RETAIL BANKING

Topic 3: Processes & Systems

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Agenda
Understand the misconception in credit

management

Explain the various stages in the credit cycle. Understand the loan approval process.

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Balance Risk & Reward

Overall objective of all banks is to make profit Does the bank always prefer a borrower who

pay promptly?

If you are a risk manager..who is your favorite customer? Pays promptly & never late Has capacity to pay but habitually late Has cash flow problem & cannot pay

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Balance Risk & Reward

TYPICAL LOSS RATES*

Which is the most profitable portfolio?

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* Source: David Lawrence, Arlene Soloman (2002). Managing a Consumer Lending Business. Soloman Lawrence Partners. p11.

Balance Risk & Reward

Cost of funds 1% Credit Line 17.95% 3.20% $700,000 $125,650 $7,000 $118,650 $22,400 $96,250 Mortgage 3.15% 0.20% $700,000 $22,050 $7,000 $15,050 $1,400 $13,650

Interest Loss Rate Receivables Interest Revenue Cost of funds Spread Bad Debts Net Income

Portfolios with a low loss rate might not necessary be more profitable.

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Credit Risk Management Concepts

Retail Banking
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Credit Cycle

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Plan

1. Define product
2. Select target customers 3. Know your competitors
5X rewards at Cafes, Cinemas, Nightspots, Books/Music Stores

4. Set profit targets

Pricing below the market Pricing at the market

Exclusive privileges at Zouk and other nightspots

Pricing above the market

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Know your competitors

Features
Min Loan Max Loan

Bank A
$100,000 $2mil

Bank B
$50,000 $1mil

Bank C
$200,000 $8mil

Min Tenure
Max Tenure Pricing Fixed Floating Enhancements Fire Insurance Legal subsidy

1 yr
15 yrs Bank A 3yrs @ 4.5% Prime + 2% Bank A Free 1 yr Up to $5,000

1 yr
10 yrs Bank B 5yrs @ 3% Prime + 5% Bank B Free 3 yrs Up to $3,000

1 yr
20 yrs Bank C 2yrs @ 2.5% Prime + 3% Bank C Free 5 yrs Up to $8,000

Shopping vouchers

Metro $1,000

NTUC $500

Taka $2,000

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Credit Cycle

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Acquisition
Objectives: 1. Attract target customers 2. Minimize fraud 3. Establish a fast and cost-effective approval process Methods: Branch walk-in, advertisement, internet, cross-sell, direct mail, take ones, purchase portfolio etc.

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Approval Process
No
1. Application 2. Documentation complete? Yes

4. REVIEW
Debt burden ratio Collateral assessment Loan to value 3. Prescreening Credit policy

Score / judgment
Fraud Credit bureau Existing credit records Verification Reject

Approve
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Step 1 - Application
Personal bankers help customers with a needs analysis to help decide on the kind of loan that will best meet their needs. Check that information in loan application is complete. Applications fail because Important details are missing Information in application is inconsistent

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Step 2 - Documentation
Gather the necessary documentation for the loan
These documentation may include: Application form Personal Identification Income document Purchase agreement (secured loans) Others

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Step 3 - Prescreening
Quick review Identify fraudulent applications Reject applications which fail minimum standards

Min / Max age Minimum income Unacceptable collateral

to

meet

Unfavorable credit records (both internal &

external)

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Step 4 - Review
By who? Can be system or credit officer Debt burden ratio < X%

All debts + New application Monthly income

Loan to value ratio < X%

Loan Amount Current Market Value

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Step 4 - Review
Credit Scoring

5 Cs of Credit
1. Character Profile of applicant 2. Capacity Income 3. __________ Applicants investment 4. Collateral Liquidate in case of default 5. __________ Match timing of receipt against repayment

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Scoring
Credit Scoring

a number derived based on statistical analysis

used to assess the credit worthiness of applicants and also to predict the probability of default 2 types of scoring _______________ Behavioral scoring

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Scoring Sample Score Card

Characteristics Gender Age (years)

Credit Scoring

Type of Housing

Housing Ownership

No of dependants

Industry

No of years with current company

No of credit cards

Classifications Male Female 21 - 29 30 - 39 40 - 49 50 - 59 60 & above HDB flats 3 - 4 room HDB flats 5 room, executive Condominium Landed Rent Own Live with parents Mortgaged 0-2 2-4 >4 Accountancy Banking & Finance Education IT & Telecommunication Medical & Law 0 -2 2-5 5-8 >8 0 -1 1-3 >3

Points 10 20 50 60 70 40 10 20 50 80 100 30 80 50 50 80 60 40 50 60 20 40 20 10 20 30 40 30 50 10

Score 500 450 400 350 300 250 200 150

Good Percent 92 86 81 76 69 62 53 21

Bad Percent 8 14 19 24 31 38 47 79

Cut off Score 300

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Credit Cycle

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Post approval
Customers acceptance required Accept letter of offer
Personal

conditions Eg Mortgage loan follow by other documentations like fire insurance, lodgment of title deeds Actual disbursement
Customers acceptance not required; send out
Welcome package Terms and conditions

Banker

to

explain

terms

and

Line activation / disbursement

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Post approval
Others
Record transactions Process payments Handle inquiries

Handle disputes
Change address Inform customers of subsequent interest rate

change Restructuring of credit facilities / line increase Launch marketing campaigns / cross-sell

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Credit Cycle

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Collections
Identify high risk / low risk customers
Different strategy for different ageing / buckets
Reminder letters Phone calls

Site visits (house / office)

Legal actions

Can be in-house or out-sourced to collection

agency Reward to performing collectors

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Credit Cycle

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Write-off

Liquidate collateral
Foreclose properties

Repossess motor vehicles

Work-out repayment plan Offer hair-cut Recognize credit loss

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Q&A

1. Behavioral scoring is used to a. manage accounts already book. b. decide if an application should be approved. 2. Borrowers who never fail to pay on time are the best customers. a. True b. False

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Q&A

3. Collateral assessment is important to determine a. liquidity b. depreciation / appreciation rate c. all of the above
4.

Judgmental approval is better than using credit scoring. a. True b. False

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Retail Banking
Computation For Loans Payment
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Simple Loan
Formula:
PMT = PV * i 1 1/(1 + i) n
PV = i = n = Present Value annual interest rate number of years

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Fixed-Payment Loan
Calculate the monthly installment for 20 year mortgage of $100,000 at 5% interest rate p.a. Formula: PMT = PV * i 1 [1/(1 + i) n] 100,000 * (5%/12) 1 [1 / (1 + (5% /12))20*12]

=
=
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Fixed-Payment Loan
Calculate the monthly installment for 20 year mortgage of $100,000 at 5% interest rate p.a. Using the Present Value Interest Factor of Annuity Table (PVIFA Table) Loan Amount = Pann(PVIFA5%,20) $100,000 = Pann(12.462) Pann = = Pmon = =

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References

David Lawrence, Arlene Soloman (2002). Managing a Consumer Lending Business. Soloman Lawrence Partners.

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