Lending SME- risks and management of those risks

Date: 2015-10-07; view: 416.

Increase in demand for credit from small and medium-sized businesses at the beginning of the XXI century has leaded to an increase in risks. "Credit risk is the risk associated with the possibility of violations of the debtor under the credit agreement. VN Cherkashenko calls this kind of risk transaction risks. He describes them as risks related to the variability of creditworthiness of individual borrowers that occurs in response to changes affecting its economic, industrial, social, demographic and other factors."[18] Identifying these factors is the first step in the management of credit risk. This include:

1. Factors associated with suppliers or buyers, ie risk associated with debtors.

2. The risk of market fluctuations, when the borrower for any reason is forced to reduce the prices of his products or in case of a rise in price of raw materials he needs to raise prices, while the demand is reducing, if the elasticity of demand for his product is high.

3. Technological and production risks, such as breaks in the production because of technical equipment failure or lack of electricity for a period of time. These risks require additional large costs, which can significantly reduce the creditworthiness of the borrower.

4. Risks associated with illiquid collateral. They can arise when borrowers are unable to fulfill their contractual obligations. In this case the realization of collateral may be delayed or the sale price can be very low, and other reasons.

5. Poor quality management in the organization. Quite often such businesses are run by people who don't possess management skills or not familiar to the industry and niche which they occupy . This problem is one of the most important for small and medium-sized businesses in Russia.

6. Risks associated with conducting illegal activities. Running parallel "shadow" business might lead to a significant debt, which the bank don't not know. Another option - the optimization of taxation, when official statements greatly distorted, making it impossible to assess the quality of the borrower.

All these risks are associated directly with each borrower individually, require good management. The whole procedure of credit risk management involves the same steps as the conventional risk management, namely:

1. Risk identification through the collection and analysis of analytical data

2. Quantitative and (or) a qualitative assessment of risk. It is performed by different methods, which are developed around the world quite a lot.

3. The establishment of the level of credit risk based on the selected model.

4.Making decision to reduce the level of risk.

5. The accounting and planning possible risk levels and maintaining them in a certain limit.

In this work I will describe in more details the second stage of credit risk management, since it is the foundation of this issue.

In all developed countries, loans are only given to borrowers who have completed the assessment of creditworthiness. In the West, such procedures are called scoring. Credit scoring is a fast, accurate, objective and robust procedure for the assessment of credit risk and has a scientific basis. It can be any mathematical model that relates the level of credit risk with a variety of parameters characterizing the borrower. In this model, the threshold is determined by "cut-off". If the borrower happens to be higher than the threshold value then he can get loan, and those who are below, they can't.

An example of the scoring models developed for companies in the US are Altman models. The first one was developed in 1968 on the basis of statistical data on 60 companies, half of which were bankrupt. The model looks like this:

Z = 1,2х₁ + 1,4х₂ + 3,3х₃ + 0,6х₄ + 0,999х₅.[19] , where

x1 (share of net working capital in assets)

x2 (the share of assets due to the formation of retained earnings)

X3 (return on assets, calculated on the basis of earnings before interest and taxes)

x4 (ratio market value of liabilities)

X5 (asset turnover ratio)

This model is suitable for the evaluation of large companies of the basic sectors of the US economy, whose shares are traded on the market.

Another model was created by the American economist Fulmer in 1984 for small businesses with an annual turnover of up to $ 1 million 0,5mln $. The model is as follows:

Z = 6,075 + 5,528V₁ + 0,212V₂ + 0,073V₃ + 1,270V₄ + 0,120V₅ +
+ 2,335V₆ + 0,575V₇ + 1,083V₈ + 0,849V₉,[20], where

V1 - the ratio of retained earnings to total assets;

V2 - the ratio of sales volume to total assets;

V3 - the ratio of profit before tax to total assets;

V4 - the ratio of cash flow to total debt;

V5 - the ratio of debt to total assets;

V6 - the ratio of current liabilities to total assets;

V7 - logarithm of tangible assets;

V8 - the ratio of working capital to total debt;

V9 - logarithm of the ratio of profit before interest and taxes to interest paid.

It is important to understand in what circumstances and conditions we can apply those models. For example two discussed just above models are suitable for the US economy and possibly for a number of other developed countries, but they are hardly applicable to Russia because of significantly different economic and socio - political conditions.

To conclude with, it is necessary to develop one's own scoring models for small and medium-sized businesses with regard to their characteristics. Moreover, it is necessary to develop different models for each sector separately. But this requires extensive practical experience of lending to small and medium-sized enterprises, and Russian banks not so long ago began to actively lend to small and medium businesses. It is important to have a large number of not only "good" but also "bad" borrowers in the portfolio for proper selection of the coefficients but banks in Russia, avoiding high risk, do not have in their portfolios a sufficient number of "bad" borrowers.

Thus, the creation of Russian scoring models lies on the future generations of economists, when the experience of lending to small and medium-sized businesses will be more extensive and complete. Nevertheless the example of credit risk estimation of a borrower ROSBANK illustrated in the third part of the work- give an illustration of the credit process.

In this situation in order to minimize the credit risk Russian banks may use the following measures:

• Diversification of the portfolio, ie, attracting more borrowers who are independent from each other;

• Set of credit ceilings or floating limit for borrowers;

• Continuous collection of information on the activities of the borrower from different sources;

• Consideration of both quantitative and qualitative factors in evaluating the creditworthiness of the client as well as his business reputation;

• Well-functioning security system;

• Development of schemes and methods for calculating collateral.

Another mechanism to minimize the risks associated with bank lending to small and medium-sized businesses may be the securitization of portfolios of bank loans to SMEs. This mechanism allows to diversify the firm's debt and sell them to investors at a better price. Ivanishchev PA notes that "the most appropriate mechanism for the securitization of Russia is a traditional securitization, designed to speed up the turnover of credit assets by the early repayment of loans."[21]

Thus, for the Russian Federation, it is important to gradually gain experience of the relationships of banks with SMEs and on the basis of this experience as well as the experience of other countries to develop their own methods of credit risk management and actively introduce new risk management tools, such as securitization.