Workshop on Credit Risk Management

Managing Individual Credit Risks

Understanding the Borrower and Borrower’s Risk Environment

June 18, 2008, ShanghaiAsia Pacific Finance and Development CenterWorld Bank Institute

Cash Cycle

Cash

Raw Materials

Work In Process

Finished Goods

Receivables

Value Added

Value Added

Value Added

Value Added

Value Added

Greater the number ofCycles/year ; better the riskDays of RM of Annual ConsumptionDays of WIP of av. time factory floorDays FG of total productionDays of Receivables of annual sales

Finished Goods Inventory

Work In Process Raw Materials

Accrued Wages Fixed AssetsAccountsPayable

Accounts Receivable

CASH

EquityDebt

Dividends

CapitalBudgeting

Investments

Taxes Interest

LaborRM on Credit

Credit Sales

Cash Sales

Repay Loan

Trade CreditRepayments

De

pre

cia

tion

Flows Within A Firm• Your Loan will cause a change somewhere • Use this Schematic in the first meeting• Use this with small firms to construct a proforma B/S, IS and CFS•Use this Schematic to Trace Money Flows•Use this schematic to examine every part of a firm’s operation•Track money flows within firm•Identify Management Controls•Benchmark efficiency•You can’t control what you can't measure!

Source: Adapted from Brigham and Kapenski

Understand Your Borrower’s Business

Fixed Assets

Core Current Assets

Fluctuating Cuurent Assets

LT +E

quity

Sho

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erm

Time

Bal

ance

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Assets and Sources of Financing

Check-List of BorrowerQualitative Aspects

• Corporate Objectives and Corporate Strategy• Product Lines

– Marketing– Sales Channels and Sales Force– Manufacturing– Finance

• Shareholders• Working Capital• Dividend Policy• Accounting Systems

– Control Systems• Management Structure

– Owner– Family Involvement– Professional Management

• Sector Business Environment --- Competition, Imports, Exports• Infrastructure Availability• Macro Environment

Borrower Client FileKnow your customer well Continuous and systematic investment in getting to know everything about borrowers. Develop Client file on each borrowing client. All files will have the same structure Client File Structure. •Summary Fact Sheet. Summary covering all key features about the client.•Detailed Fact Sheet. This would consist of the following sections :

– Demographic History. Basic information address, phone numbers, industry classification, product sold, legal status, organization structure Business Operations History. Basic information on how the firm was started, how it has grown, the main products it sells,

– Financial and Borrowing History. financial information about the client such as balance sheet, income and cash flow summaries and key financial ratios, the indebtedness of the client and the borrowing history.

– Customer Relationship History. What, where and how the borrower sells or buys products and services. History of relationships with its buyers and sellers.

– Technical and Production History. This section would contain information about manufacturing and technology aspects.

– Other History. This section would cover all other relevant information that is not covered in the other sections such as brochures, newspaper/magazine clippings, product catalogs

Client File Summary Sheet

Demographic Data– File Number – Date of last major review– Name, address, phone, fax, web address– Industry Classification (SITC or HS)– Legal status of the firm– Management structure and key contact persons– Nature and duration of relationships with bank. – Latest audited annual accounts

Relationship with Bank – Duration of relationship – Total value of past and existing assistance and loans currently outstanding– Repayment track record – Share of bank loans in total firm indebtedness

Summary Histories– Key financial ratios– Summary of positive and negative features under each section of the credit file. – Exceptional developments positive or adverse.

Client Credit File

Operations HistoryHistorical growth profile of the firm

– Age of the company– Main promoters and pattern of ownership over the years– Ownership/equity/joint venture relationships domestic and foreign – Main business segments and evolution of business segments– Organization structure and management– Significant historical milestones and events in the life of the firm (such as

major projects, public issues. industrial disputes, major financial distress etc.)

To answer the following types of credit risk questions– Has the growth of the firm been balanced?– Can it rely on associated firms for financial assistance or conversely are

associated firms a drain on the resources of the firm and could jeopardize the operations of the firm?

– Are there management depth, professionalism and stability? Can the firm survive the sudden departure of key management personnel?

– Has the firm been responding to market changes?

Client Credit File• Financial History

– Financial Position Summary balance sheet, income and cash flow analysis latest 3 to 5 years.

– Loans from Your Bank loans outstanding how much, maturity, currency, instrument, purpose, past loans repaid, current repayment history, collateral

– Loans from Other Financial Institutions. – Loans from non-financial parties. Particular emphasis to trade and

supplier credit. To undertake a qualitative and quantitative assessment

– Balance sheet and profitability position of the firm improved? – Is its liquidity and cash position commensurate with its level of

operations? – Can it service its debt obligations comfortably existing and new?– Diversion of short-term sources of funds to long-term uses? – Quality of collateral to secure its borrowings?– Does the firm stand by its financial commitments?– Can the firm raise resources at short notice? – Does the firm enjoy high standing with trade creditors and suppliers? If

necessary can it expand these credit channels?– Does the firm have significant cross-company obligations that could puts

its financial position into risk?

Client Credit FileTechnical and Production History

– Technical specifications of the products manufactured/sold by the firm– Age of plant and machinery– Installed Capacity and capacity utilization– Technology agreement, licensing, and transfer agreements and sales

restrictions stemming from these agreements. – Key technical and manufacturing personnel employed– Conformance with international/industry quality standards and quality

certifications obtained by the firm.– Percent/value of imported inputs in production. – Value and frequency of rejections in export orders because of technical

defects or for non-compliance with specifications. This information would be used to undertake a qualitative and quantitative

assessment with a view to answering the following key credit questions:– Does the firm possess the capacity to execute a specific orders in

terms of production capacity and quality standards?– Is the firm vulnerable to disruption in import of inputs?– Does the firm have the technical manpower to oversee export

production?

Organization Chart for a Credit Reporting System

BanksBanks RetailersRetailersProviders of

CreditInformation

Major Collectorsof Credit

Information

Minor Collectorsof Credit

Information

Public CreditRegister

Private CreditRegistries

Retail & Industry-Specific Credit

Registries

Non-FinancialBusinesses:

Utilities, Cell Phones, Agribusiness

• Court Records• Other Public Records: marriage, driving, business, penal, etc.• Regional Registries• Licensing Certifications• Business Transaction Records• Other sources, media, investigation

Non-BankFinancial

Institutions

COPY THIS MODEL!COPY THIS MODEL!

Efficiency gains from using credit registry information

0%

10%

20%

30%

40%

50%

60%

70%

decrease inprocessing time

decrease incosts

decrease indefaults

% o

f re

spo

nd

ed

ba

nks

change of25% or more no change

Based on the results of 2001-2002 survey of banks in 34 countries, World Bank

Key Questions for Participants

• What are the Key Risk Factors in your country/location?• Currently how are you assessing them?• Do you have data for quantitative analysis?• Is the data well organized --- centralized or

decentralized?• To what extent do you rely on relationships and informal

sources of information?• Can you use in your current situation some of the

concepts discussed in this presentation?• What is missing?

Thank You