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Typical credit risk strategy

INTRODUCTION

Credit risk is the economic loss suffered if counterparty defaults on either interest or principal

repayments or both when they fall due. Credit risks include: loans, acceptances, interbank

transactions, trade financing, foreign currency transactions, equities, and letters of credit.

Management of credit risk requires the availability of a documented credit risk strategy for

Raybank.This credit risk strategy spell out the institutions plan to grant credit based on various

client segments and products, economic sectors, geographical location, currency and maturity.

It also considers the target market within each lending segment, preferred level of

diversification or concentration. The details of the strategy are given as follows:

A. GUIDELINES FOR LOAN APPROVAL

a) Evaluation of loan applications

The strategy is to evaluate all applications by all clients, regardless of category, prior to

lending. The credit criteria is mainly based on the 5 Cs of credit will be used by looking at the

capacity, collateral, condition, character and capacity of the borrower. These can be explained

as follows:1. Capacity

Capacity to repay a loan is the most important criterion used to assess a borrowers

creditworthiness. The borrower must be able to satisfy us of his ability to repay the loan. We

will consider various factors including: profitability, cash flows, payment history, debt levels,

industry evaluation, financial ratios, amongst others.

2. Collateral

While cash flows are the primary source for the repayment of a loan, collateral will provide a

secondary source of repayment for the bank. Collateral represents the assets that are provided

to the lender to secure a loan. In the event that the borrower fails to repay the loan, the

collateral may be seized by the lender to repay the loan. Most preferable forms of collateral are

hard assets like real estate, gold jewellery, office equipment or manufacturing equipment.This

is because of the environment we are operating in which is still uncertain especially with the

possibility of the advent of the dollar. The bank will also settle for bilateral arrangements where


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the form of security acceptable for individuals is in form of cash and marketable security, Life

insurance policies, accounts receivable and inventory i.e in form of margin. Personal

guarantees and surety may not be acceptable as collateral as this will expose the bank to extra

risk or expenses of trying to evaluate even the credit worthiness of third parties.

3. Capital

Capital represents the money that shareholders have at risk should the business fail. We will

lend money to a borrower if shareholders have invested a large amount of their own money in

the business which shows that they have confidence in the business venture. If the business

runs into financial difficulty, then the capital of the business provides a cushion for repayment

of the loan.

4. Conditions

On this section, the strategy refers to two issues:

Firstly, the intended purpose of the loan. The borrowers reasons for seeking the loan should be

spelt out in detail in the loan application. Will the money be used to buy new equipment for

expansion? The bank will not lend to a customer whose intentions are not clear.

Secondly, overall economic climate, both within the borrowers industry and in the economygenerally, that could affect the borrowers ability to repay the loan. For example, during the

2003/2004 Zimbabwean credit crunch and 2008 global financial crisis it became more difficult

to get enough funds to lend and for businesses to repay loans. Thus, during similar periods the

bank may not lend even to customers with flawless loan applications. In good years, the bank

will grant more loans. Loan officers should consider current business climate, trends for the

borrowers industry, borrowers fitness, industry potential, market features, political

environment.

5. Character

Character refers to the general impression that the borrower makes to us. The bank will only

consider customers with impeccable credentials. A checklist will include the character and

reputation of management, educational background and level of experience of management, the

borrowers attitude towards waste disposal, quality of life for its employees, and charitable


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contributions, the borrowers payment history and legal actions pending against the borrower,

if any, the reason for these legal actions.

b) Credit Culture

Strategy does not allow an officer who is closely related to an applicant to process the sames

loan application for the sake of transparency hence avoiding any cronyism. If the relationship is

not intimate, the officer can process the application but under supervision by a superior. If the

relationship is just a formal one, the loan officer can process applications independently.

c) Credit limits

These will be set considering the abilities of each and every client. No specific figure can be set

for all clients in general as this may end up leading to loss of business for the bank from those

clients who are capable or over-committing funds to customers who deserve small loans.The

techniques to be used in setting credit limits are:

Trade References - trade references are compared with the amounts of the High Credits

awarded to a customer. The bank can choose the Highest from the High Credits or take an

Average or pick the Lowest.

Bank References - a bank reference on applicants gives the amount of line of Credit that was

established by the applicant with the bank. If this line is unsecured then perhaps it can give a

little more comfort in setting a relatively higher credit limit for the applicant.

