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LEVERAGING RISK RATING SYSTEMS FOR EFFECTIVE CREDIT
DECISIONS
1. Introduction:
The credit risk management process implemented by banks may differ, with each bank
often developing a credit process that reflects the character and understanding of the bank
itself. The credit process involves several working units that are independent and support
each other so that the credit process can be implemented effectively, and consistent with
the company's objectives. The credit process needs to be reviewed periodically as needed
to support business improvement and control the bank's risk, and in accordance with
applicable regulations.
While the form and approach of the loan management process may vary from bank to
bank, there are several key success factors of the loan process in general, including:
•
There is a strong credit culture, supported by leadership from senior management for
the execution of credit processes in accordance with the power bu.
•
The application of risk/reward factors in the credit decision-making process.
•
Clear accountability in credit risk management.
•
Professionalism and discipline in managing risk.
•
Have a clear credit policy that is communicated to all levels of the credit process, and
a system to ensure understanding of the policy by relevant levels of the organization.
•
A risk rating system with proven predictive power is available.
The commercial loan process begins with the initiation stage, which involves receiving
the application file, followed by an initial interview to understand the purpose of the loan.
This is followed by verification of the validity of credit documents, followed by
qualitative and quantitative analysis.
Qualitative analysis includes:
•
Analyze the industry where the debtor's business is located.
•
Analyze sources of credit repayment.
•
Analyze management aspects.
•
Marketing aspects.
•
Technical aspects.
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•
Legal and collateral aspects.
•
Credit structure.
•
Quantitative aspects in the form of financial analysis.
Credit risk management is carried out at both the transactional and portfolio levels
with the aim of minimizing the level of risk to the planned level. Furthermore, the bank
provides capital to cover the residual risk. Based on this, banks can set lending interest
rates to earn a return commensurate with the risk taken.
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Initiation:
At this stage, the bank receives the customer's credit application or makes a credit offer to
the customer. The customer's credit application must be submitted in writing.
Credit applications submitted by customers can have various purposes, as follows:
•
New credit application.
•
Application for additional credit that has been running.
•
Request for an extension of the maturity period of a loan.
•
Other requests such as changes in terms and so on.
The credit application file from the customer consists of a credit application letter
signed by the customer, or the party authorized to apply for credit in the customer's
company (if the customer is a business entity), equipped with documents required by the
bank, including the company's deed of establishment (if the customer is a PT business
entity), necessary data such as production and sales realization and projections, customer
financial statements, customer account mutations and collateral data to be submitted.
Against the documents submitted to the bank, it is necessary to carefully examine the
reasonableness and consistency of the data in these documents, before a deeper analysis
is carried out.
Credit offers can be made to certain customers who are the bank's target market, and
or have been included in the pipeline set by the bank. Credit offers are made based on a
brief analysis conducted by the bank to see the feasibility of the customer's business to
obtain credit and the offer is made based on the bank's own analysis but not yet binding
on the bank. For this credit offer, the bank will conduct a more detailed analysis to see the
feasibility of the customer's business.
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2.1
Interview – Interview:
The next step taken by the bank is to conduct an interview with the customer, which is
generally done through an on-site visit. The interview process is intended to find out,
among others:
•
The size of the customer's credit needs and the intended use of the credit.
•
The credit period required by the customer.
•
Credit repayment plan by the customer.
•
Assess the quality of prospective customers' answers to problems found on credit
applications.
2.2
Target Market
Credit marketing in this era of intense banking competition is carried out by changing
the old paradigm, namely from serving mainly "walk-in customers" to targeted
customers. The advantages of the target market approach:
•
Marketing is more structured.
•
Get more qualified prospective debtors.
•
Risks are easier to mitigate.
•
The potential of the target area can be further exploited.
•
Banks can focus on business sectors that are considered profitable.
Some factors that must be considered in determining the target market in each region
include:
1) Local area conditions
The economic condition of the local area needs to be considered in determining the
target market. Each region has its own characteristics.
2) Competitors
The banking business is currently in a state of intense competition. Therefore,
banks need to provide better, faster services with a simple process, but not
neglecting the principle of prudence.
3) Business Strategy
In a situation of intense competition, banks must develop business strategies that
are more proactive in meeting market demands, as well as proactive in selecting
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target debtors who are considered prospective in the form of product
programs/credit schemes.
