|Topic:||Credit Risk Assessment for Cellular Services: A Conceptual Framework|
|Organisation:||The Indian Institute of Management, India|
The diversity of product types that cause credit risk and the variety of control options available for each product can make the control of operating credit risk seem unduly complicated. Here, Mr. Verma proposes a framework that aims at minimising risk exposure by establishing specific credit granting guidelines and practices. The primary concern is to maintain a balance between prudent risk management and an aggressive sales plan, which support targeted revenue goals.
The process for managing credit risk evolves gradually as operating businesses grow, and the pace of evolution should be determined by analysis of the trade-off between the costs and benefits of risk control. The diversity of product types that cause credit risk and the variety of control options available for each product can make the control of operating credit risk seem unduly complicated. In the context of operating credit risk, it includes the constant measurement of past and projected revenue flows associated with the customer and the product, and the continuous evaluation of customer credit-worthiness. This framework aims at minimising risk exposure by establishing specific credit granting guidelines and practices. The primary concern is to maintain a balance between prudent risk management and an aggressive sales plan, which support targeted revenue goals. Product Risk Profiles To determine the potential frequency and severity of the exposure it is important to assess the risk associated with each service. The product profiles are streamlined modular designs, which facilitate the comparison of risk levels between products as the risk dynamics change. The following elements need to be identified: Ÿ Credit Risk Description – it provides an assessment of the timing and mechanics of the credit exposure, legal and regulatory impacts and current market practices on the service offering. Ÿ Customer Risk Calculation – the operator should consider both the magnitude and duration of the credit exposure as well as factors that impact the likelihood of suffering a loss. Customer Approval Process The overall credit characteristics of the customer base need to be examined to determine the service offering and evaluate the credit risk of individual customers. Analyse Customer Base The review allows the operator to extensively analyse applicant characteristics across a wide variety of categories with reference to previously approved applications. The parameters for Credit Grade determination include: Ÿ amount and stability of income; Ÿ rental or home ownership; Ÿ length of time at current residence; Ÿ current financial commitments; Ÿ previous credit history. Applicants whose Credit Grade cannot be determined either due to conflicting data or lack of the above information are classified as ‘ungraded’ customers. In such cases the framework devised could be determined by product and exposure levels rather than driven by Credit Grades. The strength of the product-driven approach is that the business unit responsible for the service can often eliminate the need for customer credit approval because it has the option of building product features that limit risk. The two primary areas of concerns are with regard to those customers who have a poor credit quality rating and the ungraded customers whose credit quality is unknown. Credit Limits Credit Limits refer to the maximum outstanding balance allowed on an individual account at any time. The amount is determined as a percentage of the applicant’s annual income net of other financial commitments. The above figure can be further modified with reference to the following factors: Ÿ Expiration date ‘- the duration chosen by the operator would effect the extent of exposure to risk; Ÿ Minimum Payment – high minimum payments may lessen your risk potential because they reduce the time required for the cardholder to pay off an outstanding balance. The parameter chosen should be competitive with market offerings, provided the operator can contain ‘bad debt’ at an acceptable level. The initial credit limit determined is subject to further review and modification based on Usage Patterns and Payment History. Credit Risk Assessment The worksheet enables the operator to assess the aggregate credit risk it incurs across the customer base and helps determine the level of credit risk controls it needs for each of these services: Ÿ Potential Exposure – this section summarises the magnitude and duration of the total potential exposure and is composed of the following elements. o Determine Time Horizon – a time horizon is determined to evaluate exposure levels and are based on the frequency of the audit process. o Choice of Tariff Plan – the customer chooses the service package from the set of offerings available to him within his Credit Grade. o Evaluate Exposure Level –the exposure limits should be based on the customer’s Credit Grade or operating need, whichever is more restrictive. The credit risks should not be given limits higher than their operating needs for specific services. o Risk Reduction Techniques and Controls – the risk reduction process is triggered by finding an unacceptable level of credit risk and identifying additional measures that will be considered as candiates for implementation to reduce the risk exposure of the operator. o These include the application of techniques to reduce the probabili ty of loss, ranging from informal control, to periodic review, to interactive control. Ÿ Net Aggregate Exposure – the operator’s net exposure is calculated after considering the impact of risk reduction and risk controls currently in place. The key component of the risk-effective control is the business decision that balances the trade-off between the cost of increased risk-control with a reduced potential for financial loss. Subscriber Review Process The periodic credit review function establishes criteria for the regular screening of existing accounts for Credit Limit increases and Credit Grade appraisal. The review should include performance measures such as Subscriber Delinquency and Over-limit