Credit Risk
Credit Risk Types & Definitions
Credit risk is the risk of inefficiencies related to the MFI’s credit activities. It is the most frequently addressed risk by MFIs since it directly affects their main asset: the loan portfolio. It includes the loss of income resulting from the inability to collect anticipated interest earnings, the loss of capital resulting from loan default, as well as the social inefficiencies resulting from inadequate credit activities (for example transparency towards the clients). Two subcategories have been identified within credit risk: credit transaction risk and portfolio risk.
• Portfolio Risk – Portfolio risk refers to the risk of inefficiencies in the composition of the overall loan portfolio, caused by inadequate portfolio diversification.
• Credit Transaction Risk – Credit transaction risk refers to risk of inefficiencies within individual loans, caused by inadequate policies regarding loan disbursement, follow-up and recovery.
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Portfolio Risk
Policies
Tier 3 Guidelines |
Tier 2 Guidelines |
Tier 1 Guidelines |
| Formal set of portfolio diversification policies and procedures | Formal set of portfolio diversification policies and procedures |
Limits
Tier 3 Guidelines |
Tier 2 Guidelines |
Tier 1 Guidelines |
| Maximum loan amount for each credit product | Maximum loan amount for each credit product | Maximum loan amount for each credit product |
| Portfolio concentration and PAR limits by: | Portfolio concentration and PAR limits by: | |
| • Product | • Product | |
| • Branch | • Branch | |
| • Economic sector | • Economic sector | |
| • Credit methodology | ||
| • Region |
Risk Management Tools
Tier 3 Guidelines |
Tier 2 Guidelines |
Tier 1 Guidelines |
| Annual analysis of geographical areas and economic sectors | Quarterly analysis of geographical areas and economic sectors |
Risk Monitoring Tools
Tier 3 Guidelines |
Tier 2 Guidelines |
Tier 1 Guidelines |
| Portfolio risk matrix | Up-to-date portfolio risk matrix | |
| Weekly portfolio concentration and PAR reports by: | Weekly portfolio concentration and PAR reports by: | |
| • Product | • Product | |
| • Branch | • Branch | |
| • Economic sector | • Economic sector | |
| • Credit methodology | ||
| • Region |
Credit Transaction Risk
Policies
Tier 3 Guidelines |
Tier 2 Guidelines |
Tier 1 Guidelines |
| Formal set of credit policies and procedures to manage credit risk, including: | Formal set of credit policies and procedures to manage credit risk, including: | Formal set of credit policies and procedures to manage credit risk, including: |
| • Target client and niche | • Target client and niche | • Target client and niche |
| • Credit process | • Credit process | • Credit process |
| • Borrower screening | • Borrower screening | • Borrower screening |
| • Data verification | • Data verification | • Data verification |
| • Products, services and their characteristics | • Products, services and their characteristics | • Products, services and their characteristics |
| • Use of credit bureau information | • Use of credit bureau information | • Use of credit bureau information |
| • Parallel loans | • Parallel loans | • Parallel loans |
| • Repayment capacity and overindebtedness prevention | • Repayment capacity and overindebtedness prevention | • Repayment capacity and overindebtedness prevention |
| • Loan structuring | • Loan structuring | • Loan structuring |
| • Required guarantees, and their valuation | • Required guarantees, and their valuation | • Required guarantees, and their valuation |
| • Loan monitoring | • Loan monitoring | • Loan monitoring |
| • Loan collection (extrajudicial and judicial) | • Loan collection (extrajudicial and judicial) | • Loan collection (extrajudicial and judicial) |
| • Related-party loans | • Related-party loans | • Related-party loans |
| • Loan restructuring | • Loan restructuring | • Loan restructuring |
| • Loan provisioning | • Loan provisioning | • Loan provisioning |
| • Write-offs | • Write-offs | • Write-offs |
| • Permitted lending activities | • Permitted lending activities | • Permitted lending activities |
| • Credit approval levels | • Credit approval committees | • Credit approval committees |
| • Code of ethical conduct | • Code of ethical conduct | |
| • Transparency policy towards clients | • Transparency policy towards clients | |
| • Client classification | ||
| • Avoidance and management of conflicts of interests | • Avoidance and management of conflicts of interests |
Limits
Tier 3 Guidelines |
Tier 2 Guidelines |
Tier 1 Guidelines |
| Portfolio quality: | Portfolio quality: | Portfolio quality: |
| • Limit on PAR30 | • Limit on PAR by ageing structure, product and branch | • Limit on PAR by ageing structure, product, branch, credit methodology, economic sector and region |
