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IBLF Improving financial literacy and responsible lending: the MDM experience Michelangelo Mazzarelli – Head of Strategy planning department Moscow, October, 17 2006 1 ©2006 MDM Bank – Strategic Planning Department Agenda ~ Agenda ~ Introduction Market situation MDM example Conclusion 2 ©2006 MDM Bank – Strategic Planning Department Introduction ~ Introduction ~ This presentation is covering only retail loans because companies are generally managed professionally and they are able to understand the credit market and the banking products in general and realize all the consequences of their actions in such field The retail customer instead, especially in a vastly under banked country like Russia where loans to individuals are a recent development of the economy, can often lack of the necessary knowledge to support correct decision making interacting with a financial institution As the deposit insurance scheme secured over 90% of the Russian deposits and investment in funds is not extremely popular, the area where we see more risk in the interaction with banks is lending Recently a share of bad loans in overall portfolio have been neglected because retail portfolio was growing extremely rapidly As bad loans emerge with a certain delay compared to the disbursement time the real situation may be worse 3 ©2006 MDM Bank – Strategic Planning Department Agenda ~ Agenda ~ Introduction Market situation & steps to avoid MDM example Conclusion 4 ©2006 MDM Bank – Strategic Planning Department Market situation & steps to avoid The overall strong growth of the Russian banking market is expected to continue although growth rates will slow ~ Introduction ~ Loans of the banking system has been rapidly increasing with the Retail segment (CAGR01-05 loans – 91%) ~ Retail loans volumes and growth ~ 60,00 State-owned banks are dominating the market due to cheap resources and increased competitiveness (~45% of loans) 111,52% 110,81% 56,50 106,51% 95,96% 50,00 100,00% 40,00 80,00% 30,00 42,13 50,19% 22,30 The interest margin is decreasing, prospectively giving greater meaning to non-interest income of banks 60,00% 25,52% 20,00 10,00 10,18 3,14 0,00% 2001 2002 2003 Retail loans 5 40,00% 20,00% 4,47 0,00 Distribution networks of competitors are widening making later penetration of the market more expensive 120,00% 2004 2005 2006H1 growth rate ©2006 MDM Bank – Strategic Planning Department Market situation & steps to avoid Fast growth of retail segment is driven by ‘target’ consumer loans (autoloans etc.) and increasing welfare of individuals. Still a slowdown is expected due to satiation of market ~ Retail loans share on the market ~ 13,27% 14,00% 12,00% 12,44% 10,00% 8,67% 8,00% 5,35% 6,00% 4,00% 3,00% 3,43% 6,47% 3,69% 2,00% 0,00% 5,67% 1,06% 1,31% 2001 2002 2,26% 2003 2004 % of GDP Источник: Анализ рыночных источников 6 2005 2006H1 % of BS ©2006 MDM Bank – Strategic Planning Department Market situation & steps to avoid Overdue loans have increased significantly both in relative and absolute measurement, in this case difficulties with loan repayment may cause negative impact on further growth ~ Overdue loans ~ 45 42,13 2,94% 40 3,00% 35 2,32% 2,44% 2,50% 30 28,06 25 10 2,00% 22,30 20 15 3,50% 1,84% 1,11% 1,50% 1,63% 1,34% 1,00% 10,18 0,50% 5 0 0,00% 2003 2004 Retail loans, bln. USD 2005H1 Bad loans vs. current portfolio 2005 Bad loans vs. previous portfolio Bad loans have reached 686 mln USD at the end of 2005. With an average loan of 2000 USD around 340.000 borrowers (families) have a problem of bad debt Источник: Анализ рыночных источников 7 ©2006 MDM Bank – Strategic Planning Department Market situation & steps to avoid In order to avoid situation with growing bad loans ratio Bank’s should follow certain rules ~ Steps to avoid ~ Do not oversell Properly inform the client Источник: Анализ рыночных источников Banks should establish a limit for how much credit they can give as opposed to the financial situation of the people (overall expense for credit service as opposed to the family total income minus reasonable living expenses) Banking offer should be understandable and transparent to the client – besides interest rate, each commission should be clearly stated on paper and the client should understand in advance how much he will really pay 8 ©2006 MDM Bank – Strategic Planning Department Market situation & steps to avoid Consumers are not reading carefully agreements while some fees and commissions are hidden inside them ~ Examples of not-proper behavior in Consumer lending (ex. # 1-2) ~ Practice Effect Russian financial institution Monthly payment for debt account management based on the % of outstanding loan amount 1,5% monthly for debt account servicing will bring to a yearly interest rate of 15,6% with annuity payments on top of the interest rate Moscow mortgage bank 3 % lump sum of the total outstanding debt for late payment of even one installment 3 % lump sum of the total outstanding debt on a mortgage of 200.000 USD is 6.000 USD Источник: Анализ рыночных источников 9 ©2006 MDM Bank – Strategic Planning Department Market situation & steps to avoid Consumers are not properly calculating the interest rates and compare rates with the annual ones ~ Examples of not-proper behavior in Consumer lending (ex. # 3) ~ Medium consumer lending bank Client takes 8,000 RUR for 4 months Pays every month 2,279 RUR Preliminary interest rate excluding additional commissions is 13,95% per 4 months or 41,85% per annum Источник: Анализ рыночных источников 10 ©2006 MDM Bank – Strategic Planning Department Agenda ~ Agenda ~ Introduction Market situation MDM example Conclusion 11 ©2006 MDM Bank – Strategic Planning Department MDM Example MDM Bank is working on transparent and understandable product offering for retail customers, close to foreign best practices ~ Examples of not-proper behavior in Consumer lending~ Some European regulations In most European countries the law obliges the banks to state the “total effective yearly interest rate” on the credit including all the commissions (TEYIR). Since the introduction of this rule, all fees were incorporated in the stated interest rate which converged with the TEYIR, while before large differences were recorded. MDM Bank practice MDM Bank has a comprehensive scoring system which allows to reject all applications not suitable for our portfolio Important condition is to respect low risk ratios between payments for the credit and family income We have no hidden fees: all conditions are clearly stated to the client and written in the main body of the contract. A detailed plan of repayments is handed out to the client and for each payment interest and body of the credit are stated Источник: Анализ рыночных источников 12 ©2006 MDM Bank – Strategic Planning Department Agenda ~ Agenda ~ Introduction Market situation MDM example Conclusion 13 ©2006 MDM Bank – Strategic Planning Department MDM Example ~ Conclusion ~ The regulatory environment in Russia does not require to show clearly the total effective yearly interest rate Russian consumers have little experience in borrowing and in financial product in general Therefore each bank is responsible of properly informing the client: • On the characteristics of the product he is purchasing • Of the risk he might take Responsible lending should be first a banks policy Источник: Анализ рыночных источников 14 ©2006 MDM Bank – Strategic Planning Department