BTO

W
E Banking Technology
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and Operations
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Credit Evaluation Process

Diploma in Financial Informatics

04 Year 2

Last update: 01-05-2018

Chapter Outline

 Overview on lending process

 Credit evaluation framework
 Ratings
 Loan monitoring & management

Diploma in FI
Year 2 Slide 2
Learning Objectives
 Gain an overview on the corporate lending process
 Understand the credit evaluation framework
 Appreciate internal credit rating to determine client’s credit
standing
 Understand the key components of loan management

Diploma in FI
Year 2
Overview of Lending Process
Lending Process

Prospect Identification
Preliminary Due Diligence
• Risk Assessment
Calling Prospects • Risk Mitigation
Meeting Prospects
Obtain information for
Credit Assessment
credit process
Offer to customer Credit Approval
Acceptance
Documentation
Activation Usage Monitoring

Diploma in FI
Year 2
Repayment Priority
The priority in which the debt claims
are paid by the firm in bankruptcy or
liquidation.
Secured
Debts
Preferential
Debts Cost of
financing
Assets Sources of Financing Unsecured increases
Debts

Subordinated Debts

Equity

Diploma in FI
Year 2
Principles of Good Lending
 The most important consideration for a lender is how will the loan under
consideration be repaid.

 The lender generally looks towards the cash flow from the operations of the
business as the primary source of repayment failing which realisation of the
assets pledge as security will be an alternate source of repayment.

 The lender must ensure that the loan is used for the business operations
and not siphoned out of the business as the primary source of repayment is
generally from borrower’s business operations.

Diploma in FI
Year 2
Principles of Good Lending
The danger of adopting a policy to lend purely against the security value and
not take into consideration other sources of repayment is that:

 the value of security realised may be below the expected amount;

 there may be complications in the process of realising the security

 A good credit must have more than one way out

 There must be more than one source of repayment

Diploma in FI
Year 2
The 6 Qualitative Factors

Character Integrity, willingness to pay

Capacity Ability to pay

Capital Owner’s investment in the business

Conditions Economic and business environment

Credit Structure Type, term and pricing appropriate for lender

Collateral Asset pledged in support of loan

Diploma in FI
Year 2
What is Credit Risk?
Credit exposure:
Amount owning
when default
Exposure occurs
Credit
Risk + • Loan
Uncertainty Outstanding
• Line Limit

Default Probability + Recovery Rate

Default probability: Likelihood that Recovery Rate –

the counterparty will default on its fraction of the
obligation either over the life of the exposure that may be
obligation or over some specified recovered.
period. Calculated for a one-year
horizon = expected default frequency

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Year 2
Legal Structure

Company Others

Private Company Sole-proprietorship

Private Exempt Company Partnership

Public Company limited by shares Limited liability partnership

Public Company limited by guarantee Limited partnership

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Year 2
Private Company Limited by Shares
Private Company
 This is a locally incorporated company where the maximum number of shareholders is limited to 50.

Exempt Private Company

 This is a private company:
—which has not more than 20 shareholders, and none of the
shareholders is a corporation or
—that is wholly owned by the Government and which the
Minister, in national interest, declares by notification in the
Gazette to be an exempt private company

Diploma in FI
Year 2
Public Company
Public Company limited by shares
 A public company listed by shares is a locally incorporated company in which the number
of shareholders can be more than 50.

 The company may raise capital by offering shares and debentures to the public. A public
company must register a prospectus with the Monetary Authority of Singapore before
making any public offer of shares and debentures.

Public Company limited by guarantees

 A public company limited by guarantees is one which carries out non-profit making
activities that have some basis of national or public interest, such as for promoting art, or
charity etc.

 The Minister may approve the registration of the company without the addition of the word
“Limited” or “Berhad” to its name.

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Year 2
Sole Proprietorship / Partnership
Sole Proprietorship
 A sole-proprietorship is a business-owned by one person or one company. There are no
partners. The sole-proprietor has absolute say in the running of the business.

Partnership
 A partnership is a business firm formed by two to twenty partners.

 Partners are jointly liable for the debts of the business.

Diploma in FI
Year 2
 Limited Partnership

 Consist of a minimum of two partners, with at least one general partner and at least one limited
partner.

 An LP does not have a separate legal entity from the partners, i.e. it cannot sue or be sued or own
property in its own name.

 An individual or a corporation may be a general partner or a limited partner. Appointing a local manager
is not mandatory unless all the general partners are residing outside Singapore. LLP is primarily meant
for carrying a profession (e.g. accountants, law firms, architects, etc.) where two or more professionals
build a joint practice in a common field.

 LLP gives owners the flexibility of operating as a partnership while having a separate legal identity like
a private limited company.

