Credit Risk Management

RESEARCH DESIGN OBJECTIVES OF THE STUDY

Understanding credit risk management conceptuall ! Stud ing t"e #arious pri#ate $anks practicing credit risk management! To make a dept" stud o% t"e met"od in &"ic" t"e pri#ate $anks in India go a$out credit risk management! Stud ing t"e di%%erence $et&een retail credit risk management and corporate credit risk management practiced $ pri#ate $anks! Understanding t"e importance o% t"e credit risk management and "o& use%ul it is to t"e pri#ate $anks and "o& it $ene%its t"em in #arious &a s!

PURPOSE OF THE STUDY

T"e main reason to select 'C(EDIT (IS) *+,+-E*E,T. as a topic is to understand t"e importance o% t"e (ole pla ed $ credit risk management department and/or practices &"en t"e $ank lends mone to its $orro&ers! In t"is pro0ect1 I "a#e tried to understand t"e di%%erence $et&een corporate credit risk management and retail credit risk management! T"e anal sis and inter#ie&s &it" industr personnel "as gi#en me a practical and real li%e e2posure to t"e $anking scenario as %ar as t"e credit risk management goes1 &"ere$ I could correlate $et&een t"e t"eor and t"eir practical application!

Credit Risk Management

RESEARCH METHODOLOGY

D+T+ CO33ECTIO,
T"e data collection i!e! t"e ra& material input %or t"e pro0ect "as $een collected keeping in mind t"e o$0ecti#es o% t"e pro0ect and accordingl rele#ant in%ormation "as $een %ound! T"e met"odolog used is a descripti#e met"od o% t"e (esearc"! Follo&ing are t"e sources4

PRIMARY DATA
T"e data regarding 'C(EDIT (IS) *+,+-E*E,T. &as collected t"roug" primar data4 Semi5structured inter#ie&s &ere conducted &it" *(666!!1 *anager (+7- personal loans o% ICICI $ank1 *r! 661 Credit +nal st o% IDBI B+,) 3TD!1 and *r! S"a"0i Jaco$1 C"ie% *anager o% T"e FEDE(+3 B+,) 3imited! T"is &as done to understand t"e current practices and t"e st le o% %unctioning o% t"e credit risk management departments o% pri#ate $anks!

SECONDARY DATA
T"e data "ad $een collected $ reading #arious $ooks on Credit (isk *anagement1 Bank 8uest1 Bank 9eekl Bi$liograp" ;! T"e data regarding t"e $anks introduction and "istor &as collected and rele#ant 9e$sites :re%er

%rom t"eir o%%icial &e$sites on t"e recommendations o% t"e persons

Credit Risk Management inter#ie&ed! +lso some part o% t"e data &as collected $ re%erring to t"e (BI Bulletin1 Bank Booklets1 and ,e&sletter!

SAMPLING METHOD

T"e Sampling *et"od &as used to collect t"e data a$out t"e current practices %ollo&ed $ t"e pri#ate $anks in India as %ar as credit risk management goes! Onl 7ri#ate Banks "a#e $een taken $ecause t"e purpose o% t"is pro0ect &as to understand t"e in5dept" kno&ledge on 7ri#ate Banks practicing Credit risk management!

LIMITATIONS:

(eluctance and resistance on t"e part o% t"e inter#ie&ees :7ri#ate Banks; to s"are in%ormation as t"e considered it as con%idential! Visiting all pri#ate sector $anks &as not possi$le! Banks "a#e certain rules and regulations!

Credit Risk Management

INTRODUCTION
9it" t"e ad#ancing li$erali<ation and glo$ali<ation1 credit risk management is gaining a lot o% importance! It is #er important %or $anks toda to understand and manage credit risk! Banks toda put in a lot o% e%%orts in managing1 modeling and structuring credit risk! Credit risk is de%ined as t"e potential t"at a $orro&er or counterpart &ill %ail to meet its o$ligation in accordance &it" agreed terms! (BI "as $een e2tremel sensiti#e to t"e credit risk it %aces on t"e domestic and international %ront! Credit risk management is not 0ust a process or procedure! It is a %undamental component o% t"e $anking %unction! T"e management o% credit risk must $e incorporated into t"e %i$er o% $anks! +n $ank toda needs to implement e%%icient risk ad0usted return on capital met"odologies1 and $uild cutting5edge port%olio credit risk management s stems! Credit (isk comes %ull circle! Traditionall t"e primar risk o% %inancial institutions "as $een credit risk arising t"roug" lending! +s %inancial institutions entered ne& markets and traded ne& products1 ot"er risks suc" as market risk $egan to compete %or management=s attention! In t"e last %e& decades %inancial institutions "a#e de#eloped tools and met"odologies to manage market risk! (ecentl t"e importance o% managing credit risk "as gra$$ed management=s attention! Once again1 t"e $iggest c"allenge %acing %inancial institutions is credit risk! In t"e last decade1 $usiness and trade "a#e e2panded rapidl $ot" nationall and glo$all ! B e2panding1 $anks "a#e taken on ne& market risks and credit risks $ dealing &it" ne& clients and in some cases ne& go#ernments also! E#en $anks t"at do not enter into ne& markets are %inding t"at t"e concentration o% credit risk &it"in t"eir e2isting market is a "indrance to gro&t"! +s a result1 $anks "a#e created risk management mec"anisms in order to %acilitate t"eir gro&t" and to sa%eguard t"eir interests!

