CHAPTER II THEORETICAL FOUNDATION

Transcription

1 CHAPTER II THEORETICAL FOUNDATION 2.1. Definition, Function, and Type of Credit According to Law No. 7 Year 1992 on Banking, credit definition is: "the provision of money or bills are similar, based on the consent agreement between the bank lending by other parties, which requires the parties to borrow to pay off their debts after a certain period with the amount of interest, compensation or profit sharing". Functions and benefits of credit For Business / Debtor As a source of capital to sustain or increase its business. Returns must be made timely, expected to be derived from business profits Provide business profits with additional capital and business development For Financial Institutions / Lenders Providing funds for public funds (deposits, savings, current accounts) in the form of credit to the business world. Giving profit from the difference between lending interest or other services Loan type based on duration and credit usage can be classified into three types, namely: Credit investment Credit medium / long term given to the (potential) borrowers to finance capital goods in the framework of the rehabilitation, modernization, expansion or establishment of new projects, such as for purchases of machinery, buildings and land for the factory, which is callable from the results of its operations with goods -capital goods financed Working Capital Loan (WCL) Working capital loans are given both in rupiah and foreign currency to meet working capital is depleted within one business cycle with a maximum term of one year and renewable. 1

2 Consumption Credit Short or long term loans that are given to (potential) borrowers to finance goods /consumption in the household scale, with the repayment from the monthly income of the debtor Credit Management Credit management is to control credit in order to run properly so it can provide benefits for both debtors and creditors. Three important things that must be considered in credit management are: The credit application must comply with the requirements (if the number of credits required will be burdened with excessive interest large enough) Use of credit in accordance with business development goals Credits earned maintained as good as possible so that the repayment schedule and repayment can be met Definition of Credit risk According to Workbook level 1 Global Association of Risk Professionals BSMR (2005: B.37), Credit risk is defined as the risk of losses associated with the possibility that counterparty will fail to meet its obligations when they fall due; in other words the risks that a borrower won t repay what is owed. Another addition of literature information from Indonesia book by Mahmud (2006: 191) also claimed that, Credit risk is a risk of loss that bank will suffer, as associated with the probability of default, which the counterparty is failed to pay their duties to the bank. In short term, credit risk is a risk of loss that the debtor cannot fulfill the loan of its creditor. 2

3 2.4. Credit Scoring Many literatures state that small business lending has a strong positive effect on bank profitability. But we find, in contrast with Kolari and Shin (2004), that lending to SMEs is riskier than to large corporate. As a consequence, it is demonstrated that banks should develop credit risk models specifically addressed to SMEs in order to minimize their expected and unexpected losses. Many banks and consulting companies already follow this practice of separating large corporate from small and medium sized companies when modeling credit risk. Charles B. Wendel and Matthew Harvey define credit scoring is a statistical technique that combines several financial characteristics to form a single score to assess a borrower s credit worthiness. Since experience has shown a strong link between the payment behavior of the business owner and that of the business, SME credit scores usually include financial characteristics from both the business and the business owner. Credit scoring model is used to identify credit risks and mitigating factors, evaluating borrower viability and growth potential, assessing entrepreneurial capabilities and resources, determining financing requirements and earnings for bank, monitoring loan performance risks in crisis situations, and structuring facilities based on credit score ratings Credit Scoring Model Framework Scoring systems utilize information relating to the traditional 5Cs of credit: (1) character (the willingness to repay debt), (2) capacity (the financial ability to repay debt), (3-4) capital and colral (possessions or equities from which payment might be made), and (5) conditions (reflecting the general economic environment, or special conditions applying to the borrower or the type of credit) (Savery 1977, Sparks 1979, Galitz 1983). However, those five main points to be considered in credit scoring will be divided more into several sub variables by considering several factors: Risk Scorecard on Borrower s Business Model Background and business Direction, goals and objectives Key business success factors 3

