Literature review

This chapter is written to provide some theoretical and technical resources for commercial banks in the lending process management. After the definitions of general types of loans offered by the bank, relevant framework about the loan facility and corporate credit landing procedures will be introduced and analyzed according to the 留學生dissertation網research case. Observing the quantitative methodologies that bank in advanced economies use for certain aspects of credit risk management can be a helpful guideline for Metrobank to develop its own corporate lending management process in a developing economy. The framework and models mentioned in this chapter are all successful in certain circumstance. However, their own characters and functions still needed to be further discussed and to see if they can be adapted for Metrobank’s case in its current condition. Following with the information identification, the main indicators for risks analysis will be further discussed. Those indicators will represent in Chapter 4 in actual case from the bank. Finally, the identification of Credit risks and Credit risk management will be illustrated as guideline for Metrobank Shanghai branch to evaluate their own internal procedures.

2.1 Introduction of Loan Structuring and types
2.1.1 Loan Tenor and Facilities
With the exception of mortgage lending[James Weaver, Credit Analysis and Commercial Lending, 1st Edi, (2007), International Finance Corporation Private Enterprise Partnership for China, pp.35-37
], most loan facilities to companies have tenors between a few months and five years. The fundamental tenor structure for corporate lending is divided into two categories:
Short-term facility: final repayment is scheduled within one year of the first day the facility loan agreement is in force
Long-term facility: final repayment is scheduled one year or more after the first day the facility loan agreement is in force.
There are many types of commercial loan facilities, as well as variations on each basic type. Each type of loan structure is designed to fit specific categories of customer needs while providing lender a degree of risk protection and control consistence with the credit worthiness of the borrower. The following outline describes the most common types of commercial loan facilities, and how the loan structures derive from borrowing need and credit risk management factors. In this diagram, the This chapter is written to provide some theoretical and technical resources for commercial banks in the lending process management. After the definitions of general types of loans offered by the bank, relevant framework about the loan facility and corporate credit landing procedures will be introduced and analyzed according to the research case. Observing the quantitative methodologies that bank in advanced economies use for certain aspects of credit risk management can be a helpful guideline for Metrobank to develop its own corporate lending management process in a developing economy. The framework and models mentioned in this chapter are all successful in certain circumstance. However, their own characters and functions still needed to be further discussed and to see if they can be adapted for Metrobank’s case in its current condition. Following with the information identification, the main indicators for risks analysis will be further discussed. Those indicators will represent in Chapter 4 in actual case from the bank. Finally, the identification of Credit risks and Credit risk management will be illustrated as guideline for Metrobank Shanghai branch to evaluate their own internal procedures. Borrowing source, Repayment source and Borrowing requirement pattern can be regarded as the main factors to define a loan character. Meanwhile, the Borrower credit worthiness will be further analyzed in the process of credit risk accessing.#p#分頁標題#e#

2.1.2 The Types of General Commercial Loans
According to Tomothy W. Koch[ Timothy W.Koch & S.Scott MacDonal. Bank Management 6th edition (2006). South-Western, Thomson Learning,pp135-136], for most banks, the largest and most obvious source of credit risk comes from loans, or to be more specifically, from the customers behind those loans. In view of this case, the following loans are generally provided for SMEs in China[ CBRC. CBRC Annual Report 2006.Part Two-Development of China’s Banking Industry.P32]:
Working Capital Loan---is designed to satisfy customers’ needs for temporary and seasonal funding the process of operation in order to guarantee the normal production and operation activities. By loan term, it can be divided into temporary working capital loan (within 3 month), short-term working capital loan (3 month to 1 year), and mid-term working capital loan (1 to 3 years). Working capital loans has high liquidity, which is applicable to the industrial and commercial customers with mid- and short-term financing needs.

Project Loan---is a sort of loan granted by commercial bank to borrower for the fixed assets investment projects such as new construction, expansion, reconstruction, development and purchase, etc. It can be also divided by period including short-term, mid-term and long-term.

