Loans or Assets are key to a Bank’s business and an important health indicator. In competitive environment banks are under constant pressure on various fronts, to;
1) Constantly increase Asset Base
2) Ensure Asset or Loan Portfolio remains healthy
3) How to minimize risk
4) Take corrective measures or re-calibrate business plans.
While these are issues a bank struggles with on a daily basis, there are also black swan events that create major disruptions and completely throw banking operations out of gear.
The Coronavirus or COVID 19 is a recent black swan event that is affecting banks globally. Its impact on the non-retail or wholesale assets or loan portfolios is being felt by over 1200+ banks across 50+ countries across the world. Central Bank in China, and elsewhere too, infused considerable liquidity to support credit in order to help banks and customers.
For retail portfolio the impact may remain more local in short term, say for banks in China, It may however expand geographically over longer period of time.
Need for an Early Warning System / Signal
Recently witnessed spate of Bad Loans in non-retail segment, especially in India, forced Reserve Bank of India (RBI) and Department of Financial Supervision (DFS) to issue a set of guidelines to be followed by member banks. The guidelines, a regulatory compliance, lists 46 and 80 such points provided by RBI and DFSI respectively. Banks, through its internally followed mechanism, need to monitor their Assets or Loan Portfolio against these 126 odd parameters or Key Risk Indicators (KRI). Regulators want Banks to develop an Early Warning Signal (EWS) or System for their Borrowers / Loans or Assets.
Under the guidelines, banks need to monitor various parameters such as Cheque Returns, excessive case of intra-day overdraft, heavy cash withdrawals, low account balances, excess cash movement, inability to service interest, EMI not paid on time, bills dishonoured, exports proceeds not being realized, import bills outstanding, excess stock in warehouse, irregular submission of stock statements or failure to submit other required documentation such as insurance, management instability, industry health, sector performance, negative news about borrower, a facility going bad with some other bank in the market, so on and so forth…..
Of the parameters or KRIs provided by regulators, transaction related data is by and large available with the bank in Core Banking System and can easily be examined to alert Credit Monitoring Teams for them to take suitable action. Ideally, a workflow should enable key stakeholders to take a view of exceptions (say too many cheque returns for want of funds or constantly outstanding overdraft) and take corrective measures. Challenges may however be faced in collating data from other sources, such as aggregators providing Industry related reports, gathering data from Ministry of Corporate Affairs, key suppliers, manually reading of various balance sheets to identify dark spots, negative market sentiments, information available on Web and Social Media etc. and finally to correlate this information and data with Transactional Data. Taking concerted action on the outcome of analysis is next logical step, easier said than done…..
Regulators, as part of their review, would also like to see how automated are the above mentioned process and do banks have a mechanism that ensures timely follow-up, audit trails of actions taken (including remedial) and sophistication of process followed by each entity engaged in Assets of Loans business.
Assets - Impact of Local, Regional & Global events
Efficient supply chains developed by big firms such as BMW, IBM, Apple or Volkswagen have focused on cost reduction, on leveraging the local expertise and availability of raw material to ensure Low Cost Production and Profit Maximisation. It may mean that some parts of the car are manufactured in Korea, some in Taiwan & Thailand, tyres are provided by Philippine while the car finally gets rolled out from its plant in China. Backed by efficient logistics, companies have also tightly integrated their key suppliers and have worked on extremely efficient production methodologies such as JIT (just in time) which enables a manufacture or its sub manufacturer to stock supply of just about a week (will vary for different products though) or so. Same goes for dealer, who is sure of supply of goods in short span of time not requiring to maintain a large inventory.
Smell the Risk and think of Risk Mitigation methods…….
Unless extremely local in nature of business, no firm in big countries is insulated from developments taking place elsewhere in the world. It is true especially for countries integrated with global / regional markets in trade / services such as India, Korea, China, Taiwan, Japan, Malaysia, Philippines, Sri Lanka, Vietnam, Thailand, Cambodia or countries in Middle East, Europe, Africa, South America and North America etc. A disruption in global supply chain will affect firms in all nations, slowly but surely. Impact will be felt both on buy and supply side.
Intensity of impact may vary from country to country and firm to firm depending upon engagement level with supply chain. Illustratively speaking, compared to a nation such as South Korea, India is less entangled in global supply chain, hence may feel the impact little later. Similar to South Korea, many South East Asian countries under ASEAN play a major role as part of cross or often entangled supply chain, they will feel the impact of disruption much faster & more severely.