 It is a body corporate and has a legal personality separate from its partners
 Perpetual succession – change in the partners of an LLP will not affect its existence, rights or liabilities.
Diploma in FI
Year 2
Credit Rating – Internal vs. External
 Credit rating – a summary indicator of the risk inherent in the credit.

 Rating process – assessment of the risk of loss due to failure by a

given borrower to pay as promised, based on consideration of relevant
quantitative and qualitative information.

 External rating systems use the same methodologies to assess the

risk of similar customers across banks, while internal rating systems
differ significantly in their design and operations.

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Year 2
Internal Ratings
 In-house ratings systems

 System customised to the given bank’s needs

 Internal ratings – grades assigned to borrowers or facilities ranking their

relative risk

 Most bank clients are not rated by external credit agencies but are rated
internally due to
—large volume and
—cost considerations

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Year 2
Uses of Internal Ratings
Banks have devoted considerable resources to developing internal
risks models for purposes such as

 approving of loans,
 portfolio monitoring and management reporting,
 analysis of the adequacy of loan loss reserves or capital,
 profitability and loan pricing analysis
Diploma in FI
Year 2
Internal vs External Ratings
 Internal ratings system differ significantly from
external agencies
—in their design and operation,
—partly because internal ratings are assigned by bank personnel and
—are usually not revealed to outsiders

Diploma in FI
Year 2
External Ratings
 Widely known credit rating systems
 Role – evaluate and quantify credit risks, within a context of
effective benchmarking of risks across industries and
countries

 Aim – provide lenders and investors with independent and

objective credit opinions

 Playing an increasing regulatory role

Diploma in FI
Year 2
Types of External Rating Agencies

External Credit Ratings

Agencies

International Agencies National Agencies

Standard & Poor’s Corporation Global ICRA India
Moody’s Investors Service Global Korea Investors Service Korea
Fitch Group Global Rating Agency Malaysia Berhad Malaysia
Dominion Bond Rating Service Mainly North America Pakistan Credit Rating Agency Pakistan
Japan Credit Rating Agency Mainly Japan Philippine Rating Services Corporation Philippines
Rating & Investment Information Mainly Japan Thai Rating & Information Services Thailand
Capital Intelligence Emerging markets
Source: Table created using data from the Financial Times Credit Ratings Credit Rating
International and Financial Times Rating s in Emerging Markets.
www.ftinteractivedata.com
Agencies

Diploma in FI
Year 2
Rating Scale Comparison
Standard and Poor’s Corporation Moody’s Investors Service
Long-term Short-term Long-term Short-term

 The top quality AAA / Aaa rating

AAA
AA+
A-1+
A-1
Aaa
Aa1
P-1
P-2
represents the highest capacity to AA A-2 Aa2 P-3
AA- A-3 AAa3 NP
pay interest and repay principal. A+ B A1


A C A2
Long term ratings of BBB- / Baa3 A- D A3
and above are deemed BBB+
BBB
Baa1
Baa2
investment grade. BBB- Baa3


BB+ Ba1
Ratings below this level are BB Ba2

deemed speculative grade (also BB-

B+
Ba3
B1
known as high-yield debt or ‘junk’ B B2
B- B3
bonds). CCC+ Caa1

 D represents default. CCC

CCC-
Caa2
Caa3
CC Ca
C C
D

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Diploma in FI
Year 2
Lending Process

Prospect Identification
Preliminary Due Diligence
Calling Prospects
Meeting Prospects
Obtain information for
Credit Assessment
credit process
Credit Approval

Credit Application Not Approved

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Year 2
Alternative Available if Loan Application is Rejected
Not all credit applications are approved. If the credit application is still rejected after appeals, the bank
needs to inform the applicant promptly.

 Explain the concerns that the bank has, discuss how the company can address the concerns by:
— Additional collateral / credit support from a better rated party / credit insurance
— Capital restructuring
 Suggest alternate sources of funding
— New start ups – private banking, venture capital, angel funds, alternate financing
— Other sources – mezzanine finance
— Export financing against other bank’s risk

Diploma in FI
Year 2
Lending Process

Prospect Identification
Preliminary Due Diligence
Calling Prospects
Meeting Prospects
Obtain information for
Credit Assessment
credit process
Offer to customer Credit Approval
A sub function
Acceptance of loan
management
Documentation
Activation Usage Monitoring

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Diploma in FI
Year 2
Objectives of Loan Management

 Identify prospect of additional business

opportunities
 Ensure loan repayment in full and on time
 Identify signs of potential problem loans
 Initiate loan recovery actions upon identification of
early warning signs

