CREDMFI/FINCRED RISK-BASED CAPITAL

IMPORTANT LENDING REGULATIONS  Minimum ratio which the net worth of a

bank must bear to its total risk assets,
GENERAL BANKING LAW OF 2000
may include contingent accounts
DEFINITION OF BANKS  In line with BASEL I standards
“Banks shall refer to entities engaged in the
lending of funds obtained in the form of PROVISIONS ON LOAN ACCOMMODATION
deposits.”
 Single-borrower limit (SBL): 25% of bank
TYPES OF BANKS capital
 Universal  Exposures to Directors, Officers,
 Commercial Stockholders and Their Related
 Thrift Interests (DOSRI): shall be upon terms
 Rural not less favorable to the bank
 Cooperative  Loan values against collaterals:
 Islamic o Real Estate: max of 75% of
 Others appraised value, 60% of insured
improvements
o Chattels, intangibles: 75% of
COMMERCIAL BANKS appraised value
 Accepting drafts, issuing letters of credit  Requirements for grant of loans/credit
 Discounting/negotiating evidences of facilities:
debt o Purpose of the loan
 Accepting or creating demand deposits o Statement of assets and
 Receiving other types of deposits and liabilities
deposit substitutes o Income and expenditures
 Buying/selling FX, gold and silver o Microfinancing: cash-flow
 Acquiring marketable and other debt based lending
securities  Loan Amortization
 Extending credit o Shall be adapted to nature of
the operations to be financed
o Loan of more than 5 years:
UNIVERSAL BANKS
provisions for periodic
 All powers of commercial banks amortization, at least annually
 Powers of investment house o No immediate revenues for
 Investment in non-allied undertakings regular amortizations. Initial
payment can be deferred but
 not later than 5 years of loan BSP MORB: CREDIT RISK MANAGEMENT
grant
Credit Risk Management Framework
 Prepayment
 Borrower can prepay whole or in part  Appropriate risk environment
subject to reasonable terms and  Sound credit-granting process
conditions agreed upon with the bank  Maintaining appropriate credit
administration, measurement,
monitoring and control
TRUTH IN LENDING ACT
Finance charges
Responsibilities of the Board of Directors and
 A finance charge includes interest, fees,
Senior Management
service charges, discounts, and such
other charges incident to the extension  Board of Directors: approval and regular
of credit as may be prescribed by the review of credit risk strategy and credit
Monetary Board of the Bangko Sentral policy, implementation of an effective
ng Pilipinas through regulations. credit risk management system,
consistent products and activities both
at the individual and portfolio levels
Required disclosures to the borrower
 Senior Management: ensure that credit
1. The cash price or delivered price of the risk-taking activities aligned with credit
property or service to be acquired; risk strategy
2. The amounts, if any, to be credited as
down payment and/or trade-in;
3. The difference between the amounts Credit Risk Management Structure
set forth under clauses (1) and (2);  Front office
4. The charges, individually itemized, o Credit origination
which are paid or to be paid by such
o Recommends internal credit
person in connection with the
ratings
transaction but which are not incident
o Day-to-day monitoring
to the extension of credit;
 Back office
5. The total amount to be financed;
o Credit administration
6. The finance charge expressed in terms
