6

Chapter I: Theoretical aspects regarding the credit portfolio of a commercial bank

1.1 Principles of credit activity management

All decisions regarding the credit activity process are based on the following principles: Compliance of legal requirements Safety Liquidity assurance Profitability 1.1.1 Compliance of legal requirements Compliance of legal requirements means performing the credit activity in the legal framework provided by the legislation of the country in which the commercial bank performs its activity. In the Republic of Moldova the following requirements regarding the credit activity are set: The net exposure undertaken by the bank vis--vis one person or a group of people actioning together must not exceed 25% from its Total Required Capital Maintaining the capital sufficiency coefficient at the required level of 12% The participation of a bank to the social capital of a non-financial institution must not exceed the stipulated level of 15% form the banks Total Required Capital The volume of credits launched to affiliated persons must not exceed the level of 20% form the banks Total Required Capital Banks must hold capital against 8% of their assets after adjusting their assets for risk, according to the first pillar of Basel II Banks must follow market discipline which is based on enhanced disclosure of risk, according to the second pillar of Basel II

Based on the restrictions imposed by the legislation as well as by the National Bank and taking into consideration the economical conjuncture and the banks position in the total banking sector, each bank tries to create its own credit policy. 1.1.2 Safety The credit represents the main and the most profitable activity from the banks active operations but at the same time it is the most risky one. That is why the credits must be carefully analyzed using a series of specific techniques regarding the reimbursement capabilities in due time stipulated in contracts. Each bank assumes a certain degree of risk when launching a credit and, for sure, each bank experiences the definite loss of some placements or of a late recovery of them. That is why each placement must be thoroughly analyzed. The placements made on the banking market are relatively sure, in the case when the debtors are well-known banks. More than that, these credits are pledged with government securities which mean a high level of safety. The credits offered to the state or other state organizations are not a problem because as we know the state is the best debtor. The credits launched to enterprises are exposed to a high risk of not being reimbursed at maturity and this risk may happen due to three causes: 1. because of the debtor, mainly, because of its financial situation and of the enterprises management abilities. Any enterprise may find itself in a situation of not being able to pay the interest on credits or even the credit itself which is a result of a bad management, of an unpredicted situation, of a wrong estimation of its own risks or due to a hard competition. 2. because of the national economy situation. The macroeconomic instability highly influences the banking activity in conditions when the economic growth and the rate of inflation are in a permanent

evolution. In such a situation it is very difficult for a bank to evaluate the credit risk. 3. because of the bank. In the majority of cases, the problems regarding a portfolio of bad credits originate in a poor management of the credit activity. Analyzing the causes that lead to the failure of a number of banks, the following main reasons were highlighted: acceptance of overvalued mortgages launching credits before performing and creating the credit file the lack of cash flow analysis and of the ability of credit reimbursement

launching new credits to cover the afferent interest the credit was used in other purposes than the one it was offered for ignorance of rumors and references regarding the clients credits at other banks launching the credit without complete documentation : feasibility studies, marketing studies, authorizations ,contracts etc.

failure in mortgage valuation

non observance of the rules regarding credit classification and creation of specific reserves of risk a wrong registration in accounting of some commitments 1.1.2 Liquidity assurance The banks necessities of liquidity represent the immediate payments that the bank must perform, such as: deposits withdrawal, the demand for new credits that the bank has to satisfy in order to maintain its market share and other current payments that need to be honored. Some factors tend to impose placements with a longer maturity than the banks resources. One of these factors is the clients wish to be offered long term loans, anticipating the evolution of interest.