Diploma in FI
Year 2
Loan Management & Credit Control Process
Managing & controlling the risk underwriting process
 Credit control functions – ensure that the credit risks taken are in-line with the bank’s credit policy.
Keys areas include
— Ensure proper activation of approved limits,
— Ensure appropriate endorsement of excesses and policy exceptions,
— Monitor compliance with credit standards and credit covenants

Managing the loan after it has been disbursed

 Day-to-day monitoring of credit exposures and the external environment that may have an impact
on credit risk is important to Bank’s effective credit risk management

 Credit trends including industry analysis, early warning signs and poor weak credits are reported to
management for formulation of action plans

Diploma in FI
Year 2
Loan Management & Credit Control Process
Reviewing the credit risk underwriting process
 Credit risk review team conducts:
—regular reviews of credit exposures and credit risk
management processes
—independent validation of internal credit risk rating
processes on an annual basis
 Goals of credit reviews
—Provides the bank’ senior management with objective
and timely assessments of the effectiveness of credit risk
management practices
—Ensure that the bank’s credit policy, internal rating
models are being adopted consistently
Diploma in FI
Year 2
Three Components of Loan Management

Monitoring
Review information about the progress of the
borrowers and events that affect them
Loan
Identification
Management
Spot trouble signs that indicate the borrower may
have difficulty repaying the loan
Ensure repayment on detection

Take action to ensure that the loan is repaid

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Diploma in FI
Year 2
Customer Review - Frequency

MAS 612
Five P
Grades as
s
Special
Mention
Classified
Substandard Grades

Doubtful

Loss
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Diploma in FI
Year 2
Loan Classification

Pass
 Indicates that timely repayment of the outstanding credit
facility is not in doubt
 Repayment is prompt and credit facility does not exhibit
any potential weakness in repayment capability, business,
cash flow or financial position of the borrower

Diploma in FI
Year 2
 Loan Classification

Special Mention
 Indicates that the credit facility exhibits potential weaknesses that, if not corrected in a timely
manner, may adversely affect repayment by the borrower at a future date, and warrant close
attention by a bank
 Characteristics of “special mention” credit facilities include the following:
—A declining trend in the operations of the borrower that
signals a potential weakness in the financial position of
the borrower, but not to the point that repayment is
jeopardised
—Economic and market conditions that may unfavourably
affect the profitability and business of the borrower in the
future
Diploma in FI
Year 2
 Loan Classification
Substandard
 Indicates that the credit facility exhibits definable weaknesses, either in respect of the business,
cash flow or financial position of the borrower that may jeopardise repayment on existing terms
 Characteristics of “substandard” credit facilities include the following:
— Inability of the borrower to meet contractual repayment terms of the credit facility
— Unfavourable economic and market conditions or operating problems that would affect the
profitability and business of the borrower in the future
— Weak financial conditions or the inability of borrower to generate sufficient cash flow to service the
payments
— Difficulties experienced by the borrower in repaying other credit facilities granted by the same
bank, or by other financial institutions (where such information is available)
— Breach of any key financial covenants by the borrower
 A bank shall assess the severity of each weakness exhibited by the credit facility and consider
whether the weakness, when considered singly and in combination with other weaknesses, would
adversely affect the repayment ability of the borrower

Diploma in FI
Year 2
 Loan Classification
Doubtful
 Indicates that the outstanding credit facility exhibits more severe weaknesses than those in a
“substandard” credit facility, such that the prospect of full recovery of the outstanding credit
facility is questionable and the prospect of a loss is high, but the exact amount remains
undeterminable as yet
—Consumer loans past due for 120 days or more, but less
than 180 days fall under this classification
Loss
 Indicates that the outstanding credit facility is not collectable, and little or nothing can be
done to recover the outstanding amount from any collateral or from the assets of the
borrower generally
—Consumer loans past due for 180 days or more fall under
this classification

Diploma in FI
Year 2
Case Study:“The Importance of Due Diligence in Lending”

• How can banks make use of technology to ensure that due diligence
processes are followed? Tracking and monitoring, biometrics to
authenticate and verify identity, benefits, reduce complexity and time and
cost saving.
• Why are coordination and cooperation across banking divisions, such as
lending and payments processing, important for stopping fraud?
• How might have the geographic distance between the European banks
and their intended Singaporean customer been a factor in the APB case?
• How could the banks’ transaction processes be enhanced to detect cases
like this early in the fulfillment stage of the transaction lifecycle?

Diploma in FI
Year 2 Slide 34
References

 Websites of MAS, Investopedia

 Various internet websites
http://www.temenos.com/Documents/Graphics/Software
/TCB/TCB_FA.jpeg
 http://financial-information systems.com/core-banking-
systems/fundamentals.htm

Diploma in FI
Year 2 Slide 35