Credit Risk Analysis - Control - GC - 2

CREDIT RISK
ANALYSIS & CONTROL
06/10/2017 1
CONTENTS
Definition of Risk Management
Definition of Credit Risk
Credit Risk Analysis
Pillars of an Effective Credit Risk Management System
Board & Senior Management oversight;
Policies & procedures;
MIS; and
Internal Controls.
Measuring and monitoring Credit Risk
Risk rating process
Credit Classification and Provisioning
Challenges in Credit Risk Management
Managing Bad Debts
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Risk Management
Risk management is the identification,
assessment, and prioritization of risks followed
by coordinated and economical application of
resources to minimize, monitor, and control the
probability and/or impact of unfortunate events.
Risks can come from uncertainty in financial
markets, project failures, legal liabilities, credit
risk, accidents, natural causes and disasters as
well as deliberate attacks from an adversary .(An
Intr to Risk Management-Crockford Neil)
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Risk Management
A Sound Credit Risk Management framework
is underpinned by basically four pillars namely:
(a) Adequate board & senior management
oversight, sound risk management ;
(b) Sound risk management policies &
procedures;
(c) Adequate Management Information Systems;
and
(d) Adequate internal control systems.
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Risk Management & Internal
Audit
Internal auditing is an independent, objective
assurance and consulting activity designed to
add value and improve an organization's
operations. It helps an organization accomplish
its objectives by bringing a systematic,
disciplined approach to evaluate and improve
the effectiveness of risk management, control,
and governance processes. (IIA)
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Internal Audit
Internal Auditors' roles include monitoring,
assessing, and analyzing organizational risk and
controls; and reviewing and confirming
information and compliance with policies,
procedures, and laws.
Working in partnership with management,
internal auditors provide the board, the audit
committee, and executive management
assurance that risks are mitigated and that the
organization's corporate governance is strong
and effective.
Internal auditors also make recommendations for
enhancing processes, policies, and procedures.
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Other types of risk management
Centralized Risk Management/Companywide
Risk Management?
This is where a company has a single risk
management group that monitors and controls
all the risk-taking activities of the organization.
(www.cfainstitute.org (Alt AV&FI)
Enterprise Risk Management?

A form of centralized risk management that
typically encompasses the management of a
broad variety of risks, including insurance risk.
(www.cfainstitute.org)
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What is credit risk?
Credit risk - the potential that a borrower or
counterparty will fail to meet its obligations in
accordance with agreed terms.
It can also be defined as the risk of a trading
partner not fulfilling their obligations in full on
due date or at any time thereafter.
The risk emanates from uncertainty in a
counterpartys ability or willingness to meet its
contractual obligations.
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What is credit risk?
Organizations are exposed to credit risk from
diverse financial instruments such as loans,
acceptances, inter-bank transactions, trade
finance, foreign exchange transactions,
financial derivatives etc.
A further particular instance of credit risk relates
to the process of settling financial transactions. If
one side of a transaction is settled but the other
fails, a loss may be incurred that is equal to the
principal amount of the transaction.
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Sources of Credit Risk
Firms are increasingly facing credit risk (or
counterparty risk) in other instruments other than
loans, including acceptances, inter-company
transactions, trade financing, foreign exchange
transactions, financial futures, swaps, bonds,
equities, options, and in the extension of
commitments and guarantees, and the settlement
of transactions.
Credit risk exists both on and off the balance
sheet.
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What is Default Risk
A Credit risk is typically represented by means of
three factors: default risk, loss risk and exposure
risk:
Default risk (PD): the probability that a
default event occurs and this is called the
probability of default (PD). The probability has
values between 0 and 1.
The default risk depends on many factors.
Counterparts with a weak financial situation,
high debt burden, low and unstable income have
a higher default probability.
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What is Default Risk
A default is considered to have occurred with
regard to a particular obligor when either or
both of the two following events have taken
place:
a) Subjective default-an institution considers
that the obligor is unlikely to pay its credit
obligations in full, without recourse by the
banking institution to actions such as realising
available security or
b) Objective default-the obligor is at least 90
days past due on a credit obligation.
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Estimating Credit Losses
Most familiar risk metric is often the adequacy of
general and specific loan loss provisions and the
size of the general and specific loan loss reserve
in relationship to the total exposures of the
organisation.
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Estimating Credit Losses:
Common Measures
Loss risk (LGD): The loss risk determines the loss
as a fraction of the exposure in the case of default.
Under Basel II, this parameter is known as the
Loss Given Default (LGD).
LGD can also be defined as the amount of the loss
if there is a default, expressed as a percentage of
the EAD. LGD = (1-R) where R is recovery rate.
In the case of no loss, the LGD is equal to zero.
When one loses the full exposure amount, the LGD
is equal to 100%. A negative LGD indicates a profit
(e.g., due to penalty fees and interest rate).
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Common Measures
In some cases, the LGD can be above 100%,
e.g., due to litigation costs and almost zero
recovery from the defaulted counterpart.
Probability of Default (PD) The likelihood that
the borrower will fail to make full and timely
repayment of its financial obligations.
Exposure At Default (EAD) The expected value
of the loan at the time of default
Recovery Rate (RR) The proportion of the EAD
the bank recovers.
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Common Measures
Unexpected loss (UL) is the average total loss
over and above the mean loss.
It is calculated as a standard deviation from the
mean at a certain confidence level. It is also
referred to as Credit VaR.
A business will safeguard itself from unexpected
losses by allocating capital.
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Common Measures
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Estimating Credit Losses
Common Measures
Loss Loan
Probability
Given Equivalen
of Default
Expected Default Exposure
= (%)
Loss (EL (Severity) (Exposure
% )
X $
X
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CREDIT RISK ANALYSIS
Credit analysis of any entity i.e. corporation, a
municipality, government entity or sovereign
government involves the analysis of a number of
quantitative and qualitative factors.
The overall aim of credit analysis is to determine
Credit Quality.
Credit Quality is defined in terms of the
probability of a customers default. Firms use
various methods to measure credit quality.
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Credit decisions are based primarily on the
creditors assessment of the customers
likelihood of payment.
Setting a maximum on the amount of credit
offered to a customer (marking a limit/credit limit)
limits the exposure of the firm/lender to the risk
of non payment.
In deciding to grant credit, the Credit Manager
must evaluate the chances of non-repayment
and estimate the benefits of extending credit.
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Credit risk origination is premised on 5-major
process in credit evaluation.
Origination Underwriting
Collateral Collateral Recovery
Management Management Past Due
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Credit risk analysis (finance risk analysis, loan
default risk analysis) and credit risk
management is important to firms such as
financial institutions which provide loans to
businesses and individuals.
Credit can occur for various reasons: bank
mortgages (or home loans), motor vehicle
purchase finances, credit card purchases,
installment purchases, and so on. Credit loans
and finances have risk of being defaulted.
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To understand risk levels of credit users, credit
providers normally collect vast amounts of
information on borrowers. Statistical predictive
analytic techniques can be used to analyze or to
determine risk levels involved in credits,
finances, and loans, i.e., default risk levels.
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The benefits results from making sales which
would otherwise be lost to competitors or would
not be made because customers can not afford
to pay cash.
This explains why Credit providers are literary
fighting to extend credit periods to customers
despite the high delinquency levels in the
economy.
The following approaches can be adopted
when analyzing credit risk:
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CREDIT ANALYSIS
Approach Methodology
Judgemental methods Applies the assessors exp & understanding of the