Fixed Asset Loans---can be applied when company is short of capital when building plants, purchasing equipments, renovation technology or investing in other fixed assets. The loan includes the capital construction loan and the technological renovation loan.
 

2.1.3 Motivation for the Concepts
Since this report is revolving around the corporate lending to SMEs from Metrobank Shanghai branch, the researcher should has certain understanding about the loan structuring and types provided by the bank. The facility and character of working capital loan offered to SMEs in China are the core Thus further credit analysis can be developed later to confirm if the initial process and indicators from Metrobank are effective for its current situation.

2.2 The Corporate Lending Process

The flowchart above outlines the key elements of the credit process for corporate lending[James Weaver, Credit Analysis and Commercial Lending, 1st Edi, (2007), International Finance Corporation Private Enterprise Partnership for China, pp.14-18
].
Strategic Plan: determined by senior management, sets the long-term business directions and ultimate goals of the bank. This plan should indicate which markets and businesses the bank wants to be in, and how much risk it is willing to take in order to earn profits in each of those businesses.

Business Plan: are normally created annually, and modified as needed on an ongoing basis, by every management level in a bank. They are written for the bank as a whole, for departments, branches, and teams.#p#分頁標題#e#

Target Markets: guide loan officers to focus their efforts on selected markets. Loan officers use target market lists as an initial filter to determine whether potential business would likely be acceptable and be approved. Bank senior executives manage risk levels by adjusting target market volume objectives, pricing, and security requirements, or buying and selling loans in those markets where banks trade loans among one another.

Risk Acceptance Criteria: provide loan officers a second filter to help determine which new loan opportunities are worth investing valuable time and resources on to perform a detailed and comprehensive credit analysis and write an approval memo. These criteria are a set of simple key measurements representing minimum standards that all loans in a particular market or industry must comply with. They often relate to basic leverage and debt service coverage ratios, security requirements, borrower characteristics, and similar fundamental credit considerations.

Origination: refers to how loan officers obtain, assesses, and “book” new business opportunities. They can use the Target Markets and Risk Acceptance Criteria developed by the bank to quickly determine whether a new business opportunity is worth the considerable time and effort required to fully analyze the opportunity and prepare a credit approval package.

Credit Analysis: represents a major part of a loan officer’s work (new business development and loan monitoring make up the other dominant tasks). The main analytical objectives are to thoroughly understand the borrower’s business, and to identify and assess risks in the borrower’s business and risks that could affect the borrower’s ability to make future debt service payments.

Structuring and Negotiation: involve the application of lending principles to determine the major loan terms and conditions to be recommended for approval. While there are important risk control principles to guide the loan officer and the reviewing credit officers, these principles may allow a range of acceptable possibilities.

Risk Rating: refers to application of the risk factors revealed through the credit analysis process, along with risk factors related to the loan facility structure, to determine borrower and facility risk rating categories according to a bank’s internal risk rating system.

Application and Approval: refers to the process of writing a credit approval memo and preparing the supplementary information required to support the conclusions and recommendations of the memo. The approval process has tow basic models: CAP review and approval (1) through a chain of individuals with increasing lending authority, or (2) by a loan committee or series of committees of increasing lending authority. There are “best practice” variations or combinations of both models, but all require approval for each credit facility from an independent Credit Department.
Documentation: involves the creation of legal documents that reflect the terms and conditions for a loan that were approved at the appropriate bank level and agreed to by the customer.#p#分頁標題#e#

Disbursement: is a crucial point at which the cash leaves the bank’s control and is transferred to the borrower. It is also the point at which the credit risk factors become threats to repayment and lenders become fully “exposed”.

http://www.400190.com/thesis_sample/Canada_Thesis_Sample/Monitoring: is one of the most important parts of the credit process. It is conducted over the greatest time frame in the credit process, lasting from loan document signature to final repayment.

