DBK finances capital-intensive and complex projects where second-tier banks (STB) and other financial institutions do not go, how does DBK deal with credit risks?
If we talk about the process of risk management - any, not only credit, as we know it consists of 4 stages - identification, assessment, control and monitoring. In this part, the work with credit risk is no different from this classical understanding.
The main and basic difference between the process in DBK and STB probably is that credit risk management at the portfolio level, such as in retail lending or SME lending is almost impossible, because almost all projects differ in almost all parameters, between them there is no logical statistical correlation with some or other macroeconomic factors. Accordingly, the focus in credit risk management within DBK credit portfolio on compliance with all the same classical principles of credit risk management, but within each project, each individual counterparty.
If we talk about the stages of identification and assessment of credit risk, in this process I would highlight three main “kits” necessary to ensure financial stability of DBK: qualification of experts, quality of methodology and availability of clear procedures. In terms of experience and procedures in project analysis, DBK can be called a flagship, because now it has a fairly high level of competence and clear regulations.
Control and monitoring of credit risk is also ensured by the availability of necessary procedures in accordance with international best practices - control and monitoring of limits, establishment and observance of risk appetites, clear assignment of functions and responsibilities of the authorized bodies, ensuring post-control at all stages of a credit process. As well as objective monitoring of credit risk for each project - regulated procedures for regular on-site complex and quarterly monitoring, the availability of mechanisms to eliminate risks of unauthorized use, building an early warning system which allows early detection of any problems with clients.
Due to the Covid-19 pandemic, capital markets have become less accessible and new risks for the financial sector are emerging. Do you think they will invest in transitional markets such as Kazakhstan in the current and next years?
Usually, an investment strategy involves diversification, which implies a risk appetite for developing countries. This means that with increasing risks, including those due to the pandemic, it may reduce the amount of investment with a constant level of risk appetite. On the other hand, the methods of stimulating the economies of those countries that can invest in Kazakhstan, including a significant monetary expansion in the economy, which, accordingly, may lead to a revision of risk appetite for developing countries towards increase and subsequently to obtain greater returns on investment.
As a result, it is probably difficult to answer the question unambiguously, since the answer is related to modeling a situation where there are several factors with both plus and minuses.
DBK has faced crises in 2008 and 2013 during its 19 years of operation and has developed its effective risk management system, how will DBK adapt to new realities and consequences due to coronavirus?
DBK risk management system is constantly being improved, which allows to create an adequate response to any external challenges. Work is now underway to integrate the risk management system and achieve the strategic goals of DBK. Previously, the task on transition to risk management based on stress testing and forecasting in the horizon up to 1 year was implemented. Since the strategic goals of DBK are more long-term, we can say that we are gradually moving towards risk management, which is based on increasingly long-term information.
Continuous improvement of the risk culture level is also of great importance for the risk management system functioning. In this direction, work is being done to create training material for employees, and work is constantly being done to increase the information flow in terms of risks between all employees and the Bank's authorized bodies.
Not least important area is building an effective internal control system. In this area, a number of initiatives are currently being implemented that already allow to see some points of growth in terms of improving the efficiency of DBK control environment.
All these initiatives allow the Bank to identify and assess risks of the external environment in a timely manner and, accordingly, to create adequate and effective response measures to ensure achievement of its goals and objectives.
How has the Bank's work changed since the implementation of IFRS-9?
The topic of financial assets impairment gained ground during the financial crisis. The financial crisis of 2008 contributed to the development of a new system for international accounting of financial assets - the new International Financial Reporting Standard (IFRS 9) was developed. Taking into account the weaknesses of IFRS 39, the new standard fundamentally changed the approach of recognizing financial assets impairment.
The new approach offers a model of expected, rather than already incurred, losses. It also requires entities to recognize losses immediately upon initial recognition of financial assets and to review a created loss reserve on a regular basis. In revising the reserve, not only negative events that have occurred, but also current and future circumstances are taken to note.
Thus, after implementation of IFRS 9, it was concluded that adequate estimation of expected losses is very important when using the standard, forecasted information and risk analysis for individual financial tools come to the fore. In other words, IFRS 9 is not a strict set of clearly stated prescriptions (guidelines), but rather principles that DBK's risk managers and analysts interpret at their discretion based on the scope of the standard. Proceeding from this, it is logical that increased freedom of choice implies increased responsibility, which in turn affects the risk management and they come to the fore to determine in a timely manner the criteria for possible deterioration of counterparties' activity.
Understanding the importance and responsibility of the new approach, DBK has introduced a number of control procedures in its processes, which give an understanding for the authorized bodies of DBK what effect a particular transaction has on the financial condition of the bank. As an example, as part of the banking expertise, an assessment is made to determine the possible impact of a financing tool, including changes in financing conditions, on the bank's financial stability indicators.