Credit Risk Management T"e c"allenge %or %inancial institutions is to turn credit risk into an opportunit ! 9"ile $anks attention "as returned to credit risk1 t"e nature o% credit risk "as c"anged o#er t"e period! Credit risk must $e managed at $ot" t"e indi#idual and t"e port%olio le#els and t"at too $ot" %or retail and corporate! *anaging credit risks re>uires speci%ic kno&ledge o% t"e counterpart ?s :$orro&ers; $usiness and %inancial condition! 9"ile t"ere are alread numerous met"ods and tools %or e#aluating indi#idual1 direct credit transactions1 compara$le inno#ations %or managing port%olio credit risk are onl 0ust $ecoming a#aila$le! 3ike&ise muc" o% traditional credit risk management is passi#e! Suc" acti#it "as included transaction limits determined $ management tec"ni>ues! t"e customer=s credit rating1 t"e transaction=s tenor1 and t"e o#erall e2posure le#el! ,o& t"ere are more acti#e

CREDIT

RISK

MANAGEMENT

PHILOSOPHY

*ostl all $anks toda practice credit risk management! T"e understand t"e importance o% credit risk management and t"ink o% it as a ladder to gro&t" $ reducing t"eir ,7+?s! *oreo#er t"e are no& using it as a tool to succeed o#er t"eir competition $ecause credit risk management practices reduce risk and impro#e return capital!

Credit Risk Management

INTRODUCTION TO RISK MANAGEMENT

+n acti#it in#ol#es risk1 touc"ing all sp"eres o% li%e1 &"et"er it is personal or $usiness! +n $usiness situation in#ol#es risk! To sustain its operations1 a $usiness "as to earn re#enue/pro%it and t"us "as to $e in#ol#ed in acti#ities &"ose outcome ma $e predicta$le or unpredicta$le! T"ere ma $e an ad#erse outcome1 a%%ecting its re#enue1 pro%it and/or capital! Ho&e#er1 t"e dictum ',o (isk1 ,o -ain. "old good "ere! DEFINING RISK T"e &ord (IS) is deri#ed %rom t"e Italian &ord (isicare meaning 'to dare.! T"ere is no uni#ersall accepta$le de%inition o% risk! 7ro%! Jo"n -eiger "as de%ined it as 'an e2pression o% t"e danger t"at t"e e%%ecti#e %uture outcome &ill de#iate %rom t"e e2pected or planned outcome in a negati#e &a .! T"e Basel Committee "as de%ined risk as 't"e pro$a$ilit o% t"e une2pected "appening @ t"e pro$a$ilit o% su%%ering a loss.! T"e %our letters comprising o% t"e &ord (IS) de%ine its %eatures! ( A (are :une2pected; I A Incident :outcome; S A Selection :identi%ication; ) A )nocking :measuring1 monitoring1 controlling; (IS)1 t"ere%ore1 needs to $e looked at %rom %our %undamental aspects4 Identi%ication *easurement *onitoring

Credit Risk Management Control :including risk audit;

RISK V/S UNCERTAINTY :(isk is not t"e same as uncertaint ; In a $usiness situation1 an decision could $e a%%ected $ a "ost o% e#ents4 an a$normal rise in interest rates1 %all in $ond prices1 gro&ing incidence o% de%ault $ de$tors1 etc! + compact risk management s stem "as to consider all t"ese as an o% t"em could "appen at a %uture date1 t"oug" t"e possi$ilit ma $e lo&!

TYPES OF RISKS:
T"e risk pro%ile o% an organi<ation and in t"is case $anks ma $e re#ie&ed %rom t"e %ollo&ing angles4 +! Business risks4 I! Capital risk II! Credit risk III! *arket risk IV! 3i>uidit risk V! Business strateg and en#ironment risk VI! Operational risk VII! -roup risk B! Control risks4 I! Internal Controls II! Organi<ation III! *anagement :including corporate go#ernance; IV! Compliance

Credit Risk Management

Bot" t"ese t pes o% risk1 "o&e#er1 are linked to t"e t"ree omni$us risk categories listed $elo&4 B! Credit risk C! *arket risk D! Organi<ational risk WHAT IS RISK MANAGEMENT? T"e standard de%inition o% management is t"at it is t"e process o% accomplis"ing preset o$0ecti#esE similarl 1 risk management aims at %ul%illing t"e same speci%ic o$0ecti#es! T"is means t"at an organi<ation/$ank1 &"et"er it?s a pro%it5 seeking one or a non5pro%it %irm1 must "a#e in place a clearl laid do&n parameter to contain @ i% not totall eliminate t"e %inanciall ad#erse e%%ects o% its acti#ities! Hence1 t"e process o% identi%ication1 measurement1 monitoring and control o% its acti#ities $ecomes paramount under risk management! T"e organi<ation/$ank "as to concentrate on t"e %ollo&ing issues4 Fi2ing a $oundar &it"in &"ic" t"e organi<ation/$ank &ill mo#e in t"e matter o% risk5prone acti#ities! T"e %unctional aut"orities must limit t"emsel#es to t"e de%ined risk $oundar &"ile ac"ie#ing $anks o$0ecti#es! T"ere s"ould $e a $alance $et&een t"e $ank?s risk p"ilosop" and its risk appetite!

