Risk Assessment Model(RAM) :-
Risk assessment can be done from 2 aspects:
Risk assessment can be done from 2 aspects:
- Quantitative aspect:
Quantitative aspect refers to managing the credit risk by
using the quantitative tools and techniques such as ratio
analysis, and reaching a concrete number for every loan
which would indicate the magnitude of risk and expected
returns, on a case by case basis.
using the quantitative tools and techniques such as ratio
analysis, and reaching a concrete number for every loan
which would indicate the magnitude of risk and expected
returns, on a case by case basis.
- Qualitative aspect:
Qualitative aspect is taking a holistic view by a bank at its
overall portfolio, deciding the lending limits to a sector,
setting up the broad policies and procedures, and so on.
Both quantitative and qualitative aspects need to be taken
into consideration while computing the risk levels. In the case
of corporate clients, post-mortem of the balance sheet is one
of the main instruments. Ratio analysis helps us determine
whether the loans have to be extended. But, past performance
is not an ideal indicator of the future performance. This raises
overall portfolio, deciding the lending limits to a sector,
setting up the broad policies and procedures, and so on.
Both quantitative and qualitative aspects need to be taken
into consideration while computing the risk levels. In the case
of corporate clients, post-mortem of the balance sheet is one
of the main instruments. Ratio analysis helps us determine
whether the loans have to be extended. But, past performance
is not an ideal indicator of the future performance. This raises
the necessity to consider other qualitative parameters such as
technological status, reputation, repayment track with others
and so on.
technological status, reputation, repayment track with others
and so on.
A. Liquidity Risk
Liquidity risk is the non-availability of cash to pay a
liability that falls due. A company is deemed to be financially
sound if it is in a position to carry on its business smoothly
and meet all the obligations - both long term as well as short
term - without strain. Assessment of the efficiency with
which the funds are put to use is very important for credit
analysis.
The study of efficiency of debt-service management
becomes essential to banks as the ratios reveal
• Whether the profit of the firm is enough to cover not
only the interest payment, but also to provide a
reasonable cushion against future uncertainty
• Whether the profit is sufficient to provide enough
coverage for repayment obligations
• Whether the assets of the firm provide adequate
security for loans sanctioned.
In short, the coverage ratios show the relationship between
the debt servicing commitments and the sources for meeting
these burdens.
Debt Equity Ratio
The ratio brings out the extent to which the firm is
dependent on outsiders for its existence and indicates the
proportion of the owners’ stake in the business. A high ratio
means that claims of creditors are greater than owner’s funds.
Excessive liabilities tend to cause insolvency. This is the
most unfavorable situation for a banker, as he may gain the
position of just one among the many creditors of the
company.
Current Ratio
The current ratio is an index of the concern’s financial
stability since it shows the extent of the working capital,
which is the amount by which the current assets exceed the
current liabilities. A high current ratio indicates inadequate
employment of funds while a poor current ratio is a danger
signal to the management. It shows that business is trading
beyond its resources.
Current ratio of 2 is ideal. The presumption is that for
every two rupees collected by the business; one rupee is used
for discharging the current liabilities, leaving another rupee
as the margin of safety. However, this ratio should be seen in
relation to the component of current assets and their liquidity.
If a large portion of current assets are obsolete stock the firm
may fail even with a ratio higher than 2.
Liquidity Ratio
This ratio is also an indicator of the short-term solvency of
a firm. Ideal ratio is 1:1. A comparison of current ratio to
liquid ratio indicates inventory hold-ups. The higher the
amount of liquid assets to current liabilities the greater the
assurance of current liabilities being paid off.
Interest Coverage Ratio
It tells the analysts the extent to which the firm’s current
earnings are able to meet current interest payments. When
Liquidity risk is the non-availability of cash to pay a
liability that falls due. A company is deemed to be financially
sound if it is in a position to carry on its business smoothly
and meet all the obligations - both long term as well as short
term - without strain. Assessment of the efficiency with
which the funds are put to use is very important for credit
analysis.
The study of efficiency of debt-service management
becomes essential to banks as the ratios reveal
• Whether the profit of the firm is enough to cover not
only the interest payment, but also to provide a
reasonable cushion against future uncertainty
• Whether the profit is sufficient to provide enough
coverage for repayment obligations
• Whether the assets of the firm provide adequate
security for loans sanctioned.
In short, the coverage ratios show the relationship between
the debt servicing commitments and the sources for meeting
these burdens.