At the same time those people that make investments in the bank the deponents, prefer short term maturities, in order to protect their money from inflation. The satisfaction of the banks necessity for liquidity imposes a permanent correlation between the maturity of its placements and resources. More that that, the banks must face the constraint that it has to maintain a set level of liquidity, which means less profitability. The legal requirements set by the legislation of the Republic of Moldova regarding the liquidity sufficiency were presented in the form of two principles that the banks have to comply with:

Principle I : the sum on the banks assets with the maturity of reimbursement greater than 2 years must not be greater than the sum of its financial resources Principle II : the current liquidity of a bank, expressed as a coefficient of liquid assets to total assets must be less than 20%

1.1.3 Profitability A bank makes all its placements in order to obtain a profit. But it must assure that the profit placements are well managed so that the ratio owner _ equity will increase. Each bank wants to maximize its profits in order to please its shareholders, employees, to cover the eventual losses and to create legal reserves imposed by the authorities. So, obtaining a big profit is not just a simple aim, but a necessity for assuring a sound financial position in the banking market. 1.2 Methods of determining the credit portfolio quality The credits are the main assets of a bank and they generate the bigger part of its revenues.

10

The credit activity implies a risk because it very easy to lend some money, but there are situations when it is about an art to manage to recover a loan. The credit risk may be defined as the risk of recording some losses or of not performing profits, as a result of not honoring by the client the contractual commitments. The decision of launching a credit is based on elements of anticipation of the debtors activity ( the analysis of cash flows and some financial indices), which implies the risk evaluation and its acceptance. Consequently, the risk may not be avoided, but only prevented and diminished. A credit portfolio may be defined as the 1. totality of credits launched by a bank at a given moment of time. 2. the weight of each type of credits offered by a bank. The quality of a credit portfolio can be determined using the following criteria: Structure Liquidity (in terms of maturity) The degree of utilization Profitability Stability 1.2.1 Computing the structure of the credit portfolio By its structure the credit portfolio can be classified according to the following criteria: depending on the type of debtors, there are: 1. credits offered to juridical persons 2. credits offered to natural persons depending on the type of credits, there are: 1. consumption credits 2. mortgage credits 3. investment credits and so on.

11

The scope of the credit allows to determine the degree of efficiency of each type of credit for a bank. From its earlier experience the bank determines what types of credits are the most profitable and the least risky for the bank, in order to stimulate the growth of the volume of this type of credits in the credit portfolio. Depending on the branch of the economy that is being credited, these are credits offered to legal entities according to branches: 1. industry 2. trade 3. agriculture It is important to determine the type of credit which represents the optimum amount for the bank and that needs further investment to be developed. 1.2.2 Credit portfolio analysis according to its degree of risk In order co cover the losses which are a result of the risk appearance generated by the credit activity, and to maintain its stability the bank creates a special fund, named risk fund- for covering the losses generated by credits. Following this idea, the bank classifies all the launched credits in five big categories, according to their exposure to the risk of not being reimbursed:
1. Standard: the credit is considered standard if it is at maturity, all the

which can be classified into subgroups

commitments stipulated in the contract are observed and there is no reason for the bank to consider that, at present or in the future, it will be exposed to the risk of loss.
2. Supervised: the credit has potential problems, connected to the financial

situation of the client as well as to the pledge associated to the credit. These type of credits require the bank managements attention, because if no measures of solving the problems will be undertaken, they may lead to damaging the banks assets and to the reduction of the probability regarding the satisfaction, in the future, of the banks claims to the credits.

12 3. Substandard: these are credits characterized by a degree of the risk of losses

higher that the usual one, determined by one of the following factors: a. the financial state of the debtor is unfavorable or is worsening b. the pledge( in case this exists) is insufficient or is worsening c. other unfavorable factors, that cause worrying regarding the debtors ability to satisfy the banks claims, in conformity to the existing conditions. This type of conditioned commitment, requires the banks management special attention, because there is a probability that the bank will suffer losses, if the drawbacks will not be omitted.
4. Doubtful: when there are problems that arise doubts and diminish the

probability of satisfaction of a banks present/future claims afferent to the whole volume of the credit, based on the circumstances, created conditions as well as on the market value of the pledge in case when the asset is pledged.
5. Compromised: at the moment of credit classification the banks present/future

claims afferent to it can not be satisfied. According to the legal requirements, the banks are obliged to create and maintain reductions/provisions for losses from credits at a level not lower than the required one. Following this idea, the risk fund for losses from credits will be formed, by weighting each type of credits to the afferent risk coefficient, as it follows: 1. Standard credits- 2% 2. Supervised credits- 5% 3. Substandard credits- 30% 4. Doubtful credits- 60% 5. Compromised credits- 100% An analysis of the credit portfolio according to the risk criterion may offer information about the validity of the models used for estimating the credit risk at the

