What Is Credit Research And Why Is It Important?
Do you have an idea about individuals who carry out Credit Research? If not, now is the time to learn about credit analysis. Evaluating the creditworthiness of a business or an individual is an important task performed by many lenders. This is said so because lending money without understanding the history of a borrower can put the financial institution in trouble. This article will enlighten you on the concept of credit analysis, its structure, and the skills, and roles of a credit analyst.
Credit analysis is a method used by lenders to find out the creditworthiness of a potential borrower. In simple words, it is a process to assess the capacity of the borrower to fulfill the interest obligations and repay the principal. Any entity can be a debtor; an individual or a business. If the contract is between an individual and a financial lender, it is called personal lending. If the borrower is a business, the concept is referred to as commercial lending.
The lenders are usually called creditors. They employ a range of quantitative and qualitative techniques in credit analysis to forecast the price risk.
Structure of Credit Analysis:
There are 5Cs in the structure of credit analysis to evaluate the creditworthiness to assign a risk rating to the clients and choose loan pricing models.
Character: This C determines the financial character of the borrower. It involves examining the credit history of the client. It is integrated into the framework as it allows the lender to decide on providing credit facilities based on the credit research done to study the behavior of the borrower and conclude his repaying abilities.
Capacity: As the word suggests, it is a C to find out the capacity of the borrower to make payments. The borrower’s assets, debt-to-income ratio, and current income are evaluated by the lender using internally built cash flow.
Collateral: Any assets that are considered as security in terms of nonrepayment of the loans come under the category of collateral. Valuable items, real estate, bonds or stocks, artwork, savings accounts, and jewelry are usually considered collateral.
Capital: Available cash reserves of the borrower to meet the short-term obligations in emergencies are put under the category of capital. In simple words, it is an alternative source of liquidity when collateral is absent to pay off debts.
Conditions: The fifth C has more to do with understanding the requirement for loan proceeds and conditions that may affect the borrower’s cash position and financial health.
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Importance of Credit Analysis
Credit analysis is a technique used by lenders to understand the credit profile of an entity or an individual for the risk assessment related to a specific loan. It is a tool that gives insight to borrowers into their creditworthiness and personal finances to make necessary changes to become eligible for a loan application.
The main purpose of credit research is to minimize risk for the lender regarding financing a borrower. This is a way to reduce the loan-related risk for the lenders and protect themselves from default payments.
It is believed that only lenders are benefitted from credit analysis but the fact is even borrowers can gain from it. Borrowers can review their credit report and make changes in areas of improvement to avail of approval for loans or get additional loans in need. For example, they can improve their credit score by making payments for bills on time or clearing off their debts, or increasing their savings rate to get loans with lower interest rates. In short, it is a tool that can facilitate improving the financial health of the borrower.
Drawbacks of Credit Analysis
Though the process of credit analysis is fruitful to lenders and borrowers, there are some limitations that affect the outcomes of it. Here are a few challenges faced by both parties associated with credit analysis.
- Risk assessment
- Analysis of financial statements
- System to assign a credit score
- Gathering and interpretation of data
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The process of assessing the risk associated with a loan approval to a borrower involves analyzing their business and personal finances along with the performance of background checks to understand their capacity to repay the credit facilities. However, any mistake in quantifying the risk can negatively impact the lender’s operations.
Analysis of Financial Statements:
The financials of the borrowers are analyzed as part of the credit analysis. This is done to know the borrower’s ability to repay the principal. The financial statements of the borrower are analyzed as they contain the past credit history that provides assistance to the lender in gaining insights into the client’s repayment capabilities. Any mistake in analysis can lead to disastrous outcomes.
System to Assign a Credit Score:
Credit scores are important to assess the borrower’s creditworthiness. Credit scoring systems are models used to generate a credit score for a borrower as per the given inputs. They are believed to produce accurate results. However, they may show inaccurate outcomes due to the input of wrong data.
Gathering and Interpretation of Data:
Collection and interpretation of data is crucial to decide on advancing a loan to the borrower. Lenders gather the borrower’s information relevant to the credit analysis such as balance sheets, liabilities, income statements, assets, etc. The collected data is used to analyze the financial position of the client for providing approval for the loan. Any misinterpretation can negatively influence both parties.
Required Skills Test for a Credit Analyst
Any job can be effectively done when the hired candidate has the necessary qualifications and skills. Performing credit research is not everyone’s cup of tea. It requires a certain amount of knowledge and faculties. Some of them are listed below for you if you are considering credit analysis as a career path.
- Accounting skills
- Industry knowledge
- Computing skills
- Communication skills
- Problem-solving skills
- Attention to detail
- Organization and documentation skills
- Knowledge related to risk analysis
- Investigative skills
- Quantitative analysis skills
Having an accounting background is important to efficiently conduct credit analysis. Simple accounting techniques like the creation of financial statements, review of statistics, and balancing of credit and debit amounts in the financials are prerequisites for a credit researching role. Also, knowledge about the usage of the latest technologies in finance, business, and economics has to be part of a candidate’s profile.
