2Introductions Introduce trainers Introduce participants Leveling of expectationsIntroducing the course
3Risk-Based SME Lending 2 day seminar, with 4 actual casesDesigned for banks, coops and financial institutions involved in SME lendingStudent Handbook contains all handouts, notes and materials.
4Risk-Based SME Lending Session 1 – Opening sessionIntroductionsLeveling of expectationsCourse objectivesCourse outlineMethodologyRules of the game
5Common abbreviations BRR – means Borrower Risk Rating FRR – means Facility Risk RatingSBC – Small Business CorporationPD – Probability of DefaultLGD – Loss Given DefaultCAMP – Cash, Admin, Marketing, ProdnCR – Current RatioDSC – Debt Servicing Capacity
6Basic definitionsCredit 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.
7Basic definitionsRisk-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 .
8Biggest riskBiggest 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.
9Why risk-basedImportance of doing risk-based lending. Why is it important?Better way of identifying and measuring risks in the SME businesses being financed
10Course objectives Learn about BRR and FRR system and tools Practice doing BRR rating on casesIdentify key risks in businessesLearn about SBC’s financing programsLearn how to design your own BRR and FRR system
11Course outline 19 sessions Introduce BRR and FRR Four actual SME cases Plenty of practice to hone skillsSmall group discussion
12Methodology Will use adult education techniques Case discussion method Ask questions anytime, please…Quizzes every day; final quiz at the endAttendance recording is a mustCome on time.
13Rules of the game Sign attendance sheet daily. Ask questions if anything is unclear.Participate actively in group discussionsShare your views and experiences.Respect the views of your peers.
14Rules of the gameDo 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
15Basic definitions Loan delinquency Loan default Probability of default (PD)Loss given default (LGD)
16Session 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
17Global trendThere 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).
18Risk ratingGlobal trend in banking: systematic risk assessment of borrower-clientsBasel II – endorses 2 tier approach: BRR and FRRBasel II includes both qualitative and quantitative analysesBSP endorses and requires credit risk assessments; could increase CAMELS rating of banks
19BRR introductionQuantitative and qualitative evaluations are used in BRR.Not a purely numerical exerciseHuman judgement is still very important
20BRR introductionBRR 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.
21BRR introductionBRR 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 analyzedTotal score is obtained;BRR score translated to BRR rating; Grade 1 to 10. See Handbook page 18
22BRR introductionFour major components of the business are analyzed deeplyC – cash – financials (50% weight)A – administration (20% weight)M – marketing (15% weight)P – production (15% weight)
23BRR introduction Under C- cash / financials, 4 items are analyzed CR – current ratioDER – debt-equity ratioDSC – debt-servicing capacityARL – accounts receivable level
24BRR introduction Under A- administration, 4 items are analyzed EOM – experience of owners/ managersOHS – owner’s health, age, successionFC – financial capacityAB – attitude to banks
25BRR introduction Under M- marketing, 2 items are analyzed Sales – concentration of salesGrowth – increase of sales past 3 years
26BRR introduction Under P- production, 4 items are analyzed Supplier – concentration of suppliersInventory speed – turnoverProduction service capacityBusiness location
27BRR 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 clientGrade 5 is considered acceptable.Qualitative descriptions shown in Student FolderBRR User Guide is used in BRR rating exercise
28Will it be useful? What are the possible benefits to the banks? To the SMEs?To the economy?
29Session 3Introduce briefly how BRR rating is done using a first actual SME caseSBC has developed a good BRR systemBRR scorecardGroupings into 4 or 5 groups.
30BRR introduction Work in small groups. Introduce briefly the case Read the case brieflyWork together in rating the borrowerQuestion-and-answer portion
31Report 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
32Session 4BRR 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 riskBRR will help screen out bad accounts and identify good and bad credit risks
33BRR User Guide SBC has developed a BRR User Guide Brief explanations about the User Guide
34BRR introductionBRR is related to many things in the organization. They are:Loan pricingLoan portfolio quality and overall profitabilityIntensity of loan monitoringNumber and kind of loan covenants or conditionsLoan loss provisioningOrganizational structureCalculation of PD and LGD
35BRR 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.
36FRR 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
37FRR 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.
38FRR introductionA 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 113FRR rating of zero is very high quality collateral while an FRR rating of 10 means very poor or no collateral at all.
39Bangko SentralThe BSP requires all banks to put in place a credit risk management system.See BSP circular in Appendix 2Several BSP circulars released.
40Session 5 Let us do a BRR rating of one actual SME company. A brief introduction to the caseWork in small groups; within time limitReport back