OREANDA-NEWS. September 13, 2013. Risk management is the life line of a financial institution. Over the years, China Development Bank (CDB) has explored and established a stringent, effective risk management system which is distinctive from typical commercial banks' as well as a unique developmental financing risk culture while it catered to national development strategies to realize its developmental financing philosophy. Developmental financing risk management is an important exploration for risk management of strategic, developmental and medium- to long-term businesses that is tailored for China. It is an integral part of developmental financing implementation.

Characteristics of developmental financing business risks

The mission of developmental financing is to serve national development strategies by providing medium- to long-term financing. It combines sovereign credit with commercial operations. It is a form or means of financing established to ease the socioeconomic development bottleneck constraint, maintain stability of the national financial system and increase economic competitiveness.

As an explorer and achiever in China's national developmental financing sector, CDB undertakes the mission to serve the State's development strategy and objectives. It mainly lends to sectors that constrain the State's socioeconomic development. Domestically, these are usually social development or livelihood related sectors such as infrastructure, basic industries and pillar industries, rural areas, agriculture and farmers, community housing for low to mid-level income earners, micro, small and medium-sized enterprises and student loans. Overseas, these would be overseas energy or resource related sectors or Chinese enterprises' international expansion or cooperation projects. Given its mission and the specialized nature of the sectors it supports, CDB's businesses and risk management are set to differ from that of typical commercial banks.

(1) Strategic. As a bank that serves the State's strategies, CDB must put satisfying the State's development strategies as well as fulfilling the government's intentions and policy directives as top priorities in selecting projects. For instance, CDB will inevitably take on sovereign risks in its international businesses when providing services to the State's energy or resource projects and economic diplomacy strategies.

Also, CDB will need to play the important role of stabilizing and driving basic industries which are essential to the domestic economy such as electric power and railway when they face operating and financing difficulties during economic downturns. CDB will actively carry out anti-cyclical adjustments to prevent important projects' or industries' financing chain from disintegrating and to avoid severe economic fluctuations.

(2) Developmental. Bottleneck sectors are characterized by immature market, inadequate credit quality, highly demanding in terms of initial investment and weak debt servicing ability. The risks of these sectors are difficult to manage and project return is usually low and uncertain. These sectors can hardly meet the standards and requirements of commercial financial institutions while fiscal funds cannot cover them fully. Majority of the projects supported by CDB are within socioeconomic development bottleneck sectors. Therefore, CDB naturally face greater risks as compared to commercial banks. Accordingly, developmental financings are required to support these projects through optimizing resources of various parties, innovating credit structure and channeling non-government capital while preventing risks and finally allow such sectors with immature market to grow into commercially sustainable sectors.

(3) Long-term. CDB is mainly engaged in medium- to long-term businesses. Its risks are long-term, large-denomination and concentrated. "Long-term" means the loan maturities are long. The average contracted term is over 10 years. There are numerous risk factors for these projects and uncertainty is high. "Large-denomination" means the loans are large in size. Many infrastructure projects require investment of over billions or tens of billions of yuan. "Concentrated" means loans are rather concentrated within certain priority industries and large enterprises. In the event of economic downturn, such industries or enterprises may face operating difficulties or losses and CDB will take the brunt.

Exploration and implementation of CDB's medium- to long-term risk management

With years of track record and exploration, CDB has formed a risk management regime that is distinctive from other commercial banks' based on risk characteristics of developmental financing businesses. Overall, CDB's risk management is founded on its research and prediction on long-term development trends of China's economy. It aims to promote development and at the same time achieve risk prevention and dissolution. Specifically, CDB takes measures such as preplanning, bank-government collaboration, credit structure, bond issuance, financial innovations, improving mechanisms. Combinations of these measures represent effective developmental financing risk management tools.

(1)Through preplanning, increase the foresightedness and proactiveness of development promotion and risk management. Preplanning is not only an important way to lead business development, but it is also an objective requirement for medium- to long-term business development. It is an effective tool to cope with "long-term, large-denomination and concentrated" risks. First, preplanning can be used to promote scientific development in various regions then in turn to prevent systemic and regional risks. CDB acts according to the State's macroeconomic policies and also takes into account local governments' regional, industrial, social and market development plans in order to avoid blind and duplicated investments such that economies in various regions can develop healthily.

At the same time, it also creates a favorable external environment for the bank itself. Second, CDB can grasp key support targets through planning to prevent the risk associated with borrowing sectors. Based on socioeconomic development needs and long-term development trends of industries, CDB will determine the financing support focus and direction and carefully set project selection criteria to maximize the extent of risk prevention. Third, project failure risks can be prevented through planning for incubation projects. When setting targets and frameworks for blanket cooperation, CDB will formulate staged arrangements and implementation according to the maturity of the project.

