1. Risk-Based SME Lending

2. Introductions Introduce trainers Introduce participants
Leveling of expectations
Introducing the course

3. Risk-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.

4. Risk-Based SME Lending
Session 1 – Opening session
Introductions
Leveling of expectations
Course objectives
Course outline
Methodology
Rules of the game

5. Common 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

6. Basic 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.

7. Basic 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 .

8. Biggest 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.

9. Why 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

10. Course 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

11. Course outline 19 sessions Introduce BRR and FRR Four actual SME cases
Plenty of practice to hone skills
Small group discussion

12. Methodology 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.

13. Rules 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.

14. Rules 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

15. Basic definitions Loan delinquency Loan default
Probability of default (PD)
Loss given default (LGD)

16. Session 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

17. Global 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).

18. Risk 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

19. BRR introduction
Quantitative and qualitative evaluations are used in BRR.
Not a purely numerical exercise
Human judgement is still very important

20. BRR 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.

21. BRR 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

22. BRR 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)

23. BRR introduction Under C- cash / financials, 4 items are analyzed
CR – current ratio
DER – debt-equity ratio
DSC – debt-servicing capacity
ARL – accounts receivable level

24. BRR 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

25. BRR introduction Under M- marketing, 2 items are analyzed
Sales – concentration of sales
Growth – increase of sales past 3 years

26. BRR introduction Under P- production, 4 items are analyzed
Supplier – concentration of suppliers
Inventory speed – turnover
Production service capacity
Business location

27. BRR 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

28. Will it be useful? What are the possible benefits to the banks?
To the SMEs?
To the economy?

29. Session 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.

30. BRR introduction Work in small groups. Introduce briefly the case
Read the case briefly
Work together in rating the borrower
Question-and-answer portion

31. Report 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

32. Session 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

33. BRR User Guide SBC has developed a BRR User Guide
Brief explanations about the User Guide

34. BRR introduction
BRR is related to many things in the organization. They are:
Loan pricing
Loan portfolio quality and overall profitability
Intensity of loan monitoring
Number and kind of loan covenants or conditions
Loan loss provisioning
Organizational structure
Calculation of PD and LGD

35. BRR 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.

36. FRR 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

37. FRR 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.

38. FRR 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.

39. Bangko 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.

40. Session 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