Debt Equity Ratio
The ratio brings out the extent to which the firm is
dependent on outsiders for its existence and indicates the
proportion of the owners’ stake in the business. A high ratio
means that claims of creditors are greater than owner’s funds.
Excessive liabilities tend to cause insolvency. This is the
most unfavorable situation for a banker, as he may gain the
position of just one among the many creditors of the
company.
Current Ratio
The current ratio is an index of the concern’s financial
stability since it shows the extent of the working capital,
which is the amount by which the current assets exceed the
current liabilities. A high current ratio indicates inadequate
employment of funds while a poor current ratio is a danger
signal to the management. It shows that business is trading
beyond its resources.
Current ratio of 2 is ideal. The presumption is that for
every two rupees collected by the business; one rupee is used
for discharging the current liabilities, leaving another rupee
as the margin of safety. However, this ratio should be seen in
relation to the component of current assets and their liquidity.
If a large portion of current assets are obsolete stock the firm
may fail even with a ratio higher than 2.
Liquidity Ratio
This ratio is also an indicator of the short-term solvency of
a firm. Ideal ratio is 1:1. A comparison of current ratio to
liquid ratio indicates inventory hold-ups. The higher the
amount of liquid assets to current liabilities the greater the
assurance of current liabilities being paid off.
Interest Coverage Ratio
It tells the analysts the extent to which the firm’s current
earnings are able to meet current interest payments. When
this ratio is high it shows that the business would earn
sufficient profits to pay the interest charges periodically. A
low interest coverage ratio may result in financial
embarrassment.
Debt service coverage ratio
The standard ratio is 1.5. However, if the ratio is between 1
and 1.5, suitable spacing of the repayment period and thereby
lowering the annual repayment obligations, may raise the
ratio and make the proposal financially viable. A persistently
low ratio indicates heavy repayment obligations, which the
business is at pains to meet. The level of these ratios reflects
the result of business risk drivers and the funding policies.
Generally speaking, higher the level of coverage, higher is
the rating.
B. Operations Risk
In a competitive market, it is critical for any business unit
to control its costs at all levels. To measure the operational
efficiency, the turnover ratios and profitability ratios are used.
They measure how efficiently the firm is employing the
assets. They also represent the relationship between profit
and sales, and between profit and investment.
Net profit trend
The final profit figure arrived at after charging all the
expenses of the firm against all its income is called net profit.
A banker would look at the trend of net profit over the years.
A company, which has been consistently achieving positive
growth rates, reflects a healthy industry position and the
management’s commitment to the business, effective steps
taken by the management to promote their sales in the market.
The company with positive growth is favored than those
whose growth is static or negative.
Cash profit trend
Cash profit represents the annual profit arrived at before
charging depreciation. Cash profit is superior to net profit
due to the following reasons:
• Though depreciation charged to profit and loss
account, there is no actual outflow of cash
• Depreciation is the total cost of fixed assets annually
averaged over the life of the machine. Regarding
annual depreciation once again would amount to
double charging.
Fixed Assets Turnover Ratio
This ratio measures the sales per rupee of investment in
fixed assets or the efficiency with which fixed assets are
employed. A high ratio indicates a high degree of efficiency
in asset utilization and a low ratio reflects inefficient use of
assets.
Total Assets Turnover Ratio
This takes the total view of the business as a producing unit.
It determines the produce ability of the assets of the business,
which also indicates the managerial capacity of the
entrepreneur in putting the assets to best use.
Return on Investments
The ROI is the key factor of profitability of a business. It
matches the operating profit with the assets, which earn this
profit. Efficient utilization of assets will have a relatively
high return, while a less efficient use will have a low return.
Higher profitability implies greater cushion to debt holders.
Free Assets to Total Assets
sufficient profits to pay the interest charges periodically. A
low interest coverage ratio may result in financial
embarrassment.
Debt service coverage ratio
The standard ratio is 1.5. However, if the ratio is between 1
and 1.5, suitable spacing of the repayment period and thereby
lowering the annual repayment obligations, may raise the
ratio and make the proposal financially viable. A persistently
low ratio indicates heavy repayment obligations, which the
business is at pains to meet. The level of these ratios reflects
the result of business risk drivers and the funding policies.
Generally speaking, higher the level of coverage, higher is
the rating.
B. Operations Risk
In a competitive market, it is critical for any business unit
to control its costs at all levels. To measure the operational
efficiency, the turnover ratios and profitability ratios are used.
