Improving risk rating methodology to support and foster MSME lending in Malawi

Heikens, Koen Joris (2010) Improving risk rating methodology to support and foster MSME lending in Malawi.

Abstract:Risk rating is the most important activity for a financial institution before disbursing a loan to a client. Risk rating methods for developed countries are widely spread, but for developing countries like Malawi no sufficient methodology is available. Within this study a search for applicable risk rating methods for Malawi was conducted. Main question of the research was: Which adjustments need to be made on a typical internal risk rating system in order to rate the risk of default of potential MSME clients in a Malawian context? An important fundamental idea for the principal, a commercial bank in Malawi, is the profitable basis which is necessary to unroll this lending activity. Commercial lending needs to be distinguished from lending activities at microfinance institutions which do have an established literature base. Using the three underlying sub questions a brief summary of the current study will be given. 1. What is a typical risk rating system? A typical risk rating system is an assessment of a firm‟s credit risk and expected repayment capacity. Typical risk rating systems consist of a client rating which assesses the characteristics of the borrower and a facility rating which assesses the characteristics of the credit facility. In terms of modification, the bank has far more influence on the credit facility than on the client. Consequently, the most important part of a risk rating is the client rating, because this gives an indication whether the potential client will be able to repay its facility or not. 2. How can client rating within a typical risk rating system be adjusted in order to make it applicable in Malawi from a theoretic perspective? To apply the steps of the existing RRS in Malawi the procedure needs to be adjusted or better defined. The first problem is that the financial assessment exists of very complicated calculations which are not applicable to assess MSMEs in Malawi. The most important qualifier for risk rating is the quality of the financial information of the applicant. Without proper financials no calculations can be made at all. If the firm has proper financial information, the weekly profit is a useful indicator. The weekly profit can be used to determine the amount of money the firm can repay in that period. The second adjustment is done with the entrepreneurial capacity, which will be assessed using: personality characteristics, skills and experience and education. The personality Improving risk rating methodology to support and foster MSME lending in Malawi Management Summary | iii characteristics assessment produces a profile of the entrepreneur based on several characteristics which can be compared with the norm profile of a successful entrepreneur. The entrepreneurial skills will show whether the entrepreneur has the necessary skills for running his firm. And the experience of an entrepreneur indicates how experienced he is with activities that need to be done during the growth cycle of a firm and gives an estimate of his quality. Together with the level of education this part of the client rating will show whether the entrepreneur is expected to become successful or not. The last item is the business‟ position within the industry, which shows the strength of the competitive position of the firm and whether this industry is one the financial institution favors. Together these 3 items will be the adjusted client rating as depicted in table 1. Step Activity Items Part 1 Financial Assessment & Quality Financial Information Quality of financial information Client Rating Profit margin Employment growth 2 Entrepreneurial Assessment Personality Characteristics Skills Experience & Education 3 Position within Industry Industry Selection Tier Assessment Table 1 - Adjusted client risk rating method 3. Is client rating applicable in Malawi and does it differentiate between strong and poor performing businesses? The results indicate that both financial and entrepreneurial assessment result in difficulties. The financial assessment is often impossible because of lack of proper financial records. If there is information the assessment can be made but the entrepreneurial assessment is only partly applicable. Both the test of personality characteristics and skills within the entrepreneurial assessment gave results which are not valid. The main reason seemed to be the fact that the respondents did not understood the questions because the questionnaires were developed for use in developed countries. Although the first two items did not work, the test of experience gave useful results. Some extra questions which are typically for the Malawian business culture have made this item very useful. The position within the industry proofed to be a good item which easily showed the strength of the market position of a firm. Altogether, the most critical point within the rating is the problem with the financial assessment, which is not caused by inconsistencies of the client rating, but by the poor financial records of the MSMEs. A reason tends to be the financial illiteracy of the entrepreneurs which is caused by the fact many business are started not because they like to become entrepreneur, but because it is the only way to earn money for living when a paid job cannot be obtained.
Item Type:Essay (Master)
First Merchant Bank, Blantyre, Malawi
Faculty:BMS: Behavioural, Management and Social Sciences
Subject:85 business administration, organizational science
Programme:Business Administration MSc (60644)
Link to this item:
Export this item as:BibTeX
HTML Citation
Reference Manager


Repository Staff Only: item control page