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Risk-Based SME Lending

Risk-Based SME Lending. Day Two. Session 10. What are loan covenants? Why do we need to impose or require loan covenants? To control, mitigate, reduce and manage business risks Standard covenants in the Loan Contract plus some special covenants. Loan covenants.

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Risk-Based SME Lending

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  1. Risk-BasedSMELending Day Two

  2. Session 10 • What are loan covenants? • Why do we need to impose or require loan covenants? • To control, mitigate, reduce and manage business risks • Standard covenants in the Loan Contract plus some special covenants.

  3. Loan covenants • Two kinds of covenants: (1) affirmative [or do] covenants and (2) negative [or don’t do] covenants. • Examples of both types of covenants • Common loan covenants, see SF page 26

  4. Early warning system • Banks should set an Early Warning System through systematic and close monitoring of borrowers. • Banks should identify various warning signals and take appropriate actions on timely manner • This EWS could help prevent serious problems

  5. Loan monitoring • Loan officers should monitor the accounts based on the BRR and FRR rating • Risky accounts should require closer and more frequent monitoring • The BRR rating should be repeated every 6 or 18 months

  6. Loan monitoring • A sample monitoring guide • BRR 1 to 4: annually. • BRR 5 to 6: every six months. • BRR 7: every three months. • BRR 8 to 10: ongoing (report once at least a month) • Another sample found in page 89

  7. Collateral monitoring • What is collateral monitoring? • How frequently should it be done? • Who should do it? • Why is it needed?

  8. Loan pricing • Banks may implement a risk-based pricing of its loans. • The BRR rating of a borrower will determine how much interest should be charged. • The higher is the risk, the higher is the price and vice-versa. Why? • See suggested formula on page 115

  9. FRR • The FRR rating scale • You can develop your own scale. It is very easy to create your own. • FRR is very useful especially if the bank is strongly collateral-focused

  10. Calculating LGD • LGD considers the financial implications to the bank in case the borrower actually defaults on his loan. • It measures the potential losses • The LGD can be calculated using a mathematical formula; • See SF page 114 • Why is this LGD important?

  11. Organizational structure • The organizational structure will have to be altered or modified in a bank to accommodate the new credit assessment functions • Why is this so? • Some examples of banks and financial institutions with various structures

  12. Quiz No. 2 • Let us stop for a while and see how much new knowledge we have absorbed in our minds. • Quiz No. 2

  13. Session 11 • Let us practice our rating skills by doing another rating exercise • Refer to 4th case in page 101 • Briefly introduce the case • Work in small groups within time limit

  14. Session 11 • Report back • What is the BRR rating? Will you lend to this company? • What is the FRR rating? • What risks did you identify? • What loan covenants should you require or impose? • Question–and-answer

  15. Homework • Reflect on what we learn today and write in a piece of paper 1 or 2 questions to clarify things that are unclear. • Think tonight – will your bank adopt BRR and how you will do it • Does your bank need more money? Prepare your questions about SBC and its financing programs

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