non-compliance by counterparties can have serious financial, regulatory, and reputational repercussions. Companies currently must go to multiple sources to monitor the compliance of their counterparties. This is error-prone, inefficient, and expensive. The Rubix ARMS™ platform accesses compliance data (AML, PEP, Financial Crime, Court Cases, etc.) from multiple statutory, regulatory, and other data sources, while the Rubix EWS platform provides automated, seamless, and inexpensive compliance monitoring of counterparties on an ongoing basis.

Priorities for Chief Risk Officers in Financial Institutions in the VUCA World

In rapidly changing times such as these, the top priority for Chief Risk Officers is to ensure that their companies’ growth is sustainable. One of the key prerequisites of this is identifying, monitoring and mitigating current and future risks that businesses face. Chief Risk Officers (CROs) are the front and centre in this task.

CROs must take an integrated and enterprise-wide approach to risk and foster a culture that spots and responds to early warning signals before they snowball into losses. This involves identifying, assessing, and monitoring, not just financial risks (forex, commodity pricing, interest rate risk etc) but also non-financial ones such as operational, cybersecurity, climate change, compliance, regulatory, reputational, and security risks to name a few. Due to the sheer quantum and variety of these risks, it is no longer possible to undertake risk management exercises through traditional tools. Therefore, a key priority for CROs is to become digitally fluent to be able to use and understand modern risk analytics tools. For starters, they should push for use of Artificial Intelligence and Machine Learning in routine but critical Anti-money Laundering (AML) and Know Your Customer (KYC) processes. They should deploy data-driven advanced risk analytics techniques to improve decision-making and prevent fraud.

Once these priorities have been addressed, CROs should enhance their ability to spot future trends in risk exposure by broadening the scope of data collection to include new factors such as ESG risks, geopolitical risks, cyber threats, etc. This is critical to help CROs stay ahead of the curve.

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