Credit Risk – You’ll Take the Blame If Your Vendor Doesn’t Have the Credit

Vendor risk management is an ongoing process—one that begins with due diligence before a contract is signed and continues with monitoring throughout the length of the relationship. This blog series on the Top 10 risks will help you more effectively address how third-party vendor risk throughout every department in your financial institution.

#10 – Credit Risk

Banks and credit unions maintain loan loss reserves to protect against loan defaults—but what can a financial institution do to protect itself against the possibility of a vendor going under?

It can avoid choosing a financially troubled vendor in the first place.

That’s the goal of credit risk—or the strength and ability of a company to manage debt and stay in business to ensure continued operations—in the vendor management process. This is separate from operational risk, which is the broader risk of financial loss when processes, people or systems fail.

Credit risk is a real concern. A financial institution that partners with a financially unsound vendor may find itself suddenly cut off from a critical product or service if that firm goes under—drawing the wrath of regulators and customers.

That’s why the FDIC says that FIs should evaluate significant third-party vendors’ financial condition at least annually and that the review should allow the financial institution to understand if the vendor can maintain business operation.

The good news for bankers and credit union professionals is that the board and management should be very experienced in evaluating businesses, audited financial statements and publicly available documents.

Areas to look at include:

  • Financial condition. A company’s liquidity and leverage figures reveal the strength of its condition.
  • Financial performance. Reviewing profitability and cash flow are essential.
  • Litigations. Claims for punitive or exemplary damages from pending on threatened litigation can wreak havoc on the bottom line.
  • Acquisitions. Acquisitions can expand a company’s offerings, spread its resources too thin or rapidly increase the debt load.

Armed with this knowledge, your FI can make an informed assessment of a vendor’s soundness and include credit risk in its overall vendor management risk assessment.