applicant
Expert Systems (eg A panel is used to judge an applicant using
Lending Committee) lending systems & procedures
Analytic models Uses analytic methods based on quantitative data
to arrive at a decision
Statistical models (credit Uses statistical inference to derive appropriate
scoring) decisions
Behavioural models Observes behaviours over time o derive
appropriate relationships for reaching decisions
Market models Relies on financial market information as
indicators of insolvency
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CREDIT ANALYSIS
CREDIT RATINGS
A Credit rating is a formal opinion given by a
specialized company of the default risk faced
by a particular organization or country.
Ratings are current opinions regarding
creditworthiness and are not verifiable
statements of fact.
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CREDIT ANALYSIS
The specialized companies are referred to as
credit rating agencies. Some of the widely
recognized international rating agencies include
Moodys Investors Services, Standard & Poors
Corporation, Fitch Ratings Limited and Dun and
Bradstreet (now TransUnion).
The agencies sell rating information and certain
investment advisory services on investment
opinions.
Such rating agencies are normally used when
corporations are vetting big organizations,
sovereign countries or banks.
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CREDIT ANALYSIS
A rating agency may also be requested to
provide a rating for a company especially for
cross border business. e.g. NRZ might secure a
contract to upgrade the war ravaged railway
network in the vast DRC country. The DRC
Railway Company may then request to pay after
6 months. NRZ will then need to assess the
companys capacity to pay and appropriately
price the short term loan.
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CREDIT ANALYSIS
A rating can be upgraded or downgraded to
reflect changes in credit quality depending on new
information received.
In Zimbabwe, most organizations offering credit
loans normally use FCB and TransUnion (formerly
Dun & Bradstreet) for credit information and credit
references.
(Business Information & Marketing Services, Credit Reporting and Commercial
Collection Agency, Commercial Credit, Reports, 8th Floor, Club Chambers, N.
Mandela Ave-ph 704891-5, 794488-9, 720334, e-mail dunsmail@
transunion.co.zw)
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CREDIT ANALYSIS
In traditional credit analysis, the credit analyst
considers the four C of credit:
Capacity;
Collateral;
Covenants;
Conditions;
Common Sense;
Capital;
Country;
Currency; and
Character.
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CREDIT ANALYSIS
The originally four Cs are commonly referred to
as the core principles of lending and provide the
minimum lending assessment standards in
credit risk management.
Capacity is the ability of the borrower to repay
their obligations. The analysis involves financial
statement analysis (ratio analysis-profitability
ratios, Liquidity ratios, Solvency and Capital
ratios), cash flows.
The question should be asked whether the
borrower has the financial ability or means to
pay on due dates.
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CREDIT ANALYSIS
The borrowers earnings should be high enough.
Other obligations of the borrower should be
taken into account.
Capital denotes the financial strength of the
borrower i.e. the net worth of the borrower
(Assets-liabilities).
The borrowers capital may enable one to
continue paying should a financial occur.
Conditions include economic conditions ,
political conditions that may impact on the
borrowers ability to repay a loan.
Unemployment and high interest rates may
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affect the ability of the borrower to repay a loan.