President K. Tokayev in his speech at the State Commission meeting to ensure the emergency rule, spoke about DBK capitalization and the need to finance the manufacturing industry. In this regard, DBK may receive more applications. Is DBK ready for a greater flow of applications from the manufacturing business?
Probably, from the point of risk management, the main task in the readiness for the influx of applications will be to preserve the quality of expertise and project structuring. I hope that the built system will allow to consider a large volume of applications without loss of quality, but here, of course, the first place is taken by a package of documents developed by potential clients. Clients also need to understand that questions an expert has not received an answer to, for example, if a client has not yet thought about how and what he will implement in a project, affect the risk assessment of transaction, and this in turn may lead to a refusal in financing or worsen the conditions of financing for him, because lenders put risk-margin in the lending rate.
Is the issue of non-repayment risks or a later return on investment very important? How can DBK determine the success of a project at an early stage, because it is difficult to foresee all the risks at 100%?
If we talk about the tools that have already become standard and mandatory for DBK to review projects and “cut off” obviously problematic - it is a three-stage bank expertise, the use of consultants on technical part, marketing development, standardized requirements for business plan, clear procedures and distribution of responsibilities within the bank for each component, for each stage of bank expertise and availability of detailed methodology for each participant in the bank expertise. All these tools are the result of almost 20-year evolution of DBK as the main state operator in financing long-term and capital-intensive projects in the field of production infrastructure and manufacturing industry. Of course, most of the tools used by the bank in project analysis and credit risk assessment are borrowed from international practice (S&P in particular) and are based on the principles of the Basel Committee on banking supervision.
And since the economy, both global and local, is subject to constant changes, often unpredictable and far from cyclical, all these already developed tools and procedures are constantly being improved and updated, based on current realities, new international practices and constant changes in the external environment. This is a continuous process, in which both performers and management are always on the move towards improvement.
Since we mainly finance projects that are, to put it mildly, “unliftable” and not attractive to second-tier banks both in terms of payback periods and lack of sufficient liquid collateral, i.e. in terms of their profitability to creditors, here the mission of DBK, which in financing should ensure at least - break-even performance, is more about ensuring the minimization of risk, that an asset will become problematic. Most of our projects can be attributed to project financing, when only 30% of the loan is secured by hard collateral, and the rest is represented as an asset created under the project. We have well-established project and credit risk management tools which we have successfully implemented and are using in investment lending. Many of these tools have been used for the first time in banking practice in the country. In general, DBK quite often has to act as a “pioneer”, I think it corresponds to its mandate as a development institution. It is more correct to say that the task of DBK is not only to “cut off” a problematic project, but also to cut off the risk that the project will become problematic. And here it is more correct to proceed from understanding what an investment project is. An investment project is, after all, a project participant and a contract structure that correctly reflects the stages, tasks, obligations and responsibilities of each participant.
Therefore, the process of banking expertise is actually broader than just assessment and analysis, and contains the most important step - the structuring of transaction. At the same time, the main work on the banking expertise is not so much on working out the terms of the loan with the initiator, as on structuring the entire project and minimizing project risk. During the whole 20-year period the Bank has been constantly developing and improving its competence in structuring “long” projects with long payback periods, using its experience and international practice. Banking expertise in DBK is essentially the work of a project team, where the Bank's participants are involved in structuring contracts with suppliers and contractors, trying to minimize their risks to a potential client and bring the structure to international best practice, interact with local executive bodies, where their infrastructural involvement is important, and with other creditors. Standardized requirements for contracts concluded by potential clients with their key counterparties under projects (construction contracts, sales contracts) are built on FIDIC principles, and have already become a mandatory tool for external financial and technical monitoring of construction progress, stage-by-stage financing of projects as they pass certain “milestones” and stages, legal stipulation of shareholders' responsibility in project agreements with the Bank, interloan agreements with other financing parties, control over expenditure of funds by concluding agency agreements with second-tier banks both in the investment phase and operational phase.
What methodologies do you use in this direction? Not all projects are well assured, especially now. How do you see the quality of projects and their assurance?
In general, the bank uses S&P's methodology to assess credit risk of a project. As I mentioned earlier, one of the main distinctions of DBK is that the Bank accepts as collateral assets created within the investment project and which may amount to 70% of the total mass of collateral. At the same time, contracts under which the object is created are recommended to be structured on EPC terms (Engineering, procurement and construction), i.e. turnkey. It should be noted that the assets, receiving in the future may amount to 100% with guaranteed cash flows under project financing and PPP projects, in particular compensation of capital outlay.
Considering the above, DBK works more to ensure a good level of project maturity, proper structuring (minimization of risks through project structure and transactions) and early prevention of negative factors during project implementation.
