Professional Documents
Culture Documents
Management quality Business model Competitiveness Key success factors Credit Analysis Proposed activity & financing requirement Financial history, performance, capital usage and financing strategy Debt capacity , Cash Flow and Fund Flow analysis Industry cycles and business risk Internal Rating and probability of default Purpose of financing Determine type of financing - asset /receivable/cash flow financing/structured Risk mapping of transaction, is it bankruptcy remote the obligor ? Are there any risk sharing arrangements ? Co financing, Bank acceptances or Letter of credit backing etc. Transaction Is the transaction self financing ? i.e. commodity based lending analysis Extent of collateral risk-collateral value and market risk Is there a need to obtain additional collateral or balance sheet cash flow is adequate? Are there any contingent risks in the transaction which needs to be priced ? Transaction rating based upon credit support available and risk sharing Arrive at residual risks which are open in the transaction Think through the possibility of either sharing or pricing the residual risks Iterate the RAROC based pricing based on residual risk and transaction rating ( based upon additional structuring of credit support). In case of treasury based transaction , we can look at market credit support such as liquid collaterals . Arrive at the final pricing and transaction rating and residual risks which are open Specify the terms and conditions required to govern the transaction Put up the credit note for committee approval 1
Credit Structuring
Credit Approval
Carry credit reviews and rating watch both Internal & External rating migration Monitor collateral risk In case of structured transactions such as securitization track quality of asset pool, collection efficiency and default rates if any Revise rating in case of any downgrades or upgrades and review with Credit & Risk committees Follow classification as per asset classification norms Report and trigger action in case of any impairment
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Five Force analysis of Industry competitiveness local/global Industrial policy environment Key success factors that drive performance Key Industry risks Past financial performance of Industry
Business Model
Product /service Fixed capital Intensive or working capital asset driven business Distribution driven/relationship driven Customer types Impact of competitive forces on business model Does the business model have the key Success Factors?
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Corporate Strategy
Product positioning, marketing supply chain & pricing strategy Competitive Advantage Operations strategy
Financial Strategy
Financing leverage Earnings model Cash flow management Fund Flow alignment Long term sustainability Asset creation for future growth Enterprise Value creation
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Capital efficiency ROCE ROE ROCE-Cost of Capital-=spread Stock Beta Enterprise Value
Benchmarking Bench financial ratios with mean of rating cohorts Benchmark financial performance strategy and earnings with industry peers
Working capital strategy Net working capital / Current assets Aging of debtors Aging of payables
Future plans and financial projections analysis Challenge assumptions for future financial projections
Profitability
Liquidity
Current Ratio Quick ratio Operating cash flow to sales
Debt repayment capacity DSCR for short term debt DSCR for long term debt Interest cover ratio
Liquidity and use of capital Fund flow analysis Cash flow analysis
Credit Risk evaluation & selection of MSME exposure-Using credit scoring model Qualitative factors
Credit Score
Conditioned on business management and other soft factors
Willingness to pay
Ability to pay
Use of credit scoring model is widely applied in MSME segments. For IRB approach, preparedness on this front is a must
Market discipline
Definition of capital
Credit risk
Core Capital
Supplementary Capital
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IRB Approach
IRB method of risk capital measurement is based upon Internal ratings of bank credit exposures Unexpected losses ( UL) Expected losses (EL) IRB Risk weight function equation or model produces capital for the UL Expected losses (EL) are to be treated separately Unexpected losses (UL) concept relies on the Value at Risk concept as its foundation
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Driver of Credit Risk Obligor risk Transaction risk Likely size of exposure Maturity
Standardised Approach Credit assessment institutions Credit risk mitigation techniques Credit conversion factors Limited recognition
IRB Approach Probability of Default (PD) Loss Given Default (LGD) Exposure at Default (EAD) Maturity (M)
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Frequency 50 100 150 200 250 300 350 0 -3.84170562 -3.577063509 -3.312421398 -3.047779286 -2.783137175
-2.518495063
-2.253852952 -1.989210841 -1.724568729 -1.459926618 -1.195284507 -0.930642395 -0.666000284 -0.401358172 -0.136716061 0.12792605 0.392568162 0.657210273 0.921852384
1.186494496
1.451136607 1.715778719 1.98042083 2.245062941 2.509705053 2.774347164 3.038989275 3.303631387 3.568273498 3.832915609
Frequency
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LGD measures for the IRB model should be based either on supervisory estimates or internal bank historical data. Under foundation IRB method, downturn LGD will be provided by the regulator and in case of IRB advanced model, the same needs to be estimated by the Bank and used in the model
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Asset correlations and default rates are related through an exponential function within limiting limits of 0 to 100% default rates. For very high PD, correlation limits are 12% for very high PD and 24% for very low PD.