CREDIT ANALYSIS
Collateral is the pledged assets used to secure
a debt. Collateral provides additional aid,
comfort and support to the debt.
Covenants are the terms and conditions of the
lending agreement. They lay down restrictions
on how management operates the company
and conducts its financial affairs thereby
minimizing risk to creditors.
Character of management is the foundation of
sound credit risk. Analysis of character involves
looking at the reputation and qualification of the
board and senior management of the borrowing
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company.
CREDIT ANALYSIS
Credit history reflects the assumption that the
borrowers past management of credit will
continue in the future.
Poor repayment of debts may occur again in the
future and this can be reflected by poor
payment records and judgments obtained
against the borrower.
Common sense is the intuition that is not
backed up by tangible evidence. An opinion can
be formed whether a default will occur based on
experience and observation of a particular
borrower.
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CREDIT ANALYSIS
A number of credit providers have adopted
lending models using the principles of credit.
Some of the models include:
a) COMPARI;
b) I-PARTS;
c) ICE.
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CREDIT ANALYSIS
ICE-
a) Interest-Margin-how much are we going to earn, risk
return ratio.
b) C-Commissions-expansion, or to fund business
problems
c) Extras-do the cash flows support the request and are the
forecasts realistic.
d) R-Repayment-period required and the repayments
acceptable, have you paid similar loans before.
e) I-Insurance-type of collateral offered, is it adequate, any
additional collateral.
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CREDIT ANALYSIS
CAMPARI
a) C-character-age, health, integrity, personal assets,
banking history, commitment to business.
b) A-Ability-business acumen, management structure,
succession plan,
c) M-Margin-how much are we going to earn, risk return
ratio. Or
Means-the cos technical, managerial and financial
or how the borrower manages and monitors its risks and
the suitability of its assets to generate sufficient cash to
meet repayments.
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CREDIT ANALYSIS
CAMPARI
d) P-Purpose-expansion, or to fund business problems
e) A-Amount-do the cash flows support the request and are
the forecasts realistic.
f) R-Repayment-period required and the repayments
acceptable, have you paid similar loans before.
g) I-Insurance-type of collateral offered, is it adequate, any
additional collateral.
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CREDIT ANALYSIS
I-PARTS
a) I-Integrity
b) P-purpose.
c) A-amount\
d) R-repayment
e) T-terms
f) S-security.
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CREDIT ANALYSIS
Credit industries rely on judgmental methods.
Judgments are made from past experience on
important factors such as customer payment
history, debt service capacity, leverages,
relevant references, credit agency ratings, and
information extracted from various financial
statements. Judgmental rules are used to arrive
at ratings.
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CREDIT ANALYSIS
Normally, this process is performed manually.
With the advancement of predictive rule engines,
it is now possible to automate this process. This
can incorporate the best of both judgmental
scoring and statistical scoring methods.
Critical data which is the basis of judgment can
be collected from financial statements, credit
agency reports, past customer payment records,
and so on. Judgmental data may be included as
well. Judgmental data is subjective soft data.
From financial statements, certain judgmental
data may be extracted as subjective assessment
by staff.
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CREDIT ANALYSIS
Rules are developed to score risks based on
critical and judgmental data. This type of
automated systems will promote scoring
consistency and accuracy in ratings while
maintaining flexibility.
Predictive models may be included in
judgmental rules. That is, rules can be used to
assess outcomes of statistical predictive models.
Combining both judgmental and statistical
predictive models can result in best industry
practices.
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CREDIT ANALYSIS
Credit scoring models/systems-credit scores
are normally computed from information
available in credit reports collected by external
credit bureaus and ratings agencies.
Internal Credit Score-a numerical rating of credit
loans. It measures the level of risk of default.
The level of default risk can be best predicted
with predictive modeling. Credit scores can be
measured in terms of default probability or
relative numerical ratings. The following are
some of the credit scoring models that can be
used:
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CREDIT ANALYSIS
Credit scoring is a system creditors use to help
determine whether to give you credit. It also
may be used to help decide the terms you are
offered or the rate you will pay for the loan.
Information about you and your credit
experiences, like your bill-paying history, the
number and type of accounts you have, whether
you pay your bills by the date theyre due,
collection actions, outstanding debt, and the age
of your accounts, is collected from your credit
report.
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CREDIT ANALYSIS
Using a statistical program, creditors compare
this information to the loan repayment history of
consumers with similar profiles.
A credit scoring system awards points for each
factor that helps predict who is most likely to
repay a debt.
A total number of points a credit score
helps predict how creditworthy you are: how
likely it is that you will repay a loan and make
the payments when theyre due.
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CREDIT ANALYSIS
Organizations, such as mobile phone companies,
insurance companies, estate agencies, and
government departments employ credit scoring .
Credit scoring also has much overlap with data
mining, which uses many similar techniques.
Data mining (the analysis step of the "Knowledge
Discovery in Databases" process, or KDD), an
interdisciplinary subfield of computer science, is the
computational process of discovering patterns in large
data sets involving methods at the intersection of
artificial inteligence, stastics, and database systems.
The overall goal of the data mining process is to extract
information from a data set and transform it into an
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CREDIT ANALYSIS
a) Decision trees-Decision tree can be used for
predicting segmentation-based statistical
probability of credit loan defaults.
b) Neural Networks (NN) is a very powerful
predictive modeling technique. Neural network
is derived from animal nerve systems (e.g.,
human brains). The heart of the technique is
(artificial) neural network. Neural networks can
learn to predict in detail with high accuracy.
An artificial intelligence technique that mimics
the operation of the human brain (nerves and
neurons)
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CREDIT ANALYSIS
NN works differently from decision tree. It can be
trained to predict either relative default levels or
expected default amounts. When the former is
used, network will predict relative level of credit
defaults. The latter will predict expected default
amounts.
Analyzing distribution of scores, default
probability may be deduced.
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CREDIT ANALYSIS
c) Regression Analysis-The most widely used
technique for relating one variable to another
(or to a group of other variables). A linear
regressionalso referred to as ordinary-
leastsquares (OLS) estimationestimates a
linear relation between the dependent and
independent (explanatory) variables by
minimizing the sum of the squared errors.
Regression produces mathematical functions
for predicting default risk levels. It can be very
limiting to be used as general-purpose credit
risk predictive modeling methods. However
when it is used with above methods, it can be a
very useful method.
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CREDIT ANALYSIS
Credit scores may indicate financial history and
current situation. However, external credit
scores do not tell you exactly what constitutes a
"good" score from a "bad" score. More
specifically, it does not tell you the level of risk
for the lending you may be considering.
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CREDIT ANALYSIS
Internal credit scoring methods address this
problem. Although some credit decisions are
subjective many firms use sophisticated
statistical methods such as Multiple Discriminant
Analysis (MDA) to assess credit quality.
MDA is similar to multiple regression analysis.
The dependent variable is the probability of
default and the independent variables are
factors associated with financial strength and the
ability to pay off the debt if credit is granted.
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CREDIT ANALYSIS
MDA models are set up to score the quality of
credit based on variables considered important
for differentiating between potentially good and
potentially bad credit customers.
Independent variables include the following:
does customer own a house, length of
employment at current, age, other borrowings
etc.
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CREDIT ANALYSIS
MDA relates the independent variables to each
customer and assigns weights to each of the
critical factors producing an equation that looks
like a regression equation. When
data/information on a customer is plugged into
the equation, a credit score is produced.
Using the MDA credit scoring system, customer
credit quality is expressed as a single numerical
value. The value is then used to make a decision
based on credit policy e.g. score of 80% we
grant credit.
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CREDIT ANALYSIS
Credit Risk models-involve detailed risk
assessments which is a quantitative analysis of
the likelihood that an individual will not pay for
goods or services purchased on credit.
Firms can use past events as a guide for
predicting future events, (predictive modelling)
as an excellent technique for credit risk
management.
Predictive models are developed from past
historical records of credit loans, containing
financial, demographic, psychographic,
geographic information, etc..
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CREDIT ANALYSIS
From the past credit information, predictive
models can learn patterns of different credit
default ratios, and can be used to predict risk
levels of future credit loans
It is important to note that statistical process
requires a substantially large number of past
historical records (or customer loans) containing
useful information. Useful information is
something that can be a factor that differentially
affects credit default ratios
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ASSIGNMENT QUESTION NO. 1
You have noted that Credit granting in a parastatal
involved in food processing is the prerogative of the
Chief Executive Officer and in most cases the
decision is based on gut feeling. You have been
engaged by the Minister Responsible for Parastatals
as a Credit Risk Consultant to improve the credit
analysis process of the parastatal. The minister has
requested you to provide him with a preliminary report
containing recommendations to improve the credit
granting process for the parastatal. Your paper
should detail how the principles of credit (Cs of
credit) can be used to guide analysts in credit
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evaluation.(25 marks)
Credit risk governance-
overview
An effective credit risk management system should
enable management to identify, quantify, measure,
monitor and control the risk.
Effective credit risk management systems should
be underpinned by an effective board and senior
management oversight, well defined policies and
procedures, strong management information
systems, risk management structures and
adequate internal controls.
organizations need to manage the credit risk
inherent in the entire credit portfolio as well as
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the risk in individual credits or transactions.
Credit risk governance-
overview
Organizations should adopt a holistic approach
to assessing and managing credit risk and
ensure that credit risk management is part of an
integrated approach to the management of all
risks such as Liquidity, Interest rate, Operational,
Foreign exchange, Legal and Compliance,
Reputation, Strategic and Country risk etc.
The goal of credit risk management is to
maximise a firm's risk-adjusted rate of return by
maintaining credit risk exposure within
acceptable parameters.
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CREDIT RISK MANAGEMENT
The sound practices in credit risk management
need to address the following areas:
establishing an appropriate credit risk
environment;
operating under a sound credit-granting process;
maintaining an appropriate credit administration,
measurement and monitoring process; and
ensuring adequate controls over credit risk.
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Although specific credit risk management
practices may differ among firms depending
upon the nature and complexity of their credit
activities, a comprehensive credit risk
management program will address these four
areas.
These practices should also be applied in
conjunction with sound practices related to the
assessment of asset quality, the adequacy of
provisions and reserves, and the disclosure of
credit risk.
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The prerequisites for effective management of
credit risk is premised on the following pillars:
Establishing an effective board and senior
management oversight;
Well defined policies and procedures;
Strong management information systems; and
Ensuring adequate internal control systems over
credit risk.
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a) Board & Senior Management
Oversight
(i) Role of the Board of directors:
providing overall strategic direction.
approving and reviewing the credit risk strategy . The strategy
should clearly specify the companys appetite for credit risk,
adequately cover all the activities of the organization in which
credit exposure is a significant risk.
approving and reviewing credit risk policies including loans to
related parties, subsidiaries and insiders.
Clearly defining delegation of authority and approval levels.
Putting in place an internal audit function capable of assessing
compliance with the credit policies.
Ensuring management and review of the entire credit portfolio.
In banks directors may have a loans Committee to review
credit-related matters in-depth.
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(ii) Role of senior management
implement credit strategy and policies approved
by the board
develop procedures for effective management of
credit risk.
In addition senior management should ensure
that:
credit granting activities conform to laid down procedures.
Written policies and procedures are developed and implemented and
responsibilities of various functions clearly defined.
Credit policies are communicated throughout the organization.
Compliance with internal exposure limits, prudential limits and regulatory
requirements are enforced.
Development and implementation of a clear reporting system.
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Internal audit reviews of credit risk management systems and credit portfolio
(iii) Risk Management Structure
An organization should adopt a risk
management structure that is commensurate
with the size and scope of its lending activities.
The structure should facilitate effective
management oversight and execution of credit
risk management and control processes.
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Credit Risk management structure of
an organisation
Credit structure
Recovery Officer
Board of Directors
Loan officers
Procedures
Credit strategy Credit Policies And
processes
Credit Analysts
Senior Mngt/Credit Administrators

Manager
Loan reviewers
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b) Credit Policies
Credit policies set out the conditions and

guidelines for the granting, maintenance,
monitoring and management of credit at both
individual and portfolio levels.
Policies set standards for portfolio composition,
asset quality, individual credit decisions and
compliance with regulations.
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b) Credit Policies
Policies are a set of decisions that spell out a
firms credit period, credit standards, collection
procedures and discounts offered.
Credit period-length of time buyers are given to
pay for their purchases.
Credit Standards-minimum financial strength of
acceptable credit customers and the amount of
credit available to different customers
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Policies and procedures
Collection policy-details the toughness or laxity

in following up on slow-paying accounts.
A firm with restrictive credit terms will have a
lower investment in accounts receivable, lower
bad debt losses and usually lower sales volume.
The policies and procedures should be reviewed
periodically.
The organization's risk tolerance should be
clearly articulated.
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Policies should also spell out the nature and
level of risk the organization is prepared to
undertake including granting credit to related
parties or subsidiaries.
Policies establish credit concentration limits
single client, connected borrowers and/or sector
of economic activity e.g. The Banking Act
[Chapter 24:20] prescribes the following
prudential Lending Limits:
Single borrower 25% of capital
Connected borrowers 75% of capital