4) System
To support business development, we need the assistance of systems, including:
loan portfolio management, rating and scoring system, loan automation system,
loan monitoring system, collection system and non-performing loan management
system.
5) Risk Management
Risk management applies acceptable credit criteria to target specific markets and is
tailored to the regional conditions and business nature of the economic sector to be
financed.
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2.3
Negative List:
Banks generally maintain a list of industry categories that are temporarily excluded
from the bank's target market. This list can save the credit marketing unit from having
to waste time processing a group of borrowers that the bank does not want to finance.
In general, the bank's policy regarding the negative investment list is that the bank
does not immediately reject loans that fall into this category, but needs to be more
careful, for example by increasing the authority to terminate loans in this category to
higher authority holders.
2.4
Credit Purpose Analysis:
Analysis of the intended use of credit should at least include the following.
•
An assessment of whether the intended use of the credit submitted by Nasa Bah is
business feasible and does not violate the law.
•
The intended use of credit is consistent with the bank's credit policy.
•
Does the credit application require expert assessment or special handling?
Examples of credit usage include:
General use:
As business capital to finance receivables, finance stock or inventory, buy assets such
as machinery to carry out the production process.
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Specific objectives:
•
Project financing.
•
Financing to carry out the acquisition process.
•
Building construction financing.
•
Trade financing.
2.5
Repayment Source:
The source of loan repayment should be primarily cash flow from business activities.
In addition, given that financial projection assumptions may not match reality, it is
also important for the bank to see that there are other sources of repayment as a
backup or second source, if the main source of repayment is insufficient or
unavailable.
The categories of credit repayment sources are as follows.
•
Operating cash flow. A business that is able to generate operating cash flow is a
business with an ongoing process of business results.
•
Refinancing. The source of credit repayment from refinancing can be done through
two variations as follows.
–
Financing from other financial institutions, i.e. loans from the originating bank
are repaid from new loans granted by the financial institution.
–
Issuance of securities, proceeds from the issuance of new equity, or issuance of
new debt securities used to repay debt.
•
Acquisition of the customer by another company. This repayment alternative may
result in the loan being repaid from the cash flow generated in the acquisition deal.
In some cases, an acquisition triggers a financing takeover by a corporate bank
which makes an acquisition that causes the relationship between the customer and
the original bank to end.
•
Collateral liquidation, which generally occurs when a customer is experiencing
problems, and restructuring alternatives are not feasible.
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Credit Analysis:
The form, format, and depth of credit analysis are determined by the bank in accordance
with the amount and type of credit.
The credit analysis should illustrate the concept of the total relationship of the credit
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applicant, especially if the applicant has previously received credit facilities from the
bank or at the same time submitted other credit applications to the bank.
Credit analysis is a significant factor that influences credit decisions to customers. The
objectives of credit analysis are:
•
Help banks make informed lending decisions.
•
Helps banks avoid inappropriate lending.
2.1
Management Aspect Analysis
Things analyzed in the management aspect include:
•
The character of management, which is the party that manages the company.
•
The character of the customer relates to honesty, morals, and management's
willingness to cooperate with the bank.
•
Banks will only provide credit to customers who have good faith and have a
commitment to repay the credit given.
Some of the things that banks can do to gather information about management include:
•
Conduct bank checks on the Bank Indonesia database, or research the black list.
•
Identify the main competitors of the customer's business.
•
Trade checking on raw material suppliers to the nasa bah company, to ensure that the
customer is trustworthy, and to ensure that the customer has a good reputation in
business.
•
Management's orientation towards business goals or objectives, which indicates
management's perception of the company's future in the market and the steps to be
taken to achieve the goals.
•
Background, describing management experience in business in general and in the
current company.
2.2
Economic and Industry Analysis:
Banks need to qualitatively assess several external factors that may affect the company,
including the level of competition, seasonal nature of the industry, economic cycles,
industry cycles, product cycles, government regulations and economic conditions. One
method of assessing industry conditions is by Porter's analysis as follows.
a)
Porter's Analysis:
According to Porter, the competitiveness of a business depends on five main
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competitive forces, namely (1) the potential for new entrants to enter (threat of new
entrants), (2) the threat of substitute products (threat of substitutes), (3) the bargaining
power of buyers (bargaining po- wer of buyers), (4) the bargaining power of suppliers
(bargaining po- wer of buyers), (4) the bargaining power of suppliers (bargaining
power of suppliers) and (5) competition among existing firms (intensity of rivalry).