Problem Situations: require a specialized approach and skill to manage. If problems develop, loan management responsibility should be transferred to a separate team experienced in handling problem loan situations. Problem loan management techniques, including the practical and legal aspects of maximizing cash from collections from ongoing borrower operations, liquidation of collateral, and calling guarantees.
Generally, loan officers in the business origination teams are directly involved in most steps in the credit process, but not all. A loan officer’s direct involvement begins with the application of Target Markets to screen potential new loan customers and ends with Monitoring through final repayment of a loan.

2.2.2 Motivation for the concept
During the process of reaching a lending decision, it is necessary to considerate and to assess a large number of credit factors and then choose the appropriate analytical tools for application. There is a variety of successful approaches, all incorporating common basic principles. Also this model shows an overall picture for the researcher on how to design and create a comprehensive framework for Metrobank Shanghai branch to manage their loan risks on SMEs with considering of their current condition.

From the researcher’s view, the flowchart above provides interesting insight that marketing and business development are integral parts of the credit risk management process. It seems to be logical with the current view, because finding new customers and developing new business with existing customers is essential to a bank’s revenue and profit generation for its growth in a competitive environment. With this origination, controlling the risks that arise from the business is equally essential to protect the bank’s profits, growth, and competitive position. The two key activities, new business development and risk management, must be managed together in order for Metrobank to be successful in China.

Furthermore, the framework describes the whole corporate lending process as a cycle, where the “end” of the credit process is tied directly back to the “beginning”. As what can be imaged, this cycle would better support the sustainable development for bank in lending business and cover a substantial amount of other operating and financial information essential to the loan decision making. Therefore, the researcher will consider it as the main reference to make recommendations for Metrobank Shanghai branch in Chapter 5.#p#分頁標題#e#

2.3 Information Processing in Lending Process
2.3.1 The Types of Obtained Information
During the lending process, banks have to assess to different types of information in order to manage risk through capital allocation for Value at Risk coverage. Usually, the two types of information[ Godbillon-Camus, Brigitte and Godlewski, Christophe LaRGE, Credit risk management in banks: Hard information, soft Information and Manipulation” December 2005, pdf] that loan officer need to collect and analyze are:
Hard information, which is external via public information, is contained in balance sheet data and produced with credit scoring. This sort of information is quantitative and verifiable, which makes it is easily collected, stockable and transmissible. The advantages of hard information include the low cost, easier comparability, allowing separating processes of collecting and easier delegation of treatment functions.
Soft information, produced within a bank relationship, is qualitative and non verifiable, therefore manipulable, but produces more precise estimation of the debtor’s quality. Collecting soft information is personal and includes its production and treatment context.

2.3.2 Types of Lending Technologies

The two different types of information also imply two lending technologies: transaction lending versus relationship banking[ Dr. Godfrey Yeung, “How Banks in China make Lending Decisions” Published in the Journal of Contemporary China, Vol. 18, No 59, March 2009, pp. 285-302.].
In transaction lending, the bank is involved in an arm’s length transaction in which the loan is purely a funding transaction or ‘commodity product’, and the loan evaluation is mainly based on the ‘hard’ quantitative criteria.
In relationship banking, banks invest in building relationships with borrowers and use their sector or firm-specific expertise to improve the project’s payoff for the borrower. Loan decisions are based on ‘soft’ qualitative information. As part of relationship banking, banks collect confidential borrower-specific information through such processes as screening, monitoring, and liquidity transformation[ S. Bhattacharya and G. Chiesa, ‘Proprietary information, financial intermediation, and research incentive’, Journal of Financial Intermediation 4, (1995), pp. 328-357 ].