Credit Risk Management

IMPORTANCE OF RISK MANAGEMENT

T"e Concern o#er risk management arose %rom t"e %ollo&ing de#elopments4 In Fe$ruar BFFG1 t"e Barings Bank episode s"ook t"e markets and $roug"t a$out t"e do&n%all o% t"e oldest merc"ant $ank in t"e U)! Inade>uate regulation and t"e poor s stems and practices o% t"e $ank &ere responsi$le %or t"e disaster! +ll components o% risk management @ market risk1 credit risk and operational risk @ &ere t"ro&n o#er$oard! S"ortl t"erea%ter1 in Jul BFFH1 t"ere &as t"e +sian %inancial crisis1 $roug"t a$out again $ t"e poor risk management s stems in $anks/%inancial damaged t"e monetar s stem o% t"e institutions coupled &it" per%unctor super#ision $ t"e regulator aut"orities1 suc" practices could "a#e se#erel #arious countries in#ol#ed and "ad international rami%ications! B anal <ing t"ese t&o incidents1 &e can come to t"e %ollo&ing conclusions4 (isks do increase o#er time in a $usiness1 especiall en#ironment! Increasing competition1 t"e remo#al o% $arriers to entr to ne& $usiness units $ man countries1 "ig"er order e2pectations $ stake"olders lead to assumption o% risks &it"out ade>uate support and sa%eguards! T"e e2ternal operating en#ironment in t"e CBst centur is noticea$l di%%erent! It is not possi$le to manage tomorro&?s e#ents &it" esterda ?s s stems and procedures and toda ?s "uman skill sets! Hence risk management "as to address suc" issues on a continuing $asis and install sa%eguards %rom time to time &it" t"e tool o% risk management! Stake"olders in $usiness are no& demanding t"at t"eir long5term interests $e protected in a c"anging en#ironment! T"e e2pect t"e organi<ation to install 9 in a glo$ali<ed

Credit Risk Management appropriate s stems to "andle a &orst5case situation! Here lies t"e task o% a risk management s stem @ pro#iding returns and en0o ing t"eir con%idence!

RISK PHILOSOPHY AND RISK APPETITE

Ideall 1 t"e risk management s stem in an organi<ation/$ank must codi% its risk p"ilosop" and risk appetite in eac" %unctionall area o% its $usiness! Risk phil s ph!4 It in#ol#es de#eloping and maintaining a "ealt" port%olio &it"in t"e $oundar set $ t"e legal and regulator %rame&ork! Risk "pp#$i$#: Is go#erned $ contours o% risk perception! Risk phil s ph! "%& 'isk "pp#$i$# must go "and5in5"and to ensure t"at t"e $ank "as strengt" and #italit ! t"e o$0ecti#e o% ma2imi<ing earnings &it"in t"e

RISK ORGANISATIONAL SET(UP

9"ile creating a $alanced organi<ational structure1 it must $e $orne in mind t"at t"e primar goal is not to a#oid risks t"at are in"erent in a particular $usiness :%or e2ample1 in t"e $anking $usiness lending is t"e dominant %unction1 in#ol#ing t"e risk o% de%ault $ t"e $orro&er; $ut rat"er to steer t"em consciousl and acti#el to ensure t"at t"e income generated is ade>uate to t"e assumption o% risks! PRINCIPLES IN RISK MANAGEMENT +n acti#it or group o% acti#ities needs to $e done according to clear principles or I%undamental trut"s?! In risk management1 t"e %ollo&ing set o% principles dominates an organi<ation?s operating en#ironment! Close in#ol#ement at t"e top le#el not onl at t"e polic %ormulation stage $ut also during t"e entire process o% implementation and regular monitoring!

10

Credit Risk Management T"e risk element in #arious segments &it"in an organi<ation ma #ar

depending on t"e t pe o% acti#ities t"e are in#ol#ed in! For e2ample1 in $ank t"e credit risk o% loans to priorit sectors ma $e percei#ed as $eing o% I"ig" %re>uenc $ut lo& #alue?! On t"e ot"er "and1 t"e operational risk in#ol#ed in large deposit accounts ma $e seen as Ilo& %re>uenc $ut "ig" #alue?! T"e se#erit and magnitude o% #arious t pes o% risk in an organi<ation must $e clearl documented! T"e c"ecks and sa%eguards must $e stated in clear terms suc" t"at t"e operate consistentl and e%%ecti#el 1 and allo& t"e po&er o% %le2i$ilit ! T"ere s"ould $e clear times o% responsi$ilit and demarcation o% duties o% people managing t"e organi<ation! Sta%% accounta$ilit must $e clearl spelt out so t"at #arious risk segments are "andled $ #arious o%%icers &it" %ull understanding and dedication1 taking responsi$ilit %or t"eir actions! +%ter identi%ication o% risk areas1 it is a$solutel essential t"at t"ese are measured1 monitored and controlled as per t"e needs and operating en#ironment o% t"e organi<ation! Hence1 like t"e internal audit o% %inancial accounts1 t"ere "as to "e a s stem o% Iinternal risk audit?! 9it" regular risk audit %eed$ack1 t"e principles o% risk management ma c"anged! +ll t"e risk segments s"ould operate in an integrated manner on an enterprise5 &ide $asis! (isk tolerance limits %or #arious categories must $e in place and Ie2ception reporting? must $e pro#ided %or &"en suc" limits are e2ceeded due to e2ceptional circumstances! In t"e terminolog o% %inance1 t"e term credit "as an omni$us connotation! It not onl includes all t pes o% loans and ad#ances :kno&n as %unded %acilities; $ut also contingent items like letter o% credit1 guarantees and deri#ati#es :also kno&n as non5 %unded/non5credit %acilities;! In#estment in securities is also treated as credit e2posure! 11 $e laid do&n or

Credit Risk Management

CREDIT RISK MANAGEMENT 9H+T IS C(EDIT (IS)J

'7ro$a$ilit o% loss %rom a credit transaction 'is t"e plain #anilla de%inition o% credit risk! +ccording to t"e Basel Committee1 'Credit (isk is most simpl de%ined as t"e potential t"at a $orro&er or counter5part &ill %ail to meet its o$ligations in accordance &it" agreed terms.! T"e (eser#e Bank o% India :(BI; "as de%ined credit risk as 't"e pro$a$ilit o% losses associated &it" diminution in t"e credit >ualit o% $orro&ers or counter5parties.! T"oug" credit risk is closel related &it" t"e $usiness o% lending :t"at is B+,)S; it is In%act applica$le to all acti#ities o% &"ere credit is in#ol#ed :%or e2ample1 manu%actures /traders sell t"eir goods on credit to t"eir customers;!t"e %irst record o% credit risk is reported to "a#e $een in BKLL B!C! CREDIT RISK MANGEMENT((((FUNCTIONALITY T"e credit risk arc"itecture pro#ides t"e $road can#as and in%rastructure to e%%ecti#el identi% 1 measure1 manage and control credit risk 555 $ot" at port%olio and indi#idual le#els555 in accordance &it" a $anks risk principles1 risk policies1 risk process and risk appetite as a continuous %eature! It aims to strengt"en and increase t"e e%%icac o% t"e organi<ation1 &"ile maintaining consistenc and transparenc ! Beginning &it" t"e Basel Capital +ccord5I in BFKK and t"e su$se>uent Barings episode inBFFG and t"e +sian Financial Crisis inBFFH1 t"e credit risk management %unction "as $ecome t"e centre o% gra#it 1 especiall in a %inanciall in ser#ices industr like $anking!