Agency Credit Reports - Credit Agencies generally give two pieces of information that are

quite popular among credit professionals that aid in the setting of credit limits:

1. Payment Performance: This section lists the paying habits of the applicant. The information

is collected from different suppliers to the applicant.

2. The Rating: Based on certain credit and financial information obtained on the customer, theAgencies assign ratings. These ratings assist in setting our own credit limits.

Financial Statements - Financial statements are also used in assigning Credit Limits to

customers. Mainly ratios or factors like net worth and working capital are taken and trended or

compared to Industry norms or standards. If a customer shows liquidity and efficiency as per

industry norms then a high credit limit can be given.


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B. STAFF TRAINING

Training can be introduced if performance appraisal identifies a staff performance gap, as part

of an overall professional development and or as part of a succession plan. A number of

methods can be used which include seminars, conferences, classroom method, workshops, on

the job training, guidelines and departmental manuals. Loan officers can be trained in areas of

financial analysis, credit reports, loan documentation and credit information exchange. This

minimises the risk of committing discretionary mistakes to loan officers and enhance ethical

standards. This also helps avoid stormy seas of imprudent lending.

C. DIVERSIFICATION

This strategy requires diversification by product, industry, geography, currencies and maturity.

More detail is given in the following table.

Basis Details (by order of preference)

By product Business, housing, personal, credit card, educational,

auto

By sector/industry Mining, construction, communication, manufacturing,

government, energy, hotel and tourism, transport

services, food, agriculture, products, paper, others

Geographically Zimbabwean borrowers and outsiders in pursuit of higher

rates of interest.

Maturities Short term, medium term and long term

Currencies US$, ZAR, ZWD if reintroduced

At large, loans will be made to locals in consistence with the local empowerment programme.

Based on maturity, short term maturities of one year and below will be preferred, medium term

maturities of 1-5 years are acceptable and long term maturities of above 5 years are risk and

less preferable because of the economic instability hence uncertainty in predicting the future.

Different currencies will also be used with major transactions denominated in the currency in

use/circulation. Diversification reduces total risk of loans as investments increase provided

correlation between markets remain imperfect as it is now in Zimbabwe.

D. STRATEGY FOR MANAGING CREDIT EXPOSURE

These strategies encompass the use of risk mitigating approaches. The following strategies are

suggested;

collaterilising exposures by first priority claims with cash or securities


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Insuring exposures with insurance companies

Formal credit reminder using standardized and automated procedures. This avoids

overlooking of credit reminders. This gathering of own customers, default information is

very important because Zimbabwe does not have credit bureaus as yet who can providedefault statistics.

Other approaches such as stringent credit standards for borrowers and counterparties, strict

portfolio risk management and constant focus on changes in the economy or other

circumstances that can lead to deterioration in the credit standing of our counterparties.

Diagrammatic representation of risk mitigation approaches

If the problem still persists and the customer defaults, the following strategy is used.

E. LOAN RECUPERATION

In case risk mitigation strategies have failed to work, then there is a need for loan recuperation.

This entails action that can be taken to recover losses if a customer defaults with the use of

legal action, public action to dispose the collateral pledged as security, taking possession of the

collateral and claiming cover from insurance companies.

IN CONCLUSION

Risk management strategy for Raybank is structured as detailed above with loan approval, staff

training, diversification, risk mitigation and loan recuperation as major strategies.

BIBLIOGRAPHY

collateralisation

Other

Credit insurance

Credit reminders

15

%

50%

15

%

20%
http://www.bankersacademy.com/riskmanagement.php?BOL_FCRM_PPThttp://www.bankersacademy.com/riskmanagement.php?BOL_FCRM_PPT


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1. Foreest, P.W. (2002), Creating a robust credit culture,Bankers Journal Malaysia (120-

133): 15-19

2. Mueller, P.H. (1990), Credit Culture Vital to Risk Management, The Journal of

Commercial Bank Lending 72: 4-1

3. Wesley, D.H. (1993), Credit Risk Management: Lessons for Success, TheJournal of

Commercial Bank Lending

4. Jorion, P. (2003), Financial Risk Manager Handbook, 2nd ed, John Wiley & Sons, inc,

New Jersey

5. Brendan Le Grange, (2011), Credit Risk Strategy, Word Press

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