o Credit and collateral files
of pesos and centavos; and
 Middle office
7. The percentage that the finance bears
o Policy formulations and limit
to the total amount to be financed
setting
expressed as a simple annual rate on
o Workout or problem loan
the outstanding unpaid balance of the
management
obligation.
 o Low capital levels of
internationally active banks
AGRICULTURAL AND AGRARIAN REFORM
o Advantages enjoyed by banks
CREDIT
with lower capital requirement
Purpose of the Law  Two ratios required
 Provide access to credit to agricultural o Tier I core capital: 4% of risk
and agrarian reform weighted assets
enterprises/entities o Tier II total capital: 8% of risk-
weighted assets
What is credit quota?
 Constituents of capital
 Set aside 25% of total loanable bonds o Tier I core capital: Equity
for agriculture and fisheries credit in capital, retained earnings
general o Tier II total capital: Revaluation
 10% of which available for agrarian reserves, loan loss provision
reform beneficiaries
Risk weighted Assets
BASEL ACCORDS
BRIEF HISTORY
 Initially named the Committee on
Banking Regulations and Supervisory
Practices
 Established byG10 central bank
governors
 Precursors
o Dissolution of Bankhaus
Herstatt (Settlement Risk)
o Arab-Israeli Yom Kippur War
(Financi)
 Central aim: Serves as a forum for Basel II
regular cooperation between member  Revision of Basel I to give way for other
countries on banking supervisory banking risks aside from credit risk
matters" and improving the "quality of  Revisions due to increased
banking supervision worldwide." securitizations of mortgages, advances
in risk management
Basel I  Three pillars of bank regulations:
 Accord on ban’s capital requirements o Minimum Capital
 To address concerns on  Capital charge for 3
kinds of risk
 1. Credit Risk  Higher RSF: assigned to illiquid assets
2. Market Risk
3. Operational Risk Liquidity Coverage Ratio
o Supervisory Review
 CBs ensure that 𝐿𝐶𝑅 = 𝑆𝑡𝑜𝑐𝑘 𝑜𝑓 𝐻𝑖𝑔ℎ 𝑄𝑢𝑎𝑙𝑖𝑡𝑦 𝐿𝑖𝑞𝑢𝑖𝑑 𝐴𝑠𝑠𝑒𝑡𝑠 (𝐻𝑄𝐿𝐴).
𝑇𝑜𝑡𝑎𝑙 𝑛𝑒𝑡 𝑐𝑎𝑠ℎ 𝑜𝑢𝑡𝑓𝑙𝑜𝑤𝑠 𝑜𝑣𝑒𝑟 𝑡ℎ𝑒 𝑛𝑒𝑥𝑡 30
minimum capital
𝑐𝑎𝑙𝑒𝑛𝑑𝑎𝑟 𝑑𝑎𝑦𝑠
requirements are being
followed  The higher, the better
 Referee system  HQLA: reliable source of liquidity even
o Market Discipline during stressed market conditions
 Enhanced disclosure of
risk NSFR
 May use internal
assessments but must
be duly disclosed
Basel III
 2008 Global Financial Crisis (GFC)
sparked concerns on banks’ exposure to
other risks other than those identified
in the Basel II
 Too big to fail banks / financial
institutions will actually fail (e.g.
Lehman Brothers, Bear Sterns)
 Large exposure to less liquid assets such
as mortgage backed securities
HQLA
 Two key liquidity ratios:
Level I Assets
o Net Stable Funding Ratio (NSFR)
• Cash on Hand
o Liquidity Coverage Ratio (LCR)
• Central Bank Reserves
• O/N and term deposits with the Central
NSFR and LCR
Bank
Net Stable Funding Ratio (NSFR)
• Eligible Securities issued
o NG and BSP
𝑁𝑆𝐹𝑅 = 𝐴𝑣𝑎𝑖𝑙𝑎𝑏𝑙𝑒 𝑆𝑡𝑎𝑏𝑙𝑒 𝐹𝑢𝑛𝑑𝑖𝑛𝑔 (𝐴𝑆𝐹)
o Other sovereigns, CBs and
𝑅𝑒𝑞𝑢𝑖𝑟𝑒𝑑 𝑆𝑡𝑎𝑏𝑙𝑒 𝐹𝑢𝑛𝑑𝑖𝑛𝑔 (𝑅𝑆𝐹)
multilateral agencies
Level II Assets
 The higher, the better
• Eligible securities issued by CBs, PSEs,
 HigherASF: assigned to more stable
MDBs
funding
 • Corporate Debt Securities  Business Development: marketing bank
• Common equity shares in peso that are services to existing and potential clients
included in organized exchange  Credit Analysis: default risk analysis