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Policies and procedures - Credit
granting/origination
There should be a clearly established process of
approving credit facilities including renewing,
and refinancing existing credit facilities
The policy should document
Roles and responsibilities of units involved in
granting, administration and monitoring
Credit risk acceptance criteria/credit analysis
General terms and conditions including pricing
Acceptable types of collateral
Standards for credit review and monitoring
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Credit analysis
The bank should have a clear understanding of
the borrower and obtain adequate information to
conduct comprehensive assessment of the risk
profile of the borrower:
purpose of the loan; Identify the source of
repayment; the borrower's:
Character, risk profile, sensitivity to economic
and market developments, repayment history,
current capacity to repay, business expertise
and industry position/reputation.
adequacy and enforceability of collateral or
guarantees (where applicable).
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assess the business risks that could inhibit
repayment,
Financial analysis encompasses ratio analysis.
The key ratios required in credit analysis are:
Liquidity ratios
Leverage/Capital ratios
Activity/Asset Management ratio
Profitability ratios
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Ratio Analysis
Type of ratio Formulae interpretation
iquidity ratios
Current ratio Current Assets -the extent to which a
Current Liabilities firm can meet its short
term obligations
Quick ratio/Acid Test Current Assets-inventory -the extent to which a firm
atio Current Liabilities can meet its short term
obligations without relying
upon the sale of its
inventories
everage/Capital
tructure ratios
Debt-to-total assets Total Debt -the percentage of total
atio Total Assets funds provided by
creditors
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Debt-to-equity ratio Total Debt -the percentage of total
Ratio Analysis
Leverage/Capital
structure ratios
Long term debt-to-equity Long term debt -the balance between
ratio Total equity debt and equity in a firms
long term capital
structure
Times-interest earned Profit before Int & Taxes -the extend to which
ratio (interest cover) Total Interest charges earnings can decline
without the firm
becoming unable to meet
its annual interest costs.
Activity/Asset
Management ratios
Inventory
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turnover ratio Sales -whether the firm 74
holds
Inventory of finished excessive stocks of
Ratio Analysis
Activity/Asset
Management ratios
Fixed assets turnover Sales -sales productivity and p
ratio Fixed assets & equipment utilization.
Total assets turnover Sales -whether a firm
Ave Total Assets generating a suffic
volume of business for
size of its asset investme
Account receivable Annual Credit Sales -the average length of t
turnover ratio Accounts receivables it takes a firm to col
credit sales (%)
Average Collection period Accounts receivable -the average length of t
Total sales/365 it takes a firm to collect
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credit sales (days)75
Ratio Analysis
Profitability ratios
Gross profit margin Sales-Cost of goods sold Total margin
Sales available to cover
operating expenses
Operating profit margin Earnings before int & tax Profitability without
Sales concern for taxes &
int
Net profit margin Net Income After tax profits
Sales per dollar of sales
Return on assets Net income After tax profits
Total Assets per dollar of assets
Return on equity Net income After tax profits
Total Stockholders Equity per dollar of
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stockholders 76
equity
Credit Approval process should be
documented.
Who makes the credit decision?
Need for a sequential process of credit approval
that allows sufficient time to analyse the
proposal
Lending limits should be stipulated officer,
Branch Managers, Relationship Managers,
committees etc.
It provides maximum level of decision making
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Typical credit granting process
Business origination function

Identify loan
Credit analysis function

Is the customer creditworthy?
Approval Function Approval Function

Loan approved Loan rejected
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Policies and procedures credit
limits
Setting adequate credit limits is crucial to minimizing
problem credits
Credit risk limits should take account of the banks
historical loss experience, capital adequacy, desired
level of return, diversification objectives.
Limits may be set in various ways individually and in
combination e.g.
Characteristic of individual loans
Single borrowers and groups of connected borrowers
Industries or economic sectors
Geographic regions
Specific products
Composition of the portfolio
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c) Strong MIS
Organizations should have adequate MIS to
facilitate effective credit risk management and
control.
The sophistication of the MIS should be
consistent with scope and complexity of the
operations of the organization.
The MIS should be able to provide
information/reports with the following
characteristics; timely, accurate, consistent,
complete and relevant.
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Strong MIS
The MIS should be sufficiently flexible to cope
with various contingencies and be capable of
monitoring compliance with established policies
and procedures.
Timely and accurate reports (from a reliable
MIS) are critical elements of an effective MIS.
Management should strive to reduce manual
intervention in the preparation of reports and
monitoring of credit risk.
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Strong MIS
Credit Risk Reports should be produced
regularly for use by management to facilitate
effective oversight.
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d) Adequate internal Controls
A system of effective internal controls is a critical
component of effective credit risk management.
Internal controls include policies and procedures
established by the board and senior
management to provide reasonable assurance
on the safety, effectiveness and efficiency of the
organizations operations, reliability of financial
reports and compliance with regulatory
requirements.
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Elements of a sound internal control
environment
Elements of a sound internal control environment
(i) Policies & procedures-these should be
documented and periodically reviewed to
ensure they reflect current practices.
(ii) Code of conduct-guides organizations in
conducting their activities with prudence and
integrity. The code states ethical values of the
organization and prescribe guidelines for
employees to observe when discharging their
duties.
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environment
(iii) Board & Senior management oversight-the
board has an ultimate responsibility for
ensuring an adequate and effective system of
internal controls is established and
maintained.
(iv) Delegation of authority-organizations should
clearly define the responsibilities and levels of
authority required in relation to various
activities.
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environment
Limits should be approved by the
board/management and assigned to personnel
in line with their seniority and responsibilities of
the concerned people.
Delegation of authority needs to be clearly
documented and specify authority being
delegated, the authority and restrictions placed
on delegated authority.
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environment
(v) Segregation of duties-management should
ensure adequate segregation of duties to
mitigate the risk of unauthorised transactions or
fraudulent activities. Management should ensure
that staff is not assigned incompatible duties
which may allow an organizations data to be
manipulated or for financial irregularities to be
concealed.
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environment
Management should conduct periodic reviews of
the responsibilities of key personnel in credit risk
to minimise areas of potential conflict of interest
and ensure independent checks are in place.
(vi) Audits-organizations should be subjected to an
audit at least annually. Auditors should audit the
credit risk management process and the results
of the audit/reviews and the management
comments/responses should be documented.
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environment
(vii) Compliance-anomalies detected in a the
Credit Risk section should be escalated to
Senior Management for further action.
(viii) Other elements organizations should put in
place adequate succession plans in place to
ensure business continuity, institute relevant
training to equip staff with knowledge on new
products, laws and regulations as well as
enhance their efficiency and effectiveness and
put in place adequate compensation
schemes.
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ASSIGNMENT 2
2. Using each of the following key pillars of
effective credit risk management, illustrate how
each of the components can assist in coming
up with an effective credit risk management
framework:
a) Board and Senior Management oversight;
b) Effective Policies and procedures;
c) Adequate Internal controls; and
d) Strong MIS. (25 marks)
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Credit Risk Mitigation
A variety of mitigating techniques can be used in
controlling credit risk. Some of the techniques
include collateral, guarantees and netting off of
loans against deposits of the same counter-
party.
The use of such techniques reduces or transfers
credit risk
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Credit Risk Mitigation tools
Netting (on Guarantees Credit
b/s) Collateral Derivatives
(Shares, MBs,
Cash, NGCBs, SNCBs)
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CREDIT RISK MITIGATION: credit
Derivatives
A Derivative is a contract to buy or sell an asset or
exchange cash based on a specified condition, event,
occurrence, or another contract.
In finance, a Credit Derivative refers to any one of
"various instruments and techniques designed to
separate and then transfer the credit risk" or the risk of
an event of default of a corporate or sovereign borrower,
transferring it to an entity other than the lender or debt
holder.
Option or swap contracts serves as a hedge or
insurance policy, and whose payoff depends on risk
factors associated with a credit event (such as a firm's
bankruptcy or changes in its prospects for bankruptcy).
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Derivatives
These derivatives separate specific factors of a credit risk
(which may be managed) from the market risk (which
may not be) and are used where a partys cost of
managing a risk exceeds the cost of transferring it to
another party.
E.g. Company A can transfer the risk of a customers default (or a specified
drop in its credit rating) through a contract to company B and pays a fee.
If the default occurs (or the credit rating falls to that level) within the
contracts duration, company B will compensate company A up to the
agreed-upon sum. Otherwise, company-A gets nothing.