13

stage of credit launching. In order to estimate the global degree of credit risk, assumed by the bank, we can compute the coefficient of insurance against the credit risk in the following way: k1 = risk _ fund _ volume *100% credit _ portfolio (1.2.1)

This coefficient of following the credit risk may be used to evaluate the efficiency of the banks credit policy and of the mechanisms used to determine the credit risk at the stage of working with the debtor, of evaluating the minimum risk fund. A positive tendency in credit risk management, at the portfolio level, is the reduction of this coefficient. In international practice the global risk fund must not be grater than 15%, because otherwise the credit portfolio is considered too risky. If this coefficient is placed in the interval 10-15% means the credit portfolio exposure to a high level of risk, in the interval 5-10% the level of risk is acceptable and under 5% we can speak about a safe credit portfolio. 1.2.3 Credit portfolio analysis according to its components A qualitative analysis of the credit portfolio in the field of risk supposes the separation of the portfolio into performant credits, which are Standard and Supervised credits. The improvement of the credit portfolio quality implies the growth of the following coefficient: k2 = performant _ credits *100% credit _ portfolio (1.2.2)

The level of credits classified as unperformant, is the total sum of Substandard, Doubtful and Compromised credits. A comparison of the level of credits classified as unperformant along a period of analysis will indicate the negative tendency in the credit portfolio quality and this

14

may have as a result the increase of the volume of reductions made for losses from assets and of the provisions made. k3 = unperformant _ credits *100% credit _ portfolio (1.2.3)

In order to have a clearer image, the value of unperformant credits must be compared with the Total Required Capital and Total Assets, as it follows: k4 = unperformant _ credits *100% Total _ Re quired _ capital

(1.2.4)

k5 =

unperformant _ credits *100% Total _ assets

(1.2.5)

A current rule in the Republic of Moldova at the moments is that if the total amount of credits classified as unperformant increases the level of 50% from the banks Total Required Capital, then the quality of assets is very low. Another useful analysis of the coefficient is to compare the level of expired credits to Total credits. Normally, when the expired credits are at the level of 20% or more, from the total amount of the banks credit portfolio, then the quality of assets is low and any result higher than the level of 40% represents a serious problem for the bank. k6 = exp ired _ credits *100% credit _ portfolio (1.2.6)

The expired credits and those in the state of non accumulation of interest are: o doubtful and compromised credits
o credits with maturity expiration of 90 days and more

o credits with payment at sight at which the first payment of the interest has expired o reimbursed credits, in partial installments, at which the rate of credit amortization has expired

15

An analysis of the rate between actual losses at the average of credits launched along a set period of time will show the evolution of the credit risk management. k7 = credit _ losses *100% credit _ portfolio (1.2.7)

If this coefficient increases, this may mean a high risk for the bank, generated by the decrease of effects of the banks credit policy or by the banks inability to follow a set policy or by the increase of the credit activities in domains characterized by a high level of risk. 1.2.4 Determining the profitability of a credit portfolio The profit, is finally, the most important aim of a banks shareholders, and the objective is the increase of the banks value, through risk preventing and decrease as well as through the increase of the banks market position. The main source of profit in a banks activity is the credit operations. And by solving the problem of credit portfolio profitability leads to the realization of the banks main objective. A credit portfolio profitability may be analyzed and appreciated using the following indicators:
the degree of profitability of a credit portfolio (Dprof)

D prof =

int erest _ inf lows int erest _ outflows unperformant _ credit _ exp enses credit _ profit (1.2.8)

