Credit Risk - SME
Traditional SME risk frameworks fail due to reasons such as lack of quality firm data, recent portfolio vintage and insufficient default information. Using a breakthrough technique called Dynamic Sector Benchmarking, BrainMatics has developed a forward looking tool for SME risk management and stress testing.
Small and Medium Business Lending Risk Assessment
- Multilayered hybrid approach to leverage the complete information and hence better predictive power.
- Ability to rank order with limited default data ( since the default event is not as frequent as in retail portfolio, estimates are biased towards no default).
One would rather over estimate the probability of default than under estimate.
In India and other emerging economies we find the following issues
- Quality of information available
- The balance sheet information may not represent the true state of the firm.
- Need for thorough understanding of the data provided to understand the true financial health of the firm.
- Depending on the bank one may or may not have seen the maturity of such portfolio to be able to estimate the true potential default.
- Depending on the vintage of the portfolio, it might become difficult to understand the impact of business cycle and there impact on credit quality transition of the portfolio.
- Unavailability of default data or even if it’s available, remains a rare event.
- Standard scoring techniques which is typically used for scoring SMEs more often then not fails to distinguish between a good firm and a bad firm.
- At different stages of a firm there are different set of financials which plays in role in determining whether the firm will succeed going forward or not.
- Proper segmentation and bucketing is the key.
- When do we start dissociating the individual from the firm?
- The threshold has to be optimized.
- Rating is a function of previous period performance. Degree of such dependence on previous period performance depends on the weighting assigned to various parameters from past performance.
- To create leading indicator one need to have a way to be able to forecast these factors based on some observed factors as of today to understand truly the future performance of the firm.
- The said issue is important if one wants to have a truly forward looking strategy for risk assessment.
- The BrainMatics framework for SME credit rating, allows for having a truly unbiased model mainly due to hierchical approach.
- Structural in nature and hence allows for what ifs and stress testing which one can track.
- Allows for incorporating business cycles in the model.
- Allows for tracking near term, medium term and long term credit quality movement of the SME.