Having said that, in an event of disruption to Global Supply Chains banks won’t be left untouched. In fact, they would bear the brunt…….
So what should banks do?
Banks have exposure on their borrowers with various types of Loans and Facilities, both for Funded and Non Funded limits. A Bank with reasonable exposure to merchants, manufactures, exporters or importers etcetera must make efforts to insulate itself from any negative impact from disruption. To safeguard its Asset and interest of customers as well as that of shareholders, Bank should deploy an Early Warning System or EWS for its Loan or Asset portfolio.
An EWS at the bank should have the required features to identify risk areas in relation to activities of its borrowers. Say for example in current context, an Exporter or Importer with large dependency on South East Asia would need immediate attention, as against the one that is working in area of Technology Services with focus on North American markets.
For an EWS system to work efficiently, banks need to ensure their Asset & Transactional data has the required granularity to provide the desired results.
Details on key determinants regarding customer such as Industry, sector, country of operation, nature of business, type of produce, engaged in area of exports or imports, list of key suppliers, related parties, average requirement & utilization of working capital, limits sanctioned & utilized, market intelligence, stock valuation, MTM of collaterals, proceeds outstanding & pipeline are some of the critical components for bank to take an informed call, should there be an event that requires selective or mass review of Asset & Loan portfolio.
These data components should be available with the bank in Core Banking System (CBS), Loan Origination System (LOS), Loan Management System (LMS), Rating Application or any other solution used for the purpose of Asset or Loan Management. (Trade Finance, also referred to as Cash Management in some regions, related data may again be sourced from Core Banking System or any other application deployed)
Having said that, constantly validating a large portfolio on tens of parameters and take action on extract or output in manual environment is extremely difficult, if not out rightly impossible. The complexities only increase if bank needs to monitor customers with several relationships and various limits for an entity. Expectation is to monitor the client or customer relationship as a Group Borrower as well. To create a solution that would automate the compliance requirements to meet regulatory guidelines amidst always growing expectations from agencies is certainly a tough task and requires sustained efforts at the banks end.
Newly built platforms are data hungry and need this for its internal Analytics and to unleash its power of intuitive data and ever evolving User Experience.
Historical transactional (quantitative) and Market (Qualitative) data collected over period of time, will play a large role in providing a trend, forecast, alerts and early warning signals on suspect or stressed accounts of borrowers. This means that a deployed system should have capabilities of Machine Learning (ML), Artificial Intelligence (AI) and should have high configurability driven by a UI (User Interface) and UX (User Experience) architecture backed by updated technology.
A capable system would empower a bank to extract information on all such borrowers who are likely to be impacted due to an adverse event that has taken place in their respective country or any other country in their region or outside.
Reporting is an important part of solution that should address Regulatory and Compliance requirement. A capable & efficient system, in addition to providing the required reports to various stakeholders in the bank (or lending organization such as NBFC – Non Banking Financial Corporation, Lending Agencies, Asset Management Companies, FIIs, Large Corporate having exposure on subsidiaries etc), should also be strong on custom required reports having little or no dependency on solution provider. Same goes with configuration management in the application where users should be able to change the values, say for example severity attached to a case of Cheque Bounce, on their own. Regulator often raise the requirement for specific values in reports or customized reports, system should be able to provide such flexibility to the user bank.
Regulators love to see system that ensures compliance is an automated affair and not thorough Excel Reports churned out by someone in the chain. An EWS platform deployed by the bank will surely add more credibility to the process of monitoring portfolio.
Asset or Loan Business has its anxious moments and they are everywhere, it doesn’t matter which geography, segment or scale at which you as a bank are operating. Need is to have a system in place that enables and equips you to have a clear view of risk or financial stress building in the portfolio.
An intelligent, adaptive & self-learning system with well-defined workflow will ensure bank is able to work on every signal that data is generating, is able to have a causal analysis and is able to take corrective action, well in time, every time.
A simple example that can summarize the scope of system or solution framework for an Early Warning System is to list out all Exporters and Importers having exposure in South East Asia in following Industry or Sector – “Auto, Mobile, Commodities, Chemicals and Consumer Goods”. The generated data of such borrowers would require heightened monitoring and constant engagement with the borrowers, even reviewing the limit and facilities and take corrective action. Simple, isn’t it?
Article authored by Sharad Bishnoi,
Practice Head, Care Risk Solutions
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