This indicator determines the net profitability of one MDL given as credit. In this formula all types of credits are equivalent, that is why, it is recommended to determine the net profitability associated to different types of credits. But the problem is to determine the resources that finance these credits.
credit profitability (Cprof)

16

C prof =

int erest _ inf lows int erest _ outflows operational _ exp enses total _ credits

(1.2.9)

This ratio allows the bank to determine the profitability of each type of credits in particular. 1.3 Methods of credit portfolio management One of the most significant changes to affect wholesale banking in recent years is the shift from the traditional buy and hold origination model to active credit portfolio management. In the active credit portfolio management approach, a centralized group of portfolio managers assumes responsibility for making buy/sell/hedge decisions about the composition of the portfolio and acts to optimize the risk/return performance of credit assets. The active credit portfolio management method was created in order to: reduce concentration and credit portfolio volatility(unexpected losses) increase capital velocity-use economic capital more efficiently and create the capacity to do more business improve returns on risk and capital Active credit portfolio management involves three key principles:

hold credit only when the institution is being paid well for

the marginal portfolio risk-the extra portfolio risk associated with a small increase in exposure size.

reduce concentration and hence credit portfolio correlation

caused both by excessive origination in single names, countries and/or industries and by deterioration in credit quality. When the credit quality deteriorates on an obligor, correlation of that obligors exposure with the credit portfolio increases. Those exposures are no longer being as well diversified by the portfolio. to reward liquid and penalize illiquid exposures in the portfolio through an illiquidity premium when measuring marginal portfolio

17

credit risk and return. Because a credit portfolio manager cannot forecast a priori which exposures will deteriorate in credit quality and therefore need to be reduced. Liquidity is very important for active credit portfolio management and should be rewarded. Historically, credit portfolio management had focused on the monitoring of exposure by broad portfolio segment and, if necessary, the imposition of exposure caps.

Source: Credit portfolio management, by T. Garside, A. Stevens

Figure 1.3.1 Optimization of origination and portfolio management activities The creation of a stand-alone credit portfolio management function, armed with sophisticated portfolio models and with controlling mandate over assets held on the balance sheet, now enabled the credit portfolio to be optimized independent of origination activity. Active credit portfolio optimization has enormous potential to enhance profitability. 1.3.1 Credit risk measurement framework Credit risk is conventionally defined using the concepts of expected loss (EL) and unexpected loss (UL).

18

Source: Credit portfolio management, by T. Garside, A. Stevens

Figure 1.3.2 Credit loss volatility Because expected losses can be anticipated, they should be regarded as a cost of doing business and not as a financial risk. Obviously credit losses are not constant across the economic cycle, there being substantial volatility (unexpected losses) about the level of expected losses. It is this volatility that the credit portfolio models are designed to quantify. Volatility of portfolio losses is driven by two factors concentration and correlation

19
Source: Credit portfolio management, by T. Garside, A. Stevens

Figure 1.3.3 Effects of concentration and correlation on credit risk Concentration describes the lumpiness of the credit portfolio. Correlation describes the sensitivity of the portfolio to changes in the underlying macro-economic factors. In all but the smallest credit portfolios, correlation effects will dominate. When quantifying credit risk, two alternative approaches can be used when valuing the portfolio:

Loss-based method: under this approach an exposure is assumed to be held to maturity. The exposure is therefore either repaid at par or defaults, and thus worth the recovery value of any collateral. Using this approach credit migration has no effect on the book value of the obligation.

Net Present Value method: under this approach the embedded value of an exposure is assumed to be realizable.

In general, the Net Present Value method is most applicable to bond portfolios when for the majority of commercial banks exposures the Loss-based method is mostly used. 1.3.2 Credit portfolio methodology In order to accurately model portfolio credit risk the correlation between exposures must first be measured. An attractive solution to calculating credit risk correlation is to use a causative default model that takes several observable financial quantities as inputs and then transforms them into a default probability. The most used models are: Merton default model.

