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Presentation made at Manila PRMIA Chapter on the 19th June

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Presentation made at Manila PRMIA Chapter on the 19th June 2008 on invitation. The Focus is on what India is doing on credit risk management in relation to SME sector ... – PowerPoint PPT presentation

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Title: Presentation made at Manila PRMIA Chapter on the 19th June


1
 CREDIT RISK MANAGEMENT SME SECTOR(Specific
reference to credit risk insurance)
  • Dr. B.YERRAM RAJU
  • REGIONAL DIRECTOR,
  • PRMIA, HYDERABAD CHAPTER
  • www.prmia.org
  • hyderabad_at_prmia.org

2
Snapshot of the Presentation
  • Current concerns
  • Credit Risk Management (CRM) practices currently
    in vogueand Reengineering
  • Risk Mitigation instruments
  • Credit Risk Insurance practices

3
Why SMEs and Risk twin up?
  • Engines of Economic Growth
  • Sources of Innovation
  • Incubators for new entrepreneurs and new
    workforce
  • Motivators of free market competition
  • Suppliers of materials, components, products and
    services to other businesses
  • Generators of value addition and export earnings
  • Sources of employment and income distribution
  • They take RISK and spread RISK

4
Risks that abound for SMEs
  • Enterprise-Choice of Business organization
  • Marketing Domestic, International, Branding,
    co-branding
  • Technology Inadequacies Inappropriateness
  • Pricing and the last
  • Financial

5
Contribution of SMEs
  • More than 65 ways in which the SMEs are defined
    over the world
  • Centering round Investment, Employment, and
    Turnover
  • 8 out of 10 Jobs U.S.
  • 78 of Manufacturing Employment
    Japan
  • 34 of Total Value Addition
    Singapore
  • 42 of total exports Korea
  • 53 of Total Exports Taiwan
  • 40 of Manufacturing production
  • 39 of total exports India
  • 98 of enterprises and gt45 of exports Malaysia
  • 99 of business enterprises employing 55 of
  • total workers contribute 32 of GNP with 9 out
    of
  • 10 export firms
    Philippines

6
Facilitation around the Globe
  • US Small Business Administration
  • South Korea SME Basic Law for Protection and
    Promotion
  • Taiwan SME Guidance System
  • Hong Kong Special Finance Scheme for SMEs
  • Philippines Magna Carta for SEs (RA6977)SMED
    Council
  • Small Business Guarantee
    Fin Corpn
  • Malaysia Credit Guarantee Corporation and Fund
    for SMEs(RM1.25bn) New Entrepreneurship Fund
    (RM900mn)
  • India
  • NSIC,SFCs (1950s) SIDBI (1994) SMERA (2004)
  • MSME Development Act 2006
  • Credit Guarantee Fund Trust for MSMEs under which
    up to Rs.5mn collateral free loan can be
    extended.

7
Still
  • SMEs thrive on private high-cost credit
  • Survive on low margins and low profits
  • Exit fast
  • According to a Study presented by Mr. Supriya
    Sithikong nearly 77 of new entrepreneurs exit
    in the first five years of setting them up
  • Exit rules in many developing economies are
    hostile.

8
Still
  • Several supports from the governments in Asia did
    not get adequate support from the financing
    institutions.
  • In India, all the positive policy reforms did not
    take beyond 6.34 (US2.9bn) credit to the SMEs
    by 2006-07 despite NPLs going down from 21 in
    2001-02 to 5.4 in2006-07.
  • After the entry of Basel II norms Banks
    preference weighed in favor of firms that
    wouldnt entail excess provisioning of capital
    and this is driving away some of the erstwhile
    well-run SMEs seeking exit.
  • Competition driven by new trade rules, new FTAs,
    WTO, high-end games

9
Indian Economy
  • A sustainable growth of over 8.6 percent in the
    short term and 9-9.5 percent in the medium term
    targeting 10 next Plan
  • Growth in manufacturing at 7 at end June08
    down from 11.8 last year due to the US recession
    and downward global demand curve.
  • Eloquent on economic reforms and tardy on
    implementation agenda
  • International Rating Agencies have scaled up the
    rating for viewing the country as a good
    destination for future investments.
    (SPMoodysFitcher)
  • DunBradstreet Business Optimism index moved up
    -13.3 growth
  • Call for convergence, competitiveness efficiency