12

Credit Risk Management

DISTINCTION )ETWEEN CREDIT MANGEMENT AND CREDIT RISK MANAGEMENT +lt"oug" credit risk management is analogous to credit management1 t"ere is a su$tle di%%erence $et&een t"e t&o! Here are some o% t"e %ollo&ing4

CREDIT MANAGEMENT B! It in#ol#es selecting

CREDIT RISK MANAGEMENT and B! It in#ol#es identi% ing and anal <ing t"e risk in a credit transaction! C! It re#ol#es around measuring1

identi% ing

$orro&er/counter part ! C! It re#ol#es around e2amining t"e

t"ree 7?s o% $orro&ing4 people :c"aracter managing and controlling credit risk in and capacit o% t"e $orro&er/guarantor;1 t"e conte2t o% an organi<ation?s credit purpose :especiall i% t"e pro0ect/purpose p"ilosop" and credit appetite! is #ia$le or not;1 protection :securit o%%ered1 $orro&er?s capital1 etc!; D! It is predominantl concerned &it" D! It is predominantl concerned &it" on t"e risk

t"e pro$a$ilit o% repa ment! pro$a$ilit o% de%ault! M! Credit appraisal and anal sis do not M! Depending o% sanction! G! T"e standard %inancial tools o%

usuall pro#ide an e2it %eature at t"e time mani%estations o% an e2posure1 an e2ist route remains a usual option t"roug" t"e sale o% assets/securiti<ation! G! Statistical tools like Va( :Value at

assessment %or credit management are (isk;1 CVa( :Credit Value at (isk;1 $alance s"eet/income statement1 cas" %lo& duration and simulation tec"ni>ues1 etc! statement coupled &it" computation o% %orm t"e core o% credit risk management! speci%ic accounting ratios! It is t"en %ollo&ed $ post5sanction super#ision and 13

Credit Risk Management a %ollo&5up mec"anism :e!g! inspection o% securities1 etc!;! N! It is more $ack&ard5looking in its antecedents/per%ormance $orro&er/counterpart ! o% N! It is %or&ard looking in its

assessment1 in terms o% stud ing t"e assessment1 looking1 %or instance1 at a t"e likel scenario o% an ad#erse outcome in t"e $usiness!

RISK MANAGEMENT POLICIES

*ere codi%ication o% risk principles is not enoug"! T"e need to $e implemented t"roug" a de%ined course o% action! T"ere%ore a $ank re>uires policies on managing all t pes o% risks! T"ese "a#e to $e dra&n up keeping in mind t"e %ollo&ing elements4 T"e risk management process must gi#e appropriate &eig"tage to t"e nature o% eac" risk considering t"e $ank?s nature o% $usiness and a#aila$ilit o% skill sets1 in%ormation s stems etc! +ccordingl 1 t"ere s"ould $e a clear demarcation o% risks and operating instructions! T"e met"odolog and models or risk e#aluation must $e $uilt into t"e s stem! +ction points o% correcting de%iciencies $e ond tolerance le#els must $e pro#ided %or in t"e polic ! (isk polic documents need to $e uni%orm %or all t pes o% risks and1 in %act1 it ma not $e practica$le! T"ere%ore1 separate polic documents "a#e to $e made %or eac" segment5like credit risk1 market risk or operational risk5&it"in t"e %rame&ork o% risk principles! +n appropriate *IS is a must %or t"e smoot" and success%ul operation o% risk management acti#ities in t"e $ank! Data collection1 collation and updating must $e accurate and prompt! T"e organi<ational structure must $e so designed as to %it its risk p"ilosop" and risk appetite! Functional po&ers and responsi$ilities must $e speci%ied %or t"e o%%icials in c"arge o% managing eac" risk segment!

14

Credit Risk Management + I$ack testing? process5&"ere t"e >ualit and accurac o% t"e actual risk measurement is compared &it" t"e results generated $ correcti#e actions taken5must $e installed! T"ere s"ould $e periodical re#ie&s5 pre%era$l on semi annual $asis5 o% t"e risk mitigating tools %or eac" risk segment! Impro#ements must $e initiated &"ere necessar in t"e lig"t o% e2perience gained! T"ere s"ould $e a contingent planning s stem to "andle crises situations t"at elude planned sa%et nets! t"e model and

THE C(EDIT (IS) *+,+-E*E,T 7(OCESS

T"e &ord Iprocess? connotes a continuing acti#it or %unction to&ards a

particular result! T"e process is in %act t"e last o% t"e %our &ings in t"e entire risk management edi%ice @ t"e ot"er t"ree $eing organi<ational structure1 principles and policies! In e%%ect it is t"e #e"icle to implement a $ank?s risk principles and policies aided $ $anks organi<ational structure1 &it" t"e sole o$0ecti#e o% creating and maintaining a "ealt" risk culture in t"e $ank! T"e risk management process "as %our components4 B! (isk Identi%ication! C! (isk *easurement! D! (isk *onitoring! M! (isk Control! RISK IDENTIFICATION: 9"ile identi% ing risks1 t"e %ollo&ing points "a#e to $e kept in mind4 +ll t pes o% risks :e2isting and potential; must $e identi%ied and t"eir likel e%%ect in t"e s"ort run $e understood! T"e magnitude o% eac" risk segment ma #ar %rom $ank to $ank! T"e geograp"ical area co#ered $ t"e $ank ma determine t"e co#erage o% its risk content! + $ank t"at "as international operations ma e2perience di%%erent 15

