Credit Risk Practices for Business Banking I

Question 1

What areas need to be examined to carry out an analysis and assessment in a risk management strategy?

Answer 1

• Market or industry risk assessment - inc. cost structure, industry maturity etc.
• Business risk assessment - inc. general characteristics and goals, product market match etc.
• Financial risk assessment - inc. operational risk, audit risk etc.
• Documentaion and pricing for risk - inc. insurance/collateral

Question 2

The industry that a business operates in is classified by what?

Answer 2

Standard Industries Code (SIC)

by the UK Standard Industrial Classification of Economic Activities

Question 3

What are the degrees of risk?

Answer 3

1. Low risks which perhaps we do not require to mitigate
2. Moderate risks which should be mitigated
3. Higher risks which must be mitigated otherwise the probability of loss is too great

Once all the risks have been found they should be compared to the rest of the market

Question 4

What are Porter’s 5 forces?

Answer 4

1. Degree of Rivalry
2. Threat of Substitutes
3. Buyer Power
4. Supplier Power
5. Barriers to Entry

Question 5

What are the market/industry risks?

Answer 5

1. Economic condition
2. Scale of seasonality
3. Industry cycle compariative to economy
4. Industry profitability
5. Industry status
6. Degree of overcapicity in the market
7. Cost structure
8. Barriers to exit
9. Strength of domestic competition
10. Strength of foriegn competition
11. Sales - customer/industry concentrated
12. Threat of substitutes
13. Bargaining power of buyers
14. Bargaining power of suppliers
15. Barriers to Entry
16. Degree of outside regulation

Question 6

What risks are associated to Economic Condition?

Answer 6

• Low risk - stable or slow growth in the economy
• Moderate risk - rapid growth or moderate levels of inflation in the economy
• High risk - a downturn in economic activity is evidenced by 2 or more consequtive quarterly declines in gross domestice products (GDP) or other key indicators, such as high unemployment rates or high rates of inflation

Question 7

What risks are associated to Scale of Seasonality?

Answer 7

• Low risk - the majority of earning are generated evenly during a 12 month trading period
• Moderate risk - income in 1 quarter may be generally higher than in any of the 3 remaining quarters in a 12 month trading period
• High risk- income in one quarter accounts for more than 50% of the total income for a year during a trading year

Question 8

What risks are associated to Industry Cycle Comparative to Economy?

Answer 8

• Low risk - the industry cycle is unaffected by what is happening in the economy and can therefore be regarded as indpendent
• Moderate risk - the industry cycle moves in a converse pattern to that of the economy and is therefore regarded as counter-cyclical
• High risk - the industry cycle moves parallel with that of the economy (concurrent); or the industry cycle preceded economic recovery or slowdown (leading); or the industry cycle follows with a time gap any economic recovery or slowdown (lagging)

Question 9

What risks are associated to Industry Profitability?

Answer 9

• Low risk - typically, net margin (NM%) will be low and profitability moves very little during economic downturns
• Moderate risk - typically NM% will be stable and will suffer a moderate reduction in profitability in economic downturns
• HIgh risk - typically, profitability will be high during expansionary period and loss making during economic downturns. NM% will fluctuate dramatically

Question 10

What risks are associated to Industry Product Cycle?

Answer 10

• Low risk - products or services are fairly standard; there is a degree of oversupply in the market; real prices are falling, and lower profits are being seen. The industry is generally considered to be mature
• Moderate risk - the market for the products or services continues to grow and improvements to design are necessary i.e. maturing
• High risk - emering businesses will have been recently established as a result of demand changes for products and services in their markets. Declining business is characterised by mass produced products or services, lowering prices and profitability

Question 11

What risks are associated to Degree for over capacity in the market?

Answer 11

• Low risk - this is characterised by a minor overcapacity of demand in the market. It is displaying demand that is exceeding the supplies availabe for the industry’s products
• Moderate risk - demand and supply and production are balanced
• High risk - there is significant over-capacity in the industry and demand from consumers is not keeping up with what the industry is producing

Question 12

What risks are associated to Cost Structure?