10
CURRENT CONCERNS
  • BANKS
  • HIGH RISK
  • HIGH TRANSACTION COSTS
  • ASYMMETRY OF INFORMATION
  • MORAL HAZARD
  • LOW ON COLLATERALS GUARANTEES
  • DEMAND CONCUSSION
  • HUGE DATA REQUIREMENTS
  • POOR COMPLIANCE
  • HIGHER CAPITAL ALLOCATION
  • GOVERNMENT, RBI
  • WIDEN DEEPEN THE SME PORTFOLIO
  • INCREASE THE REACH
  • RATIONALISE COST OF LOANS
  • MAKE USE OF CART RAM OF SIDBI
  • LIBERALISE POLICIES
  • BANKS TO DISPLAY FACILITIES AT BRANCHES
  • CLUSTER DEVELOPMENT TECH MODERNIZATION
  • 2008-RBI set up Working Group to suggest more
    sustained strategies for
  • SME growth and to rehabilitate the sick SMEs on
    firm and faster footing.
  • The Report is under consideration.



11
SME sector in India
  • The sector currently contributes 40 percent of
    the total industrial production in the country
    and over 39 percent of national exports.
  • The total number of small-scale industrial units
    and small business enterprises is 11.39mn
    accounting for nearly 95 per cent of the total
    industrial units of the country, providing
    employment to nearly 27.13mn people, which is
    nearly 86 percent of the total employment in the
    country.

12
With Reengineering Credit processes
  • They will reposition themselves through the new
    financing facilities to earn more profits and
    expand their businesses.
  • Win-win situation for Banks, Entrepreneurs and
    National Economy

13
The New Direction
  • The overall context and direction of commercial
    bank lending can be epitomized as follows
  • Growing competition in Financial industry leading
    to emphasis on total banking solutions to
    customers
  • Risks managed more prudently because of
    diversified Portfolio reflected in capital
    adequacy ratio of gt9 for most banks in India

14
Approach To Risk
  • RISK BY CHOICE AND NOT BY CHANCE
  • INTEGRATED, NOT FRAGMENTED APPROACH (ASSET,
    LIABILITY, OFF-BALANCE SHEET ITEMS)
  • INTEGRATED APPROACH TO MARKET AND CREDIT RISKS
  • -- MOTIVES AND ROLES OF FINANCIAL
  • INSTITUTIONS AND CORPORATE
  • TREASURY
  • -- IMPLICATIONS

15
The credit process
  • Banks use two basic methods for determining
    credit-worthiness- or assessing the banks risk
    level Judgmental or Credit Scoring Method.
  • On the basis of training personal experience,
    the loan officer attempts to predict the
    likelihood that the applicants will be good or
    bad credit customers.
  • The scoring method draws profiles from the banks
    lending experience using statistical techniques.

16
Change on Cards
  • Building new customer base of SMEs could earn
    relatively higher margins and soaks some excess
    liquidity
  • New equilibrium between supply and demand of
    loanable funds at higher price Depositors also
    benefit.
  • Prudence and Profitability Two Pillars on which
    SMEs are built
  • Risk aversion will drain banks profitability

17
Change on Cards (contd)
  • Lack of access to capital
  • Has not allowed SMEs to modernize their
    production techniques
  • To hire skilled human resources, upgrade the
    quality of management and invest in new
    equipment.
  • Separate Stock Exchange for SMEs is on cards.
  • LLP Act tabled in the Parliament
  • SMEs can accomplish new product mix to meet the
    demands of domestic and export markets.
  • The credit provided to them will enable them to
    acquire new technology and improve the quality of
    their products to meet the future needs.

18
Migration to Automated Processing of Applications
  • Banks that receive many applications, typically
    process and score them with automated systems,
    with the help of data entry terminals.
  • A preliminary score may decide whether a Credit
    Bureau report is required.
  • Some banks use automated processing for handling
    applications but use a judgmental method for the
    final credit decision.
  • Approvals are followed by Credit Review functions
    including, Credit Origination, Extension,
    Customer Service, Security and Collections.
  • Internal scoring is the most preferred option for
    SMEs

19
Current Credit Risk Management Practices
  • Existing SME Loan Products and their nature
    Term LoanThis is being sanctioned by the Banks
    and financing institutions for setting up the
    plant and machinery, modernization and purchase
    of new technology for a period of 3 to 7 years
    repayable in monthly, quarterly or half yearly
    installments.
  • Working Capital Cash Credit in form and
    content-mostly based on Balance Sheets and the
    related ratio analysis or the normative lending
    prescribed by the RBI. 