The majority of credit analysts are professionals with bachelor’s degrees in accounting, finance, risk management, economics, and relevant fields. However, there are a few entities that gain these skills from employment experiences and on-the-job training.
As mentioned earlier, credit analysts must have accounting knowledge. If they lack information about the industry they work for, they may have to undergo relevant training sessions. Different industries have different ways of investigation. This indicates that credit analysts must have the required information to create accurate analyses and reports as per the industry they work in. This also brings us to an important point that credit analysts are expected to update their knowledge as and when required.
As discussed in the above paragraphs, the collection and interpretation of data are part of credit analysis. The processing of information is done using computer software. Knowledge and ability to use basic computing tools can make the lives of credit analysts easier.
Preparation of financial reports is one duty of an individual who performs credit research. Strong writing skills are required for the same. Credit analysts may sometimes be part of meetings with clients and company management meaning they will have to effectively communicate their views and ideas on the chosen topic. Not just that, they will have coworkers with whom they need to regularly interact for the completion of assigned tasks. All this points to the need to develop communication skills to clearly communicate with subordinates and peers.
Clients may request advisory services from the company management. At such times, the management will involve credit analysts to assist their clientele in resolving financial issues to meet their objectives and requirements. This kind of task requires the professionals performing credit research to have good problem-solving skills, a positive attitude, and resourcefulness. If the clients get satisfied with the guidance of the credit analysts, they will continue the relationship with the company alongside letting the professionals sharpen their analytical skills through proposals to handle more difficult situations.
Attention to Detail:
Financial statements and credit reports have sensitive data. Missing any detail can lead to producing inaccurate results. Credit analysts with the ability to focus and pay attention to almost every detail are hired to prevent receiving negative feedback from the clients alongside protecting the interests of the lender.
Organization and Documentation Skills:
One of the responsibilities of a credit analyst is to maintain the records of clients. They also have the obligation to properly arrange the documents to avoid misplacement or loss of data. Proper organization of files will allow the supervisors to access them whenever they want and make decisions. One solid reason for credit analysts to be organized is that the muddled arrangement of documents may contribute to violations of guidelines or regulations in their industry that can threaten their job security.
Knowledge Related to Risk Analysis:
Having knowledge about risk analysis facilitates the analysts to predict potential challenges during the process of credit analysis to prepare reports and recommendations. The professionals who conduct credit research must be in a position to give valid reasons to managers or business owners why a certain investment or loan application must be approved or rejected. For that, an entity must have required information about risk management in safeguarding the interests of the lenders and avoiding increasing their capital.
The ability to probe to get more details from clients is essential to validate the truthfulness of the facts shared. Being a credit analyst is interesting as they are expected to make sensible judgements based on their recommendations. For instance, while dealing with a rest estate client, the credit analyst performs a background verification alongside getting the essential documents supporting the process to make sure that the borrower makes the loan repayment within a chosen period.
Quantitative Analysis Skills:
One of the daily responsibilities of a credit analyst is to deal with figures from the client’s statements. This means the professional must have good quantitative analysis skills to analyze figures.
Duties of a Credit Analyst
An individual who is hired to perform credit analysis is supposed to perform certain standard tasks on a daily basis. Some of them are shared to make you understand their roles and responsibilities.
- Evaluation of credit risk
- Financial data analysis
- Reviewing credit limits
Evaluation of Credit Risk:
The credit analyst owns the accountability to assess the credit risk of a potential borrower by considering their debt-paying history, earnings from employment or business, savings, and purchase activities. This is followed by professionals making recommendations to the lender about providing credit facilities to the clients. In the case of a credit card issue, the credit analyst may perform the evaluation and then suggest the company to reject an application, reduce credit limit for a customer, or grant a credit card.
Financial Data Analysis:
Credit and commercial unions hire credit analysts to analyze a potential client’s financial data. The recruited individual evaluates the potential customer’s assets, credit history, earnings history, and liabilities to check their eligibility for availing of a credit facility. If the client is a corporation, the credit analyst will evaluate its financial statements, market data, annual report, and management accounts.
Credit analysts also estimate the risk of dealing with a certain client to determine the condition of the lender if the borrower fails to fulfill their obligations. It means the risk analysis carried out by a credit analyst plays a crucial role in the lender’s business as they get to decide to grant credit facilities to the clients.
Reviewing credit limits:
Some existing customers place a request for increasing their credit limit. Credit analysts take up the role of reviewing the credit limits of such clients to check their eligibility. This is done by assessing the borrower’s earnings information, repayment history, and credit-defaulting history if any.