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Derivatives
A credit derivative is an OTC derivatives designed to
transfer credit riskfrom one party to another. By
synthetically creating or eliminating credit exposure, they
allow institutions to more effectively manage credit risks.
Credit derivatives take many forms. Three basic
structures include:
a) credit default swap: Two parties enter into an agreement whereby one
party pays the other a fixed periodic coupon for the specified life of the
agreement. The other party makes no payments unless a specified credit
event occurs. Credit events are typically defined to include a material
default, bankruptcy or debt restructuring for a specified reference asset. If
such a credit event occurs, the party makes a payment to the first party,
and the swap then terminates. The size of the payment is usually linked to
the decline in the reference assets market value following the credit event.
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Derivatives
b) total return swap: Two parties enter an agreement
whereby they swap periodic payment over the specified life of
the agreement.
One party makes payments based upon the total return
coupons plus capital gains or lossesof a specified reference
asset. The other makes fixed or floating payments as with a
vanilla interest rate swap. Both parties payments are based
upon the same notional amount. The reference asset can be
any asset, index or basket of assets.
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Derivatives
c) credit linked note: A debt instrument is bundled with
an embedded credit derivative. In exchange for a
higher yield on the note, investors accept exposure to a
specified credit event. For example, a note might provide
for principal repayment to be reduced below par in the
event that a reference asset defaults prior to the
maturity of the note.
The fundamental difference between a credit default
swap and a total return swap is that the credit default
swap provides protection against specific credit events.
The total return swap provides protection against loss of
value irrespective of causea default, market sentiment
causing credit spreads to widen, etc.
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MEASURING & MONITORING CREDIT
RISK: Measuring credit risk
Every organization should have procedures for
measuring overall exposure to credit risk including
parties, products, customers market segments.
An institution should have robust MIS capable of
providing timely, accurate and detailed reports to the
board and management
An institution must have comprehensive internal systems
and models that effectively measure credit risk. The
credit risk measurement tools should take into account
the nature of the credit, maturity, exposure profile,
collateral
Measurement of credit risk must quantify the expected
losses and unexpected losses on account of credit
portfolio.
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Monitoring credit risk
Organizations must have an internal risk rating system that
comprises methods, processes, controls, data collection and
IT systems that support the quantification of defaults and loss
estimates
An effective monitoring system should ensure that:
the organization understands the borrower,
monitors compliance to terms and conditions,
assesses collateral value.
identifies NPLs at an early stage.
enforces proper and timely classification and loan loss provisioning.
The institution should undertake detailed credit portfolio
review. The frequency of review should reflect risk profile of
the portfolio.
Stress testing is a useful way for credit monitoring to assess
areas of potential problems.
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MONITORING OF CREDIT RISK -RISK
RATING PROCESS
William F Treacy 1998: Credit risk rating at large US Banks, federal Reserve Bulletin, November 1998
Factors considered
in rating:
Use of ratings
A
Financial analysis
Quantitative loss characteristics
Industry analysis - Portfolio monitoring, Loans loss provisions
Rating criteria loan/business line pricing and profitability analysis
Quality of financial Preliminary
Data Written/ Rating
Approval
Formal proposed for
Process
External ratings Elements Loan
(per policy)
Approval
Risk
Use of ratings
Analytical tools or Subjective/ Process General credit quality characteristics
Models Informal rating
Assigns assessing attractiveness of customer
Elements Relationships
(cultural) final
Firm size/value rating --Evaluation of rater effectiveness
Administrative and monitoring requirements
Raters own Relationship Frequency of loan reviews
Management Experience Manager and/
and Credit staff
Terms of facility/LGD judgment
Other considerations
Watch process Loan review

