[Interview] Credit risk: Misconceptions and best practice
Sep 04, 2019
In the countdown to the upcoming RiskConnect conference in November, the RiskConnect team sat down with Paysafe GM, Card Not Present, USA – Shaun Lavelle.
Paysafe has supported the development of high-margin businesses with a unique expertise in risk & fraud mitigation and specialised in-house credit underwriting for more than 20 years. Here Shaun shares his views on credit risk and his key takeaways since speaking at the RiskConnect event last year.
What are the common misconceptions about credit risk particularly in view of other acquirer risks?
There is no doubt that acquirers with many high-risk merchants in their portfolio need to implement a solid monitoring framework. It’s not an option, but a legal obligation. However, a major misconception is that acquirers shouldn’t rock the boat too much. For example, 'asking for financials upfront will kill sales'. This is not the case. Reputable acquirers understand these risks well, and established merchants do too. They will understand why financials are required, but if they don’t, then you should be concerned whether they really understand their business.
Another fallacy is that all merchants are not created equal, but in the eyes of credit risk they are. Many acquirers tend to treat VIP merchants differently than the rest. All merchants must go through the same processes. Big firms do go insolvent and this approach can ultimately lead to huge losses, especially in verticals such as travel, given the extended delivery of services and goods.
In addition to the acquirer risks, are there any misconceptions around the activities of the credit risk department?
The large consensus with many companies it that 'it’s risk’s fault when there are losses'. This is not necessarily true. Businesses do go insolvent. Risk teams need a strong credit risk policy and good credit risk monitoring tools, but not all insolvencies can be predicted in time – even by the highest paid market commentators. The key is that risk appetite is agreed, policy is followed, and monitoring tools remain strong. Where there are losses, analyse postmortem and learn and improve your policies first, then look for fault, if any, second. A risk team that fears loss can impede a business’ growth.
An additional misconception is that 'credit risk is all about the underwriting'. It is actually quite the reverse – underwriting is certainly important, but real-time monitoring of changes to the levels of exposure and merchant credit worthiness are far more important. If you don’t review your merchants regularly and have the alerts in place you will miss the warning signs, and by the time you find out there is an issue, it may well be too late to avoid a loss.
Where does credit risk sits in the underwriting and on-boarding process?
First you must ensure you have identified the merchant concerned, through KYC, KYB, Sanctions, and MATCH. Then it’s all about credit risk and reputational risk. However, the question implies again that credit risk is all about underwriting. As discussed earlier, monitoring is equally, if not more, important.
From your experience, what advice can you provide around underwriting and monitoring with respect to credit risk?
Don’t make false economies by choosing poorer performing tools (or no tools at all) if you are taking on significant credit risk. Ensure that all your senior executives understand what credit risk is. You also need to make certain that your company has fully defined its own risk appetite. Finally, ensure that you have detailed policies and calculations of credit risk signed off by senior executives.
Are there any points that you would particularly like to emphasise or explain in more detail?
Yes, it’s important to look at portfolio management and the key role that credit risk plays in properly managing a portfolio and setting a sales strategy. The best practices in underwriting, monitoring, and portfolio management go hand in hand and it’s important to understand this first. Balancing a portfolio so that the risk return matches the company’s risk appetite is key. Losses will happen but taking some losses can open-up the possibility for new market opportunities.