2.3.3 The Impacts of Information Types to the Organizational Structure

The adaptation of the organizational structure to the type of information used in banking has received theoretical and empirical evidence. Stein (2002)[ Stein, J.C., 2002, Information production and capital allocation: Decentralized versus hierarchical firms, Journal of Finance 57, 1891–1921.] investigates the influence of banks’ organizational structure on their optimal funds allocation’s decision. In his theory, it confronts two types of information (hard versus soft), and two types of organizational structure (hierarchical and centralized versus non-hierarchical and decentralized). He shows the existence of an adequacy between organizational structure and information type, allowing optimal funds’ allocation, through better incentives. Soft information is associated with decentralized organizations, because they provide the agent more power and authority. In such a framework, agent has better incentives to make efficient use of the information in the funds’ allocation process. Hard information is associated with centralized organizations, because it facilitates its transmission to superior hierarchical levels where funds’ allocation decision is made. In a word, the type of information implies a more or less important level of authority and power delegation toward the agent in charge of information’s treatment.#p#分頁標題#e#

2.3.4 Motivation for the Concepts
The role of information’s processing in bank intermediation is a crucial input of lending process design. As what mentioned in Chapter 1, the information asymmetry is a main problem confronted to foreign bank to provide credit services in China. Also, regarding to borrowers’ informational opacity, SMEs being considered as the most opaque (because of lack of public information) type of all business. Considering the different types of information require different treatments and imply different lending technologies from bank, it occurs on the researcher that the current lending practice from Metrobank might not match with the current condition in Shanghai branch to provide working capital loans for SMEs in China sufficiently.

2.4 Indicators to Assess a Business
2.4.1 The Business Risk Analysis Framework

The business risk analysis framework[ Chicken, C. John, Posner, Tarmar, 1998. The Philosophy of Risk. Thomas Telford.] is based upon management of the operating and capital investment cycles, as well as industry and company factors that affect the nature of these cycles. There are six major analytical elements, plus incorporation of industry risk, divided into two categories: general risks relating to a company, and risks arising from the nature and management of a company’s asset conversion cycle.
General Company Risks
Industry Risk: the level of industry risk normally affects the level of business risk adversely: high industry risk generally creates higher business risk levels. There might be rare exceptions to this, situations where a conservatively managed company has solid market leadership and a strong outlook in high risk industry. Lower industry risk may or may not lead to lower overall business risk levels when companies decide to pursue very risky business strategies or make risky operating decisions.
Bank analysts must also look for situations where company management may not realize the risks inherent in strategies or plans they decide upon; or situations where the ownership structure places few controls, or demands for strong corporate governance, on management (ie. State-owned company).
Company Maturity: maturity risk for companies arises from the uncertainties of newness, the lack of an operating record which is necessary to provide evidence of successful management and company performance and which forms the basis for concluding whether or not a company could repay a loan. New companies with a short or volatile operating record and significant uncertainty with respect to future performance thus represent very high maturity risks. Companies with at lease several years’ operation where management has a demonstrated record, represent relatively low maturity risk. Analysts should also keep cyclicality in mind when assessing maturity risk. #p#分頁標題#e#
Risks Directly Related to the Asset Conversion Cycle
Supply Risk: analysis can be conducted by focusing on three risk areas including Concentration, Availability, and Price Characteristics.
Concentration risk arises when a company is dependent on one or just a few suppliers of key inputs, in particular raw materials. Availability risk arises when a company’s operating consistency and profitability are vulnerable to unexpected changes in the availability of necessary inputs, including both raw material and human resources inputs. If a company can not obtain necessary operating cycle resources like meeting required specifications or quality at the time needed, business operations will slow or stop. Supply price risk arises when a company (1)has little or no “buyer’s bargaining power” to influence the price charged by suppliers. Or (2) requires supplies whose price is subject to volatile global or regional market prices.
Production Risk: production risks arise from events or changes in production conditions which can (1) slow or stop the operating cycle, or (2) increase the costs of production processes. To assess a company’s production risk, three key areas can be analyzed as a basis for the assessment: Consistency, Technology and Fixed Assets.
Consistency refers to a company’s ability to continually produce products in the required amounts; at the required level of quality; on schedule and at predictable production costs. It is also essential to achieve and maintain low production costs.
Technology risk arise primary from vulnerability to technological change. Companies face the technology risk if their added value, productivity, production cost advantage, or product differentiation depend upon machinery or methodologies employing technology that must be constantly renewed.
Last but not the least, Production fixed asset risks other than those related directly to technology can arise from the need to maintain Fixed Assets in good condition and in such a way as to prevent breakdown and other productivity loss.
Sales Risk: sales risk can be assessed by reviewing seven broad risk areas affecting the overall sales process including: Product Importance, Diversification of Products, Product Differentiation, Competitive Position, Customer Base, Demand Characteristics, and Price Characteristics. The following diagram highlights some of the general relationships using the seven Sales Risk areas in the above framework

