Modernizing Credit Risk Management The Role of Credit

Modernizing Credit Risk Management: The Role of Credit Rating Agencies and Credit Bureaus in the Caribbean Association of Banks Annual Conference 2012 Montego Bay, Jamaica 15 November 2012 Caribbean Information & Credit Rating Services Limited

Cari. CRIS’ Mission Ø To contribute to the development of a vibrant, integrated Caribbean capital market by setting the highest standards of credible independent analysis and opinion to enable informed financial decisions 2

96 entities rated 3

Regional Client Base Country Trinidad & Tobago Jamaica Barbados St Lucia Antigua & Barbuda St Kitts & Nevis Dominica St Vincent & the Grenadines Anguilla Grenada Other Total No. of Ratings 39 27 8 7 3 3 3 2 2 1 1 96 % 41% 28% 8% 7% 3% 3% 3% 2% 2% 1% 1% 100% 4

The world has changed • US economy struggling to regain growth and fiscal cliff looming • Europe plagued with sovereign debt crisis • Slowed growth in China and India • Caribbean - heavily indebted and limited fiscal flexibility ØNegative impact on performance of loan and investment portfolios 5

Fundamentals of Credit Risk Management remain the same • Creation of a sound credit environment – Critical role of Board of Directors and Senior Management • Existence of a sound credit granting process – Well defined criteria – Clear limits and process – Arms length basis 6

Fundamentals of Credit Risk Management remain the same • Appropriate measurement & monitoring systems – Risk Rating System & Information System • Adequate controls and review system – Independent and ongoing – Management of problem credit • Basic skills and training • Role of the External Supervisors 7

Role of Credit Rating Agencies & Credit Bureaus 1. Valuable information source – CRAs and CBs provide credit risk reviews and credit reports with up-to-date information to enable informed loan decision making – Powerful information database which can provide crucial industry statistics 2. Independent – Their independence allow them to be objective in their pronouncements and to ‘call it as they see it’ 8

Role of Credit Rating Agencies & Credit Bureaus 3. Training – Can play a valuable role in imparting their core credit risk assessment skills by way of workshops and training programmes – Cari. CRIS has trained over 600 risk and finance professionals from around the region in credit risk analysis 9

Role of Credit Rating Agencies & Credit Bureaus 4. Risk Solutions – Can provide risk software solutions for credit risk management – Cari. CRIS/CRISIL’s Risk Assessment Model (RAM) – Cari. CRIS’ SME Ratings Model for loan decision making and pricing – Scoring models/scorecards for consumer and small business lending 10

SME Rating Model Management Risk Industry Risk Business Risk Final Performance Grading Market Position Operating Efficiency Financial Risk 11

SME Grading Scale Grade Definition Description SME 1 Excellent Displays excellent business and financial performance and has excellent prospects for sustaining this performance SME 2+ Strong Displays better than average performance with reasonable prospects for improving its performance SME 2 - Strong Displays better than average performance with reasonable prospects for maintaining its performance SME 3+ Average Displays average performance with reasonable prospects for improving its performance SME 3 - Average Displays average performance with reasonable prospects for maintaining its performance SME 4 Below Average Displays less than average business and financial performance and has below average prospects for improving or even sustaining its performance SME 5 Weak/Vulnerable Displays weak performance and is highly vulnerable with low prospects for maintaining viability 12

SME Ratings Success Stories • SMEs have been able to use their ratings to: – – – – Renew existing credit lines with their bank Access new loans from the bank Negotiate lower interest rates Attract a joint venture partner Negotiate credit from international suppliers Procure new contracts Generally improve business operations • Can be used to support loan guarantee schemes and other lending programmes

Risk-Based Pricing of Loans • Assuming that the Prime Rate is reserved for the “best clients” i. e. lowest risk client, the table below presents a suggested framework • Increases between categories can be widened (or narrowed) depending on the overall target yield and competitive environment 14