The bank assesses and analyzes the management strategy to deal with these
industry conditions. A conservative company will limit borrowing from banks, limit
its growth rate and be very strict in setting its receivables policy.
Aggressive companies tend to have high debt levels, have high inventory levels, a
more liberal receivables policy and rely more on debt as a source of funds.
Porter's analysis can be used as a basis for:
•
Determined market potential and estimated market share and sales assumptions of
the customer's business.
•
Determine the marketing plan.
•
Determine market segmentation and measure business opportunities.
•
Criteria for determining the target market.
•
Risk acceptance criteria (RAC)
•
Marketing analysis measures the customer's ability to sell the product (sales volume
and selling price).
b)
Growth rate:
The development of an industry generally follows a cycle called the industrial cycle.
Companies can improve the position of the industry by creating new innovations, so
that the stage of the industry towards saturation can be delayed.
Companies in mature industries generally have a large amount of capital
accumulated over a long period of time, and do not need bank credit assistance.
Companies in growth industries generally require more bank credit to provide a source
of funds to finance inventories, receivables or new investments to accelerate business
growth.
Companies with industries in the growth stage tend to have more capital
expenditure greater than the depreciation cost. Companies that are saturated tend to
have capital expenditures approximately equal to depreciation costs.
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2.3
Marketing Aspect Analysis:
Marketing analysis aims to conclude how much the company's ability to gain market
share, sales volume and selling price, taking into account the structure of the industry in
which the company is located, and competitive conditions.
To assess the competitiveness of the company, Porter's analysis can be used to see
how the conditions of barriers to entry, the existence of substitute products, and the
bargaining position of buyers of the company's products and sellers of raw materials, as
well as the competitive map in the industry in which the company is located.
Debtor's business from the side:
1) In terms of barrier to entry, debtor companies are considered good if competitors do
not easily enter the same industry.
2) In terms of substitute products, the debtor's business will be better if there is no or
difficult to find substitute products that can replace its function.
3) In terms of the company's bargaining position towards raw material suppliers, the
debtor's business will be more secure if the raw materials needed are sufficient, and
there are many parties who provide them.
4) In terms of the company's bargaining position towards end consumers, the debtor's
business will be more secure if the company's production can be absorbed by the
market at large, no party can control or dictate the selling price of the finished product.
5) The debtor's business will be more secure if the competition map of the industry
chosen by the debtor is not too tight and there are not too many competitors.
At the end of the marketing analysis, the analyst must conclude what sales volume and
at what price, as a basis for determining the assumptions to be used in the financial
analysis.
2.4
Technical Aspect Analysis:
Technical aspect analysis is carried out to assess the amount of investment and working
capital required, production capacity and production costs. The technical analysis process
includes, among others, analysis of the location of the debtor company, the condition of
the land and building facilities, machinery and equipment used, lay out/factory layout,
production capacity and balance of factory machinery, production processes and
production management, the need for raw materials, auxiliary materials, direct labor and
other production factors, as well as other information related to the production process,
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from planning production schedules, monitoring goods in process, to controlling the final
product and production costs.
Investment Needs
Investment needs include analysis of the business location, access roads, land, buildings,
production machinery, supporting equipment, vehicles and pre-operational costs required
for the company to carry out production as planned.
For some projects that require long-term development, such as plantation projects, it is
also necessary to take into account the construction period interest that is capitalized as
part of the investment.
In the investment needs analysis, the analyst must ensure that the investment is indeed
needed for production, and the investment cost is scrutinized to avoid price inflation.
Production Cost:
Analysis of the company's ability to carry out production, production costs both direct
costs and indirect costs, taking into account the elements of raw materials, auxiliary
materials, direct labor costs and general costs.
The debtor's business will improve if the production process is more efficient than
competitors, with lower operating and general costs.
Environmental Aspects:
AMDAL or environmental impact assessment is an analysis of the impact on the
environment on land, water, and air as well as human health if the project is carried out.
AMDAL is a study of the major and important impacts of a planned business or
activity on the environment, which is necessary for the decision-making process about
organizing a business or activity in Indonesia. AMDAL is made when planning a project
that is expected to have a significant effect on the surrounding environment.
