What is Credit Risk….?

The degree of probability that a borrower might default on repayment of an advance.

 

We are in the business of risk taking. To strike a balance we must learn to manage risks.

 

Credit Risks…

• Management Risk
• Market Risk
• Technological Risk
• Financial Risk
• Non Economical Risk

 

Management Risk

• Character of the owners/ Directors.
• Integrity of the owners/ Directors.
• Past track record of the business, other related businesses, owners/ directors.
• Ability to carry out the activities related to the core of the business.
• Financial discipline of the owners/ Directors.
• Past experience of the owners/ Directors in related business activities.
• Organizational ability of the owners/ Directors.
• Labor Relations – whether the owners/ Directors have good rapport with the employees.  

 

Market Risk

• Product stage in the life cycle (Renew )
• Every product has a life cycle shown in a form of a sine wave. Before the life cycle of a product is coming to an end it must be renewed. (E.g. Manufacturers periodically  change the wrapping of a product)
• Competitors (If ruthless do not lend)
• Some times the competitors are well known multinational companies who are strong enough to destroy the new entrant to the market.
• Demand for the product
• Check whether there is a demand for the product or service. There may be existing providers of the product. Check whether there is a vacuum in the market. What are the alternative products which are available in the market.
• Marketing strategies (Price, Distribution, people, service
• Marketing edge (advantage over competitors )

 

 

Technological Risk

• Threat of new or improved technology.
• The new technology may be more cost effective of have more features.
• New inventions.
• New inventions might make your technology obsolete.

 

 

 

Financial Risk

• Amount of the advance.
• Is the amount adequate to fund the project? Will they have to borrow from other sources at a higher interest cost?
• Debt / Equity ratio.
• What is the owner’s contribution toward the business?
• Interest cover.
• How safe is our debt to the client. Can they service the interest from there earnings.
• Repayment capacity.
• The ability of the client to repay the loan capital & interest.
• Security available.
• The second mode of repayment if the project fails. The bank will have to have a safe fall back cushion. How strong is the second mode of repayment?

 

 

Non Economical Risk

• Socio Cultural Risk.
• Fresh water fishing in Anuradhapura will be Cultural Risk.
• A Bar in a Holy City might cause a public outcry.
• Political Risk.
• Liquor Licenses are issued to politically favored individuals.
• A competitor may be a politically influential party.
• Environmental.
• Does the project need environmental clearance from the relevant authorities.
• Government policies.
• Inconsistent Policies on taxes and other issues may affect the project. Religious
• Is the project controversial, going against accepted religious norms?

 

 

 Other Risk Factors.

•  Age of the borrower.
• Personal customers – Capacity to borrow if too old.
• Corporate customers – Older the better.
• Means Of the borrower.
• Assets of the borrower.
• Income from other sources.
• Break even point of the business.
• What is the production/ sales level required to cover costs.
• Remuneration to the bank.
• Is the bank retting properly remunerated for the risk it is taking.
• Term of the facility.
• Is the term of the facility inconsistent to the banks tending policy.
• Security.
• Second mode of repayment if the projected methods of repayment fails.

 

 

 

 

Here are some Examples…..

Strengths….

• Market potential.
• Market leaders / Monopoly.
• Connections.
• Immediate / consistent buyer.
• Well established Buyer / supplier network.
• Lack of strong competition.
• Strong / influential management.
• Management expertise.
• Financial support from a group.
• Past performance with the bank.
• Owners’ commitment towards the business.
• Increase in profitability / Growth in Capital.
• Tax holidays.
• Diverse range products.
• Ability to diverse.
• New technology.

 

Weaknesses….

• Start up business.
• Competition.
• Buyer plays a dominant role in pricing strategy.
• Lack of clear succession plan.
• One decision maker.
• High reliance on imported raw materials.
• High buffer stock requirement.
• No tangible security available.
• Substantial carried forward loses.
• Negative growth in financial indicators.
• Profitability depends on large volumes.

By

Sanjeeva Pieris