CDB will also consolidate various factor inputs and continuously solve existing problems such that implementation conditions can be gradually met to increase success rate of the project. Fourth, success of the plans should be promoted and project financing risks prevented. CDB collaborates with various regions by blending its systemic financing plan with the regions' overall planning. It designs financing proposals for major projects, channel non-government capital to promote planned implementation and avoid risks associated with funding failure of project construction.

(2) Strengthen bank-government collaboration to jointly manage risks through systems. First, a favorable credit environment and healthy market entity should be jointly developed by CDB and the government. Bank-government collaboration serves both the market building function and risk prevention function. CDB acts as a bridge between the government and the market. It combines the government's organizational advantage and CDB's financing advantage so risk prevention can be an important area of cooperation for the two.

CDB and the government can jointly promote the establishment of credit, market and system and strengthen enterprises' risk management awareness and capability. For instance, to support urbanization CDB jointly built financing platforms with local governments. It promotes consolidation of various resources to fortify the platforms' capabilities, standardize platform management, continuously discover and unearth credit potential of the platforms and cultivate a large group of market entities and enterprise entities. All these effectively prevent credit risks and address the financing issue in the process of urbanization.

Second, bank-government collaboration strengthens Total Process Management (TPM) for loans: (i) In the early stage and assessment stage of a project, strengthen collaboration with the government, select high-quality projects that are suitable for the local development plan then propagate a credit structure and loan terms for project implementation; (ii) after the loan has been extended, maintain close communication with the government to track and digest project information. At the same time, allow the loan facilitating institution that it set up jointly with the government to serve its purpose to strengthen project supervision and management; (iii) during the loan repayment period, adopt measures such as linking loan repayment with loan extension to adjust the proactiveness of various parties and work with the government to promote debt servicing (including both interest and principal) and dissolution of non-performing assets. Third, leverage on socialist methods to develop loan project supervision. CDB shall work with organizations such as local governments and disciplinary inspection & supervision departments to creatively establish a joint supervision mechanism such that loans can be supervised using public forces. Project management and risk prevention radius can be extended to the maximum, forming a strong and forceful risk management network which can serve as yet another shield to safeguard assets.

(3)Build a comprehensive credit structure to ensure loan risks are manageable. Credit structure is the key to project loan risk distribution. CDB has been developing innovative credit structures according to regulatory requirements and latest market conditions, making it possible for loans to flow into bottleneck sectors and for long-term credit risks to be effectively managed. For instance, a credit structure can be practically fortified by using government's city municipal construction funds as well as operating profit of municipal construction groups and land reserve centers as supplementary sources of loan repayment. CDB innovatively designed the government platform mining right large-denomination financing model to allow platform companies to use mining rights as collateral in fundraising and the bank in turn gains access to project cashflows through appreciation of the collateralized mining rights.

In slum redevelopment, CDB targets the characteristics of complicated structure, numerous process segments as well as challenging use of fund, regulation and cash collection management to effectively lock down risks through receivables pledging comprising of guarantee from provincial platform company, income from return of land development cost and other cash subsidies of the project together with other risk management mechanisms such as account monitoring and negative pledge. For industrial enterprises, CDB offers an innovative intellectual property (IP) collateralized financing solution to technology enterprises and strategic emerging industrial clients that own IPs and possess market potential.

The borrower may use legally owned and transferrable patents, trademarks or copyrights as collateral. In the area of supporting Chinese enterprises' international expansion, CDB devised measures such as borrower's business license or asset pledging plus guarantee and risk sharing between CDB and the Chinese enterprise when financing overseas buyers in acquiring Chinese equipment and that it is difficult to assess the credit standing of overseas customers, credit risks and sovereign risks. Overall risk level can be reduced as a result. In the area of international energy and resource cooperation, CDB selectively lend to overseas petroleum companies with strong capabilities and ability to provide reliable oil supply. It has also designed a credit structure which takes the borrowers' revenue from oil exports to China as collateral considering the stable cashflows of oil trading as well as the cash flow supervision model that "collect, deduct then return" to ensure oil sales revenue can operate in a close circuit and can first be used to repay CDB loans.

(4) Leverage on the bond issuing bank advantage to achieve reasonable asset and liability maturity allocation. By leveraging on the sovereign credit, CDB pools resident savings and non-government capital, lengthen maturities and establish long-term stable sources of funds through financial bond issuances to cover and cope with long-term, large-denomination and concentrated risks. At the same time, CDB insists on its prudent asset and liability management strategy. It sees liquidity management as the core of asset and liability management and pivot of capital management, allowing CDB to leverage fully on its ability to take on liabilities so that it can balance and maximize safety, liquidity and efficiency and effectively prevent maturity mismatch risks and liquidity risks.

