RISK MANAGEMENT
FOR
SME LENDING
Lawrence Antioch
MD - Risk Management Group
DBS Bank Ltd
Disclaimer
The views and opinions expressed in this
presentation are strictly those of the
author and do not represent DBS Bank Ltd
current and /or emerging views.
2
Risk assessment of SME borrowers presents some
unique challenges …
SME
lending



Diverse customer
base
Large exposure size
Complex deal
structuring




 Opaqueness


Homogeneous
customer base
Small exposure size
Large volume of
customers
Diverse customer base
Relatively small exposure size
Large volume of customers
— It is difficult to assess borrower’s willingness & capacity to repay
 Willingness to repay is a direct result of asymmetries of information
(particularly moral hazard)
 Capacity to repay largely relates to challenges associated with the
nature of business
 Heterogeneity
—
Refers to the diverse structures in business ownership
 Such as, sole proprietor / partnerships / privately owned companies
3
Risk management has traditionally relied on relationship
lending for this segment and this is not likely to change…
 In essence, relationship lending relies on “qualitative”
information to mitigate opaqueness of borrower’s risk that
includes
— Understanding SME product offering
— Assessing demand for this product & market structure /
characteristics
— Assessing the quality of owners & managers, years of experience
— Any exposure to FX risk
 It is also common to supplement qualitative assessment
with quantitative analysis such as:
— Business profitability
— Cash flow generation capacity
— Structure of balance sheet
— Guarantees
SME financials are generally
unreliable and therefore
considerable reliance is
placed on collateral.
If banks are to be successful in the SME segment, there is
a need to ensure that internal processes and strategic
business objectives are aligned …




Cost of origination too high
Bad debts high
Inadequate data &
systems
Inadequate customer
segmentation




Diverse ownership
structure & operations
Information asymmetries
Poor risk differentiation &
lack of price
differentiation

Risk appetite not well
defined
Inadequate ROE / RAROC
- usually a combination of
low margins (high internal
cost &/or tough
competition)
5
Alignment of internal process starts with a segmentation
approach that can support different types of risk
assessment …
Complex
relationship
SME portfolio
Non-Complex
relationship
Expert rating
tool
New customers
Established
Strong
relationship
Weak relationship
Existing
customers
 SME segmentation should
take account of:
Target market segment
(leveraging off the Bank’s risk
appetite)
— New and existing relationship
— Strength of relationship
— Size of exposure & borrower’s
sales / turnover
—
Start up
Score-based
rating tool /
program
lending
 Other borrower characteristics
include:
Number of employees
— Type of SME (ownership structure,
operating industry)
— Type of lending (term loan vs.
revolving facility)
— Years in business and experience
through downturns
—
There are a few different approaches to risk
assessment, and they are not mutually exclusive …
 Credit scoring / rating methodologies
— Scoring methodologies are based on consumer business (such
as behavioral and application scores are developed based on
customer information)
— Rating methodologies are developed based on borrower’s
balance sheet and P&L, usually for larger corporate businesses
— Expert / Judgment templates are usually based on credit
culture and lending policies
 Program-lending
— Predetermined risk acceptance criteria (via policy) to fast-track
credit approvals
 Portfolio approach
— Identify vulnerabilities of portfolio and regularly undertake stress
testing
7
Risk models can add value to risk management in
SME lending but they are not infallible …
 Assuming historical data is available & reliable, we can utilize
different risk assessment techniques
— Use of multiple approaches allows banks to:
 Reduce time & cost of risk assessment
 Reduce bad debts (combination of better risk differentiation and
early warning & management)
 Achieve more objective & consistent credit decisions
 Virtuous cycle of improving data quality through use
 Models are incomplete but they can support credit intuition
and reduce uncertainty
 Risk focus should be directed at
— Demystifying assessment of risk
— Build bridges with the business to drive value
— Provide pro-active value-added engagement with borrowers
8
An emerging capability is to augment borrowerlevel risk management with portfolio management
capabilities …
Risk
Appetite
Macroeconomy
Credit
exposure
Likelihood of
default
Estimates of
recovery
Exposure
weight
Borrower
risk
Portfolio
risk
Systematic
risk &
correlations
Macroeconomy
Volatility of
PD & LGD
 Provides an additional perspective of risk
— Portfolio vulnerabilities and management action(s)
 Allows for the integration of risk appetite and stress-testing
 Provides a basis for a better balance between risk and return
— Through risk-adjusted pricing, profitability & growth
 Provide pro-active, valued added, engagement with
borrowers
9
10
A forward-looking Risk Management function
needs to link risk measurement & strategy …
 Today’s risk management is predominantly backward-
looking
— Focus is on measurement, reporting & escalating risk events
that have (arguably) already occurred
 There is a need to adopt a more forward-looking
approach that involves:
— Identifying & assessing current & prospective market
conditions together with other emerging risk issues
— Identifying hidden risks and promoting commensurate
change
— Translating emerging risks into
 existing risk controls (e.g. limits, risk appetite by county, industry &
counterparty as well as lending policies and practices)
 Current and planned business growth (including both organic
and non-organic (M&A) growth)