Line/ credit review
Ongoing reviews by initial rater Review of adequacy of underwriting
Quarterly process focused on loans And monitoring from a random sample
Periodic review of each customer relationship
that exhibit current or potential
Aimed at reviewing profitability/desirability as
problems aimed at identifying Sample weighted towards higher risk loans
well as condition
Generally conducted by same authorities
the best path to improve or exit credit Loan review judgment is final say
at lowest cost
that review loans
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Monitoring of Credit Risk - Rating
Credit Risk
Identifying and rating credit risk is the essential
first step in managing it effectively.
Internal risk rating systems help to:
Differentiate the degree of risk in different credits
Determine overall characteristics of the credit
portfolio.
Determine areas of risk concentration.
Identify problem credits.
Assess the adequacy of loan loss reserves.
Determine internal capital allocation (for banks).
Aid in the pricing of credits.
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Monitoring of Credit Risk - Rating
Credit Risk
Credits with deteriorating ratings should be
subject to additional and more frequent
monitoring and review.
However, the greater the granularity of an
organization's loan grading system, the finer the
distinction between one loan grade and
another, resulting in greater differentiation of
relative risk in various loans .
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Monitoring of Credit Risk - Expectations of
Credit Risk Rating Systems
The board of directors should approve the credit
risk rating system and assign clear responsibility
and accountability for the risk rating process.
All credit exposures should be rated. The risk
rating system should assign an adequate
number of rating.
Risk ratings must be accurate and timely.
Ratings should reflect the risks posed by both
the borrowers expected performance and the
transactions structure.
The rating assigned to a credit should be well
supported and documented in the credit file.
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Monitoring Credit Risk Credit
administration
Once a loan has been granted, the credit should
be properly maintained on an on-going basis.
Proper maintenance includes:
Keeping the credit file up to date
Requesting current financial information i.e.
financial statements etc
Sending out renewal notices.
Preparing necessary loan documents e.g. facility
letters, repayment reminders etc.
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administration
Credit files must contain all necessary
information to;
ascertain the current financial condition of the
borrower
determine the borrowers capacity to repay
track decisions made and the history of the
credit. Examples of proper information include:
Credit approval documents - Credit
appraisals, financial & ratio analysis,
management assessments, Credit approval
memorandum, Collateral documentation,
Customer visit reports, risk classification
Correspondence and press clippings etc
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administration
Companies should have information
systems that enable management to
measure and manage credit risk inherent in
all on- and off-balance sheet activities.
Effective management information systems
should be able to produce reports showing:
total loans; newly granted, renewed, and
restructured loans; delinquent and non-
accrual loans; internal loan grades; loans in
excess of credit limits; loans not complying
with policy; credit exposure by type,
geography, collateral, borrower group; and
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insider and affiliate transactions.
Monitoring Credit Risk- security
administration
Collateral values impact the recoverability of
a credit.
Collateral and guarantees are potential
secondary sources of repayment. BUT
should not be a substitute for credit
worthiness.
The features of good security include:
Valuation must be easy to value, value reasonably stable or
capable of increasing, sufficient margin between the security
and amount of facility
Realisability must be easy realise or enforce, reasonable
realisation expenses, marketable
Unassailable/unquestionable title ease of formalities in
perfection or disposal, bank must obtain good title, title should
not be affected by third party rights erg. prior charges:
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Monitoring Credit Risk- security
administration
Guarantors networthy must be analysed-
individual and company cross guarantees.
Immovable property must be valued and
adequately covered by insurance.
On going valuation is required to ensure security
remains realisable.
Need for adequate internal controls over security
documents.
safe custody of the securities.
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Credit Review
Credit portfolio should be subjected to
independent reviews i.e. reviews to be
conducted by people not involved in credit
approval.
In terms of Banking Regulations S.l.205 of 2000
paragraph 20 (2) Loan reviews shall be
conducted by a committee which is
independent of any person or committee
responsible for sanctioning credit, and shall
consist of at least three persons including a
member of the board without executive officer
responsibilities
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Credit Review
Loan reviews seek to ensure the following:
Conformity of the loan portfolio and lending
function to documented policies approved by
the board;
Provide adequate information to the board
and management on the level of portfolio risk;
Properly identify and classify problem loans;
Appropriate provisions for bad and doubtful
debts;
monitor compliance with relevant laws and
regulations;
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Credit Classification System
The main risk relating to classification of credits
is the probability of not identifying poor
credits in advance until loan losses of
substantial financial impact are imminent.
Need for effective method of identifying and
monitoring poor credits by reviewing the
outstanding credits regularly.
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In general, the process of classifying credits is
designed to:-
Highlight problem credits for attention and action -
good loans today may not be as good tomorrow
categorise problems by severity of actual and
potential risk of loss
report problem credits to senior management for
review on a periodic basis
provide early warning of portfolio problems and future
loan losses action can be taken to strengthen
collection or prevent further deterioration.
provide common language and methodology for
identifying and managing problem credits.
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Credit Classification Process
Credit Classification
Business Viability Financial condition Repayment Capacity
Type of
Classification
Special
Pass Sub-standard Doubtful Loss
Mention
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Pass
no evident weaknesses,
fully protected by the current sound worthy and
paying capacity of the borrower.
Performing in accordance with contractual terms
and is expected to continue to do so.
repayments are up to date.
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Special mention
Past due 31-90 days.
although currently protected, exhibits potential
weaknesses which if not corrected weaken the
asset or inadequately protect the institution's
position such as.
inadequate loan agreement, and
long absence of current financials;
Deteriorating condition of the collaterals.
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Substandard
Past due 90days but less that 180 days.
Renegotiated loan -unless all past due interest is
paid.
Whether or not past due, inadequately protected
by sound worth e.g.
primary source of repayment is insufficient to service
debt and institution must look at secondary sources;
Unduly long absence of current and satisfactory financial
information;
Inadequate collateral documentation; and
More than normal degree of risk due to borrowers
unsatisfactory financial condition.
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Doubtful
past due 180 days but less than 360 days.
Exhibits all weaknesses of S/S.
collection in full based on current existing facts is
highly improbable but actual amount of loss is
indeterminable due to pending events e.g.
capital injection, asset disposal, liquidation,
litigation.
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Loss
past due more than 360 days unless well secured and
legal action has commenced.
The legal action will be expected in timely realization of
collateral or enforcement of a guarantee.
Has been classified doubtful, but the pending event has
not occurred within 360 days
Otherwise considered uncollectible or of such little value
that continuance as an asset is not warranted.
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The primary measure of asset quality is the level
and severity of non performing loans loans.
NPL asset not generating income. Principal,
interest or both unpaid for 90 days+
(Substandard, doubtful, loss)
Past due Principal or Interest is due and un
paid for 30 days+
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Loan Loss Provisioning
Loan loss provisioning is a method of
recognizing and covering loan losses.
Profit or reserve set aside to cover possible loan
losses in the loan portfolio and other assets.
A balance sheet item representing funds set aside
by a company to pay for losses that are anticipated
to occur in the future.
Specific provisions are charges based on evidence of
deterioration of specific assets.
General provisions are taken against general credit risk
and risk of default, not tied to specific assets. If they are
a disclosed component of net worth, they may be
included in Basel capital for banking institutions.
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A provision takes into account an expected expense,
showing it as a liability on the balance sheet. A company
will create a provision in the current period when the
likely liability becomes apparent, thus reducing the
reported profit.
For example, consider a company that has entered into a
contract on which it then becomes evident it will make a
loss. The loss will only actually occur (i.e. the payments
that will make it unprofitable will only happen) in a
future year. However, if once it is known that the loss is
probably a provision must be made in the accounts and
this will reduce the profits in the year the period in which
the provision is made.
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Specific provisions : for NPL- Substandard, doubtful
& loss
General provisions apply to performing Loans-
Pass and Special mention).
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The basis of sound provisioning by an
organization lies in the adequacy and
effectiveness of its processes relating to
monitoring credit quality and provisioning.
These include having in place:
an effective loan grading system;
consistent review and monitoring of loans; and
detailed policies and procedures for
provisioning.
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Detailed provisioning policies and procedures
include the:
criteria for setting provisions;
methodology for estimating provisions;
procedures for collateral valuation;
procedures for review of adequacy of provisions;
and
mechanism for reporting information to
management on a periodic basis.
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For financial institutions the following classes
and provisions against outstanding loans or
assets are prescribed in the banking regulations:
1% for loans or assets graded pass or acceptable
3% for loans or assets graded special mention/watch
20% for loans or assets graded sub standard
50% for loans or assets graded doubtful
100% for loans or assets graded loss
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Under Basel II (for banking institutions) in
Zimbabwe the provisioning levels have been
revised to incorporate the refined 10 tier loan
classification system as indicated below:
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Provisioning requirements under
Basel II-Banks
5-Tier 10- Descriptive Risk Level Provisioning
Grading Grade Classification Percentage (of
Exposure)
Pass 1&2 Prime & Strong Insignificant & Modest 1%
3 Satisfactory Average 2%
SM 4 Moderate Acceptable 3%
5 Fair Acceptable with care 4%
6 Speculative Management attention 5%
7 Highly Speculative Special Attention 10%
SS 8 Substandard Vulnerable 20%
D 9 Doubtful High Default 50%

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Loss 10 Loss Bankrupt 100%

Loan Loss Provisioning - collateral
Adversely classified loans (Sub standard,
doubtful, loss (8, 9 & 10) shall be exempt from
the provisioning requirement to the extent
secured by acceptable collateral.
In considering the impact of collateral on
classification, the following factors are generally
taken into account:
is it liquid and marketable?
if so, how much can be collected?
is the amount sufficient to cover payments in
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arrears?
Credit Risk Control
An institution must have an independent credit

risk control unit that is responsible for the design
or selection, implementation and performance of
the banking institutions rating systems.
The unit must be functionally independent of the
personnel and management functions
responsible for originating exposures. Areas of
responsibility must include the following:
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Credit Risk Control
a) testing and monitoring internal obligor and facility
grades;
b) production and analysis of summary reports from the
institutions rating system, including historical default
data, migration analysis and monitoring of trends in key
rating criteria;
c) implementing procedures to verify that rating definitions
are consistently applied across departments and
geographic areas;
d) reviewing and documenting any changes to the rating
process, including the reasons for those changes; and
reviewing the rating criteria to evaluate if they remain
predictive of risk.
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Overdraft Lending
An overdraft is an advance which depends on its

