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Conference on SMEs financial
inclusion
Guarantee schemes as Credit Risk
Mitigation:
a demanding opportunity
Cairo, Egypt
May11th 2016
Jean-Louis Leloir
Special Expert to the Board of Directors
Basel 2and 3 : Challenge and opportunity .
Guarantee schemes, have now a direct effect on enabling banks to reduce
their capital requirements and improve the risk rate of the guaranteed
part.
•
The BaselBasel 2 and 3 rules, aiming at creating more discipline and
stability in the financial sector are now impacting banks and financial
intermediaries;
•
The rules attend mostly the objectives of allowing a better knowledge
on the nature and weighting of all possible risks faced by lenders, and
provide stronger equity resources in order to face them.
•
Considering the trade of the guarantee business, specializing in covering
SME risks, the consequences of Basel rules can be seen in two different
aspects:
•
as an opportunity, but of what possible effect?
•
as a demanding but indispensable constraint, which will increase the
risk management skills of guarantee organizations.
The new fact: guarantee schemes are recognized as a tool enabling banks
to reduce their capital requirements and improve the risk rate of the
guaranteed part.
•
The Basel 3 brings several constraints to banks…
•
Increased capital requirements (4,5 % in core tier one, plus a
security cushion of 2,5 %, together making the „common equity“) ,
and a
•
higher solvability ratio (10,5 % objective).
A Risk based capital ratio, and Liquidity Coverage Ratio : defining
permanent resources needed to cover weighted assets; loans to
SMEs are weighted at 100 % (contrary to mortgage loans, which are
weighted in the bracket 65- 85 %)
•
And an opportunity for guarantors : from the “Substitution approach”:
Generally allows a banking organization to substitute the risk weight of
the protection provider for the risk weight ordinarily assigned to the
exposure, provided certain conditions are satisfied.
Consequently, several factors create more importance for the presence of
guarantors
•
An obligation for banks to obtain better risk coverage for ist
loans, by some form of guarantee: unguaranteed loans are assets
wheithed at 100 %, guaranteed loans are weighted at 50%.
•
The traditional unsufficiency of assets, for most SMEs, make
them unable to provide the required guarantees, is favorable to a
greater use of loan guarantee schemes.
•
The present low (or negative) interest rates reduce banks
proceeds, and makes their profits more sensitive to risk cost.
•
The attitude of banks since the global crisis remains strongly risk
adverse, increased selection of possible borrowers, not in favor of
SMEs : the presence of guarantors, when helping to improve risks
selection is quite welcome..
• Does Basel impacts on guarantors‘ volume of business ?
•
This may vary from one Institution to the other :
•
It depends whether the guarantee scheme is officialy giving,
according to the Central Bank, or another regulatory authority,
a valid coverage, weighted at 100 % of the covered risk.
•
The covered risk is taken off the banks liabilities, for the
computation of their capital adequacy ratio.
•
•
Not all guarantee companies can offer such advantage
The impact of Basel 3 also depends on other factors:
•
Banks equity constraints, according to its existing financial profile
•
Banks‘ stategic and commercial objectives concerning SMEs (a
volontary policy to grow SME clientele will be a motive).
•
The potential maximum risk volume that could be covered by the
guarantee actor for each bank.
• The importance of the “guarantee appeal” varies between different banks
•
Banks attitude depends on their type, and the part of risks shared with
guarantors can be extremely different:
•
Best target banks for guarantors are the Smaller , regional , and so called
popular banks (for VSME and craftsmen).
•
Large banks have other commercial objectives. They deal with most of the
market of Corporate and large firms, for risks size too high for most
guarantors.
•
The amount of risks covered by guarantors is a small part of banks risks on
SMEs.
•
Even in a country with a successful LGS, like in France, the outstanding risk
covered by the guarantee actors represents 8,5 % of the amount of
outstanding SME medium and long term bank loans (source OECD
SCOREBOARD 2014).
•
Consequently, reduction of capital requirements is not in itself sufficient
to modify the attitude of banks towards SME financing, and particularly
for the major actors.
•
For guarantors, development business with large banks must come from a
convincing quality image of their risk assessment.
•
A better risk selection obtained from a dual decision (banker’s plus
guarantor’s) operates risk mitigation, by a reduction of default probability in
the portfolio of guaranteed loans.
•
This feeling must be perceived obviously at branch level by local banks
managers, who can be the strongest advocates for using guarantors.
•
At head office level, banks should convinced of an efficient risk mitigation
value of the partnership, through a convincing, statistics based message.
•
This brings importance to the definition of the guarantee offer, and to the
quality factor for all operational rules, organization and processes of any
guarantee company.
Examples in Europe of the value of operational success on the relation with
banks and financial intermediaries
.
•
The French public guarantee scheme
•
It is managed by Bpifrance, which is not a Government Sponsored Entity, but
now a bank, rated AA .
•
But it does not satisfy usual conditions to be considered as a “pure” guarantee
(the guarantee should be unconditional, immediate -at first demand - and
irrevocable); the last two conditions are not met.
•
Still, it covers yearly some 8 billion of financing, on some 70 000
guarantees.
•
What explains the success ?