Credit Risk Management intensit o% credit risks in #arious countries &"en compared &it" a pure in it domestic

domestic $ank! +lso1 e#en &it"in a $ank1 risks &ill #ar operations and its o#erseas arms! RISK MEASUREMENT:

*E+SU(E*E,T means &eig"ing t"e contents and/or #alue1 intensit 1 magnitude o% an o$0ect against a ardstick! In risk measurement it is necessar to esta$lis" clear &a s o% e#aluating #arious risk categories1 &it"out &"ic" identi%ication &ould not ser#e an t"rust purpose! Using >uantitati#e tec"ni>ues in a >ualitati#e %rame&ork &ill %acilitate t"e %ollo&ing o$0ecti#es4 Finding out and understanding t"e e2act degree o% risk elements in Directing t"e e%%orts o% t"e $ank to mitigate t"e risks according to t"e Taking appropriate initiati#es in planning t"e organi<ation?s %uture areas and line o% $usiness and capital allocation! T"e eac" categor in t"e operational en#ironment! #ulnera$ilit o% a particular risk %actor!

s stems/tec"ni>ues used to measure risk depend upon t"e nature and comple2it o% a risk %actor! 9"ile a #er simple >ualitati#e assessment ma $e su%%icient in some cases1 sop"isticated met"odological/statistical ma $e necessar in ot"ers %or a >uantitati#e #alue! RISK MONITORING: )eeping close track o% risk identi%ication measurement acti#ities in t"e lig"t o% t"e risk1 principles and policies is a core %unction in a risk management s stem! For t"e success o% t"e s stem1 it is essential t"at t"e operating &ings per%orm t"eir acti#ities &it"in t"e $road contours o% t"e organi<ations risk perception! (isk monitoring acti#it s"ould ensure t"e %ollo&ing4 Eac" operating segment "as clear lines o% aut"orit and responsi$ilit ! 9"ene#er t"e organi<ations principles and policies are $reac"ed1 e#en i% t"e ma $e to its ad#antage1 must $e anal <ed and reported1 to t"e concerned aut"orities to aid in polic making! 16

Credit Risk Management In t"e course o% risk monitoring1 i% it appears t"at it is in t"e $anks interest to modi% e2isting policies and procedures1 steps to c"ange t"em s"ould $e considered! T"ere must $e an action plan to deal &it" ma0or t"reat areas %acing t"e $ank in t"e %uture! T"e acti#ities o% $ot" t"e $usiness and reporting &ings are monitored striking a $alance at all points in time! Tracking o% risk migration is $ot" up&ard and do&n&ard!

RISK CONTROL: T"ere must $e appropriate mec"anism to regulate or guide t"e operation o% t"e risk management s stem in t"e entire $ank t"roug" a set o% control de#ices! T"ese can $e ac"ie#ed t"roug" a "ost o% management processes suc" as4 +ssessing risk pro%ile tec"ni>ues regularl to e2amine "o& %ar t"e are e%%ecti#e in mitigating risk %actors in t"e $ank! +nal <ing internal and e2ternal audit %eed$ack %rom t"e risk angle and using it to acti#ate control mec"anisms! Segregating risk areas o% ma0or concern %rom ot"er relati#el insigni%icant areas and e2ercising more control o#er t"em! 7utting in place a &ell dra&n5out5risk5%ocused audit s stem to pro#ide inputs on restraint %or operating personnel so t"at t"e needless risks %or s"ort5term interests! It is e#ident1 t"ere%ore1 t"at t"e risk management process t"roug" all its %our &ings %acilitate an organi<ation?s sustaina$ilit and gro&t"! T"e importance o% eac" &ing depends upon t"e nature o% t"e organi<ations acti#it 1 si<e and o$0ecti#e! But it still remains a %act t"at t"e importance o% t"e entire process is paramount! GOAL OF CREDIT RISK MANGEMENT 17 do not take

Credit Risk Management

T"e international regulator $odies %elt t"at a clear and &ell laid risk management s stem is t"e %irst prere>uisite in ensuring t"e sa%et and sta$ilit o% t"e s stem! T"e %ollo&ing are t"e goals o% credit risk management o% an $ank/%inancial organi<ation4 *aintaining risk5return discipline $ accepta$le parameters! Fi2ing proper e2posure limits keeping in #ie& t"e risk p"ilosop" and risk appetite o% t"e organi<ation! Handling credit risk $ot" on an 'entire port%olio. $asis and on an 'indi#idual credit or transaction. $asis! *aintaining an appropriate $alance $et&een credit risk and ot"er risks @ like market risk1 operational risk1 etc! 7lacing e>ual emp"asis on '$anking $ook credit risk. :%or e2ample1 loans and ad#ances on t"e $anks $alance s"eet/$ooks;1 'trading $ook risk. :securities/$onds; and 'o%%5$alance s"eet risk. :deri#ati#es1 guarantees1 3/Cs1 etc!; Impartial and #alue5added control input %rom credit risk management to protect capital! 7ro#iding a timel response to $usiness re>uirements e%%icientl ! *aintaining consistent >ualit and e%%icient credit process! Creating and maintaining a respecta$le and credit risk management culture to ensure >ualit credit port%olio! )eeping 'consistenc and transparenc 'as t"e &atc"&ords in credit risk management! CREDIT RISK MANGEMENT TECHNI*UES (isk @taking is an integral part o% management in an enterprise! For e2ample1 i% a particular $ank decides to lend onl against its deposits1 t"en its margins are $ound to $e #er slender indeed! Ho&e#er t"e $ank ma 18 keeping risk e2posure &it"in