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Source: Credit portfolio management, by T. Garside, A. Stevens

Figure 1.3.4 The Merton default model The Merton default model assumes that a firm will default, if over a 12 month period, the market value of assets falls below the value of callable liabilities. This enables asset correlation to be transformed into credit risk correlation.

Source: Credit portfolio management, by T. Garside, A. Stevens

Figure 1.3.5 Joint probability density function for company asset values In Figure (1.3.5) the more correlated the movements in the two companies assets the greater the twist in the joint asset value distribution. Hence the greater the probability that the credit quality of the two firms will rise, fall and ultimately default together. Macro-economic factor model

21

Source: Credit portfolio management, by T. Garside, A. Stevens

Figure 1.3.6 Macro-economic factor model In figure 1.3.6 a positive factor weight indicates that a positive change in that factor produces an increase in asset value, with a corresponding rise in credit quality and reduction in default rate. Conversely, a negative factor weight indicates that a positive change in that factor produces a decrease in asset value, with corresponding fall in credit quality and increase in default rate.

Simulation method. While the risk of small credit portfolios can be calculated analytically, the large number of calculations required, mean that for most portfolios it is better to employ a numerical simulation technique. Monte Carlo simulation is the standard method that generates all possible states of the economy and the resulting impact on the value of the credit portfolio. In this way a distribution of all possible portfolio values is built up, from which its credit risk profile can be calculated.

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Source: Credit portfolio management, by T. Garside, A. Stevens

Figure 1.3.7 Monte Carlo simulation Now, we can illustrate a number of management applications of portfolio models.
1. Solvency analysis. The most obvious application of a credit portfolio

model is to calculate economic capital requirement. 2. Credit risk concentrations and portfolio optimization. Breaking down the aggregate credit risk distribution to show the credit risk of each portfolio element allows risk concentrations and hence diversification opportunities to be identified. For most credit portfolios simple optimization techniques will substantially reduce economic capital requirements.

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Source: Credit portfolio management, by T. Garside, A. Stevens

Figure 1.3.8 Potential diversification benefits in a typical bank portfolio 3. Sensitivity analysis. Portfolio models can be used to calculate expected loss rates under different economic scenarios and thus drive dynamic provisioning estimates or loan loss reserving methodologies.

Chapter II: Credit portfolio analysis of Moldova Agroindbank CB, branch X

2.1 Analysis of the Moldova Agroindbank CB, branch X credit portfolio structure.

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As it was previously mentioned the structure of a credit portfolio may be determined by classifying it according to different criteria. And after the classification is performed relevant conclusions can be drawn. In our particular situation the credit portfolio of Moldova Agroindbank CB, Branch X can be classified according to the following criteria: by the type of the debtor by the type of the credit by the branch of the economy that is credited by the maturity of the credits offered by the type of relationship of the debtor with the bank
1. By the type of the debtor. As it is known, according to this criterion there are

two types of debtors: juridical and natural persons. In our particular case, the distribution of the debtors of Moldova Agroindbank BC, branch X, Table (2.1.1) Credits offered to types of debtors according to the number of debtors Type of debtor Juridical persons Natural persons Total Weight in the total portfolio 5,5% 94,5% 100%
Source:Moldova Agroindbank portfolio CB, branch X, credit

according to this criteria can be illustrated in the following way:

Table (2.1.2) Credits launched to types of debtors according to the volume offered Type of debtor Juridical persons Natural persons Total Weight in the total portfolio 66,75% 33,25% 100%

Source:Moldova Agroindbank CB, branch X, credit portfolio

2. By the type of the credit. By performing this classification we want to

determine the weight of each type of credit that Moldova Agroindbank BC,

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branch X, offered and the profitability of each type of credit (Annex 1, Annex 2). Table (2.1.3) Credits offered to juridical persons
Type of credit Overdraft Investitional (MT) Investitional (LT) Circulant (trade) Circulant (agriculture) Investitional pentru reparatii capitale Total Amount offered,% 27 23,7 1,77 1,23 11,67 1,38 66,75