20
Credit Appraisal Technology for SMEs
  • Main tools for credit appraisalo       Portfolio
    Approacho       Program Lendingo       Credit
    Scoring MethodologyCredit analysis to develop
    competencies other than o       Balance
    sheetso       Audited Financial
    Statementso       Value of CollateralsDoing
    sensitivity analysis

21
Credit Appraisal Technology for SMEs
  • Re-engineer from the micro level Regulatory and
    infrastructure support          This we call
    change in mindset          Monitor the borrower
    instead of Account          Restructure
    repayments if unexpected exogenous shocks
    occur          Rigid approach insistence on
    original schedules despite genuine difficulties
    of borrower will only build NPAs Avoiding them
    is imperative.          Use information
    technology as an aid to monitor follow up.

22
Credit Appraisal Technology for SMEs
  • Bank Staff have to do hand holding of the
    borrowers and help in building their
    capacity.(Less attempted)
  • This new kind of relationship between bank and
    customers will alone assure success of SME
    lending
  • Learning from international best practicesWe
    dont have to reinvent the wheel but carefully
    examine what has worked elsewhere and what hasnt
    worked. 

23
Credit Appraisal Technology for SMEs
  • Risks from changes in domestic and international
    polices Examples Policy to import components
    under low tariffs led to exit of a few hardware
    manufacturing electronic units vegetable oil
    import policy tariff policies leading to some
    oil expellers shutting down the shutters.
              Production yield risks of the
    dependent Agri sector in some trade cycles
    leading to closure of small units maize, corn,
    rice, wheat, Soya bean, cotton, tobacco as raw
    material

24
Credit Appraisal Technology for SMEs
  • Market Price Risks Price uncertainty due to
    market fluctuations is particularly severe where
    information is lacking and where markets are
    imperfect (Ellis, 1988 peasant Economics, Farm
    Households and Agrarian Development, Cambridge,
    New York, Port cluster, Melbourne, Sydney)
  • The vendee a large industry to be competitive
    and stay in the market suddenly changes its
    technology and production focus and the vendor
    would not be able to readjust quickly to the
    demand raised on him/her.  

25
Credit Appraisal Technology for SMEs
  • Risk of Loan collateral limitation Banks have of
    late been seeking excessive collaterals and
    specific collaterals to hedge their risks in
    appraisal and lending because of the powers
    conferred on them to realize the assets by sale
    of collateral in case of loan default. MIS
    support Most Indian Banks are yet to build data
    bases on risk events, loan default rates
    sector-wise, area-wise, like probability of
    default, loss given default, exposure at default.

26
SCORING VS RATING
  • SCORING
  • USED IN THE REALM OF RETAIL FINANCE
  • HUMAN JUDGEMENT, DECISION TREE ANALYSIS STAT
    METHODS LIKE DISCRIMINANT ANALYSIS OR LOGISTIC
    REGRESSION ANALYSIS
  • NEUTRAL NETWORKS BASED ON HISTORICAL CREDIT
    ANALYSIS A COMPOSITE SCORE CARD IS BUILT.
  • kNN-k NEAREST NEIGHBOR ANALYSIS
  • RATING
  • USUALLY INTENDED FOR WHOLESALE BANKING
  • -JUDGEMENT-BASED METHODS, ARTIFICIAL
    INTELLIGENCE SYSTEMS
  • -STATISTICAL METHODSSTRUCTURAL, REDUCED FORM
    AND HYBRID MODELS

27
Credit Appraisal Technology for SMEs
  • The cash-strapped SME sector is still in the
    process of appreciating the advantages of rating.
  • Banks are yet to market this strategic tool among
    the user population with appropriate incentives.
  • SIDBI developed a rating product for internal use
    by Banks-Credit Appraisal Rating Tool (CART)
  • To give special focus, SIDBI and Dun Bradstreet
    promoted SMERA as an exclusive SME rating
    institution in 2004. It has rated 1400
    enterprises and conducted detailed studies of 14
    prominent clusters.

