Risk-Based SME Lending. Introductions Introduce trainers Introduce participants Leveling of expectations Introducing the course.

Risk-BasedRisk-BasedSMESME LendingLending

IntroductionsIntroductions

• Introduce trainers

• Introduce participants

• Leveling of expectations

• Introducing the course

Risk-Based SME LendingRisk-Based SME Lending

• 2 day seminar, with 4 actual cases

• Designed for banks, coops and financial institutions involved in SME lending

• Student Handbook contains all handouts, notes and materials.

Risk-Based SME LendingRisk-Based SME Lending

• Session 1 – Opening session

• Introductions

• Leveling of expectations

• Course objectives

• Course outline

• Methodology

• Rules of the game

Common abbreviationsCommon abbreviations• BRR – means Borrower Risk Rating• FRR – means Facility Risk Rating• SBC – Small Business Corporation • PD – Probability of Default• LGD – Loss Given Default • CAMP – Cash, Admin, Marketing, Prodn• CR – Current Ratio• DSC – Debt Servicing Capacity

Basic definitionsBasic definitions

• Credit risk - is defined as the risk a bank won’t receive money lent and interest earned on its loans.

• Repayment of funds and accompanying interest must occur if a bank is to succeed. If the loan principle is not returned, the bank will quickly fail. If the bank does not receive interest earned, its failure will be slower, but just as sure.

Basic definitionsBasic definitions

• Risk-based - simply means the bank or financial institution has a systematic way of assessing, measuring and managing credit risks.

• Banks are in the risk management business – they assess, assume and manage risk. Those that do it well succeed and prosper. Those that do not manage risk perform poorly and in some instances, fail .

Biggest riskBiggest risk

• Biggest Risk of All – out of the 4 or 5 major risks that a bank faces, it is CREDIT RISK which is the biggest. It comprise 80% of all risks.

• A bank which fails to manage its credit risks is doomed to fail. A Bank which manages its credit risks well is likely to become profitable and sustainable.

Why risk-basedWhy risk-based

• Importance of doing risk-based lending. Why is it important?

• Better way of identifying and measuring risks in the SME businesses being financed

Course objectivesCourse objectives

• Learn about BRR and FRR system and tools

• Practice doing BRR rating on cases

• Identify key risks in businesses

• Learn about SBC’s financing programs

• Learn how to design your own BRR and FRR system

Course outlineCourse outline

• 19 sessions

• Introduce BRR and FRR

• Four actual SME cases

• Plenty of practice to hone skills

• Small group discussion

MethodologyMethodology• Will use adult education techniques

• Case discussion method

• Ask questions anytime, please…

• Quizzes every day; final quiz at the end

• Attendance recording is a must

• Come on time.

Rules of the gameRules of the game• Sign attendance sheet daily.

• Ask questions if anything is unclear.

• Participate actively in group discussions

• Share your views and experiences.

• Respect the views of your peers.

Rules of the gameRules of the game• Do your best in the quizzes. Its an

opportunity to test your learning.

• Bring your Student Handbook every day. Bring a calculator too.

• Certificate of Participation to be given to everyone who completes the 3 day seminar

Basic definitionsBasic definitions• Loan delinquency

• Loan default

• Probability of default (PD)

• Loss given default (LGD)

Session 2Session 2• Why do pilots check their plane before

taking off?

• Why do you think it is important to check the backgrounds and risks of business of borrowers?

• Potential problems may come if there is no proper credit assessment

Global trendGlobal trend• There is now a global trend for banks to

carefully examine and measure borrower risks before a loan is disbursed. (This is in contrast to old traditional way

of banking which relied heavily on collaterals).

Risk ratingRisk rating• Global trend in banking: systematic

risk assessment of borrower-clients• Basel II – endorses 2 tier approach:

BRR and FRR • Basel II includes both qualitative and

quantitative analyses • BSP endorses and requires credit risk

assessments; could increase CAMELS rating of banks

BRR introductionBRR introduction• Quantitative and qualitative evaluations

are used in BRR.

• Not a purely numerical exercise

• Human judgement is still very important

BRR introductionBRR introduction• BRR analyses should help in making

credit decision of the bank; whether a loan will be given to a borrower or not, and what conditions to impose.

• FRR analyses should help in making decisions on loan size, loan terms, loan pricing and conditions on collaterals.

BRR introductionBRR introduction• BRR makes use of a score card;

various aspects of the business are analyzed and given a score.