The legal basis for the requirement to carry out EIA is Government Regulation No.
27/1999 on "Environmental Impact Assessment".
Technical Aspect Conclusion:
At the conclusion of the technical aspect analysis, the analyst must summarize the
investment and working capital requirements, the planned production volume according
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to capacity, and the production costs and general costs necessary, as a basis for
determining the cost assumptions that will be used in the financial analysis.
With the sales assumptions obtained from the marketing aspect, and the production
cost assumptions obtained from the technical aspect analysis, the analyst is ready to
analyze the financial aspects.
2.5
Financial Aspect Analysis:
Financial aspect analysis includes analyzing historical financial statements for example
for the last 3 years, to see the company's past performance. To carry out the financial
projection analysis, the analyst can use the analysis results obtained from the market
aspect and technical aspect analysis.
Historical financial statements provide an overview of de bitur's success in managing
the company in the past, and the problems that exist so that it can be confirmed with
prospective debtors on how to overcome the problems that occur.
Financial projection analysis provides an overview of how the company's ability to
generate operating profit as the main source of paying future obligations.
Historical Performance Analysis:
Analysis of the historical financial aspects is done to assess the company's past
performance, the problems faced by the company, and the management's ability to
overcome the problems.
To assess historical financial performance and so that analysts can find out the
problems faced by the company, tools that can be used include financial ratio analysis.
Financial ratios can be divided into several categories namely: (1) liquidity ratios,
(2) solvency ratios (3) coverage ratios, (4) profitability, and (5) activity ratios.
Financial ratios can provide information about business performance over time to see
trends or analyze trends. In addition, ratio analysis can also compare the company's
performance with competitors in similar industries.
DuPont Analysis:
Ratio analysis can individually give an indication of the company's performance. In
order to fully understand the company's problems using ratio analysis, analysts need to
understand the relationship between financial ratios, which can be explained through
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DuPont analysis.
ROE (Return on Equity) changes because ROA (Return on Asset) changes, or
Leverage, Equity Multiplier (Asset divided by Equity) changes, or a combination of
both.
A decrease in ROE due to a decrease in leverage is not negative, conversely, an
increase in ROE due to an increase in leverage is not necessarily a positive thing. But
a decrease in ROE due to a decrease in ROA needs to be investigated, whether it is
due to a decrease in profit margin or turnover.
If profit margins are declining, it is necessary to investigate whether this is due to
declining sales volume, or declining selling prices, or whether it is due to increasing
overhead costs or other causes.
If it is the asset turnover that has decreased, it is necessary to investigate whether
the decrease in asset turnover is due to a decrease in inventory turnover or accounts
receivable turnover, or a combination of both.
Once the cause of the problem is known, the analyst can confirm it with the
prospective debtor and assess whether the management per Companies have
acceptable methods and strategies to overcome problems.
Financial Projections:
Financial projection analysis is conducted to assess the company's ability to generate
operating profit, as a basis for paying future obligations. Basically, the project will run
well and be able to pay obligations if the project is considered feasible.
Project feasibility indicators include NPV (Net Present Value) and IRR (Internal
Rate of Return). The indicator of the ability to pay obligations is DSC (Debt Service
Coverage).
The financial projections used sales assumptions according to the results of the
market aspect analysis, and production cost assumptions as a result of the technical
aspect analysis. The market aspect analysis provides estimates of sales volume and
selling price. The technical aspect analysis provides estimates of production volume
and production costs.
To be able to perform financial projections and project feasibility analysis, analysts
need to do three things, namely (1) cash flow projections,
(2) determine the life of the project, and (3) determine the discount factor or
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discount rate.
i.
Cash-Flow Projection
From the assumptions of financial projections, analysts can develop cash-flow
estimates with a certain growth rate. There are two kinds of cash flow, namely (1)
Free Cash Flow to the Firm (FCFF) or cash flow for creditors and shareholders; (2)
free cash flow to equity or cash flow for shareholders, which is cash flow for
creditors in the form of interest and principal installments already paid. If the cash
flow for the company is discounted by a certain discount rate, obtained the NPV
(Net Present Value) of the project or company. In project feasibility analysis, banks
generally use FCFF or Free Cash Flow to the Firm, which is calculated in the
following way.