Distribution Risk: distribution risk can be identified and assessed by focusing on two key factors: Control and Flexibility.
Control refers to the degree to which a company (1) owns or controls the channels to move products to final consumers, and (2) can manage product marketing until purchase by the final consumer. The more control a company can exercise, the less distribution risk it is exposed to.
Flexibility refers to the degree to which a company can successfully use alternative distribution channels if current channels are disrupted or become more expensive. The more flexibility a company has, the less distribution risk it is exposed to.#p#分頁標題#e#
Management Risk: thorough consideration of management quality and potential risks stemming from weaknesses in a company’s management is particularly important where: (1) Management competency and depth are often weak; (2) the positive or negative results of a single manager’s decisions may have immediate, significant impact upon credit worthiness; (3) financial and operating information needed for credit analysis may be limited in scope and detail or of questionable quality, requiring bankers to put more “faith” in management.

2.4.2 The Operating Cycle and Cash Cycle of Business
The operating cycle and cash cycle can always help the bankers to evaluate the financial situation of a company when they consider about the lending decision for working capital loans. It is mentioned in 2.1.1, the Cash cycle or Asset Conversion[James Weaver, Credit Analysis and Commercial Lending, 1st Edi, (2007), International Finance Corporation Private Enterprise Partnership for China, pp.55-57] is the main repayment source of loan borrower and also a main indicator to evaluate the repay ability or payback period of the company. Theoretically, it can be illustrated as following:

This method of diagramming the operating cycle illustrates a simple way of estimating the length of a company’s operating cycle. The length of the operating cycle is roughly equal to the average period Inventory remains on a company’s Balance Sheet, plus the average period Accounts Receivable remain on the Balance Sheet.
A company collects cash at the end of the operating cycle, but at the beginning of the operating cycle if suppliers do not demand immediate cash payment for raw material delivery the company can delay the payment of cash for raw materials until sometime into the operating cycle. The delay from the point at which a company buys and takes possession of raw materials to the point at which it must may for the materials represents the average “payment period” that raw material suppliers provide the company.
The “Cash cycle” is the period during which a company is required to use its own or borrowed cash to finance the operating cycle, the period not financed by suppliers, the cash cycle begins at the point in the operating cycle when a company must use cash to pay suppliers, and ends with the collection of cash from customers. It is estimated by subtracting the average Accounts Payable “payment” period from the estimate of the operating cycle length.