Credit Risk Management also not $e in a position to deplo all its lenda$le %unds1 since o$#iousl takers %or loans &ill $e #er and occasional! T"e $asic tec"ni>ues o% an ideal credit risk management culture are4 Certain risks are not to $e taken e#en t"oug" t"ere is t"e likeli"ood o% ma0or gains or pro%it1 like speculati#e acti#ities! Transactions &it" si<ea$le risk content s"ould $e trans%erred to pro%essional risk institutions! For e2ample1 ad#ances to small scale industrial units and small $orro&ers s"ould $e co#ered $ t"e Deposit O Credit Insurance Sc"eme in India! Similarl 1 e2port %inance s"ould $e co#ered $ t"e E2port Credit -uarantee Sc"eme1 etc! T"e ot"er risks s"ould $e managed $ t"e institution &it" proper risk management arc"itecture! T"us I conclude t"at credit management tec"ni>ues are a mi2ture o% risk a#oidance1 risk trans%er and risk assumption! T"e importance o% eac" o% t"ese &ill depend on t"e organi<ations nature o% acti#ities1 its si<e1 capacit and a$o#e all its risk p"ilosop" and risk appetite!

FORMS OF CREDIT RISK T"e (BI "as laid do&n t"e %ollo&ing %orms o% credit risk4 ,on5repa ment o% t"e principal o% t"e loan and /or t"e interest on it! Contingent lia$ilities like letters o% credit/guarantees issued $ t"e $ank on $e"al% o% t"e client and upon cr stalli<ation5555 amount not deposited $ t"e customer! In t"e case o% treasur operations1 de%ault $ t"e counter5parties in meeting t"e o$ligations! In t"e case o% securities trading1 settlement not taking place &"en it?s due! 19

Credit Risk Management In t"e case o% cross @ $order o$ligations1 an de%ault arising %rom t"e %lo& o% %oreign e2c"ange and /or due to restrictions imposed on remittances out o% t"e countr !

COMMON CAUSES OF CREDIT RISK SITUATIONS For an organi<ation1 especiall one in $anking5related acti#ities1 losses %rom credit risk are usuall #er se#ere and non in%re>uent! It is t"ere%ore necessar to look into t"e causes o% credit risk #ulnera$ilit ! Broadl t"ere are t"ree sets o% causes1 &"ic" are as %ollo&s4 C(EDIT CO,CE,T(+TIO, C(EDIT -(+,TI,- +,D/O( *O,ITO(I,- 7(OCESS C(EDIT EP7OSU(E I, THE*+()ET +,D 3I8UIDITY SE,SITIVITY SECTO(S! CREDIT CONCENTRATION +n kind o% concentration "as its limitations! T"e cardinal principle is t"at all eggs must not $e put in t"e same $asket! Concentrating credit on an one o$ligor /group or t pe o% industr /trade can pose a t"reat to t"e lenders &ell $eing! In t"e case o% $anking1 t"e e2tent o% concentration is to $e 0udged according to t"e %ollo&ing criteria4 T"e institution?s capital $ase :paid5up capitalQreser#es O surplus1 etc;! T"e institutions total tangi$le assets! T"e institutions pre#ailing risk le#el! T"e alarming conse>uence o% concentration is t"e likeli"ood o% large losses at one time or in succession &it"out an opportunit to a$sor$ t"e s"ock! Credit concentration ma take an or $ot" o% t"e %ollo&ing %orms4 Con#entional4 in a single $orro&er/group or in a particular sector like steel1 petroleum1 etc!

20

Credit Risk Management Common/ correlated concentration4 %or e2ample1 e2c"ange rate de#aluation and its e%%ect on %oreign e2c"ange deri#ati#e counter5 parties!

INEFFECTIVE CREDIT GRANTING AND / OR MONITORING PROCESS:

+ strong appraisal s stem and pre5 sanction care are $asic re>uisites in t"e credit deli#er s stem! T"is again needs to $e supplemented $ an appropriate and prompt post5dis$ursement super#ision and %ollo&5up s stem! T"e "istor o% %inance is replete &it" cases o% de%ault due to ine%%ecti#e credit granting and/or monitoring s stems and practices in an organi<ation1 "o&e#er e%%ecti#e1 need to $e su$0ected to impro#ement %rom time to time in t"e lig"t o% de#elopments in t"e marketplace!

CREDIT E+POSURE IN THE MARKET AND LI*UIDITY( SENSITIVE SECTORS:

Foreign e2c"ange and deri#ates contracts1 letter o% credit and li>uidit $ack up lines etc! &"ile $eing remunerati#eE create sudden "iccups in t"e organi<ations %inancial $ase! To guard against rude s"ock1 t"e organi<ation must "a#e in place a Compact +nal tical S stem to c"eck %or t"e customer?s #ulnera$ilit to li>uidit pro$lems! In t"is conte2t1 t"e Basel Committee states t"at1 '*arket and li>uidit 5 sensiti#e e2posures1 $ecause t"e are pro$a$ilistic1 can $e correlated &it" credit5 &ort"iness o% t"e $orro&er.! CONFLICTS IN CREDIT RISK MANGEMENT +n organi<ation dedicated to optimall manage its credit risk %aces con%lict1 particularl &"ile meeting t"e re>uirements o% t"e $usiness sector! Its customers e2pect t"e $ank to e2tend "ig" >ualit lender5ser#ice &it" e%%icienc and responsi#eness1 placing increasing demands in terms o% "ig"er amounts1 longer tenors