Source:Moldova Agroindbank CB, branch X, credit portfolio

Table (2.1.4) Credits offered to natural persons

Type of credit Imobiliar Multioptional Nenominalizat Total Amount offered,% 5,83 24,37 3,05 33,25

Source:Moldova Agroindbank CB, branch X, credit portfolio

3. By the branch of the economy that is credited. At this criterion we can analyze

only the credits offered to juridical persons depending on the type of activity each juridical person performs according to its statute. branches of the economy (Annex 3). Table (2.1.5) Branches credited Branch of the economy Agriculture Trade Amount offered,% 37,14 29,6 Moldova Agroindbank CB, branch X, financed the development of the following

Source:Moldova Agroindbank CB, branch X, credit portfolio

26 4. By the maturity of the credits offered. Here we can determine the liquidity of

the credit portfolio, because a short-term oriented credit portfolio is considered more liquid than a long-term one (Annex 4). Table (2.1.6) Credit portfolio liquidity Time period Long term loans Medium term loans Short term loans Amount offered,% 7,58 28,14 64,28

Source:Moldova Agroindbank CB, branch X, credit portfolio

5. By the type of relationship of the debtor with the bank. According to this

criterion we can distinguish between credits offered to affiliated persons and to non-affiliated persons. In our particular case, Moldova Agroindbank CB, branch X, has no credits offered to affiliated persons. This way we can conclude that 100% from the amount of credits launched are offered to nonaffiliated persons. Conclusion: After performing structural analysis of the credit portfolio of Moldova Agroindbank CB, branch X, we can conclude that its credit portfolio can be characterized by a high degree of liquidity as the weight of short-term credits exceeds 50% and constitutes 64%. This is a quite applaudable situation because, as we know, the biggest amount of deposits are short-term deposits and in this case we can confidently state that the upper mentioned bank is not threatened by the transformation risk of liquidity. At the same time we can speak about the disadvantage that short-term and medium-term credits are less profitable than longterm ones. According to Moldova Agroindbank CB policy of credit, the agriculture is the sector of the Republic of Moldovas economy sector that is considered to have a priority in crediting. This fact can explain the increased weight of credits offered by Moldova Agroindbank CB, branch X, to the agricultural sector. The second sector that has been credited in large proportions is the trade sector. Here we can notice that the mentioned credit portfolio is not enough diversified because the

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subsidiary depends on the evolution only of two sectors of the economy. But at the same time this fact can be explained in the following way: 1. the priority given to the agricultural sector
2. the dependence of the territorys size, because in a small region like X it is

difficult to diversify the activity 3. the existence of competition Referring to the credit portfolios structure according to the type of debtors, we can say that although the number of juridical persons credited is small (only 5,5%) the volume of credits offered to these clients is relatively high (66,75%). Here we ca see the advantage that the collaboration with juridical persons is less risky, because they have a profitable activity in comparison with natural persons that are dependent on constant incomes (the salary). More than that, in small subsidiaries, the juridical persons are in the majority of cases permanent clients, and this way the subsidiary knows the credit history of the client and has general experience of collaboration with the client. But the disadvantage here is the fact that in this case we can notice a high degree of concentration- a small number of juridical persons clients and a high amount of credits launched to them. The credit portfolio, and the subsidiary as well, becomes too dependent from the activity of these clients. The failure of one client may lead to serious qualitative and quantitative damages to the credit portfolio. 2.2 Qualitative analysis of the Moldova Agroindbank CB, branch X credit portfolio As it was mentioned before, each bank has to classify all its credits into five categories of credits, according to the level of risk supposed by each credit. In the particular case of Moldova Agroindbank CB, branch X, the classification of credits looks in the following way: Table (2.2.1) Moldova Agroindbank CB, branch X, credit portfolio classification Type of credit Sum, m.u. % in the risk fund Amount of the

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Standard Supervised Substandard Doubtful Compromised Total