FCFF = EBIT (1 tax rate) + depreciation-capital cost
change in working capital
EBIT is Earnings Before Interest and Tax, or operating profit. Cost of capital is
the need for additional investment over time, change in working capital is the need
for additional working capital (inventory and receivables) as a consequence of
company growth.
For large companies that have gone public, the cost of equity is determined using
the CAPM formula. As for companies that have not gone public, the determination
of the cost of equity may use the ROE target set by shareholders.
ii.
Estimated Growth Rate
Cash flow projections require profit growth assumptions over time. In order to
make the growth assumption more rational, one that can be used is to consider
growth analysis from 3 things, namely (1) his toris growth data, (2) growth in
company fundamentals, and (3) using analyst judgment.
Fundamental growth:
Growth is fundamentally determined by the amount of retained earnings (b) and
ROE (return on equity). The greater the share of retained earnings, the higher the
growth of the business.
Analyst Judgment:
Growth by judgment or analyst opinion can be explained by example. Suppose a
new taxi company buys a large fleet, or a new company replaces its leadership
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with professionals who are known to be experts in their field, then growth is
expected to grow more than historically or fundamentally obtained.
Determination of growth rate:
From the three growth figures, weights are assigned according to the analyst's
confidence. For example, if the historical and fundamental data uses financial
statements that have been audited by an accounting firm with a high reputation,
the weight is certainly higher than financial statements that are not audited, or
audited by an accountant with an unclear reputation.
iii.
Project Feasibility Indicators:
Banks assess the feasibility of a project by looking at the indicators of project
viability, among which the most important are NPV (Net Present Value), IRR
(Internal Rate of Return), and DSC (Debt Ser- vice Coverage).
NPV is obtained by discounting the projected cash flow with a certain discount
rate; the discount rate used is WACC if using FCFF cash flow. Early projects are
feasible if the NPV value is greater than zero.
IRR is a discount rate such that it produces NPV = The project is considered
feasible if IRR>hurdle rate (in this case = WACC if the cash flow used is FCFF).
DSC or Debt Service Coverage is the ability to pay principal and interest
obligations; DSC is calculated by dividing operational cash flow by interest and
principal obligations due in the relevant period. In general (according to bank
policy) if the DSC value is > 1.25, the debtor is considered to have a good ability to
pay.
2.6
Collateral Analysis:
Common types of collateral submitted to banks can be non-fixed asset collateral
(receivables, stock) and fixed asset collateral. Customers can use almost any type of asset
as loan collateral. In addition, collateral can also include parent company guarantees or
personal guarantees.
In the event that the bank accepts receivables as collateral, considerations that need to
be evaluated include:
•
Billing: Procedures used by customers to collect overdue receivables and procedures
for sending invoices.
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•
Terms of sale: the period of time receivables are expected to be paid.
•
Internal controls: whether the customer has systems in place over approval processes
and policy making.
•
Reporting: frequency of aging of receivables, billing procedures and review process.
•
Ease of verification: receivables verification process.
If the bank accepts stock or inventory as collateral, the things that the bank considers
include:
•
Goods of a particular brand of inventory and repu tations of that brand.
•
Obsolete goods: whether the pledged inventory is obsolete and no longer trades in the
market.
•
Seasonal products: whether the pledged stock is seasonal.
•
Internal control: the process of stock recording by the company.
•
Inventory valuation methods: LIFO (Last in First Out), FIFO (First in First Out),
weighted average or other valuation methods, to prevent setting valuations that exceed
the actual conditions.
•
Ownership of inventory.
If the bank accepts equipment as collateral, the things that the bank considers include:
•
Uses: one use only or multiple uses.
•
Whether the equipment is attached to the building.
•
Costs required to move equipment.
•
Technical obsolescence: the equipment being mortgaged is obsolete.
•
Bank access to such equipment.
•
The age and general condition of the equipment and the quality of maintenance
performed so far.
If the bank accepts real estate as collateral, the things that the bank considers include:
•
When was the last assessment conducted.
•
Environmental issues related to mortgaged real estate.
•
Uses of real estate: one or more uses.
•
Real estate status: if leased, what are the terms of the lease.
Other types of collateral that can be submitted by customers include: Guarantee
It is a legal document that obliges a third party, i.e. the pen
guarantor, to pay the customer's obligations if the customer defaults. The guarantor is not
the main source of repayment of financing, but rather the willingness and ability of the
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guarantor to repay the customer's obligations. In this case, the bank must evaluate the
financing worthiness of the guarantor.