(5) Develop financial cooperation and innovation to diversity risks using commercialized means. CDB has established a medium- to long-term investment and financing market through means such as syndicated loans and asset securitization. It dredges credit asset channels and constructs market-oriented exits for projects to diversify long-term, large-denomination and concentrated risks. CDB successfully conducted the first credit asset-backed securities issuance in the national interbank bond market in December 2005, becoming a pioneer in credit asset-backed securitization in China. CDB is also a main bank in China's syndicated loan market. As at the end of June, its syndicated loan balance was close to Rmb1.3 trillion.

(6) Perfecting systems and mechanisms and continuously raise the level of detail of risk management. (i) Stringent project examination. Through establishing a roadshow review system, risk margin determination system and a two-pronged examination system that combines borrower credit rating and individual debt rating, rating and credit extension management should be strengthened and the scientific level of decision making should be raised. Establishing a "unified examination, integrated credit extension" system with clients at its core will allow the bank to comprehensively evaluate client's various business needs such that service capability can be raised while risks are being managed. (ii) Strengthen post-lending management.

Through a stringent loan classification system, credit risk early warning system, comprehensive collateral and guarantee management system and dynamic credit asset management, a multifaceted post-lending management model that covers all segments of credit management including monitoring of loan proceeds, post-lending cashflow, the project, the borrower and the guarantee. (iii) Strengthen industry analysis and case studies guidance. Based on industry development trend and risk status analysis, credit policies should be clarified. Case studies should also be produced based on typical project development assessment and risk management experience. The above measures will provide clear directions and allow the bank to focus on major risk factors in project development, assessment and post-lending management. (iv) Construct a total risk management (TRM) framework. CDB focuses on covering all risk categories, business segments and the potential risks in business processes to perfect the three lines of defense including the front offices, the risk management department and the internal audit department and in turn forming an effective shield to prevent and manage risks. Under the TRM framework, risk management assessment should be strengthened and risk responsibilities should be assigned based on each department's business lines and duties.

Actual implementation shows that CDB's risk management is effective, allowing the bank to serve the State's development strategies and at the same time achieve good operating results. CDB's principal and interest collection ratio is 99.39% as at the end of June. The ratio has remained high for 54 consecutive quarters; its non-performing loan ratio is only 0.32% which stayed below 1% for 33 consecutive quarters. CDB's asset quality remains at a leading level among domestic and foreign peers.

Risk culture of developmental financing

While CDB supports socioeconomic development and concurrently achieves good results, it has formed a risk culture with prominent developmental financing characteristics. The culture is rooted on successful realization of development financing. It starts with serving the State's development strategies and has supporting development at its core, which collectively manifest as a "macro risk perspective" where "risks are prevented when support is provided and risks are dissolved by development".

There are four dimensions to the risk culture for developmental financing, namely spiritual, policy, behavioral and physical. The culture is distinctively characterized by its comprehensiveness – it covers all staff, all processes, all bearings and all factors. The spiritual dimension manifests as the "macro risk perspective" and risk philosophies that are coherent with the former. It is the superstructure of the risk culture. The culture contains the basic philosophy of "equality before risks and equality before truths", the macro sense of "being responsible for the State's and CDB's interests", risk management awareness and responsibility awareness of all staff where "detail is the key to success and risks can be nipped during processes" and "all staff should be involved and everyone is responsible", etc. The policy dimension manifests as comprehensive and efficient risk management framework, policy and processes. It is a core vehicle of the risk culture. It includes a TRM framework that envelopes CDB's strategic development objectives and business development model and a total process policy system that covers all segments of CDB's businesses.

The behavioral dimension manifests as a code which covers risk prevention behavior in every procedure and every staff's action. The code is a practical manifestation of the risk culture. Through establishing a comprehensive code of conduct, maintaining the solemnity and authority of the policies, adopting supervisory inspection and compliance education, ethical standards of the workforce should be raised and policy loopholes should be filled by moral constraints. The physical dimension manifests as mature risk classification, evaluation and control technologies, reliable information technology systems and teams led by high-quality experts. The above constitutes support and protection of the risk culture. We can say that the risk culture is a manifestation and extension of developmental financing in cultural awareness. It plays an important role in strengthening the integrity, scientificity and effectiveness of the risk prevention system and in raising risk prevention capability.

At present, the global landscape is undergoing in-depth adjustments. In China, the economy is undergoing a transformational upgrade and the financial market is also undergoing in-depth changes. CDB's risk management team is facing an unprecedented, tough challenge which poses new and stricter requirements for CDB to better prevent risks and serves development. From a macro and strategic perspective, CDB shall correctly grasp the balance between development promotion and risk management, further strengthen risk awareness, fortify the establishment of the risk culture, create a TRM system, prevent risks associated with the priority sectors and continuously raise risk prevention capability and standard to make new contributions to the establishment of an affluent society by promoting sustainable, healthy economic development and providing comprehensive services.(The author of the article is the President of China Development Bank)