2.4.3 Key Elements of Balance Sheet and Income Statement Analysis
During the process of credit analysis, the analysis of financial statements can be seen as the main area where bankers should make efforts on. The choice of which financial statement measurements to use in a uniform bank-wide approach to Balance Sheet and Income Statement analysis should be based upon a set of basic measurements and assessments, which can be adapted to meet the needs in their particular operating environments. There are different approaches to categorize various measurements and assessments. Most system use categories including:#p#分頁標題#e#
- Profitability
- Liquidity
- Asset Efficiency
- Leverage
- Debt Service Coverage
- Financial Structure
According to Matrobank’s case, only relevant measurements[ James Weaver, Credit Analysis and Commercial Lending, 1st Edi, (2007), International Finance Corporation Private Enterprise Partnership for China, pp.120-133] will be introduced in following charts:
Profitability Ratios:
Ratio Calculation Analytical Notes
Gross Profit Margin Gross Profits
Sales *100 Measures the extent to which management can control inventory and direct production costs in relation to product prices and sales volume.
Pre-tax Profit Margin Net Profits Before Tax *100
Sales Measures the extent to which management can generate profits by (1) creating value for customer as reflected in product prices and sales volume; and (2) controlling costs, in particular operating costs over which management may have more control.
Net Profit Margin Net Profits After Tax * 100
Sales Measuring “bottom line” profitability, this ratio reflects all income and expense items.
Liquidity Ratios:
Ratio Calculation Analytical Notes
Current Ratio Current Assets
Current Liabilities Provides a limited perspective on the margin of liquidity protection provide by any excess of current assets, which may covert to cash within one year of statement date, over current liabilities payable over the same period.
Quick Ratio Quick Assets
Current Liabilities A limited but more stringent perspective on liquidity margins of protection, as only the more liquid Current Assets are included.
Inventory Reliance Ratio Current Liabilities-Quick Assets*100
Inventory Estimates the proportion of Inventory that would have to be liquidated in addition to the liquidation of all Quick Assets in order to pay all Current Lia.
Leverage Ratios:
Ratio Calculation Analytical Notes
Liabilities to Tangible Assets Total Liabilities * 100
Total Tangible Assets Measure the proportion of assets financed by creditors and providers of goods and services. The weaker the asset liquidity and the more business risk in operations, the lower the ratio should be.
Liabilities to Tangible Net Worth Total Liabilities * 100
Tangible Net Worth Measures the proportion of total financing provided by outside creditors and providers of goods and services. The lower the proportion, the greater the margin of protection for lenders. The greater the level of business risk, the greater the margins of protection required by lenders.
Debt to Capitalization Long-term Debt * 100
Capital Provides perspective on debt structure by measuring the proportion of debt in a company’s capital structure.
Debt Service Coverage Ratios:
Ratio Calculation Analytical Notes
Interest Coverage EBIT
Interest Expense Viewed over time, provides perspective on whether profit levels are generally sufficient to meet interest obligations.#p#分頁標題#e#
EVITDA Coverage EBITDA
Interest Expense + PP CPLTD Viewed over time, provides a perspective on whether profit levels adjusted to more closely reflect available cash are generally sufficient to meet both interest an Long-term Debt repayment obligations.
Fixed Charge Coverage EBITDA+ Lease Expense
Interest Expense+ PP CPLTD
+ Lease Expense Both Capital and Operating Lease expenses are added to the EBITDA Coverage calculation to more fully capture all financing costs.
Funds Flow Coverage Net Profits + Dep. and Amort. Exp. – Dividends
PP CPLTD Viewed over time, provides a perspective on whether profit levels adjusted (1) to more closely reflect available cash, and (2) to reflect possible cash requirements for dividends are generally sufficient to meet Long-term Debt repayment obligations.

2.4.4 Motivation for those concepts
The indicators introduced and described in this sector can be seen as the key elements to analyze a business as well as the elements providing a basis for risk assessing
The main purpose to identify and review on the different categories of business risks that may involve in this project is to help the researcher to identify potential risks from SMEs in order to answer part of the second research question in Chapter 4.
In 2.4.2, the Operational cycle has been introduced since identifying and analyzing the risks that potentially affect the timing and amount of operating cycle cash flows provides an excellent basis for business risk analysis because it is a necessary indicator to evaluate the repay ability and then anticipate the payback period from the borrower. If the operating cycle/cash cycle of the company becomes longer, which means the company may have problem of getting money from its customer, the potential risk to bank will consequently increase because of the bad debt. The loan amount and criteria from bank might be adjusted when the operational cycle of SMEs is easily to be influences.
The major categories of financial ratios introduced in 2.4.3 are the main indicators for bank to evaluate the financial performance of loan debtor. Analyzing the financial statement information is especially important in the lending process since those information can reflect the cumulative effect of the past investment and financing decisions from borrowers as well as the effectiveness of management operating decisions over a specific period. In chapter 4, those indicators will be mentioned with specific example, which help to better understand the loan procedure from Metrobank Shanghai branch.