4 Risk Scorecard on Business Environment and Industry Business trends and developments Industry type, characteristics and risks Business cycle contractions Risk Scorecard on Business Ideas and Projects Business structure, system and process Suppliers and buyers support Viability and growth potential Risk Scorecard on Market Demand Market segments targeted Profile and size of market segment targeted Market share, trends and growth prospects Risk Scorecard on Business Competition Profile of competitors and market share Comparison of strengths and weaknesses Core competencies and competitive advantage Risk Scorecard on Business Strategy Market positioning competitiveness Strategy type and financial objectives Product, pricing, promotion and place tactics Future growth and exit strategies Risk Scorecard on Ownership and Management Entrepreneurial capabilities and resources Quality of shareholders and management team Past and present banking relationships performance Risk Scorecard on Business Model Financing Investment, financing, dividend and restructuring decisions Debt servicing capacity and financial returns Material adverse changes and solvency risks 4

5 2.6. Credit scoring of Bank Bukopin Credit scoring that Bank Bukopin applies covers two main parts: borrower grade (assessing financial capacity, financial report quality, quality and structure of the management, and business environment) and facility grade (assessing credit facility data, credit facility analysis, colral value sufficiency, third party guarantee, and facility and documentation). There is assigned weight for each sub variable which account for 100% in total for each part, resulting certain grade (such as AAA+, AA, BB-, or CC) in final for representing the final credit scoring of the particular debtor and be used as references whether to allow this application to the next process or not. These are the sample form of output of the system after all data has been recorded by the account officer (the variables are different for each business type and plafond level): Debtors name : Industry Sector : Proposal date : Branch office : Account Officer : Table 2.1. Borrower Grade Output Sample BORROWER GRADE STEP 1 : FINANCIAL CAPACITY Assessment : Debt ratio 20% 0.57 Profitability ratio 45% 1.35 Liquidity ratio 35% 0.9 Adjustment 2.82 RISK LEVEL AFTER STEP 1 BBB- Average STEP 2 : FINANCIAL INFORMATION QUALITY Assessment : Financial report quality 25% 2 Not audited, but completed with powerful note Accounting practice 15% 1 Very consistent during 5 years consecutively Average monthly account 45% 1 Good, it increases Mutasi Rekening activity 15% 1 Good, high turonver Adjustment 2 RISK LEVEL AFTER STEP 2 BBB Average STEP 3 : QUALITY AND MANAGEMENT STRUCTURE Assessment : Management : Experience, competency 20% 1 Highly experienced and competent (less than 15 years) in relevant field Reputation & Integrity 20% 2 Good there is negative sign but not significant (the last 3 years) Historical credit performance 5% 4 No information 5

6 with Bank Bukopin Historical credit performance with other Bank 5% 1 Good there is never unpaid credit installment Assessment : BUSINESS : Experience, competency 15% 1 Good has been in the business for 5 years and the business grows well. Reputation & Integrity 15% 1 Good the business is accepted well by the market Business prospect 20% 1 Adjustment 2 RISK LEVEL AFTER STEP 3 BBB+ STEP 4 : BUSINESS ENVIRONMENT Assessment : BUSINESS ENVIRONMENT : Government regulation 20% 2 Inaffected Business prospect 50% 1 Good the business grows and well developed Social and political factors 20% 1 No social and political problem Foreign currency exposure 10% 1 The company is not exposed by foreign currency Assessment : BUSINESS PROSPECT : Market share 20% 1 Powerful enough market share % Supplier concentration 40% 1 Low dependency on supplier, have many suppliers. Marketing area 20% 1 Province Product type 20% 1 Primary good and service Adjustment 2 RISK LEVEL AFTER STEP 4 A- Good CREDIT FACILITY (Facility number : 3) 1. Type : Committed (Working capital credit, Investment Credit) Usage : KMK Business development Credit period 1 year plafond/os : 800,000/795,000 Total plf / OS =.. FACILITY GRADE STEP 5 : CREDIT FACILITY ANALYSIS Assessment : Credit facility period 45% 2 Medium risk- intermediate credit period (1-3 years) Usage type 45% 2 medium ex : business capital Credit facility structure 10% 1 Funding facility structure is appropriate Adjustment 2 RISK LEVEL AFTER STEP 5 BBB+ Average STEP 6 : Colral sufficiency (No of colral : 1 ) Assessment : Colral I : 86.93% Colral type 2 Colral solid I : Land & building Colral claim power 1 Perfect Colral Coverage % Rp 2,359,400 Adjustment Total weighted Colral 86.94% Total Liquid colral 0% RISK LEVEL AFTER STEP 6 AA- strong 6