| • Limit on restructured portfolio | • Limit on restructured portfolio | |
| • Limit on write-offs | • Limit on write-offs | |
| Provisions: | Provisions: | Provisions: |
| • Limit on risk coverage ratio (provisions with respect to PAR30) | • Limit on risk coverage ratio (provisions with respect to PAR30) | • Limit on risk coverage ratio (provisions with respect to PAR30) |
| • Limit by loan risk category | • Limit by loan risk category | |
| Limit on parallel loans | Limit on parallel loans | |
| Limit on related-party loans | Limit on related-party loans |
Risk Management Tools
Tier 3 Guidelines |
Tier 2 Guidelines |
Tier 1 Guidelines |
| Standardized application of credit policies and procedures | Standardized application of credit policies and procedures | Standardized application of credit policies and procedures |
| • Periodic training of staff | • Periodic training of staff | • Constant training of staff |
| Good and updated knowledge of the sector | Good and updated knowledge of the sector | Good and updated knowledge of the sector |
| Systematic consultation of main credit bureau | Systematic consultation of most credit bureaus | |
| Tool for the calculation of repayment capacity by product | Tool for the calculation of repayment capacity by product | Tool for the calculation of repayment capacity by product |
| Systematic visit to client’s home and business | Systematic visit to client’s and guarantor’s home and business | Systematic visit to client’s and guarantor’s home and business |
| Tool for the evaluation of guarantees | Independent entity or person for the evaluation of guarantees | |
| Statistical credit scoring model for loan analysis | ||
| Professional and well-incentivized central credit committee | Professional and well-incentivized central and local credit committees with good feedback mechanism to loan officers | Professional and well-incentivized central and local credit committees with independent opinions concerning exceptions (for example from the risk department) and good feedback mechanism to loan officers |
| Approval of restructured loans by different committee to original one | Approval of restructured loans by different committee to original one | |
| Incentive system for field personnel in line with financial and social objectives | Incentive system for field personnel in line with financial and social objectives | |
| Existence of dedicated recovery or collection department | ||
| Preventive recovery system (for example visits, calls) | Automatic preventive recovery system (for example messages, calls) | |
| Tool for the monthly provisioning of loans | Tool for the monthly provisioning of loans based on classification by risk category | Automatic provisioning of loans based on automatic classification by risk category |
| Tool for the quarterly writing-off of loans | Tool for the monthly writing-off of loans | Automatic monthly write-offs |
Risk Monitoring Tools
Tier 3 Guidelines |
Tier 2 Guidelines |
Tier 1 Guidelines |
| Credit transaction risk matrix | Up-to-date credit transaction risk matrix | |
| Post-disbursement visits to client’s business | ||
| Weekly arrears reports for field personnel | Daily arrears reports for field personnel | Automatic daily arrears reports for field personnel |
| Monthly report containing main credit risk indicators and trends, including: | Weekly report containing main credit risk indicators, trends and comparison with limits, including: | Automatic weekly report containing main credit risk indicators, trends and comparison with limits, including: |
| • PAR by ageing structure | • PAR by ageing structure, product and branch | • PAR by ageing structure, product, branch, credit methodology, economic sector and region |
| • Restructured portfolio | • Restructured portfolio by ageing structure | |
| • Write-offs | • Write-offs | |
| Monthly monitoring of statistical credit scoring reports: | ||
| • Probability of default | ||
| • Expected loss | ||
| • Unexpected loss | ||
| Monthly monitoring of provisions with respect to PAR30 | Monthly monitoring of main provisioning indicators, trends and comparison with limits, including: | Automatic monthly monitoring of main provisioning indicators, trends and comparison with limits, including: |
| • Provisions with respect to PAR30 | • Provisions with respect to PAR30 | |
| • Loan loss reserve ratio | • Loan loss reserve ratio | |
| • Provision expense ratio | • Provision expense ratio | |
| • Provisions by risk category | ||
| Quarterly report of related-party loans | Monthly report of related-party loans | Automatic monthly report of related-party loans |
| Annual client overindebtedness report | Quarterly client overindebtedness report | |
| Vintage analysis | ||
| Portfolio transition analysis |
Evaluate
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