They measure how efficiently the firm is employing the
assets. They also represent the relationship between profit
and sales, and between profit and investment.
Net profit trend
The final profit figure arrived at after charging all the
expenses of the firm against all its income is called net profit.
A banker would look at the trend of net profit over the years.
A company, which has been consistently achieving positive
growth rates, reflects a healthy industry position and the
management’s commitment to the business, effective steps
taken by the management to promote their sales in the market.
The company with positive growth is favored than those
whose growth is static or negative.
Cash profit trend
Cash profit represents the annual profit arrived at before
charging depreciation. Cash profit is superior to net profit
due to the following reasons:
• Though depreciation charged to profit and loss
account, there is no actual outflow of cash
• Depreciation is the total cost of fixed assets annually
averaged over the life of the machine. Regarding
annual depreciation once again would amount to
double charging.
Fixed Assets Turnover Ratio
This ratio measures the sales per rupee of investment in
fixed assets or the efficiency with which fixed assets are
employed. A high ratio indicates a high degree of efficiency
in asset utilization and a low ratio reflects inefficient use of
assets.
Total Assets Turnover Ratio
This takes the total view of the business as a producing unit.
It determines the produce ability of the assets of the business,
which also indicates the managerial capacity of the
entrepreneur in putting the assets to best use.
Return on Investments
The ROI is the key factor of profitability of a business. It
matches the operating profit with the assets, which earn this
profit. Efficient utilization of assets will have a relatively
high return, while a less efficient use will have a low return.
Higher profitability implies greater cushion to debt holders.
Free Assets to Total Assets
This ratio is critical to firms employing commercial
vehicles and construction equipments as it determines the
level of assets available to a banker in case of default. The
higher the ratio more secured the funding would be.
Revenue per KM/HR
Expected revenue generated on the financed vehicle will
form one of the criteria for assessing the viability. This will
show the banker whether the customer will be in a position to
repay the loan.
Operating Cost per KM/HR
The operating cost may be classified into fixed and
variable cost. Study under this classification helps in arriving
at the optimal level of utilization of the equipment. However,
the operating cost and revenue for the vehicle cannot be
measured in isolation. The profitability of the equipment is
what matters at the end of the day.
Fleet Strength
Fleet strength is the number of equipments/vehicles held
by the customer and gives an idea about the size of the
business. A lender generally looks at a small business with
high caution, as there are only few assets to turn to incase the
debts turn bad.
Work orders on Hand
The number of work orders that one has helps to check
how well the business is progressing. Generally, when the
business has many, steady work orders, it shows that they
have constant business. However, those customers who have
unsteady number of work orders need a close watch. It also
shows the trend of the business in the market.
C. Credit Risk
Credit risk is risk resulting from uncertainty in a counter
party’s willingness to meet his contractual obligations. The
business character of a borrower rests on traits as
trustworthiness and commitment.
Repayment track with others
The repayment track of the borrower with others
determines how well they have carried out their business in
the past years. A business with prompt payment has less
credit risks than those whose reputation is a question mark in
the market.
Resale value of the asset financed
The customers are generally divided into two categories,
namely ‘A’ and ‘B’. Category A represents equipments that
command high resale value and category B represents low
resale value equipments. In case of default on the part of
customers to repay the loan, the bankers will look to seize the
asset and realize the due amount from it. Thus, a category
represents a safer investment for the bankers.
Percentage funding to total cost
This helps us measure the level of financial commitment of
the borrower in the proposal. Lower ratio means more
contribution from the borrower and the risk on the banker’s
end is low.
Value and liquidity of collateral offered
As a driving note collateral must not drive lending
decisions. The best security of a lender is a thriving business
on which the appraisal should focus. Whenever, the bank is
forced to foreclose the collaterals, it demonstrates that the
lending decision in the first place had been unsound.
vehicles and construction equipments as it determines the
level of assets available to a banker in case of default. The
higher the ratio more secured the funding would be.
Revenue per KM/HR
Expected revenue generated on the financed vehicle will
form one of the criteria for assessing the viability. This will
show the banker whether the customer will be in a position to
repay the loan.
Operating Cost per KM/HR
The operating cost may be classified into fixed and
variable cost. Study under this classification helps in arriving
at the optimal level of utilization of the equipment. However,
the operating cost and revenue for the vehicle cannot be
measured in isolation. The profitability of the equipment is
what matters at the end of the day.
