CCR Chapter 6.pdf

SE ) CHAPTER 6 (N O T FO P R RIN C T O A M B M LE ER C CO IA P L Y PU R PO THE CAMPARI CREDIT RISK ASSESSMENT FRAMEWORK 6-1 THE CAMPARI CREDIT RISK ASSESSMENT FRAMEWORK 6. THE CAMPARI CREDIT RISK ASSESSMENT FRAMEWORK Learning Outcome At the end of the chapter, you will be able to: ) A...

SE ) CHAPTER 6 (N O T FO P R RIN C T O A M B M LE ER C CO IA P L Y PU R PO THE CAMPARI CREDIT RISK ASSESSMENT FRAMEWORK 6-1 THE CAMPARI CREDIT RISK ASSESSMENT FRAMEWORK 6. THE CAMPARI CREDIT RISK ASSESSMENT FRAMEWORK Learning Outcome At the end of the chapter, you will be able to: ) Apply the CAMPARI credit risk assessment tool to evaluate consumer loan related FO P R RIN C T O A M B M LE ER C CO IA P L Y PU R PO Key Topics SE creditworthiness. In this chapter, you will be able to read about: The Consumer Lending Framework The CAMPARI Model Summary Assessment Criteria During the exam, you will be expected to: Demonstrate the application of the CAMPARI model when undertaking consumer related credit risk assessment. Distinguish the relevance of each component of the CAMPARI Model in evaluating consumer credit risk. O T 6.1 THE CONSUMER LENDING FRAMEWORK (N The CAMPARI model is an alternative to the 5C framework and helps to guide credit officers in assessing loan applications. The model is deemed most useful and relevant in assessing consumer loan applications. The CAMPARI model is a credit decision support tool based on risk acceptance criteria pre-approved by the bank. 6.2 THE CAMPARI MODEL CAMPARI is an acronym for: Character Amount Margin Insurance Ability Purpose Repayment Each component is important when evaluating consumer loan applications. CERTIFICATE IN CREDIT THE CAMPARI CREDIT RISK ASSESSMENT FRAMEWORK 6-2 6.2.1 Character The character of an individual borrower is among the most important requisites for the lender, yet it is difficult to measure precisely. The lending bank needs to determine whether the customer has the right attitude and responsibility to repay the proposed loan within the stipulated time. Even though a borrower may have the capacity to repay the loan, a poor attitude SE ) or poor sense of responsibility could prevent the loan from being properly serviced. FO P R RIN C T O A M B M LE ER C CO IA P L Y PU R PO For example, there is empirical evidence showing persons of high social status are unwilling to pay their loan instalments simply because of their social influence. The bank then faces the dilemma of preserving the relationship whilst trying to recover the loan. The factors normally considered in examining an individual’s character include: Past records of the applicant/borrower and credit history Stability and duration of employment or business Experience, qualification and employability Reputation, previous and/or impending legal actions Professional status, especially where the individual requires a license. 6.2.2 Ability The ability of a borrower to repay the loan depends directly on his or her income earning capacity, which, in turn, is dependent on employment, O T business activities, or investments such as properties and shares. Should the loan applicant have little or no employment prospects due to a (N lack of skills, serious illness, old age or some stigma, the ability to repay the loan is deemed low. Other important factors affecting income generating ability include sustainability of the applicant’s business, and job stability. For business loan applicants, the ability to repay a loan weakens when business conditions become unfavourable or if the business cannot operate successfully to generate enough cashflow to meet day-to-day requirements (e.g. operating expenses and loan instalments). Poor management or a change in government licensing requirements and regulations can diminish income and the ability to generate cashflow. CERTIFICATE IN CREDIT THE CAMPARI CREDIT RISK ASSESSMENT FRAMEWORK 6.2.3 Margin of Advance The margin of loan advanced relates to the percentage of financing that the lender is willing to extend. Lenders seldom grant 100% financing because the loan applicant must show financial commitment and a minimum capacity to take risk. ) A high margin of advance, e.g., 90% of the purchase price of an asset, would SE mean that the loan applicant has little at stake and thus has a higher FO P R RIN C T O A M B M LE ER C CO IA P L Y PU R PO propensity to ‘walk away’ from the loan obligation when conditions turn bad. Generally, granting a lower loan amount is more appropriate, as it increases commitment of the borrower. This requires the borrower to invest more in the business or asset to be purchased and reduces the risk of the borrower not being able to meet debt service obligations. Higher risk borrowers are typically offered a lower margin of financing. The agreed margin of advance is dependent on the overall credit risk profile of the borrower, which includes credit risk issues such as the: amount of capital the borrower contributes to partly finance the asset; overall financial position of the borrower; quality of collateral provided; and strength of the potential repayment capacity. 