28728110 6880500 600000 6000000 1105000 43313610

2 5 30 60 100 -

risk fund 574562,2 344025 180000 3600000 1105000 5803587,2

Source:Moldova Agroindbank CB, branch X, credit portfolio

Once the classification is done, we can calculate the global degree of credit risk coefficient (k1) k1 = 5803587, 2 *100% = 13,4% 43313610 (2.2.1)

Conclusion: The global risk fund can be characterized by a high degree of risk, because it is higher that 10%, but at the same time it is acceptable as it is lower than the internationally level set at 15%. Now we have to compute the amount of profitable and unprofitable credits at the Moldova Agroindbank BC, branch X, that are needed to calculate the value of other relevant indicators that show the quality of a credit portfolio. Table (2.2.2) Classification of credits launched according to their quality Performant credits Unperformant credits 35608610 MDL 7705000 MDL

Source:Moldova Agroindbank CB, branch X, credit portfolio

k2 =

35608610 *100% = 82,2% 43313610

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(2.2.2) k3 = 7705000 *100% = 17,8% 43313610

(2.2.3)

Conclusion: According to the performed analysis we could determine that the sum of credits characterized by a low degree of risk amounts to 82,2% in the Moldova Agroindbank CB, branch X, credit portfolio and correspondingly, the sum of credits characterized by a high degree of credit risk amounted to 17,8%. Moldova Agroindbank CB, branch X, is advised to minimize the amount of credits with a high degree of risk . The credit risk can be eliminated using the following methods: 1. Increase in the quality of credits launched 2. Launching credits to clients with a good financial situation 3. Increase of the crediting profitability.

2.3 Credit risks at Moldova Agroindbank CB, branch X The credit risk can be defined as the risk that the interest, credit or the both of them will not be reimbursed at maturity or will be reimbursed partially. This risk is specific to the banks that have the important function in the economy of crediting. The credit risk appears as a result that the enterprises that were offered the credit are not able to reimburse it which may be a result of the postponement between revenues and expense, the risk appearing as their future inflow will decrease or will disappear, or a result of the debtors dishonesty, which is a risk that the bank is not able to appreciate or quantify very efficiently. The risk of future revenues insufficiency is very difficult to be anticipated especially in conditions when the evolution of inflation imposes the credit interest increase. At the same time the enterprises inability to reimburse the credit may be a result of its environment. An enterprises environment is defined as the totality of the enterprises

30

external factors of economic, political, social and branch situation nature in which the enterprise performs its activity, and the influence of which may affect its future performance. Political decisions such as the embargo set on particular products, some regional and international agreements, have a deep influence on some enterprises. When these decisions are taken the enterprise sees its market changed in a very short period of time, and this fact negatively influences the enterprises viability. The economical risks are determined by some changes in the structure of the economy of a country. In periods of recession the enterprises face some difficulties that may lead even to bankruptcy. The situation and the evolution of the branch, in which the enterprise activates, contradictory influences some enterprise. The innovations may modify the production procedure, but may determine the introduction of new products which are more competitive, and this may determine that the demand for the products of some enterprises may decrease or even disappear. So, the bank has to know the evolution of the enterprises environment through permanent monitoring and analysis. In the particular case of Moldova Agroindbank CB, branch X, the credit risk is highlighted by the lack of the credit portfolio diversification according to braches. As it was upper shown Moldova Agroindbank, CB, branch X, launched credits only to the agriculture and trade sectors which makes the portfolio too sensitive to the changes that may occur in these sectors of the economy. Speaking about the agricultural sector than it is well known that in the past 5-10 years the changes in the climate, as a result of the greenhouse effect, determined very small quantities of harvest characterized by poor quality. So the floods and droughts that were following one another influenced in a very bad way the financial situation of those enterprises that activate in this sector of the economy. We can state that these changes in the climate indirectly may seriously influence the situation of the up mentioned bank,