28
  • IT IS BETTER TO BE APPROXIMATELY RIGHT THAN
    PRECISELY WRONG

29
RISK MEASUREMENT
  • A NEW SCIENCE
  • FALLIBLE
  • AN APPROXIMATION
  • IMPRECISE

30
Credit Risk Measurement
Collateral
Transforms credit Risk to asset risk
Third Party Guarantee
Risk transfer from Only borrower to Borrower
Guarantor
Covenant
Allows corrective action
31
MODELS
  • PROVIDE AN INEVITABLY INCOMPLETE DESCRIPTION OF
    REALITY AND THEIR ROLE IS TO ASSIST INTUITION
  • NO MODEL CAN PRECISELY CAPTURE THE BEHAVIOUR OF
    AN ENTREPRENEUR
  • IT CAN AT BEST REDUCE UNCERTAINTY
  • PROVIDES AN OBJECTIVE BASE
  • VALIDITY OF STRESS TESTING COULD BE ERODED BY THE
    SUBJECTIVITY OF ASSUMPTIONS.

32
WHAT TO DO?
  • RISK TEAMS SHOULD LOOK AT HOW TO DEMYSTIFY RISK
    PRACTICE, BUILD BRIDGES WITH BUSINESS UNITS AND
    INTEGRATE OPERATIONAL RISK MANAGEMENT MORE
    CLOSELY WITH THE DAY-TO-DY CONTROL ENVIRONMENT

33
  • PRINCIPLES ARE REQUIRED TO DEFINE THE
    EXPECTATIONS, GOVERNANCE AND COMMON LANGUAGE OF
    RISK MONITIORING AND MITIGATION.
  • WE NEED TO ELEVATE RISK ABOVE THE TRADITIONAL
    SILOS TO ENSURE WE ARE ASKING THE RIGHT
    QUESTIONS.

34
New Paradigm on Risk Management left SMEs in Deep
Trouble
  • SMEs that cannot offer adequate guarantees and
    collaterals are hurt
  • Banks continue to view SMEs as high risk entities
    despite policy encouragement from the government
    and their contribution to the growth of the
    economy
  • Venture Capital and Angel Capital firms distance
    from them because they do not assure that yields
    they look for and exit routes are not clear.
  • Still, many rating institutions rate the SMEs on
    Balance sheet performances.
  • Many financing institutions too assess credit
    requirements of SMEs on the basis of Balance
    sheet ratios in several Asian economies and not
    on the basis of cash flows.

35
What is the Recourse? And Where are the Risk
Mitigants?
  • Client Education and Training hold the key
  • Cluster Approach
  • World Bank reiterates that Factoring helps a
    great deal.
  • Credit Risk Insurance holds promise if the
    Insurance Companies are persuaded to provide
    guarantee cover with subsidized premiums.
  • Technology funding, IPR funding, and Brand
    funding with support from the Education and
    Training Institutions would make them globally
    competitive.

36
The New Paradigm
Banking Prudential Norms guided by overall
financial sector reforms
Individual Bank Strategy towards AME Cluster
Lending
Credit at Lower cost (Collateral requirements
Lower interest rates ) w
Increase bank reach, with geographical intensity
of distribution
ACCESSIBILITY
AFFORDABILITY
3A APPROACH
AVAILABILITY
Making loans available at the right quantity at
the right time Bank motivation (customer focus)
towards higher SME clustering.