• Risks are identified as each component of the business is analyzed

• Total score is obtained;

• BRR score translated to BRR rating; Grade 1 to 10. See Handbook page 18

BRR introductionBRR introduction• Four major components of the

business are analyzed deeply • C – cash – financials (50% weight)

• A – administration (20% weight)

• M – marketing (15% weight)

• P – production (15% weight)

BRR introductionBRR introduction• Under C- cash / financials, 4 items are

analyzed

• CR – current ratio

• DER – debt-equity ratio

• DSC – debt-servicing capacity

• ARL – accounts receivable level

BRR introductionBRR introduction• Under A- administration, 4 items are

analyzed

• EOM – experience of owners/ managers

• OHS – owner’s health, age, succession

• FC – financial capacity

• AB – attitude to banks

BRR introductionBRR introduction• Under M- marketing, 2 items are

analyzed

• Sales – concentration of sales

• Growth – increase of sales past 3 years

BRR introductionBRR introduction• Under P- production, 4 items are

analyzed

• Supplier – concentration of suppliers

• Inventory speed – turnover

• Production service capacity

• Business location

BRR introductionBRR introduction• BRR ratings range from 1 to 10.• Grade 1 is high-quality, excellent client; very

low risk involved; • Grade 10 is a very poor, bankrupt client• Grade 5 is considered acceptable. • Qualitative descriptions shown in Student

Folder• BRR User Guide is used in BRR rating

exercise

Will it be useful? Will it be useful? • What are the possible benefits to the

banks?

• To the SMEs?

• To the economy?

Session 3Session 3• Introduce briefly how BRR rating is

done using a first actual SME case

• SBC has developed a good BRR system

• BRR scorecard

• Groupings into 4 or 5 groups.

BRR introductionBRR introduction• Work in small groups.

• Introduce briefly the case

• Read the case briefly

• Work together in rating the borrower

• Question-and-answer portion

Report backReport back• What is the BRR rating? Will you lend

to this company?

• What risks did you identify?

• What loan covenants should you require or impose?

• Question–and-answer

Session 4Session 4• BRR and its links to various aspects

and components of the bank.

• Banks faces many risks – operational risks, liquidity risks, market risks, etc.

• But the biggest risk of banks is credit risk

• BRR will help screen out bad accounts and identify good and bad credit risks

BRR User GuideBRR User Guide• SBC has developed a BRR User Guide

• Brief explanations about the User Guide

BRR introductionBRR introductionBRR is related to many things in the

organization. They are: 1. Loan pricing 2. Loan portfolio quality and overall profitability 3. Intensity of loan monitoring 4. Number and kind of loan covenants or

conditions5. Loan loss provisioning 6. Organizational structure7. Calculation of PD and LGD

BRR and PDBRR and PD• BRR is related to Probability of Default • It is logical to think that a company with a

high BRR rating (meaning high business risk) should have PD and higher loan loss provisions in the books of the bank, while a company with a lower BRR rating (lower risks) shall have a lower PD and loan loss provisions.

FRR introductionFRR introduction• What is FRR? • Facility Risk Rating, where a tool is used to

systematically assess the collateral or security being offered by the borrower as security for the loan. A bank should also conduct a risk assessment of the collateral and such an FRR rating complements the BRR rating.

• FRR factors should only affect the pricing of the loan and conditions but not the basic credit decision

FRR and LGDFRR and LGD• FRR is directly related to LGD – Loss Given

Default. Why? • The quality of the security or collateral being

offered by the client as measured by an FRR rating will allow the bank to have a good estimate of the amount of monetary loss that may be suffered by the bank in case the client actually defaults. This is called LGD – Loss Given Default.

• If the security is of high quality the LGF will be probably low, but if the quality is poor, then the LGF will be probably high.

FRR introductionFRR introduction• A FRR rating table provides clear

guidance on how to rate a business using the collateral being offered as security for the loan.

• See the FRR rating table in the 113

• FRR rating of zero is very high quality collateral while an FRR rating of 10 means very poor or no collateral at all.

Bangko SentralBangko Sentral• The BSP requires all banks to put in

place a credit risk management system.

• See BSP circular in Appendix 2

• Several BSP circulars released.

Session 5Session 5• Let us do a BRR rating of one actual SME

company.

• A brief introduction to the case

• Work in small groups; within time limit

• Report back