The professional will prepare a report on the same and provide it to the management to give a detailed explanation of the client’s financial position in relation to meeting their obligations. The company will use the credit report to consider increasing the client’s credit limit.
Career Opportunities for a Credit Analyst
Choosing credit analysis as a career path opens many opportunities for candidates. Many industries require credit analysts which is why a range of roles are available at the reach of an aspiring professional. Here are a few listed to help you pick the right designation as per your interests,
- Consumer credit analyst
- Corporate credit analyst
- Financial institution analyst
- Sovereign credit analyst
- Credit investment analyst
Consumer Credit Analyst:
A person hired for determining the financial health of a client is a consumer credit analyst. They analyze the financial strength before the lending entity grants a loan to the client. The analyst collects valuable data for analysis like defaults, credit history, real estate, investments, liquid assets, and credit score.
Corporate Credit Analyst:
The responsibility to assess the risk of lending to non-financial firms lies with corporate credit analysts. Manufacturing enterprises, service providers, industrial companies, and trading firms come under the category of non-financial firms. A corporate analyst is skilled in the niche and considers the borrower’s products, sector, and scale of geography along with financial position to assess the credit risk. They are not only experts in their industry but also have knowledge about accounting techniques.
Financial Institution Analyst:
The job to evaluate the financial intermediary’s creditworthiness is with a financial institution analyst. They assess the counterparty risk involved in dealing with a financial institution. The risk assessment is done before the lender enters a contract with the financial institution. This is done to protect the company from exposure to potential loss.
Sovereign Credit Analyst:
Borrowing and lending money between countries is a common practice. A sovereign credit analyst evaluates the creditworthiness of a borrowing nation. They work in rating agencies that handle sovereign credit ratings. The credit analysis is done based on geopolitical stability, tax compliance, government spending, tax collection, fiscal deficit, and other related factors.
Credit Investment Analyst:
Credit research is performed to evaluate fixed income securities such as corporate bonds or treasury bonds issued by governments. The analysis is carried out on a variety of risks such as interest rate risk, credit risk of the picked securities letting an investor make a decision prior to investing.
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Conclusion on Credit Research:
Credit analysis is an important tool for lenders as it allows them to assess the creditworthiness of a potential borrower and forward credit facilities accordingly. It is done to minimize the risk of loss that arises from lending money to ineligible parties. The borrower could be a common civilian or a business. The lending party is called a creditor whereas the borrowing one is referred to as a debtor. The framework of a credit analysis consists of 5 Cs.
These Cs are used to assist the creditor make informed decisions in regards to choosing debtors and thereby protect themselves from dealing with potential credit-defaulting parties. The main purpose of credit analysis is to learn about the borrower’s financial health and assess the risk that comes along with associating with them. The creditworthiness of a borrower is calculated by considering the important credit information that is found in the debt-to-income ratio, collateral value, and credit history. The lender can fix the value of the credit facility to lend and the chargeable interest based on the outcomes of the credit analysis.
Credit analysis is also beneficial for borrowers as it lets them know about their financial weaknesses and strengths. They can improve the weaker areas and improve their credit score to become eligible for availing of loans or increasing their credit limit. The drawbacks of credit analysis are usually a product of input of incorrect data, inefficient analysis, misinterpretation of information, and a lack of skills in the credit analyst.
Any aspiring credit analyst must have good accounting skills, Industry knowledge, computing skills, communication skills, problem-solving skills, attention to detail, organization and documentation skills, knowledge related to risk analysis, investigative skills, and quantitative analysis skills. The key responsibilities of a person handling credit research are the evaluation of credit risk, financial data analysis, and reviewing credit limits. Credit analysis allows a person to enter various fields based on their expertise and knowledge. Individuals with a certification in credit analysis and similar educational backgrounds can become consumer credit analysts, corporate credit analysts, financial institution analysts, sovereign credit analysts, and credit investment analysts.
In short, credit analysis has a great scope in various industries dealing with lending facilities. If you are interested in becoming a credit analyst, find a reliable college to obtain a bachelor’s degree or a certification program in accounting-related departments.
FAQs on Credit Research
Q. What do credit analysts do?
A credit analyst is a person who conducts credit research on the financial health of a borrower to make recommendations on lending credit facilities using his skills to a lender. They work for lending organizations such as banks and other financial institutions.
Q. What qualification should I have to perform credit analysis?
A bachelor’s degree in accounting and related subjects as per the chosen industry is sufficient to get you placed in reputed financial institutions. That being said, crash courses with certifications can also make you a credit analyst with the ability to conduct credit research.
Q. Do lending companies alone get benefitted from credit analysis?
No, even the entities that place a request for loan approval benefit from credit research as they get to know the stronger and weaker areas of their financial position letting them take necessary actions to become eligible for availing of credit facilities.