21

Credit Risk Management and lesser collateral! T"e organi<ation on t"e ot"er "and ma "a#e a limited credit risk appetite and like to reap t"e ma2imum $ene%its &it" lesser credit and o% a s"orter duration! +n articulate $alancing o% t"is con%lict re%lects t"e strengt" and soundness o% risk management practices o% t"e $ank! COMPONENTS ,)UILDING )LOCKS- OF CREDIT RISK MANAGEMENT T"e entire credit risk management edi%ice in a $ank rests upon t"e %ollo&ing t"ree $uilding $locks1 in accordance &it" (BI guidelines4 ./ FORMULATION OF CREDIT RISK POLICY AND STRATEGY: +ll $anks cannot use t"e same polic and strateg 1 e#en t"oug" t"e ma $e similar in man respects! T"is is $ecause eac" $ank "as a di%%erent risk polic and risk appetite! Ho&e#er one aspect t"at is common %or an $ank is t"at it must "a#e an appropriate polic %rame&ork co#ering risk identi%ication1 measurement1 monitoring and control! In suc" a polic initiati#e1 t"ere must $e risk control/mitigation measures and also clear lines o% aut"orit 1 autonom and accounta$ilit o% operating o%%icials! +s a matter o% %act1 t"e polic document must pro#ide %le2i$ilit to make t"e $est use o% risk5re&ard opportunities! (isk strateg &"ic" is a %unctional element in#ol#ing t"e implementation o% risk polic is concerned more &it" sa%e and pro%ita$le credit operations! it takes in to account t pes o% economic / $usiness acti#it to &"ic" credit is to $e e2tended1 its geograp"ical location and suita$ilit 1 scope o% di#ersi%ication1 c clical aspects o% t"e econom and a$o#e all means and &a s o% e2isting &"en t"e risk $ecome too "ig"! 0/ CREDIT RISK ORGANISATION STRUCTURE: Depending upon a $anks nature o% acti#it 1 and a$o#e all its risk p"ilosop" and risk appetite 1 t"e organi<ation structure is %ormed taking care o% t"e core %unctions o% risk identi%ication1 risk measurement1 risk monitoring and risk control! T"e (BI "as suggested t"e %ollo&ing guidelines %or $anks4

22

Credit Risk Management T"e Board o% Directors &ould $e in t"e superstructure1 &it" a role in t"e o#erall risk polic %ormulation and o#erseeing! T"ere "as to $e a $oard5le#el su$5committee called t"e (isk *anagement Committee :(*C; concerned &it" integrated risk management! T"at is1 %raming polic issues on t"e $asis o% t"e o#erall polic prescriptions o% t"e Board and coming up &it" an implementation strateg ! T"is su$5 committee1 entrusted &it" enterprise &ide risk management1 s"ould comprise t"e c"ie% e2ecuti#e o%%icer and "eads o% t"e Credit (isk *anagement and *arket and Operational (isk *anagement Committee! + Credit (isk *anagement Committee :C(*C; s"ould %unction under t"e super#ision o% t"e (*C! T"is committee s"ould $e "eaded $ t"e CEO/e2ecuti#e director and s"ould include "eads o% credit1 treasur 1 t"e Credit (isk *anagement Department :C(*D; and t"e c"ie% economist! FUNCTIONS OF CRMC: Implementation o% Credit (isk 7olic ! *onitoring credit risk on t"e $asis o% t"e risk limits %i2ed $ t"e $oard and ensuring compliance on an ongoing $asis! Seeking t"e $oard?s appro#al %or standards %or entertaining credit/in#estment proposals and %i2ing $enc"marks and %inancial co#enants! *icro5management o% credit e2posures1 %or e2ample1 risks concentration/di#ersi%ication1 pricing1 collaterals1 port%olio re#ie&1 pro#isional/compliance aspects1 etc! Besides setting up macro5le#el %unctionaries on a committee $asis eac" $ank is re>uired to put in place a Credit (isk *anagement Department :C(*D;1 &"ose %unctions "a#e $een prescri$ed $ t"e (BI! FUNCTIONS OF CRMD4 *easuring1 controlling and managing credit risk on a $ank @ &ide $asis &it"in t"e limits set $ t"e $oard/C(*C! 23

Credit Risk Management En%orce compliance &it" t"e risk parameters and prudential limits set $ t"e Board/C(*C! 3a do&n risk assessment s stems1 de#elop an *IS1 monitor t"e >ualit o% loan /in#estment port%olio1 identi% pro$lems1 correct de%iciencies and undertake loan re#ie& /audit! Be accounta$le %or protecting t"e >ualit loan/in#estment port%olio! o% t"e entire

1/ CREDIT RISK OPERATION 2 SYSTEM FRAMEWORK: *easurement and monitoring1 along &it" control aspects1 in credit risk determine t"e #ulnera$ilit or ot"er&ise o% an organi<ation &"ile e2tending credit1 including deplo ment o% %unds in trada$le securities! +s per (BI guidelines1 t"is s"ould in#ol#e t"ree clear p"ases4 (elations"ip management &it" t"e clientele &it" an e e on $usiness de#elopment! Transaction management in#ol#ing %i2ing t"e >uantum1 tenor and pricing and to document t"e same in con%ormit regulator guidelines! 7ort%olio management1 signi% ing appraisal/e#aluation on a port%olio $asis rat"er t"an on an indi#idual $asis :&"ic" is co#ered $ t"e t&o earlier points; &it" a special t"rust on management o% non5per%orming items! In t"e lig"t o% all t"e a$o#e t"ree p"ases1 a $ank "as to map its risk management acti#ities :identi%ication1 measurement1 monitoring and control;! It "as to emp"asi<e on t"e %ollo&ing aspects4 T"ere s"ould $e periodic %ocused industr studies identi% ing1 in particular1 stagnant and d ing sectors! &it" statutor /