2.5 Credit Risk and Credit Risk Management
2.5.1 What is Credit Risk?
In a normal operating environment credit risk represents the greatest proportion of overall banking risks. According to the identification on the book (Enterprise risk management (2003), James Lam)[ James Lam, Enterprise risk management: from incentives to controls (2003), published by John Wiley & Sons Inc., New Jersey, pp247-253], credit risk is the potential for financial loss resulting from the failure of a borrower or counterparty to honor its financial or contractual obligations. To be more specific, it contains two types of risks as following:#p#分頁標題#e#

 

2.5.2 What is Credit Risk Management?
Credit risk management[8 Source: Philippe Jorion, Value at Risk, New York, McGraw Hill, 1997, pp 29-32] deals with the identification, quantification, monitoring, controlling and management of credit risk at both the transaction and portfolio level. Although the level and volatility of future losses are inherently uncertain, statistical analyses and models can help the risk manager quantify potential losses as input to underwriting, pricing, and portfolio decisions.
Usually, the bank capital fulfills two functions:
Capital must be sufficient to absorb substantially all unexpected losses, and
Capital must be sufficient to support growth.
In order to achieve those, the keys to successful credit risk management can be briefly defined as:
Capable and effective senior management.
The development of a strong credit skills base among all staff involved in the credit process.
The development of a fundamental “credit culture”, exercised and enforced from the highest levels of bank management, in which all professional bank staff are charged with the responsibility, and rewarded.

2.5.3 Measurement of Credit Risk
For an individual bank, it is the dispersion of future returns on its own portfolio that is of concern, while for a policymaker charged with financial stability; it is the dispersion of possible future outcomes for the system as a whole. In practice, the focus of risk measurement is on downside outcomes, rather than upside outcomes, so that measures of risk tend to focus on the likelihood of losses, rather than characterizing the entire distribution of possible future outcomes.
This focus is clearly evident in the increasing use of value-at-risk (VaR)[ Frederic S. Mishkin and Stanly G. Eakins, Financial Markets and Institutions, 3rd Edi, (2000), pp.620-624] based models to measure credit risk. These models include amongst others JP Morgan’s Credit Metrics, Credit Risk Financial Products’ Credit Risk and KMV (Kealhofer, McQuown and Vasicek) Credit Portfolio Manager. Although the various approaches have different structures, all are trying to measure the potential loss that a portfolio of credit exposures could suffer, with a predetermined confidence level, within a specified time horizon. In measuring the range of possible future outcomes all such models can be thought of as having a number of common building blocks. These include:
A system for rating loans (generally based on some concept of the probability of the borrower defaulting);
Assumptions about the correlation of default probabilities (PDs) across borrowers;
Assumptions about the loss incurred in the case of default (commonly referred to as the LGD);
Assumptions regarding the correlation between the PD and the LGD

