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Risk-Based SME Lending


Designed for banks and financial institutions involved in SME lending ... Plenty of practice to hone skills. Small group discussion. Methodology ... – PowerPoint PPT presentation

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Title: Risk-Based SME Lending

Risk-Based SME Lending
  • August 13 to 15, 2008
  • Davao City

  • Introduce trainers
  • Introduce participants
  • Leveling of expectations
  • Introducing the course

Risk-Based SME Lending
  • 3 days seminar 8.30 am to 4.30 pm
  • 19 sessions, with 4 actual cases
  • Designed for banks and financial institutions
    involved in SME lending
  • Student Handbook contains all handouts, notes and

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

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

Basic definitions
  • Credit risk - is defined as the risk a bank wont
    receive money lent and interest earned on its
  • 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

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 .

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

Why risk-based
  • Importance of doing risk-based lending. Why is it
  • Better way of identifying and measuring risks in
    the SME businesses being financed

Course objectives
  • Learn about BRR and FRR system and tools
  • Practice doing BRR rating on cases
  • Identify key risks in businesses
  • Learn about SBCs financing programs
  • Learn how to design your own BRR and FRR system

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

  • 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 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 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

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

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

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.

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

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)

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

BRR introduction
  • Under A- administration, 4 items are analyzed
  • EOM experience of owners/ managers
  • OHS owners health, age, succession
  • FC financial capacity
  • AB attitude to banks

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

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

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

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

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

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.

BRR introduction
  • Work in small groups.
  • Introduce briefly the case
  • Read the case briefly Appendix 9
  • Work together in rating the borrower
  • Question-and-answer portion

Report back
  • What is the BRR rating? Will you lend to this
  • What risks did you identify?
  • What loan covenants should you require or impose?
  • Questionand-answer

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

BRR User Guide
  • SBC has developed a BRR User Guide found in
    Appendix 6.
  • Brief explanations about the User Guide

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

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.

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

  • 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 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.

Credit scoring
  • Credit scoring is a statistical method used to
    predict the probability that a borrower will
  • Statistical techniques assign weights to various
    borrower characteristics
  • Past performance can predict future behavior.
  • Credit scoring is another form of
    risk-management, but it is very difficult or
    nearly impossible to implement if there is no
    good client database, which should have at least
    10,000 cases, and collected over a period of 3 to
    5 years.

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.

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

Quiz No. 1
  • Let us test ourselves and see how much new
    information we have obtained from this seminar.

  • Reflect on what we learn today and write in a
    piece of paper 1 or 2 questions to clarify things
    that are unclear.
  • Read the 2nd case tonight, so we can save time
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