History. Subsequently, typical indicators have been identified which may be used for the purpose of detecting the frauds committed using mobile telephones. In order to provide an indication of likely ability of particular indicators to identify specific fraud, these indicators have been classified as: Ÿ Usage indicators related to the way in which a mobile telephone is used. Ÿ Payment history and default rate. The Payment history would be used to upgrade or degrade a customer’s Credit Grading while the Service Offerings would vary with the subscriber’s usage pattern. A change in the behaviour pattern of the mobile phone is the common characteristic in nearly all fraud scenarios. The system monitors behavioural patterns of the mobile phone comparing its most recent activities with a history of its usage. Criteria can then be derived to use as triggers that are activated when usage patterns of the mobile phone change significantly over a short period of time. Recommendations Product Improvements One way to moderate the impact of credit administration procedures on a sales oriented business is to change the thresholds for action – if the impact of the changes is tested and justified by a thorough analysis of the data. The operator could also consider bundling security and credit concerns together when designing new procedures and negotiating with customers. Pricing Strategy The credit risk framework can be understood along the lines of both product and customer specific risk components. A decision can then be made as to whether pricing should be uniform for all customers for a product, or whether customers should be categorised by risk and priced based upon the risk they contribute. The following aspects of risk funding need to be considered: Ÿ How much risk remains after implementing exposure reduction and risk control procedures; Ÿ The operational dependability of the efforts and an analysis of the likelihood of loss from the remaining exposure. The expenses should include the cost of capital necessary to support potential losses as well as the cost of operational systems and procedures necessary to control the risk. Risk-Based Pricing Framework Conventional pricing measures do not compensate for the credit risk, which the cellular operator incurs when offering the service. Customers that represent the greater credit risk to the bank should be willing to pay a premium to cover additional costs. The framework developed attempts to incorporate the credit risk as a feature of the tariff plans offered as part of the service offering. The following represent the services on offer by the cellular operator: Ÿ Telephony – Local/STD/ISD; Ÿ Roaming Services – National/International; Ÿ Value Added Services (VAS); Ÿ Activation period – Quick/Slow; Ÿ Policy decision – Waiver of Service Deposit. Nature of Credit Risk Of the above services that are provided to the subscriber it is interesting to analyse the telephony services independently. The local services differ from the Subscriber Trunk Dialling (STD) and International Subscriber Dialling (ISD) services in the following two respects: Ÿ Quantum of Risk – while the average local rates are priced at Rs.9 per minute the STD and ISD rates average to about Rs.25 and Rs.72 per minute; Ÿ Interconnect charges – there are two components to the rates paid by the subscriber. The airtime rates which are a function of the time slot in the day and are independent of the service being used, i.e. local, STD and ISD airtime rates are the same. The second component is the interconnect charges which are a necessary payment to the Department of Telecommunications (DoT) by the service provider and hence pose considerable credit risk. Service Deposits The cellular operators accept service deposits, before activating the service. The deposits serve a dual purpose. Firstly they act as a credit risk reduction instrument for the value of the deposits provided for each of the services – local, STD and ISD. Secondly, the deposits function as a cash flow measure where the service provider gains access to deposits at the outset of providing the service. The fixed service deposits suffer in two respects as a credit risk reduction instrument: Ÿ As the amount is not linked to usage the measure of credit risk protection falls over time during the billing cycle. Ÿ As within a Credit Grade the amount is fixed for all subscribers, the tariff plan does not cater to the individual requirements of customer clusters. As both the subscribers fall in the same Credit Grade, conventionally both of them would have to pay the same service deposit, as the cellular operator is subject to the same exposure from either of them. However the current system penalises Subscriber B whose STD usage is lower compared to that of Subscriber A. Hence tariff plans should be conceived so that they cater for the individual requirements of such a cluster of subscribers based on their usage needs. These modular service packages would be priced so that they incorporate the same level of risk for the cellular operator and simultaneously are tailored to the usage requirements of the customer. Conclusion The credit risk framework attempts to employ credit risk reduction and control instruments in the following forms: Ÿ Service deposits, which are linked to the Credit Grade of the customer and the range of services, which he accepts from the available set; Ÿ Pricing of the cellular services; Ÿ Landline rates existing in the country; Ÿ Cellular rates adopted in similar developing countries and adjusted for Purchasing Power Parity; Ÿ Airtime rates, which are adjusted for risk, based on the service offering, the usage of Own Network and the tariff plan; Ÿ Modular service offerings within the same Credit Grade. These tariff plans incorporate the same level of credit risk from the point of view of the cellular operator and are tailored to the usage needs of the subscriber; The measure of risk should be adjusted with respect to the proportion of calls being passed through the Own Network as compared to the DoT network. The credit risk and the usage volume would form important parameters in deciding on the option of leasing a line or establishing a network between two centres.