6.2.4 Purpose The Bank must be convinced of the loan’s purpose as stated in the application. In principle, the loan requested should be for a good cause, such as the O T acquisition of a family home or purchase of an asset. A loan should be productive, rather than a speculative one. In a speculative (N 6-3 loan there is little or no income generation and the loan repayment is uncertain. In consumer lending, the speculative element in asset acquisition is sometimes mitigated by the borrower’s individual earning capacity, instead of cashflow derived from the asset financed. This is illustrated in the following case: a dentist’s own clinic and business income are large enough to support a loan to purchase a home or expand the dental practice. This is an example of a productive loan. It would be a speculative proposition if a commissioned sales manager wished to borrow funds to purchase a large tract of land for future (as yet non-existent) agricultural business. CERTIFICATE IN CREDIT THE CAMPARI CREDIT RISK ASSESSMENT FRAMEWORK 6-4 6.2.5 Amount SE ) The amount of financing is evaluated based on the borrower’s need as well as the capacity to repay. The amount depends on the bank’s requirement for the borrower to show commitment towards the loan (principle of proportionate stake holding) and reduce risk for both the borrower and the bank. For example, a financing of 90% for the purchase of an asset should be justified in terms of risk and ability. FO P R RIN C T O A M B M LE ER C CO IA P L Y PU R PO It is possible for the borrower to request a loan amount greater than the requirements listed in the purpose of the loan, with adequate security. As an illustration, the borrower seeks a loan of RM250,000 and provides a security worth RM750,000. The loan indicated the purchase of a house for RM180,000. There is an extra RM70,000, which purpose is unknown. The credit officer should consider the discussion on “Purpose”, mentioned in section 6.2.4. 6.2.6 Repayment Structure The repayment of a loan can be structured in different ways to meet the borrower’s needs and debt servicing ability, as well as the bank’s requirement for risk reduction and loan safety. The repayment can be evaluated in terms of the following: Total length of time, i.e., tenor of the proposed loan The repayment amount for each loan instalment and the number of instalments The frequency of instalment payments, e.g., weekly, monthly or quarterly T 6.2.7 Insurance (N O In asset-based financing, the underlying asset often becomes the security for the lending bank. As the asset is important to support the loan and provides credit protection, the bank must ensure the security is maintained in a good state and continues to hold stable value. Asset damage and destruction by accident or fire or unforeseen events almost certainly reduces the collateral value. As a result, adequate insurance protection is a requirement. Adequate insurance should be evaluated in terms of: appropriate insurance risk coverage as to the types of risk, e.g. fire, accident or theft and presently additional risks emanating from ‘climate change’ phenomenon such as storms, floods and soil erosion; appropriate amount of insurance cover; reputation of the insurance company; and confirmation of insurance premium payments and annual renewal. CERTIFICATE IN CREDIT 6-5 THE CAMPARI CREDIT RISK ASSESSMENT FRAMEWORK SUMMARY In conclusion, the CAMPARI model is an alternative risk framework to evaluate a consumer loan application. While it is less complex than the 5Cs framework used for business lending, a thorough application of the model assures the lending bank of a portfolio of ) quality consumer loans. The credit officer must evaluate each element of the CAMPARI SE model to satisfaction and ensure the overall loan application additionally satisfies the FO P R RIN C T O A M B M LE ER C CO IA P L Y PU R PO bank’s consumer lending guidelines. PRACTICE QUESTIONS (INDICATIVE ANSWERS CAN BE FOUND IN THE TOPICS LISTED FOR THE RESPECTIVE QUESTIONS) 1. Explain the differences between the 5C framework and the CAMPARI model. (Chapter 5: 5.2.1 to 5.2.5 & Chapter 6: 6.2.1 to 6.2.7) 2. Describe each component of the CAMPARI model. (6.2.1 to 6.2.7) 3. Comment on the usefulness of the CAMPARI model for consumer loan assessment. (6.1 & 6.7) 4. Explain how the loan repayment structure of a consumer loan is determined. (6.2.6) KEY TERMS Margin of advance Asset-based financing Purpose of the loan O T Amount of financing Repayment of a loan (N debt servicing capacity CERTIFICATE IN CREDIT