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The maturity adjustment for the IRB equation is linear with a steep slope as at higher PD levels, the effect of maturity is lower . The factor B in the model is the regression slope of M with PD
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Facility rating or the transaction element must reflect the Loss severity consideration Facility rating should influence overall rating through effects of Seniority of the exposure Product type Collateral Collateral market risk Concentration risk through collateral Facility rating should enable estimate of LGD
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Reject
EAD
Correlations
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Based on few financial ratios which are key risk indicators and easy to monitor
The above models are also easy to validate
X1=Net working capital/TOA X2=Retained Earnings/TOA X3=EBIDTA/TOA X4=Market Value of Equity/TOA X5=Sales/TOA Z=overall credit Index Interpretation of Z Index values for credit quality
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Z=overall credit Index Interpretation of Z Index values for credit quality Critical cutoff score is 1.81. Loans having credit score below 1.81 are in higher probability of default risk Loans between 1.81 to 2.50 are in the mid category Loan exposures more than 2.50 are in the strong credit quality class
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CRISIL PD estimates
PD estimated for both the Long term and short term debt issuances
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CRISIL PD estimates
CRISIL PD estimates are for one year transition as required by IRB foundation. The below estimates are for mix of mid size and large Corporate units
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CRISIL PD estimates
CRISIL PD estimates are for one year transition of short term issuances. The below estimates are for mix of mid size and large Corporate units
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While the term credit risk model is applied loosely to cover all forms of statistical analysis, including the estimation of PDs, credit risk modelling in the true sense of the term involves the portfolio assessment of credit risks and the use of the model as the framework for managing credit risk within the bank
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Mark-to-Market Modelling
MTM models define credit events to encompass both default and migration of credit ratings
By valuing every credit in every possible state and then probability weighting them, the MTM model effectively simulates the price at which any credit could be sold hence the MTM label
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UL
P (1 P ) LGDEAD
UL will be maximum for a portfolio of credit assets in case correlation is 1 Due to diversification UL reduces EL will be recovered through risk based pricing UL- EL = economic capital
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Framework of RBPM
Setting of Risk Appetite & Limits
Estimation of Risks
Integration of Risks Stress Testing
Capital Computation
Capital Allocation Estimation of Cost of Capital Allocation of financial Revenue & Expenses Allocation & apportionment of non-financial expenses Computation of Risk Based Performance
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Risk Adjusted Return= Return- Transaction costs ( variable & semi fixed + proportion of fixed cost allocated to product line) - Cost of Risk
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Credit VaR
Market RiskVaR
Operation al VaR
EC
In modelling Economic capital correlation is set to 1 for conservative basis or based on observed correlation data Stress tests can involve correlation inputs which observed under stressed
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UL [Unexpected Loss]
RAROC
Net Income
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RAROC EQUATION
RAROC =
where,
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Other salient components and key assumptions of model: RAROC output compared to Hurdle Rate (cost of capital + risk premium) for all new/revised deals RAROC integral but not sole factor in lending decision, however, any deal falling below Hurdle requires level-up sign-off with rationale Data Inputs:
PD consistent with obligor RR; consistent with through the cycle outlook LGD facility specific and reflects average loss expected EAD based on expected utilization plus add-on factor Marginal Capital estimated using one factor model. Capital influenced by PD, LGD, and Term of deal. A Default/No Default model with loose assumptions on portfolio granularity and correlation/diversification 63
Securitized instruments (floating rate note, fixed rate notes, partially ,optionally convertible preference shares with a minimum maturity of 3 years)
Foreign Currency Convertible Bonds (FCCB) Foreign Currency Exchange Bond (FCEB)
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The fund raising options such as FCCB, FCEB, Preference shares( partially/optionally convertible) are guided by FEMA and ECB guidelines and specific scheme guidelines issued by Ministry of Finance Govt of India.
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Thank You