SourceDB Study, SMERA (India),2007
37
GoI MSME DEVELOPMENT SUPPORT SCHEMES (2008)
  • (i) Adequate credit from financial institutions
    (ii) funds for technology upgradation and
    modernization (iii) integrated infrastructural
    facilities (iv) modern testing facilities and
    quality certification laboratories (v) modern
    management practices, entrepreneurship
    development and skill upgradation through
    appropriate training facilities etc. The schemes
    so announced include-
  • Tax Holiday Scheme
  • Composite Loan Scheme
  • Industrial Estate Scheme
  • Scheme for International Cooperation
  • Scheme of Surveys, Studies and Policy Research
  • Scheme of Fund for Regeneration of Traditional
    Industries (SFURTI)
  • Scheme of Product Development, Design
    Intervention and Packaging (PRODIP)
  • Scheme of Khadi Karigar Janashree Bima Yojana for
    Khadi Artisans
  • Scheme of Interest Subsidy Eligibility
    Certification (ISEC)
  • Source
    www.laghu-udyog.com

38
INDIA MSME (Contd)
  • Small Industry Development Organization also
    operates a number of schemes for the sector-
  • Credit Linked Capital Subsidy Scheme for
    Technology Upgradation
  • Credit Guarantee Fund Trust for MSEs
  • ISO 9000/ISO 14001 Certification Reimbursement
    Scheme
  • Scheme for reimbursement of fees to adopt
    barcoding
  • Integrated Infrastructure Development (IID
    Scheme)
  • Scheme for setting up of Mini Tool Rooms Scheme
    for setting up of testing centres Scheme for
    Market Development Assistance (MDA) for exporters
  • Assistance for Strengthening of Training
    Infrastructure of existing and new
    Entrepreneurship Development Institutions
  • Scheme of Micro Finance Programme


  • Source www.laghu-udyog.com

39
Cluster Based Risk Assessment Framework
SMES in the cluster
Bank credit flow to Cluster
COMMON RISKS FACING CLUSTER
Individual RISK FACING SME
Risk parameters
Risk parameters
Source DB Study,SMERA(2007)
40
Enhancing SME Competitiveness through Cluster
Development
41
Factoring Fundamentals
Factor
Buyer
Obligation to pay

Goods
Seller
A/R
yerramraju_at_prmia.org
Source World Bank 2007
42
Credit Risk Insurance
  • The need arises from continuing Cash flows in
    business, bad debt reductions, asset reporting
    and integrity forming important charters of
    credit risk management.
  • Ever changing face of trade credit risks
    accentuated by changes in national laws,
    regulations and licensing regimes WTO, FTAs and
    other Regional Trade Agreements. Keeping track of
    them is a tough task for the Credit Manager.
  • The Manufacturing and trading entity as well as
    the credit provider are a happier lot by seeking
    credit Insurance if there is a good provider at
    affordable price!!

43
Credit Risk Insurance
  • Managing and hedging the default/loss risks
    inherent in
  • National, domestic (inter-state and intra-state),
    export, multinational transactions of firms
  • Sovereign, political and economic risks need
    coverage
  • Political risks include political unrest,
    widespread corruption/bribery economic
    instability accelerated inflation rates
    currency volatility regulatory volatility and
    high service costs.
  • These types of risks are just unthinkable for
    many SMEs irrespective of where they are
    situated.

44
Status of Credit Insurance Some Illustrations
  • Countries
  • U.K
  • France
  • Netherlands
  • Spain
  • Portugal
  • Canada etc.
  • Types of Cover
  • Medium Long term cover thru ECGD
  • High Risk Market Interest
  • Project Financing
  • Supplier Credit Finance
  • Bond Insurance
  • Overseas Investments

45
Status of Credit Insurance Some Illustrations
  • Focus on SME sector
  • Political risks
  • Environmental risks
  • Domestic Credit Insurance
  • Governments of the respective countries extend
    tremendous support thru budgetary and exclusive
    grants to premia subvention.
  • U.S
  • Small Business Policy
  • SB Environmental Policy
  • Umbrella Policy-Export Insurance for the small
    enterprises
  • Belgium
  • SME Policy T/O Bfr200m Exports outside
    Europe-Bfr250m
  • Netherlands SMEs with 7mn and less and for SMEs
    of ABN-AMRO
  • Germany
  • South Africa

45
46
To sum up
  • SMEs and FIs need to share the risks equally thru
    proper mutual understanding and better
    instrumentality Clusters, Factors, Credit
    Insurance
  • Mere mathematics, LGDs, EADs, V_at_R, Rating
    mechanisms are only poor substitutes for client
    education, client understanding as effective risk
    insurers and re-insurers.

47
  • THANK YOU
  • URL www.prmia.org
  • E-mail hyderabad_at_prmia.org
  • yerramr_at_gmail.com
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