Answer 12

• Low risk - more variable costs
• Moderate risk - balanced variable and fixed costs
• High risk - more fixed costs than variable costs

Question 13

What risks are associated to Barriers to Exit?

Answer 13

• Low risk - assets can be easily liquidated or the business can be sold within a short space of time
• Moderate risk - due to the specialised nature of the businesses assets, a buyer of the assets or the entire business would probably be a player already active in the industry; or there could be political influences that restrict realisation of the assets/business
• High risk- significant high costs of realising the assets of the business exists; there could be union arrangements in place regarding redundancy or closure terms; strategic alliances with other businesses may prevent exit due to the penalties that would require to be paid, or simply because all the other players in the market are in a similar situation and there is lack of willing buyers

Question 14

What risks are associated to Strength of Domestic Competition?

Answer 14

• Low risk - the business is part of an oligopoly or monopoly
• Moderate risk - as a result of brand loyalty, the business is minimally threatened by competitors who produce similar products
• High risk- the business has a product which is standard, readily available elsewhere and is subject to product substitution; or the loss of market share is a constant worry. Domestic competition is considered substantial

Question 15

What risks are associated to strength of foreign competition?

Answer 15

• Low risk - as the industry or its products are new, foreign imports are not a danger yet
• Moderate risk - due to customer demand, there is insufficient volume to keep pace with this need domestically and this allows competitively priced foreign imports to enter the home supply chain
• High risk - the business has a product which is standard and is readily available from over seas competitors at a cheaper price

Question 16

What risks are associated to sales - customer/industry concentrated?

Answer 16

• Low risk - sales are well spread to many customers accross many markets or industries
• Moderate risk - there are pockets of conecntration of sales to individual customers or markets/industries that make up more than say 25% of turnover
• High risk - sales concentrated on a few customers or market/industries that make up more than 50% of turnover

Question 17

What risks are associated to threat of substitutes?

Answer 17

• Low risk - the threat from subsititute products or servicces is insignificant, low or even remote, due to strong customer brand loyalty or the patents or licenses the company holds for its products
• Moderate risk - there are some substitutes available, but they have not made an impact on demand for existing company products due to their superior quality or brand loyalty or their reputation
• High risk - substitute products are wildly availabe from different industries and competition has created falling prices, or products of the smae or better quality can be obtained elsewhere and there is generally no brand loyalty

Question 18

What risks are associated to bargaining power of buyers?

Answer 18

• Low risk - consumers cannot influence the price of goods or services due to limited supply or the dearth of alternatives
• Moderate risks- consumers may be abe to influence selling price to a limited extent, but generally the businesses within the industry can control prices
• High risk - selling prices of products and services must be compeititve due to their general profiel and availability of alternatives

Question 19

What risks are associated to Bargaining Power of Suppliers?

Answer 19

• Low risk - suppliers have little or no ability to influence the price of goods or services due to availablitily of alternatives
• Moderate risk - suppliers can have some influence on the prices they charge the business for materials and suppliers
• High risk - suppliers have considerable influence over the prices of their goods or services due to limited supply or lack of alternatives

Question 20

What risks are associated to Barriers to entry?

Answer 20

• ​Low risk - start up costs are insignifacnt with merchandise not easily differentiated and this allows ease of entry into the market
• Modersate risk - some level of captial investement is needed and access to distribution channels is necessary before new entrant may begin making sales
• High risk - significant barriers exist beacuse of brand name loyalty, high capital investment requirements, or there is limited access to distribution channels and any of these makes entry into the industry diificult

Question 21

What risks are associated to degree of outside regulation?

Answer 21

• Low risk - there are few, if any, govn laws/regs affecting the industry. the industry could be self-regulated
• Moderate risk - there are some govn laws/regs affecting the industry. on the whole the industry is self-regulated
• High risk - the industry operates in an environment which is highly controlled by govn laws/regulators