BANK CREDIT ANALYSIS Credit Execution and Administration

Credit-granting process  Loan committee reviews credit
 Banks should operate under a sound proposals
credit- granting process (BSP MORB Sec.  Loan documentation
178; BSP Circular 855)  Loan releases
 Banks operate by lending funds which
were obtained in the form of deposits Credit Review
(General Banking Law of 2000)  Regular review
 Competing goals  Monitor compliance with loan
o Loan volume and loan quality agreement
o Banks’ liquidity requirements,  Institute corrective action
capital constraints and rate of
return Business Development
 Loan policy: lending guidelines that  Marketing bank services to existing and
employees follow to conduct bank potential customers
business  Identifying new customers and soliciting
 Credit philosophy/appetite: how much their banking business
risk the bank is willing to take  Maintaining relationships with current
 Credit culture: fundamental principles customers and cross-selling noncredit
that drive lending activity services
o Values-driven: Focus on credit  Market Research
quality, bank soundness and o Identify target market and their
stability, often conservative demand for bank services
o Current-profit driven: short- o Know the bank’s products and
term earnings, focus on high- services
risk undertakings  Advertising, public relations
o Market-share driven: having  Officer call programs
highest market share of loans, o Cold calls
focus on loan volume and o Warm calls
growth  Obtain formal loan request
 Set by Board of Directors and Senior o Purpose of the loan
Management o Requested facilities
o Recommended facilities
Business Development and Credit Analysis
Credit Analysis (Interest, Commission/Fees,
CREDIT RISK Extras/Fees)
 Probability of loss due to the non-
recovery of credit extended as a result
of the non-fulfillment of contractual
obligations arising from unwillingness
or inability of the counterparty or for
any other reason (Joseph, 2013).
 Assesses both the ability and
willingness to repay

Evaluating Loans o PARSER (Personal Element,

Two umbrellas of information which banks Amount Required, Repayment,
access to evaluate loan requests Security, Expedience,
Remuneration)
 Qualitative
 Quantitative
Company Analysis
Tools and Techniques
Growth Companies
 SWOT Analysis (Strength, Weaknesses,
Opportunities, Threats)  Companies that experience above-
average increases in sales & earnings
 Firm w/ management ability &
 Porter’s Five Forces opportunities to make investments that
yield rates of return greater than the
firm’s required rate of return
 Typically retain a large portion of
earnings to fund superior investment
projects
Defensive Companies

 Future earnings are likely to withstand

an economic downturn
 Other techniques/frameworks used:  Low business risk & not excessive
o CAMPARI (Character, Ability, financial risk
Margin, Purpose, Amount, Cyclical Companies
Repayment, Insurance) and ICE
  Sales & earnings will be heavily  Long-run comparative advantage vs.
influenced by aggregate business & rival
general economic activity  Potential for market stability
 Will do well in economic expansion &  Benefit from cost reduction
poorly during economic contraction  Firms that buy back shares put money
into firm
Speculative Companies

 Assets involve great risk, but also

possibility of great return

Competitive Strategies
Defensive Competitive Strategy

 Positions the firm so that is capabilities

provide the best means to ward off the
Traditional 5 C’s of Credit
effect of the competitive forces in the
industry
Offensive Competitive Strategy

 The firm attempts to use its strengths to

affect competitive forces in the industry
Low Cost Strategy

 Determined to become low-cost

producer & cost leader in industry
 Must command price near industry
average
Differentiation Strategy

 Seeks to identify itself as unique in its Commercial Banking

industry Commercial Bank
 Price premium differentiation must
exceed cost of being unique  a financial institution that accepts
demand deposits and makes
Lessons from Peter Lynch - Favorable Attributes commercial loans; also engages in
of a Firm: trust/fiduciary functions (when
 Product Not Faddish authorized).
  Credit – Money lent through bonds or Credit Line: credit arrangement with a bank,
loans to a borrower from a lender whereby the bank agrees to honor the checks of
 Debt - Obligation of that same borrower a debtor, drawn on the bank, up to a certain
to pay that money amount, even though the drawer has no
deposit in the bank. Sometimes called a
The Promise to Pay: the promise to pay in
temporary overdraft (TOD) line which may be
exchange for something of value, may be oral,
secured or unsecured.’
and still be binding upon the debtor.
Bank Loan: a loan made by a bank to be repaid
Written Promise: for debts of some size or
with interest on or before a fixed date; a major
importance, the promise must be in writing,
function of commercial banks.
subscribed by the maker, in order to be binding,
or to be enforceable against him. Kinds of Loans