Role in Basel 2

Credit risk – Standardized approach Corporates

Mapping of Rating Scales S&P’s Moody’s AM Best Insurers AAA to Aaa to AAA to A++ to A AAAa 3 AA- A+ to A- A 1 to A 3 A+ to A- B++ to B+ BBB+ to Baa 1 to BBB+ to B and BBBB- Baa 3 BBB BB+ to Ba 1 to BB+ to C++ and BB- Ba 3 BBC+ B+ to B- B 1 to B 3 B+ to B- C and C CCC+ and Caa 1 below and below Unrated Fitch AAA to AA A+ to A- DBRS – DBRS Cari. CRIS Assets Insurers AAA to IC-1 AAL AH to AL IC-2 Cari. AAA BBB+ to BBB BB+ to BB B+ to B- BBBH to IC-3 BBBL BBH to IC-4 BBL BH to BL IC-5 Cari. AA+ to Cari. AA Cari. A+ to Cari. ACari. BBB+ to Cari. BBB Cari. BB+ and below CCC+ D CCC+ and CCCH and below Unrated Unrated 17

Understand we are at a different stage of development • Globally, move is to reduce reliance on credit rating agencies (note reduce not eliminate!) • One can well understand why – They had become too powerful/Market and regulators became over-reliant – Too loosely regulated/Started cutting corners • Important to understand though that our markets are at a different stage of development – – We need the input of the agencies at this stage We have the advantage of learning from the mistakes of the more developed markets 18

Characteristics of a Credit Bureau • Objective – real data about relevant past behaviour • Many sources of data – subject is seen from all angles • Many instances of the same data – multiple confirmations • Transparent processes – lenders provide and therefore understand much of the data • High volumes – tailor-made for statistical predictions • Speedy – confirmation of identity & creditworthiness in seconds • Scorecards – with data across industry sectors and across competitors, credit bureau scorecards predict risk

Credit Scoring is …. • Scientific • Quantifiable • Consistent / repeatable • Not judgmental • Explicable • From diverse sources & difficult to manipulate • • • Quick Adjustable Effective Predictive Monitor-able Used for planning / Pricing

Important Role of Credit Bureaus • CBs are essential for predictive scorecards – Marketing – screens out definite rejects – New to lender – 360 degree view of repayment history and current commitments outperforms human underwriters every time – Customer service and management – spot financial stress or changed circumstances early so can take effective /timely action. – Helps in collections – identify can pays from ‘can’t pays’ – Debt sale/purchase – work collectible accounts, sell others – Anti-fraud anti-money laundering 21

Lenders benefits Bank Assessments of the Impact of Credit Bureaus 70 % respondent banks 60 50 40 30 20 10 0 Decrease in processing time Decrease in costs Change of 25% or more Source: Doing Business in 2004, based on World Bank surveys of banks in 34 countries. Decrease in defaults No change

Modern Credit Risk Management • More forward looking – Stress testing under plausible scenarios • Portfolio approach – To identify concentrations and diversification • Other aspects: – – credit risk provisioning active portfolio management credit derivatives sophisticated approaches to capital allocation • Best practice approach is adopt a judicious blend of qualitative and quantitative factors; knowledge and experience combined with the right analytical tools 23

Wider enterprise risk management system critical • Enterprise risk management approach needed • A greater level of communication and collaboration needed more than ever before – across all business units – avoid silos – across all disciplines – greater blending of expertise in finance, economics, law, accounting, core risk management needed • All employees must be risk managers • Preservation of the company’s capital must take priority over preservation of personal pride and ego 24

CRAs and CBs can be effective partners in credit risk management • Consider how can you better leverage our – Independence – Specialised and expert credit risk analysis and risk assessment skills – Deep knowledge of the Caribbean economies and capital markets – Integrity, professionalism and commitment to capital market development and financial system stability 25

THANK YOU Caribbean Information & Credit Rating Services Limited www. caricris. com