Workshop on Credit Risk Management Managing Individual Credit Risks Motivation and Objectives June 18, 2008, Shanghai Asia Pacific Finance and Development Center World Bank Institute

East + West Risk: “a hazard; a peril; exposure to loss or injury ( Webster’s Dictionary ) 关系 + Доверяй, но проверяй Guanxi + Doveryai, no proveryai Relationships + Trust, but Verify BASIS OF GOOD CREDIT RISK MANAGEMENT

A Few Years Ago

Why Risk Management? For the Company Preserve Value Create Value Optimize Capital For the Market Instill Market Confidence Prevent Stock Market Volatility For the Economy Preserve Macroeconomic Stability Increase Credit Flows for Increased Growth

Why Risk Management? Serious Consequences for all economic agents the current financial market turbulence underscores the importance of getting the fundamentals of sound risk management right and being ever vigilant about their consistent application, execution, and improvement in light of new data and experiences. “Defaults on subprime loans and excessive debt burdens have supplanted terrorism as the biggest threat to the U.S. economy, survey of economists by the National Association for Business Economics. “European and Asian stocks fell on concern that the increase in borrowing costs caused by the collapse of U.S. subprime mortgages will hurt banks’ earnings. Bloomberg (27th August 2007):

Why Risk Management? Fiscal Costs of Banking Crises(% GDP) Thus Reducing Growth and Poverty Alleviation GDP per capita contracts by 1.4 % inflation nearly doubles Unemployment increase by 2% Gini coefficient increase by 1-2% over pre crisis

Key Organizational Questions in Risk Management How good is the judgment of the current credit officers? What is the quality and availability of the information (financial and nonfinancial) that can be used to assess risk quantitatively? What financial and human resources are available? What is the state of competition and structure of economy? The response to these questions determine Adapting contemporary methods to local needs and reality (e.g. credit scoring system, quantitative risk methods, delegation of powers etc.) The type of due diligence system to be developed.

Credit Cycle and Risk Assessment Risk Identification You cannot manage your risks if you do not know what they are. Risk Measurement Timely, accurate, consistent and reliable information Risk Control You control what you cannot measure Risk limits, operating within limits. Financial analysis and models, supported by market analysis. Risk Reporting To markets To Regulators

Basic Objectives Credit vocabulary, the process of business & industry analysis, the calculation of historical financial ratios, and the analysis of both historical ratios and cash flow Integrate financial, cash flow and collateral analysis, management assessment, business and competitive environment analysis Perform historical and trend analysis Measure the impact of management decision-making on financial performance. Identify the different types of credit risk and how they arise in different activities Integrate financial analysis, management assessment, and business environment into an appropriate credit recommendation. Understand how credit risk can be quantified, monitored and controlled and the role of credit portfolio management tools Appreciate how capital is allocated against risk under Basel

Basic Principles Explicit statement of policy, which clearly states the organization's appetite for risk Targeted goals for portfolio mix. Appropriate policies, systems, and controls should govern the identification, measurement, monitoring, and Control of credit risk concentrations. Concentration limits defined in relation to capital, total assets, and, where available, overall risk exposure.

Basic Tools Use of Primary and Secondary Sources Financial Statement Analysis, including the following: - Ratio Calculation and Analysis: Profitability, Asset Efficiency, Liquidity, Debt Service, and Coverage, Leverage & Capital Structure, Performance The Impact of Accounting Methods Off Balance Sheet Considerations Peer Analysis, Trend Analysis, Industry Benchmarks Cash Flow Analysis

Basic Credit Risk Assessment Modules Ratio Analysis section - An explanation of the calculation and interpretation of critical financial ratios Cash Flow Analysis section Projections and the Credit Decision section technique for projecting a company's future financial performance to determine its potential and ongoing credit risk. Quantitative Risk Assessment exposure to quantitative risk analytics and models Qualitative Risk Assessment Assessing Management Risk --- assessment of financial impact of management decisions, integrity and skills Signaling to Regulators

East + West 关系 + Доверяй, но проверяй Guanxi + Doveryai, no proveryai Relationships + Trust, but Verify BASIS OF GOOD CREDIT RISK MANAGEMENT Thank You!