•
Personal Guarantee:
Personal guarantees are generally obtained from business partners or company
owners. Because personal guarantees are unse- cured, the value of the guarantee is
more psychological than real collateral.
•
Corporate Guarantee:
Corporate guarantee is a guarantee given by a corporation to pay a number of
customer obligations if the customer defaults. To ensure the validity of the guarantee
given, permission from the shareholders is required.
Collateral Valuation:
The value of collateral can be divided into (1) market value, which is the value at which
the collateral can be sold with sufficient time (2) liquidation value, which is the value of a
quick sale, usually at a discount from market value.
If the debtor defaults, the analyst needs to determine the estimated selling value of the
collateral, the time required to carry out the auction and find a buyer, then calculate the
present value of the cash flow from the sale of the collateral. The present value of the
cash flow from the sale of collateral is the basis for determining the recovery rate and
LGD (Loss Given Default), which are important components for determining EL
(Expected Loss) and PPA (Provision for Removal of Assets).
Basically, collateral is a way out if kre dit turns out to be problematic. The main
source of credit repayment must still be sought from the company's operational cash flow.
The value of the collateral needs to be updated regularly because the market value of the
collateral can change over time.
Collateral valuation can use internal appraisers or external appraisal services. The
value of the collateral should cover the value of the credit provided to the customer.
The things that form the basis of collateral assessment are the concepts of liquidity and
marketability of collateral, as well as the ease of monitoring the collateral.
a)
Collateral Liquidity Assessment:
Liquidity indicates how quickly an asset can be converted into cash. Collateral values
are generally higher for more liquid assets. Stocks, notes and marketable securities are
easy to sell and are liquid types of collateral. Receivables are also liquid collateral, but
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banks need to assess the age, concentration and validity of receivables. Stock is
collateral that is less liquid because they must be sold to become cash. Other assets
such as equipment, buildings and land are highly illiquid collateral. Selling fixed assets
collateral takes longer and involves multiple parties.
b)
Marketability Assessment
The marketability of these assets is especially important if the collateral is in the form
of fixed assets to secure long-term loans.
c)
Ease of Control Assessment
Collateral that is easy to control makes it easier for the bank to move and control the
collateral. Deposits pledged and held by the bank are easily controllable collateral.
Ease of control of receivables depends on the bank's ease of collection.
Decisions and Agreements Credit:
The responsibilities of the loan officer include:
•
Ensure that every loan granted has complied with banking regulations and in
accordance with sound credit principles.
•
Ensure that the implementation of credit granting is in accordance with the policies
and guidelines for credit implementation.
•
Ensure that the granting of credit is based on an honest, objective, careful and
thorough assessment, and is independent of the influence of parties with an interest in
the credit applicant.
A good credit agreement puts the bank and the customer in a balanced position and
describes the interests of both parties to the credit agreement made. Credit agreements are
administrative due diligence and are not a factor in loan repayment. However, in times of
declining conditions or credit problems, the quality and completeness of the credit
agreement and other related documents can be a major factor in the repayment of the loan
is the distinguishing factor in whether the bank will obtain repayment of the loan.
The credit agreement not only regulates the obligations of both parties, but also
regulates the conditions under which the credit will be repaid before the term ends.
Therefore, it must be ensured that the credit agreement is complete, minimizes the risks
faced by the bank, identifies the obligations of the parties involved at the time of the
initial granting of credit, conditions and changes that may occur in the future. Without
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proper documentation, the bank has no basis for action and may be at a disadvantage in
its dealings with customers.
Credit agreements generally contain the following.
•
Credit terms and conditions, including type of credit, value, mortgage rate, repayment
schedule and collateral.
•
Parties involved in the credit agreement and their respective roles.
•
Definition of financial, legal, and accounting terminology used in credit agreements.
•
References such as promissory notes, security agreements, and other documents that form
part of the credit agreement.
•
Representations and warranties. This section explains that some of the statements made
by the customer are true. For example, a company issues representations or warranties
that the company is legally bound, the financial statements submitted to the bank are
accurate, there are no legal issues related to the customer and the company is the owner
of the collateral submitted to the bank.