The Credit Instrument: the formal written 1. Secured Loans – covered by collaterals,
promise is called a credit instrument. pledge or guaranteed by third parties.
2. Unsecured Loans – without collaterals.
Credit Transaction: current transaction in which
3. Lines of Credit – the bank agrees to lend
present value, either in money or
money to the borrower on a recurring basis
goods/services, is exchanged with a promise to
(usually a year) up to a specified amount.
pay for the same in the future.
The benefit would be an easy and immediate
Credit Sale: sale of goods/services or money access to funds.
claims in the present, payment being in the 4. Installment Loans – requires monthly
form of a promise to pay the necessary amount payments. When the principal on the loan
in money at some future time. decreases sufficiently, a refinancing may
take place.

CREDMFI/FINCRED
TEST YOURSELF
TRUE OR FALSE
1. Commercial banks are involved in the buying/selling FX, gold and silver
2. In the provisions on loan accommodation, the single borrower limit is 20% of bank capital
3. Credit risk is the probability of loss due to the recovery of credit extended as a result of the non-
fulfillment of contractual obligations arising from unwillingness or inability of the counterparty
or for any other reason (Joseph, 2013).
4. Growth companies experience above-average increases in sales & earnings
5. In speculative companies, assets involve great risk, but also possibility of great return
6. Loan policies are lending guidelines that customers follow to conduct bank business
7. Growth companies are companies that experience below-average increases in sales & earnings
8. The three pillars of bank regulation are minimum capital, supervisory review, and market
discipline
9. One of the advantages of credit is that it provides convenience and rewards
10. One of the disadvantages of credit is that it provides emergency funds
11. The Basel Accord’s central aim is to serve as a forum for regular cooperation between member
countries on banking supervisory matters and improving the quality of banking supervision
worldwide.
12. Credit lines are sometimes called a permanent overdraft (TOD) line which may be secured or
unsecured.
13. A finance charge includes interest, fees, service charges, discounts, and such other charges
incident to the extension of credit as may be prescribed by the Monetary Board of the Bangko
Sentral ng Pilipinas through regulations.

MULTIPLE CHOICE
14. Which of the following is a type of credit?
a. Service credit
b. Credit card
c. Revolving credit
d. All of the above
15. The ability to borrow money and pay it back later is called
a. Credit
b. Credit card
c. Debit
d. Debit card
16. Which of the following is not part of the 5 C’s of credit?
a. Capacity
b. Conditions
c. Consistency
d. Collateral
17. Which of the following is false about Commercial banks?
a. Accepting drafts, issuing letters of credit
b. Discounting/negotiating evidences of debt
c. Accepting or creating demand deposits
d. None of the above
18. Cost of credit=
 a. Total price-cash price
b. Cash price-total price
c. Total price+cash price
d. Cash price+total price
19. Deferred Billing is when
a. Purchases are charged now
b. Purchases are never charged
c. Purchases are not charged to a customer until a later date
d. Purchases are charged to someone else
20. Credit risk is the probability of loss due to the __________ of credit extended as a result of the
non-fulfillment of contractual obligations arising from unwillingness or inability of the
counterparty or for
a. Recovery
b. Non recovery
c. Billing
d. Probability

ANSWER KEY
1. TRUE
2. FALSE
3. FALSE
4. TRUE
5. TRUE
6. FALSE
7. FALSE
8. TRUE
9. TRUE
10. FALSE
11. TRUE
12. FALSE
13. TRUE
14. D
15. A
16. C
17. D
18. A
19. C
20. B