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Moody's — Moody's Analytics — Technical Presentation (July 2020)
27 slides from Moody's's technical presentation, July 2020
Slide 1: East Africa Webinar Series: Risk Based Loan Pricing
East Africa Webinar Series: Risk Based Loan Pricing July, 2020
Slide 2: East Africa Webinar Series
East Africa Webinar Series Episode 1 Episode 2 Episode 3 Thursday, 2 July Thursday, 9 July Thursday, 16 July 12:00 BST | 14:00 EAT 12:00 BST | 14:00 EAT 12:00 BST | 14:00 EAT Navigating Credit Risk & Classification and Stage Risk Based Loan Pricing Expected Losses: COVID-19 Allocation of Financial I
Slide 3: Speakers
Speakers Jared Osoro – Director, Research and Policy Kenya Bankers Association Waseem Nisar – Solution Specialist, Moody’s Analytics Nash Subedar – Relationship Management, Moody’s Analytics Metin Epozdemir, CFA – Risk and Finance, Moody’s Analytics Risk Based Loan Pricing 3
Slide 4: Agenda
Agenda 1)The current pricing framework adopted by Financial Institutions in Kenya 2)Best practices in Risk Based Loan Pricing 3)IFRS 9 impact on the loan pricing methods 4)Example of a loan pricing model practical application 5)Q&A Risk Based Loan Pricing 4
Slide 5: Kenya Bankers Association COVID-19 Insights for the Banking Industry
Ab KENYA BANKERS ASSOCIATION COVID-19 Insights for the Banking Industry WEBINAR
Slide 6: The Essence of Risk Based Pricing
The Essence of Risk Based Pricing • It is at the core of the broad market-based economic policy thrust in place from the early 1990s. • Markets determine prices based on demand and supply dynamics; • Regulatory framework ensures that price determination is underpinned by competition dynamics that do
Slide 7: Credit Pricing – The Popular Implicit Assumption
Credit Pricing – The Popular Implicit Assumption • The interest rate capping law of August 2016 that lasted until November 2019: • Implicitly assumed that cost is the more binding constraint than access; indeed assumed that the two aspects can be disentangled – ‘manage the cost and access will take
Slide 8: The Banking Industry Charter
The Banking Industry Charter • Effective from 1st September 2018. • Risk-based pricing is one of the pillars. • The others are: • Adoption of customer-centric business models by banks; • Enhanced transparency and information disclosure; (e.g. the APR); • Entrenching an ethical culture in banks – doi
Slide 9: Perspectives on Risks – Returns Pricing Mechanism in the Kenya
Perspectives on Risks – Returns Pricing Mechanism in the Kenya • Conventionally, a positive risk-return relationship is to be expected. However, in Kenya the relationship between bank returns and risk indicate mixed results (based on a KBA study published in 2017 (working Paper No 21):- https://www.
Slide 10: Traditional Credit Pricing Methodology
Traditional Credit Pricing Methodology Cost + Profit Approach Borrower Facility • Financials • Base + Spread: • Business Plans • Tenor • Management • Security • Industry trends • Funding / Capital Final Price • … Costs • Overhead • Fees • Competition • … Risk Based Loan Pricing 10
Slide 11: Traditional vs Risk Based Credit Pricing
Traditional vs Risk Based Credit Pricing Spread vs Rating 45 Traditional Pricing overcharges 40 customers in higher rating grades. Will eventually lose 35 these customers to competition 30 25 20 15 10 Will win business, but will earn below the 5 hurdle rate 0 Aaa Aa A Baa Ba B Caa Ca - C Risk Based
Slide 12: Risk-Based Pricing Accounts for Volatility
Risk-Based Pricing Accounts for Volatility Additional Margin: Represents the target return on equity, i.e. the new rate of return expected by shareholders. Guided by economic fundamentals and the long term sustainability of the institution. Capital Cost: The product of hurdle rate and capital. Capit
Slide 13: Metrics for Performance and Value
Metrics for Performance and Value Accounting for Risk in Loan Pricing ROA Return on Assets Net Income (after LL provision) / Book Value of Asset Used historically to measure investment performance, does not account for risk. ROE Return on Equity Net Income (after LL provision) / Equity Capital 03 Ha
Slide 14: Impact of IFRS 9 on Loan Pricing
Impact of IFRS 9 on Loan Pricing Risk-Reward Trade off » Expected Losses/Returns only tell half the story » Risk in terms of variance or volatility of returns is a key parameter in asset allocation and pricing decisions » Introduction of IFRS9 brings returns volatility in center stage » Stage alloca
Slide 15: Best Practice Requires Consistent Measurements
Best Practice Requires Consistent Measurements Essential to Manage Strategy, Performance and Risk Risk Based Loan Pricing 15
Slide 16: Pieces of the Puzzle
Pieces of the Puzzle Different requirements of the customer and bank stakeholders What is the risk Does this grade of this exposure meet customer? bank’s strategy? What amount? Risk What price? Approvers / Manager What terms? Committees Does it meet What is my the bank’s Customer performance, how co
Slide 17: Risk Based Pricing Framework
Risk Based Pricing Framework Inform all the stakeholders well in time I know upfront the This customer’s Exposure meets amount, price and in a high risk bank’s risk terms I can get!! grade appetite, but not the hurdle rate Risk Approvers / Customer Manager Committees My portfolio return is Exposure
Slide 18: Key metrics Needed for Pricing
Key metrics Needed for Pricing Rating and Probability Loss Given of Default Default (LGD) Expected Loss • Centralized repository of • Calculate Basel LGD using • Calculate Expected credit risk rating information Collateral eligibility and Loss as a function of • Ability to capture both regulatory ha
Slide 19: Risk Grading
Risk Grading In-depth Assessment of Borrower Health » Hierarchical grade distribution » Configurable automated model selection » Support for multiple scenario’s including what-if for stress assessment » Extended override classifications » Optional business process management control » Platform for r
Slide 20: Facility and Collateral Structuring
Facility and Collateral Structuring » Facility Structuring – Create Facilities and Facility Trees – Import Facilities from Core Banking or other systems – Import exposures from core banking and booking systems » Collateral Management – Create or import collaterals – N to N Allocation of collaterals
Slide 21: Loss Given Default Analysis
Loss Given Default Analysis » LGD analysis natively integrated with deal structuring functionality » Provides a configurable framework to create products, collateral and guarantees » Leverages Model Authoring Platform to enable easier configuration of client LGD models » Incorporates calculation log
Slide 22: EAD Calculation
EAD Calculation Based on the imported utilization of existing limits and the expected utilization level of proposed facilities Risk Based Loan Pricing 22
Slide 23: Expected Loss and Capital Calculation
Expected Loss and Capital Calculation » Expected Loss is a function of PD, LGD and EAD » For capital computation, the Basel Capital Formula can be applied Risk Based Loan Pricing 23
Slide 24: Risk Adjusted Performance Management
Risk Adjusted Performance Management Achievable at Origination Risk Based Loan Pricing 24
Slide 25: Questions and Answers
Questions and Answers EAST AFRICA WEBINAR SERIES: RISK BASED LOAN PRICING
Slide 26: Thank You
Thank You EAST AFRICA WEBINAR SERIES: RISK BASED LOAN PRICING
Slide 27: Risk Based Loan Pricing
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