Fleet Strength
Fleet strength is the number of equipments/vehicles held
by the customer and gives an idea about the size of the
business. A lender generally looks at a small business with
high caution, as there are only few assets to turn to incase the
debts turn bad.
Work orders on Hand
The number of work orders that one has helps to check
how well the business is progressing. Generally, when the
business has many, steady work orders, it shows that they
have constant business. However, those customers who have
unsteady number of work orders need a close watch. It also
shows the trend of the business in the market.
C. Credit Risk
Credit risk is risk resulting from uncertainty in a counter
party’s willingness to meet his contractual obligations. The
business character of a borrower rests on traits as
trustworthiness and commitment.
Repayment track with others
The repayment track of the borrower with others
determines how well they have carried out their business in
the past years. A business with prompt payment has less
credit risks than those whose reputation is a question mark in
the market.
Resale value of the asset financed
The customers are generally divided into two categories,
namely ‘A’ and ‘B’. Category A represents equipments that
command high resale value and category B represents low
resale value equipments. In case of default on the part of
customers to repay the loan, the bankers will look to seize the
asset and realize the due amount from it. Thus, a category
represents a safer investment for the bankers.
Percentage funding to total cost
This helps us measure the level of financial commitment of
the borrower in the proposal. Lower ratio means more
contribution from the borrower and the risk on the banker’s
end is low.
Value and liquidity of collateral offered
As a driving note collateral must not drive lending
decisions. The best security of a lender is a thriving business
on which the appraisal should focus. Whenever, the bank is
forced to foreclose the collaterals, it demonstrates that the
lending decision in the first place had been unsound.
The demand for collaterals as a condition for a loan is a
sufficient indication that the borrower lacks the required level
of credit worthiness. Collaterals enhance the credit
worthiness of a borrower. The test of good collateral lies in
its ‘liquidity’, which, in other words means the saleability of
the assets. The higher the liquidity is, the better the
collaterals.
Timely submission of information
The customers are required to be prompt in submission of
information. A delay in such submission is highly likely to be
caused because of tampering of information. This reflects to a
great extent the credibility of the customer. Thus, customers
who are always regular in submitting the information score
over those who have an irregular track for submission.
D. Market Risk
The factors influencing the relative competitive position of
the customer are examined in detail. Some of these factors
include nature of business, reputation of promoters, influence
of business cycle, influence of government policies and
technology status. The result of these factors is reflected in
the ability of the issuer to maintain or improve its market
share. It may be mentioned that the customers, whose market
share is declining, generally do not get favorable long-term
ratings.
Nature of the Business
The kind of business in which the customer is in will
greatly influence the risk associated with him. It might be
against the policies of the company to advance loans to a few
businesses, like in the case of CBL, advancing of loan to cab
drivers is not entertained. Thus, the preferred businesses
might have been realized from experience or observation.
Net Worth to Netsales
The net worth of a business provides that important
cushion to withstand shocks from adverse changes in
external (economic, financial and legal) and internal
environments of the business. Net worth is thus referred to as
the risk capital. When compared to the sales of the business,
it shows the efficiency with which the capital is rotated in the
business.
Reputation of Promoters
The promoters are the ones who initiate a business idea
successfully. The background of the promoters gives an idea
of their business expertise and their talents. A promoter
hailing from a highly reputed business family is less likely to
fool the public. A person hailing from a business family,
whose reputation is not established or suspect, is to be looked
at with caution, as the probability of default is high.
Technology Status
Obsolescence is another problem that an industry faces. A
firm’s competitive position is decided based on the
technological competence it possesses. Advances in
technology can dramatically alter a firm’s landscape.
The firm is at an advantageous position when it holds
superior technology. The risk is more among the players in
the industry when the technological competence is inferior.
The risk of not keeping up with the progress of changing
technology may affect the growth. Hence a firm with a good
technological background is more attractive.
Effect of Business Cycle
sufficient indication that the borrower lacks the required level
of credit worthiness. Collaterals enhance the credit
worthiness of a borrower. The test of good collateral lies in
its ‘liquidity’, which, in other words means the saleability of
the assets. The higher the liquidity is, the better the
collaterals.
Timely submission of information
The customers are required to be prompt in submission of
information. A delay in such submission is highly likely to be
caused because of tampering of information. This reflects to a
great extent the credibility of the customer. Thus, customers
who are always regular in submitting the information score
over those who have an irregular track for submission.