operation on the use of a current account.
Generally temporary in nature. It enables to
overcome borrowers short term cashflow
working capital.
Expected to fluctuate/swing from debit to credit
and back again in response to deposits
Interest is charged monthly.
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Challenges in credit risk
Management
The absence of documented policies.
The absence of portfolio concentration limits.
Excessive centralization or decentralization of
lending authority
Poor industry analysis.
Hurried credit analysis of potential borrowers.
Excessive reliance on collateral.
Infrequent customer contact.
Inadequate checks and balances in the credit
process.
The absence of loan supervision
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Management
A failure to improve collateral position as credits
deteriorate
Poor controls on loan documentation
Incomplete credit files
The absence of asset classification and loan
loss provisioning standards
A failure to control and audit the credit process
effectively
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Management
Absence of skilled personnel in credit analysis.
At the moment financial institutions are far much
ahead in terms of Credit Risk Management and
have even gone as far as coming up with
advanced Credit Risk models to manage credit
risk.
Economic cycles which may impact on credit
performance via its impact on net worth of
borrowers.
06/10/2017 134
Management
Absence of information relating to Credit history
of potential borrowers to assist in credit granting.
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ASSIGNMENT NO.3
a) Explain your understanding of the following terms
as used in estimating credit losses:
1) LGD;
2) EAD; and
3) PD. (7 marks)
b) State and explain some of the challenges faced by
an organization of your choice in implementing an
effective Credit Risk Management System. (12
marks).
c) How can these challenges that you have
highlighted be mitigated. (6)
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136
BAD DEBTS RECOVERIES
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Loan Contract
A contract is a written or oral voluntary,
deliberate, and legally enforceable (binding)
agreement between two or more competent
parties. A contractual relationship is evidenced
by an offer, acceptance of the offer, and valid
(legal and valuable) consideration.
Each party to a contract acquires rights and
duties relative to the rights and duties of the other
parties.
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138
Fundamentals of a Contract
Existence of a contractual-relationship does not
necessarily mean the contract is enforceable, or
that it is not void or voidable.
Parties entering into a contract must be cognizant
of the following issues;
Lawfulness/ legality;
agreement (consensus ad idem- meeting of
the minds);
offer and acceptance; and
consideration (purchase price / value).
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Breach of Contract
Failure or refusal by a party to perform or act in
accordance with the contract is breach of
contract.
Failure to honour the terms of the contract can
either be on the part of the debtor (mora
debitoris) or the creditor (mora creditoris).
A party to a contract may by his behaviour
repudiate a contract i.e. displaying behaviour to
the effect that the party does not intend to be
bound by the contract or to perform part of the
obligations (anticipatory breach).
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A breach can also occur where a party attempts to
perform their obligations in terms of the contract
but does so defectively or improperly which in
essence is not performance envisaged by the
contract (or contemplated by the contract).
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Remedies for Breach of Contract
A remedy is the relief or rights available to an
aggrieved party to a contract.
An aggrieved party can seek enforcement of the
contract in a court of law through specific
performance or that the contract is cancelled
(rescission of the contract), that Damages
(actual damages, consequential damages;
patrimonial loss and foreseeable loss) be paid in
lieu of specific performance or the granting of an
interdict restricting the defaulting party from
doing certain acts.
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LITIGATION
Role of Recoveries in Litigation
In most organisations Credit Control /Loss
Control departments are responsible for
collections as well as loss control in an
organisation. In addition to managing debts, the
said department is also responsible for litigation.
The department is responsible for debtors/credit
administration including the following:
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LITIGATION
Role of Recoveries in Litigation
Managing and monitoring clients accounts payment
history/patterns, compilation of early warning lists;
Following up clients with outstanding accounts and
taking appropriate measures, in consultation with
management, to ensure settlement;
Processing letters of demand;
they can issue summons or institute court action
using an appropriate court in order to recover the
outstanding amounts or hand over the debtors to a
firm of lawyers for collection; and
To follow up all matters handed over to lawyers for
recovery and reconcile accounts.
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LITIGATION
Role of Legal Practitioners
Legal Practitioners/Lawyers are involved in a
number of roles in credit litigation such as legal
advice; legal representation; negotiating
settlements; legal action against debtors; liaison
with several arms and institutions of the legal
system in respect of debt collection- e.g., the
courts, messengers of court.
Lawyers can also negotiate out of court
settlement with debtors.
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LITIGATION
Role of Legal Practitioners
Legal Practitioners/Lawyers are however
expensive such that firms might lose large sums
of money paying them.
Firms can utilise internal Legal Resources to cut
on costs or continually train Debt Collectors on
the Litigation process.
Use of External Legal services may also strain
relationships as the whole litigation process
might alienate the debtors.
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COURTS OF LAW
Role of the Courts of Law
In credit litigation where companies or
individuals have tried unsuccessfully to get a
debtor to pay up their debt, the creditor usually
approaches the courts for relief.
The Creditors may obtain relief in the form of a
judgment entitling the creditor to a certain
amount owing with interest and usually for the
recovery of legal fees.
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COURTS OF LAW
The court to be approached for recourse
depends on the total amount owed.
In terms of SI 163 of 2012 (operationalised on
19 October 2012) the Magistrates court has a
monetary jurisdiction of $5,000 ($1,000) for
actions founded on liquid documents, actions for
delivery or transfer of movable and immovable
property with a maximum value of $10,000 and
maximum value of claim or matter in dispute of
$10,000 ($2,000) for other cases, while the High
Court has unlimited jurisdiction.
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The Supreme Court being the court of appeal
also hears credit related matters where one of
the parties appeals against a High Court order.
SI 163/2012 repeals SI 21 of 2009
The HC still retains an inherent jurisdiction over
any and all matters within Zimbabwe. Thus a
party can pursue a claim which falls under the
jurisdiction of the MC in the HC-though such an
election may result in the suing party, if
successful, being awarded costs at the
magistrate scale instead of the higher scale of
the HC.
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Role of Messenger of Court / Deputy Sheriff

Plays a number of roles such as:
serving legal documents (summons, court orders,
warrants and any such other court documents)
upon defendants, respondents, witnesses or any
such other person who is at law capable of being
served with such process or documents;
attaching and removing moveable
assets/property of defendants, respondents or
any such other person against whom a warrant or
writ of execution against property has been
issued by the court;
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facilitating the sale by public auction, such
attached and removed property for the purpose
of recovering the debt amount as spelt out by
the courts;
surrendering to the plaintiff, creditor or applicant
such proceeds from the sale in full and final
settlement of the debt; and
paying the excess proceeds from the sale to the
defendant, respondent or any such other person
as directed by the courts or whose property has
been sold by auction.
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The Litigation Process
Letter of Demand
A Letter of demand is the first step in collecting
overdue accounts. It is a written demand for
payment or performance from one party to a
contract to another.
The party that issues a letter of demand calls
upon the defaulting party to make a certain
payment or perform a certain action within a
specific period, failing which legal proceedings
will be instituted to recover the debt.
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The letter of demand should show a cause of
action and give a reasonable period within
which the party against whom the demand is
made should have complied.
Where a party against whom a letter of
demand is issued complies with the
requirements of the letter of demand, the
matter does not go any further. A letter of
demand can also initiate an out of court
settlement.
Where a party fails to respond or
inadequately responds to a letter of demand,
the matter is then handed over to a legal
practitioner to take legal action against the
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defaulting party. 06/10/2017
Summons
A summons is a legal document issued out of
court and served upon the debtor by the
messenger of court. The issuance of summons
signifies the first formal step in legal proceedings
or suing the debtor before the courts.
Summons are therefore a cornerstone of the
credit litigation process. The summons should
indicate-
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a) Name of the court and names and addresses of

the parties to the matter;
b) The claim in precise terms as well as the legal
basis for such claim;
c) Signed by the plaintiff;
d) Signed and stamped by the Clerk of Court/
Registrar of the court issuing the Summons;
e) Calls upon the defendant to pay or perform or
do or not do that which is stated therein;
f) Directed to the Messenger of Court/Deputy
Sheriff to serve upon the defendant of the
stated address;
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g) Calls upon the defendant to reply or answer to
the claim stated in the summons within a period
of time also stated (this is known as the dies
induciae), failing which the defendant will be in
default and the plaintiff can proceed to apply for
a default judgment. The period within which to
respond is seven (7) days for the Magistrates
Court; or ten (10) days for the High Court
summons.
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Where the defendant intends to oppose the claim
filed by the plaintiff, the defendant enters an
appearance to defend. Where the defendant
does not wish to defend the matter, the
defendant can consent to judgment and pay the
amount claimed to the Clerk of Court or to the
Registrar or undertake to perform certain acts in
terms of the contract.
The appearance to defend must be made before
the dies induciae expires, failing which the
defendant will be in default and plaintiff can
proceed to apply for a default judgment.
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Court Proceedings
After filing the appearance to defend the
defendant then files a plea which is the
defendants reply or answer to the plaintiffs
claim. Such answer or reply should address the
issues raised in the claim. A defendant may if he
has a related claim against the plaintiff, make a
counter claim in separate papers to the plea.
The defendants defense can be that the claim
has prescribed; matter /claim was once dealt with
by a competent court; summons are vague and
embarrassing; court lacks jurisdiction to hear and
determine the matter; or that the matter is
158 06/10/2017
pending before a superior court.
Court Proceedings
Judgments
Where a defendant fails to enter an appearance
to defend or to consent to claim, or fails to attend
any court hearing and has failed to comply with
the procedural rules within the specified period,
the court grants a default judgment in favour of
the plaintiff.
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Court Proceedings
A court can grant a provisional judgment to a
plaintiff in cases involving liquid documents or
documents sounding in money subject to
reversal/confirmation should the defendant prove
that he/she is not liable in respect of the
document/s relied upon by the plaintiff.
The plaintiff must furnish the court with security in
order to protect the interest of the defendant in
the event that he/she successfully challenges the
claim thereof.
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Examples of liquid documents involved include