2.5.4 Techniques of Credit Risk Management
The goal of credit risk management is to maximize a bank’s risk-adjusted rate of return by maintaining credit risk exposure within acceptable parameters. Banks need to manage the credit risk inherent in the entire portfolio as well as the risk in individual credits or transactions. Banks should also consider the relationships between credit #p#分頁標題#e#http://www.400190.com/thesis_sample/Canada_Thesis_Sample/risk and other risks. The effective management of credit risk is a critical component of a comprehensive approach to risk management and essential to the long-term success of any banking organization. Following are some general techniques that Metrobank Shanghai branch can refer to manage credit risks:
Screening: refers to the collection and effective review of reliable information on prospective borrowers by the financial institution. During the corporate lending process, the banker might look at data on the company’s profits and losses, assets and liabilities, and prospects for future success.
Monitoring: to reduce the risk that borrowers will engage in risky activities after the loan is obtained (moral hazard), bankers write provisions into loan agreements that place boundaries on the borrower’s activities.
This chapter is written to provide some theoretical and technical resources for commercial banks in the lending process management. After the definitions of general types of loans offered by the bank, relevant framework about the loan facility and corporate credit landing procedures will be introduced and analyzed according to the research case. Observing the quantitative methodologies that bank in advanced economies use for certain aspects of credit risk management can be a helpful guideline for Metrobank to develop its own corporate lending management process in a developing economy. The framework and models mentioned in this chapter are all successful in certain circumstance. However, their own characters and functions still needed to be further discussed and to see if they can be adapted for Metrobank’s case in its current condition. Following with the information identification, the main indicators for risks analysis will be further discussed. Those indicators will represent in Chapter 4 in actual case from the bank. Finally, the identification of Credit risks and Credit risk management will be illustrated as guideline for Metrobank Shanghai branch to evaluate their own internal procedures. Long-term customer relationship: another key principle of credit risk management, which offers bankers a way of minimizing the costs of information collection and making it easier to screen out bad credit risk. Also, long-term relationships give the borrower a more pressing incentive to avoid risky activities that would endanger its relationship with the financial institution, thus helping bankers deal with even unanticipated moral hazard contingencies.
Loan commitments: a loan commitment commits the bank, for a specified period of time, to provide the borrower with loans up to a given amount at an agreed-on interest rate. This promotes the long term relationship with the customer, in turn facilitating the collection of information.
Collateral: or property promised to the lender as compensation if the borrower defaults, reduces the banker’s losses in the case of a loan default.#p#分頁標題#e#
Compensating balances: a particular form of collateral that may be required when a bank makes commercial loans. This occurs when a bank requires the borrower to maintain a certain minimum amount of funds in a checking account at the bank.
Credit rationing: occurs when lenders refuse to make loans. Or restrict the size of the loan, even though borrowers are willing to pay the stated interest rate or even a higher one.

2.5.5 Motivation for those concepts
Since this report is suppose to recommend the framework for credit risk management, the researcher must have certain knowledge and thorough understanding about the fundamental ideas like “what is credit risk?” and “what is credit risk management”. The concept provided in 2.5.1 drew a clear picture about the definition and key elements of credit risk faced by commercial bank. In 2.5.2, more than identifying what is credit risk management, the keys to practice a successful credit risk management were also analyzed with considering its reinforces. Those concepts, which can be seen as the essence summed up from the experiences of every successful bank, certainly would provide a guideline for the research company to refer on creating a practical framework for credit risk management.
The credit risk measurement introduced in 2.5.3 are used in most commercial banks. For this case, the researcher found that Metrobank also follows the similar idea to adopt their credit risk implements. To Metrobank Shanghai branch, all the policies and strategies in risk management are conformed by the senior management and the board in Philippines’ head office and then top-down communicated to all overseas employees involved in the credit process. As what will be mentioned in Chapter 4, the techniques for credit risk management in Metrobank are also designed with a timely and consistent manner, and annually monitored by the headquarter to ensure the compliance.
2.6 Chapter’s Summary
The literature review in this chapter has begun with the introduction of the loan facility and types relating to Metrobank’s case. Following with the corporate lending frameworks, which help to classify and develop clear steps in assessing crucial information (industry risk, business risk etc) and essential element (financial statements) in an informed decision process as well as measuring credit risks.
In 2.3, the hard and soft information that bank need to process in loan providing have been discussed with their impacts on different lending technologies and organizational structures of bank.
After that, the indicators that usually used to evaluate a business have been identified. Business analysis is the first and also a crucial step for any bank to manage its 留學生dissertation網lending business. Through the risk identification in 2.5.1, a company can find out what the credit risks are and where they lay. After that, the nature of successful credit risk management has been discussed. Last but not the least, measurements and techniques for bank credit management have been further considered. #p#分頁標題#e#
The coming chapter is about Research Methods, which will introduce the methodology selection and strategy adoption of the researcher as well as explain the reasons.