D. Market Risk
The factors influencing the relative competitive position of
the customer are examined in detail. Some of these factors
include nature of business, reputation of promoters, influence
of business cycle, influence of government policies and
technology status. The result of these factors is reflected in
the ability of the issuer to maintain or improve its market
share. It may be mentioned that the customers, whose market
share is declining, generally do not get favorable long-term
ratings.
Nature of the Business
The kind of business in which the customer is in will
greatly influence the risk associated with him. It might be
against the policies of the company to advance loans to a few
businesses, like in the case of CBL, advancing of loan to cab
drivers is not entertained. Thus, the preferred businesses
might have been realized from experience or observation.
Net Worth to Netsales
The net worth of a business provides that important
cushion to withstand shocks from adverse changes in
external (economic, financial and legal) and internal
environments of the business. Net worth is thus referred to as
the risk capital. When compared to the sales of the business,
it shows the efficiency with which the capital is rotated in the
business.
Reputation of Promoters
The promoters are the ones who initiate a business idea
successfully. The background of the promoters gives an idea
of their business expertise and their talents. A promoter
hailing from a highly reputed business family is less likely to
fool the public. A person hailing from a business family,
whose reputation is not established or suspect, is to be looked
at with caution, as the probability of default is high.
Technology Status
Obsolescence is another problem that an industry faces. A
firm’s competitive position is decided based on the
technological competence it possesses. Advances in
technology can dramatically alter a firm’s landscape.
The firm is at an advantageous position when it holds
superior technology. The risk is more among the players in
the industry when the technological competence is inferior.
The risk of not keeping up with the progress of changing
technology may affect the growth. Hence a firm with a good
technological background is more attractive.
Effect of Business Cycle
Almost every industry suffers from some amount of
cyclical fluctuations. At the downturn of a cycle, credits may
be frozen, while in its upswing, there may be excessive
fluctuations of loan volumes. It is important for a banker to
know on which side of the cycle a borrowing unit is operating
to adjust to the credit needs of the borrower and the riskiness
of his fund.
A business which is least impacted by the business cycle
would be an ideal borrower. As the impact decreases the risk
also declines.
Government Policies
The pace and pattern of growth in a country depends
largely on various policies of the Government. It acts as a
regulator and a mediator between the businessmen and the
public. When the government policies are friendly and
favorable towards the industry, then the growth prospects are
high.
Provision of incentives such as export subsidy, cash
incentives, duty drawbacks, excise relief, credit at concession
rates helps an industry grow. On the contrary, absence of
such positive policies or a very stiff taxation policy may
create obstacles to the growth of that industry.
cyclical fluctuations. At the downturn of a cycle, credits may
be frozen, while in its upswing, there may be excessive
fluctuations of loan volumes. It is important for a banker to
know on which side of the cycle a borrowing unit is operating
to adjust to the credit needs of the borrower and the riskiness
of his fund.
A business which is least impacted by the business cycle
would be an ideal borrower. As the impact decreases the risk
also declines.
Government Policies
The pace and pattern of growth in a country depends
largely on various policies of the Government. It acts as a
regulator and a mediator between the businessmen and the
public. When the government policies are friendly and
favorable towards the industry, then the growth prospects are
high.
Provision of incentives such as export subsidy, cash
incentives, duty drawbacks, excise relief, credit at concession
rates helps an industry grow. On the contrary, absence of
such positive policies or a very stiff taxation policy may
create obstacles to the growth of that industry.
It had Rs 230 book value, 6 percent yield, 4 times earnings, growing at 20 percent for the last ten years, available at Rs 105
Read more at: http://www.moneycontrol.com/news/market-outlook/dhfl-lupin-buys-equal-meeting-aishwarya-rai-jhunjhunwala_1325914.html?utm_source=ref_article
Read more at: http://www.moneycontrol.com/news/market-outlook/dhfl-lupin-buys-equal-meeting-aishwarya-rai-jhunjhunwala_1325914.html?utm_source=ref_article
It had Rs 230 book value, 6 percent yield, 4 times earnings, growing at 20 percent for the last ten years, available at Rs 105
Read more at: http://www.moneycontrol.com/news/market-outlook/dhfl-lupin-buys-equal-meeting-aishwarya-rai-jhunjhunwala_1325914.html?utm_source=ref_article
Read more at: http://www.moneycontrol.com/news/market-outlook/dhfl-lupin-buys-equal-meeting-aishwarya-rai-jhunjhunwala_1325914.html?utm_source=ref_article
Risk Assesment is very useful for intraday traders
ReplyDelete