cheques, other negotiable instruments and any
form or type of a document sound in money,
including an acknowledgment of debt.
The procedure is to the advantage of the
plaintiff because the claim is usually already
proven and the rationale is that such a person
should not be inconvenienced by the delays
involved in the litigation process.
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Court Proceedings
Where the defendant has filed his plea and the
parties have set down the matter, the court
convenes a pre-trial conference. The pre-trial
conference is a meeting convened by the court
before a matter is referred to trial.
The objective of the meeting is to determine the
issues to be resolved at trial and if possible to
get the parties to reach an out of court
settlement. Where the parties involved fail to
agree the matter proceeds to trial. During the
trial the plaintiff is expected to sufficiently prove
his claim.
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After the trial is finalised, the court makes its
decision and provides its determination in the
form of a court order/judgment.
Where the plaintiff has sufficiently proved his
claim, he obtains a judgment in his favour and
where the plaintiff fails to prove his claim the
defendant is excused from liability.
The amount awarded to a plaintiff in a court
order is the judgment debt. Once a judgment
has been obtained in favour of the plaintiff the
plaintiff becomes the judgment creditor and the
defendant the judgment debtor.
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Once a judgment is granted, the judgment debtor
may if possible, pay into court the judgment debt
and the matter is finalised.
In other circumstances, the Messenger of
Court/Deputy Sheriff is involved in the execution
of judgment. The Messenger of Court/Deputy
Sheriff attaches the judgment debtors property
using a warrant/writ of execution. Once attached
the property is sold by public auction and the
proceeds forwarded to the judgment creditor and
if there are any excesses these are forwarded to
the judgment debtor.
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Court Proceedings
A court order can also be enforced through a
garnishee order. This is where a court order is
directed to the employer or the source of the
judgment debtors income or revenue, to deduct
in installments or full, the amount of the judgment
debt.
This is applicable where the judgment debtor is in
employment or has a confirmed source of
revenue or income, which is due to him or her
such that it becomes practical to deduct at
source.
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Arbitration & Out of court settlements
Arbitration is a private method of settling
disputes, based on the agreement between the
parties. It involves submitting the dispute to an
individual chosen by the parties. This form of
dispute resolution is usually used by parties to
contracts such as service contracts. The
following are the differences between litigation
and arbitration:-
Litigation is a public process and is conducted in
an open court. Arbitration is a private process
involving only the parties to the dispute,
arbitrator/s and witnesses if any.
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Litigation can commence anytime after the debt
is due or as discussed. Arbitration can only be
initiated after the parties to the dispute agree to
have the dispute resolved through arbitration
(existence of an Arbitration Agreement / clause).
Litigation is strictly formal, inflexible and
generally slow, depending on the procedures
and issues involved. In arbitration the parties
decide on the procedure to be followed as
contained in the Arbitration Agreement / clause.
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Further, with arbitration, the proceedings are
generally informal and fast.
Litigation is generally complicated, expensive in
terms of legal costs and the rendering of justice is
slow. Arbitration is generally less expensive and
simple.
In addition to the arbitration process, parties to a
contract can resolve disputes or contentious
issues out of court following negotiations. This
method is faster and less costly than the litigation
process.
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An acknowledgment of debt is a legal
document, in terms of which, the debtor agrees or
acknowledges the fact that he owes a certain sum
of money to the creditor and undertakes to pay.
The signing of this document must comply with
the requirements for a valid contract failing which
it will not be enforceable. It is wise for the credit
control department to make debtors sign these as
soon as the account is in arrears or the debt is
overdue as this makes the recovery process
easier and quicker.
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The in duplum rule
The in duplum rule is based on public policy and
is designed to protect the borrower from
exploitation by lenders. The in duplum rule is to
the effect that when unpaid interest has
accumulated until it is equal to the initial capital
sum loaned, it stops accumulating beyond that
point unless outstanding interest is reduced by
way of a payment.
170 06/10/2017
However, in the event that the lender thereafter
institutes action for the recovery of the capital
plus interest thereon, the interest begins to run
afresh from the date of litis contestatio (the date
of service of summons).
The rule applies to all debts where the capital
sum is to be repaid together with interest.
However, a diligent creditor is not prejudiced
where he/she promptly institutes action to compel
the debtor to repay their debt thereby avoiding
the application of the rule. See CBZ v MM
Builders, Trinity Engineering v Standard Chartered
Bank.
171 06/10/2017
The Supreme Court of Zimbabwe has ruled that
the rule cannot be waived either in advance or
during the course of a loan. Furthermore the rule
cannot be excluded by means of a contractual
provision between the parties at the time of the
contract. The parties in dispute are however not
prohibited from compromising once a suit has
commenced.
As a way of circumventing the application of the
in duplum rule, parties to a contract usually
novate the contract, that is agreeing to a new
contract where the initial capital plus interest
become a new debt and interest starts accruing
on that accumulated debt effectively replacing
172 06/10/2017
the old contract with a new one (novation).
Reference Books
Credit Risk Assessment: The new Lending
System for Borrowers, Lenders & Investors:
Clark Abrahams and Mingyuan Zhang: John
Wiley Sons Inc. (April 2009)
Credit Risk Scorecards: Developing &
Implementing Intelligent Credit Scoring: Naeem
Siddiqi
Enterprise Risk Management: A
Methodology for Achieving Strategic Objectives:
Gregory Monahan
06/10/2017 173
Reference Books
Credit Risk Assessment: The new Lending
System for Borrowers, Lenders & Investors:
Clark Abrahams and Mingyuan Zhang: John
Wiley Sons Inc. (April 2009)
Credit Risk Scorecards: Developing &
Implementing Intelligent Credit Scoring: Naeem
Siddiqi
Enterprise Risk Management: A
Methodology for Achieving Strategic Objectives:
Gregory Monahan
06/10/2017 174
Reference Books
Credit Portfolio Management: Charles

Smithson: John Wiley Sons Inc. (2003)
Ken Brown & Peter Moles, Credit Risk
Management, Edinburgh Business School,
UK (2008)
Credit Risk Management , GARP Risk
Series
06/10/2017 175
END OF PRESENTATION
QUESTIONS
THANK YOU
06/10/2017 176

Credit Risk Analysis - Control - GC - 2

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CREDIT RISK

ANALYSIS & CONTROL

Enterprise Risk Management?

Judgemental methods Applies the assessors exp & understanding of the

affect the ability of the borrower to repay a loan.

Senior Mngt/Credit Administrators

Credit policies set out the conditions and

Collection policy-details the toughness or laxity

Business origination function

Credit analysis function

Approval Function Approval Function

Watch process Loan review

Business Viability Financial condition Repayment Capacity

5 Fair Acceptable with care 4%

6 Speculative Management attention 5%

7 Highly Speculative Special Attention 10%

SS 8 Substandard Vulnerable 20%

D 9 Doubtful High Default 50%

Loss 10 Loss Bankrupt 100%

An institution must have an independent credit

An overdraft is an advance which depends on its

Role of Messenger of Court / Deputy Sheriff

a) Name of the court and names and addresses of

Examples of liquid documents involved include

Credit Portfolio Management: Charles

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