•
Events of default describe events that can trigger default on credit payments.
•
Remedies that the bank can take if the customer is unable to repay their obligations. Some
options of remedies that can be
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The bank may request immediate payment of credit obligations to the customer, request
additional collateral, set-off the credit received by the customer with money controlled by
the bank, such as deposits.
Credit Requirements:
Lending requirements set out the conditions that must be prepared in the event that the
bank is not yet obliged to extend credit. Such as all documents must be correct, the
customer's legal representative and the bank must approve the loan plan and certify the
terms and conditions so as to comply with applicable laws.
Credit conditions can be divided into two types, namely affirmative covenants and
negative covenants.
Affirmative Covenants are restrictive covenants, stipulating what the customer must do
until the loan is repaid.
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Example:
•
Maintain working capital at a certain level.
•
Meet certain ratio requirements (such as current mall ratiomini a certain number).
•
Submit periodic financial statements and operational reports to the bank in accordance
with PSAK (statement of financial accounting standards).
•
Report to the bank on the occurrence of a condition or event.
•
Pay all taxes and other obligations, which if not paid, will cause problems for the
customer.
•
Allow bank
Negative Covenants stipulate that without written approval from the bank, the
customer is not allowed to take certain actions before the credit is repaid.
For example, customers may not do:
•
Pay dividends to shareholders above a predetermined amount.
•
Merging, consolidating, or acquiring assets from other companies.
•
Obtain additional credit from other banks.
•
Make changes in management or share ownership that may affect the character or
philosophy of the company's operations.
Credit Administration
In addition to credit documentation, banks also carry out credit administration. All loans
granted by banks, without exception, must be recorded and recorded correctly,
completely and accurately. Credit withdrawal can be done when all documentation
required by the bank has been fulfilled by the debtor.
All copies of the credit documents are handed over to the customer, while the originals
are kept by the bank in the appropriate credit file. The credit business, although well
managed, is still potentially exposed to the risk that the credit provided by the bank will
not be returned or repaid by the debtor, with an amount that is beyond what has been
estimated. Therefore, banks need to allocate capital to cover credit risk. This is required
so that bank losses can be absorbed by capital, and do not disturb public funds deposited
in the bank.
The minimum capital requirement to cover credit risk can be determined based on
regulatory requirements called Regu- latory Capital. In addition, capital can also be
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determined by the bank's own model, called Economic Capital.
Regulatory capital is the calculation of capital requirements to cover risks according to
the formula set by the regulator. In general, regulators refer to the provisions prepared by
the Basel Com- mittee which issued the provisions in Basel II. For credit risk, the
minimum capital requirement to cover credit risk can be determined using three types of
models, namely (1) standardized models (2) the Internal Rating Based - Foundation
(IRBF) model, and (3) the Internal Rating Based - Advanced (IRBA)
3.4.1
Standardized Approach
In the standardized approach, the calculation method is the same as that used in BaselI
1988. The difference lies in the categorization of assets and the amount of risk weights
based on ratings provided by external rating agencies.
The Bank allocates certain risk weights to each asset category (on and off-balance
sheet) in determining risk-weighted assets (RWA) as follows.
RWA = Total exposure x risk weighting
The asset categories (loans, credits) are based on the general categories of lenders, i.e.
(1) government, (2) public institutions, (3) banks and multilateral development banks, (4)
commercial companies, (5) securities companies, (6) retail, housing, and others.
Assignment of risk weights to different asset categories (e.g. governments, banks,
commercial enterprises and securities firms) is based on ratings provided by external
rating agencies. Meanwhile, for some other asset categories, the risk weight is
specifically set.
Receivables to Corporations (claims on corporate):
The definition of receivables to companies includes receivables to insurance companies,
state-owned enterprises (SOEs) and regionally-owned enterprises (BUMDs).
Based on Bank Indonesia's approval, banks may apply a 100% risk weight to all
receivables to companies regardless of external rating as long as it is applied consistently.
The risk weighting of receivables to unrated companies is no better than that of
receivables to the government where the company is domiciled.
As part of the supervisory process, Bank Indonesia may assign a risk weight higher
than 100% to receivables to unrated companies after considering the default experience
of receivables to unrated companies.
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The risk weighting of receivables to corporations is as follows.