•
Emphasis on assisting the high risk projects (start ups, innovative SMEs,,
rapid growth “gazels”, immaterial investments, equity investments in risk
capital), with a high guarantee quota.
•
•
image of know-how and skill on assessing these types of projects
A well established feeling of confidence in payments amongst partner
banks
Other examples in Europe, showing the value of operational consequences on the
relation with banks
.
•
The Italian Confidis, have an essential role local small mutual (so privately
owned) financial entities), are backed by a strong structuring of regional,
professional and national counter guarantees.
•
They are currently restructuring, creating two level of entities, the 25 larger being
regulated by the Central Bank, and the smaller, confined in attending only local
VSMEs.
•
The Portugal has mutual guarantee companies working under the umbrella of
SPGM, a national level entity managing public a counter guarantee scheme.
•
The German “Guarantee banks”, regionally based (Lander), are heritage of trade
corporations, are also very efficient through a strong “regional development
philosophy”, a high skill level and excellent ground connections with the banking
sector.
From the observation on existing experiences,
how should any guarantee schemes manage risk coverage issues to ensure
commitment to its liabilities?
Basel 2 and 3 rules do impact guarantors themselves.
•
They have to satisfy rules and conditions to become well rated, and to be able to
play a true role in accompanying banks in an increase of their lending to SMEs.
•
From the same quality process, the guarantee company builds ist image of
useful safeguard partner for the banks.
•
Three main aspects have to be attended to:
•
A clear Vision on the risk policy :
•
Its consequences in the Action of the guarantor :
•
An efficient risk Measurement and visibility :
Vision
•
Define a Risk policy: in accordance with:
•
•
Existing resources (funds)
•
According to their availability and whether tey are expendable, or not
•
The net income, in the busines model, allocated to risk covering
Aptitude to master the risk analysis factor :
•
staff quality (skills adapted to the kind of projects and type of
financing) and size (network)
•
technical maturity of financial intermediaries (banks)
•
Aptitude to get proper visibility on borrowers, through processes
and proximity (relationship withbusiness environment
•
The expectations and potential demand of banks
•
The (KYC)2
Action
•
Set the risk policy
•
Express it in precise terms, detailing on clientele segments, partners, types
of financing guaranteed
•
Fully communicate internally, through reference manuals, getting beyond the
oral culture, still too much in use.
•
Use a risk rating instrument, in order to assess risk weighted liabilities
•
allowing visibility on individual risks, on their viability (PD) and the risk coverage
by traditional guarantees (LGD)
•
•
Setting a common risk measurement,
•
Bringing a common attitude in decisions
Organize adequate permanent control on operations
•
•
on the credit risk and on the operational risk
Integrate a process of permanent adaptation of management decisions,
•
reacting to alerts, to stop issuing new guarantees on categories if necessary, or
to modify the decision making process
•
Build up staff capacity, in a structured way (documented, and in training)
Measurement :
•
Measurement :
•
A Risk Management Department must man this topic, distinct from
production departments
•
It must set up accurate reporting on production flow
•
quantitative and qualitative
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At regular and frequent intervals
•
With a permanent screening and interpretation by the top
management
•
The company must develop predictive models and simulation
instruments, in order to check respect of all regulatory ratios, avoid
liquidity risk.
Role of counter-guarantee and co-guarantee and other risk coverage issues.
•
An indispensable element of the guarantee chain
•
Guarantee institutions can be great actors for their technicality, but also can
be dwarfed by their financial size (frequent problem, either through limited
mutual resources, constrained equity base or public budget limits).
•
A counter- guarantee or co-guarantee can create a leverage effect
•
Differences: counter guarantee is usually on a portfolio, (agreement based)
leaving management of decisions to the guarantee company.
•
co guarantee frequently means two decisions, and so case by case;
sometimes the guarantor can provide a service on decision making process,
and risk management.
•
Both forms are used to provide important support to the guarantee
profession from Donors
Role of rating agencies in the guarantee industry and how this role could
enrich the guarantee industry as well as their experiences
•
Rating is concentrated on non- public guarantee companies
•
Guarantors depending totally on national public support should
normally be rated at the same level than the State
•
But aspects of governance and political interference in their activity
can alter the quality of their undersigning
•
The viability of „non public guarantors“ is usually more scrutinized by their
partner banks
•
A rating can strongly influence the attitude of banks
•
Examples:
•
The direct guarantees provided directly by EIB group to banks in
Europe create a strong appeal for their use
•
As a complement) to rating, regulation of guarantors by Central Banks
can provide similar appeal
•
Example: the Italian Confidis
Conclusion
•
The Opportunity of basel 2 and 3 for guarantee companies:
•
SME representatives and governments are concerned about the
attitude of the banking sector attending the needs of SMEs.
•
SMEs are more and more challenged in the present global economic
situations, and still hold the key to more employment and GDP growth.
•
The opportunity is great, as available donors‘ resources are willing to be
offered to guarantors playing a dynamic role in stirring banks towards lending
more to SMEs.
•
Still, Basel 2 and 3 create a demanding challenge for guarantee
institutions to adapt internal organization, processes, and risk
management.
•
They must get to the technical and operational level needed for a good
rating,
•
But also convince partners of the rightful adaptation of their offer
and processes to cover market gaps, for categories of borrowers and
projects that fit the banks objectives.