7 STEP 7 : Third party guarantor Assessment : Guarantor type 4 Other colral (Lol/Coc)/ no colral Guarantee coverage 0% Adjustment 4 Guarantor Borrower Grade NA RISK LEVEL AFTER STEP 7 AA- strong STEP 8 : Facility and documentation Assessment : Business legality 34% 1 Perfect Borrower legality 33% 1 Perfect Adjustment Colral legality 33% 1 Perfect RISK LEVEL AFTER STEP Excellent Facility Grade AA - strong Scale : 1 (very good) 5 (very bad) Passing Grade AA - Strong We will only occupy the variables only to match the real situation with the expected outcome of the research, but the weight stated above for each variable won t also be used. The decision to occupy the real valuation system applied by the bank is expected to result in a more applicable project s outcome for the bank. Loan category that Bank Bukopin set through its RMG system: Table 2.2. Debtor Business Category No Loan Category Note 1. > Rp 2.5 billion 2. Rp 500 million Rp 2.5 billion Merged into > Rp 500 million loan plafond due to limited amount of sample 3. < Rp 500 million 3.1. TRADE : Mini market, electrical appliances, house equipment, drugstore, optical, and material. Export Food and pharmacy distribution, other distribution Fuel & solar (SPBU) sanitary, ceramic, furniture, decoration, shoes, bag, batik, tenun, garment, bordir, souvenir/handcraft souvenir/handcraft Gold Electronic, car & motorcycle spare part, textile, cellular phone Vehicle (showroom)nm Coal, sand, gravel Merged into < Rp 500 million loan plafond due to limited amount of sample We will only take service and trade as the business category to be further analyzed, since both of them are having largest number of debtors to be processed. 7

8 3.2. SERVICE : Printing Radio FM Giving Birth clinic General clinic Contractor Autoshop Course Car and heavy equipment rental Land transportation 3.3. INDUSTRY : Food and beverages Handicraft, souvenir, furniture, bag, shoes, household equipment 3.4. LIVESTOCK 3.5. OTHERS 2.7. Collectability According Siamat (2005:358): "Non-Performing Loan or bad debts can be defined as a loan repayment difficulty as a result of deliberate action or due to external factors beyond control of the debtor". The loan is usually classified by bank based on its collectability. The five-category system classifies bank loans according to their inherent risks as "pass," "special mention," "substandard," "doubtful" and "loss", which is primarily based on the period that payments of principal and interest are overdue. Coll 1 : 0 Pass day Coll 2 : 1-3 Special months Coll 3 : 4 months Sub Coll 4: 5-6 Doubtful months Coll 5 : > 6 Loss months Figure 2.1. Collectability Category Table 2.3. Loan Collectability Level Loan Category Definition 1 (pass) debts that the borrower is able to pay the principal and interest for in a full and timely manner 2 (special-mention) debts that the borrower is able to pay the principal and interest for in full but there exists a sign of decreasing payment ability 3 (substandard) debts that the borrower is not able to pay the principal and interest for in a timely manner and some loss of principal and interest is possible 4 (doubtful) debts in relation to which the loss of principal and interest is highly probable 5 (loss) debts that are uncollectible 8

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