The calculation of minimum capital adequacy (CAR) for credit risk is governed by
PBI No.10/15/PBI/2008 dated September 24, 2008, and SEBI No.13/6/DPNP dated
February 18, 2011 regarding guidelines for calculating risk-weighted assets for credit risk
using the standardized approach.
The problems with the implementation of the standard model in Indonesia are as
follows.
a.
Bank debtors are generally not willing to do the rating process by the rating company,
because the debtor must be bothered by providing various data required by the rating
agency to carry out the rating process.
b.
Costs that must be incurred in order to carry out the ranking process. If the bank has to
pay, it means that the loan interest will increase because the bank has to allocate these
costs to the loan interest.
Due to these issues, many banks choose not to implement a rating system, so as per
the provisions in the table above, the RWA becomes 100%, the same as the Basel I
provisions.
3.4.2
Internal Rating Based (IRB) Approach:
The IRB approach allows banks to use internal models to calculate PD (Probability of
Default), one of the components to calculate capital requirements to cover credit risk.
This approach is believed to have higher accuracy compared to the standardized
approach and results in a capital requirement calculation that is more in line with the
bank's risk profile. The main assumption in this approach is that banks basically know the
character and condition of their debtors better than rating agencies. Through this
approach, banks may apply more appropriate differentiation for each of their asset
categories.
The risk components of this approach are:
a.
Probability of Default (PD):
Probability of Default (PD) is the likelihood/probability of the debtor defaulting or not
being able to develop the debt. The PD is a forward-looking estimate and is usually
with a 1-year time horizon. PD is a forward-looking estimate and usually has a 1-year
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time horizon.
b.
Loss Given Default:
Loss Given Default (LGD) is an estimate of the bank's potential loss if a debtor
defaults. The amount of LGD is (1 - recovery rate), where the recovery rate is the
amount of loan repayment after the bank has made collection efforts and sold
collateral for bad debts.
c.
Exposure at Default (EAD):
Exposure at Default (EAD) is an estimate of the amount of exposure at the time of
default. EAD is not the same as outstanding loans because when the company is close
to default, the debtor will tend to try to withdraw the credit facility that has been
approved by the bank.
d.
Effective Maturity (M):
Maturity (M) is the remaining term of the loan/credit instrument until maturity. The M
risk component is only applied to receivables from government, corporations and
banks.
IRB Foundation:
In the IRB Foundation method, the bank calculates its own Probability of Default
(PD) associated with each borrower using its internal rating system, and the regulator
provides other inputs such as Loss Given Default (LGD) and Exposure at Default
(EAD).
Regardless of the data source used by the bank, be it internal data, external data,
pooled data, or a combination of the three, to estimate PD, the length of the historical
observation period used should be a minimum of 5 years from one data source. If the
available observation period from a data source covers a longer period, and If the data
is relevant and material, then the longer period should be used.
3.4.3
IRB Advance:
Under the IRB Advance approach, banks calculate their own Probability of Default (PD),
Exposure at Default (EAD), Loss Given Default (LGD), and term. The requirements for
using this approach are more tat compared to IRB Foundation.
Specifically for the calculation of PD for consumer loans, banks must use a minimum
of five years of historical data; while for commercial and corporate loans, banks must use
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a minimum of seven years of historical data.
EAD for on or off balance sheet positions is defined as the expected gross exposure of
the facility when the obligor defaults. For on balance sheet items, banks should estimate
EAD to be no less than the current drawn value, after recognizing the on-balance sheet
netting effect as in the foundation approach.
In determining the bank's estimate of EAD, the analyst should take into account the
possibility of additional withdrawals by the debtor up to and after default.
Banks should have LGD estimates for each corporate, government and bank exposure.
Maturity (M) is the remaining term of the loan/credit instrument. This risk component
is applied only to receivables from government, corporations and banks.
Banks using IRB Advanced are required to measure the effective term for each facility.
The Authority may exempt facilities for certain domestic small corporate borrowers from
the explicit term adjustment if the sales generated (i.e. turnover) as well as the total assets
for the consolidated group tie, where the company is part of the group, amounting to less
than 500 million rupiah.
The consolidated group must be a domestic company domiciled in the country where
the exemption applies. If this exemption is applied then all exposures to eligible small
domestic companies will be assumed to have an average maturity of 2.5 years, as in the
IRB Foundation. For all loan types, the maximum M is 5 years.