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that may find itself in the situation that the biggest part of its credits will have to be restructured and prolonged. At the same time Moldova Agroindbank CB, branch X, faces the risk of poor client diversification. As it was shown the number of juridical persons that are clients of this bank amounts to 5,5% from the total amount of clients. And at the same time the amount of credits launched to these clients is 66,75% from the total portfolio which means that the bank depends a lot on the financial health of its several but important clients. In order to avoid this risk and improve the situation the bank is advised to have a more aggressive politics of credit. Which means, offering more credits of smaller amounts, to a bigger number of clients. This way the risk of credit non reimbursement of one client will affect the banks credit portfolio and the banks financial health in smaller proportions. At the same time Moldova Agroindbank CB, branch X, faces the problem of a considerable weight of unperformant credits which amounted to 17,8% in the total amount of credit portfolio. In its further activity the bank will have to struggle to solve this problem by undertaking a particular approach to each unperformant credit by restructuring the reimbursement schedule, taking additional mortgage or by sueing the bad debtor. But in the last case the bank will face the risk of selling the mortgage at the market value which frequently is significantly lower than the book value. 2.4 Methods of credit portfolio diversification The credit portfolio diversification represents a way of optimization the banks performance. Credit portfolio diversification has two major aims: 1. risk minimization 2. maintaining and increase of the existent level of profit Credit portfolio diversification is subordinated to the principle of risk dispersation. The disadvantage here is that risks dispersation minimizes the risk but it also leads to smaller profits. The persistence towards certain placements and debtors, multiplies, in some cases, the risks, but at the same time amplifies the profits. So it is the banks

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responsibility to decide on the placements to be made and on the directions of credits to be launched. The diversification of a credit portfolio may be made on specific single directions or on several directions simultaneously. These directions can be enumerated as it follows: 1. on the debtor 2. on the branch 3. on the type of credit 4. on maturity The credit portfolio diversification on the debtor means an accurate selection of debtors which implies a persistent study of the debtors history, financial soundness, and, of course, the debtors future performance. The aim of studying the debtors history is to identify the enterprises performances, risks and its management. This study is made at the first stage of discussion with the potential client. The bank has to analyze the potential debtors financial situation by calculating relevant indicators showing the debtors ability to pay on the credit commitments and classify the debtor according to credit scoring into one of the five categories. Then the bank has to analyze the debtors future. The aim of this analysis is to determine the risks of the business that the bank is about to credit, to identify all the potential sources of credit recovery, to determine the degree to which the stockholders support the business and its viability on the market. Once the study is made and the client has been granted the credit then the next stage comes up: the work with the client and permanent credit monitoring. This will help the bank to determine whether the credit is used according to the scope stipulated in the credit contract and whether the financial health of the client remained stable, improved, or worsened. Depending on the conclusion made the bank has to create a plan of actions in order to minimize the risk. Credit portfolio diversification on the branch refers to the idea that a sound credit portfolio must not be dependent on a single or few branches of the economy because

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even unessential fluctuations in these sectors may significantly affect the banks health. The most relevant sample to support this statement is the current situation of the global economy the crisis. Due to the fact that a big number of banks betted on the real estate market development, the crash of this market lead to an even huger crash of a number of banks. A sound credit portfolio must also contain different types of credits launched. The difference between these credits is in the form of sum, maturity, scope of credit and other credit attributes. These variables must be well alternated in order to obtain the optimum result in the form of a low risk and high profitable credit portfolio. The bank has to establish the optimum proportion between long-term and short-term credits, between secured and unsecured credits, between big and insufficient exposures. The maturity of the credits also plays an important role in the credit diversification function. On the credits maturity depends the liquidity of the credit portfolio. And here the optimum level of liquidity must also be efficiently set. This must be done because a too liquid portfolio limits its profitability, while a less liquid portfolio increases the profitability and the risk as well. The maturity of the credits must also be coordinated with the maturity of the banks financing sources. A bank is not supposed to offer long-term credits when the deposits that it holds are short-term oriented.