24

Credit Risk Management Hands5on super#ision o% indi#idual credit accounts t"roug" "al%5 earl /annual re#ie&s o% %inancial1 position o% collaterals and o$ligor?s internal and e2ternal $usiness en#ironment! Credit sanctioning aut"orit and credit risk appro#ing aut"orit to $e separate! 3e#el o% credit sanctioning aut"orit proportion to t"e amount o% credit! Installation o% a credit audit s stem in@"ouse or "anded5out to a competent e2ternal organi<ation! +n appropriate credit rating s stem to operate! 7ricing s"ould $e linked to t"e risk rating o% an account 555 "ig"er t"e risk1 "ig"er t"e price! Credit appraisal and periodic re#ie&s55555 toget"er &it" en"ancement &"en necessar 555 s"ould $e uni%orm1 $ut operate %le2i$l ! T"ere s"ould $e a consistent approac" :keeping in #ie& prudential guidelines &"ere#er e2isting; in t"e identi%ication1 classi%ication and reco#er o% non5per%orming accounts! + compact s stem to a#oid e2cessi#e concentration o% credit s"ould operate &it" port%olio anal sis! T"ere s"ould $e a clearl laid do&n process o% risk reporting o% data/in%ormation to t"e controlling / regulator aut"orities! + conser#ati#e long pro#isionar polic s"ould $e in place so t"at all non per%orming assets are pro#ided %or1 not onl as per regulator re>uirements $ut also &it" some additional cus"ioning :some $anks in India pro#ide %or a %i2ed percentage55555usuall L!CGR555555o% standard assets;! T"ere s"ould $e detailed delegation o% po&ers1 duties and responsi$ilities o% o%%icials dealing &it" credit! T"ere s"ould $e sound *anagement In%ormation S stem! is to $e "ig"er in

25

Credit Risk Management T"ese make it clear t"at operations/s stems in credit risk management $ecome reall e%%ecti#e tools onl &"en t"e are led $ principles o% consistenc and transparenc !

THE CREDIT RATING MECHANISM (ating implies an assessment or e#aluation o% a person1 propert 1 pro0ect or a%%airs against a speci%ic ardstick/$enc"mark set %or t"e purpose! In credit rating1 t"e o$0ecti#e is to assess/e#aluate a particular credit proposition :&"ic" includes in#estment; on t"e $asis o% certain parameters! T"e outcome indicates t"e degree o% credit relia$ilit and risk! T"ese are classi%ied into #arious grades according to t"e ardstick/$enc"mark set %or eac" grade! Credit rating in#ol#es $ot" >uantitati#e and >ualitati#e e#aluations! 9"ile %inancial anal sis co#ers a "ost o% %actors suc" as t"e %irm?s competiti#e strengt" &it"in t"e industr /trade1 likel all 3"%"4#3#%$ %actors! T"e Basel Committee "as de%ined credit rating as a s533"'! i%&i6"$ ' o% t"e risk in"erent in indi#idual credit1 em$od ing an assessment o% t"e risk o% loss due to t"e de%ault counter5part credit risk! WHO UNDERTAKES CREDIT RATING T"ere is no restriction on an one rating anot"er $ank as long as it ser#es t"eir purpose! For instance1 a &ould5$e emplo ee ma like to do a rating $e%ore deciding to 0oin a %irm! Internationall rating agencies like Standard O 7oor?s:SO7; and undertake rating e2ercises generall t"e &"en an *ood ?s are &ell kno&n! In India1 t"e %our aut"ori<ed rating agencies are C(ISI31 IC(+1 C+(E1 and FITCH! T"e organi<ation &ants to issue de$t instruments like commercial paper1 $onds1 etc! t"eir ratings %acilitate in#estor decisions1 alt"oug" normall do not "a#e an $ considering rele#ant >uantitati#e and >ualitati#e in%ormation! T"us1 credit rating is a tool %or t"e measurement or >uanti%ication o% e%%ects on t"e %irm?s $usiness o% an ma0or tec"nological c"anges1 regulator /legal c"anges1 etc!1 &"ic" are

26

Credit Risk Management statutor /regulator lia$ilit in respect o% a rated instrument! T"is is $ecause rating is onl an pi%i % on t"e %inancial a$ilit o% an organi<ation to "onor pa ments o% principal and/or interest on a de$t instrument1 as and &"en t"e are d e in %uture! Ho&e#er1 since t"e rating agencies "a#e t"e e2pertise in t"eir %ield and are not tainted &it" an on t"em! Banks do undertake structured rating e2ercises &it" >uantitati#e and >ualitati#e inputs to support a credit decision1 &"et"er it is sanction or re0ection! Ho&e#er t"e ma $e in%luenced B t"e rating 555&"et"er a#aila$le5555 o% an instrument o% a particular part $ an e2ternal agenc e#en t"oug" t"e purpose o% a $ank?s credit rating ma $e an omni$us one555 t"at is to c"eck a $orro&er?s capacit and competence5555&"ile t"at o% an e2ternal agenc ma $e limited to a particular de$t instrument! UTILITY OF CREDIT RATING In a de#eloping countr like India1 t"e $iggest sources o% %unds %or an $ias1 t"eir ratings are "and %or market participants and regulator aut"orities to %orm 0udgments on an instrument and/ or t"e issuer and take decisions

organi<ation to ac>uire capital assets and/or %or &orking capital re>uirement are commercial $anks and de#elopment %inancial institutions! Hence credit rating is one o% t"e most important tools to measure1 monitor and control credit risk $ot" at indi#idual and port%olio le#els! O#erall1 t"eir utilit %ollo&ing angles4 Credit selection/re0ection! E#aluation o% $orro&er in totalit and o% an particular e2posure/%acilit ! Transaction5le#el anal sis and credit pricing and tenure! +cti#it 5&ise/sector5&ise port%olio stud position! Fi2ing outer limits %or taking up/ maintaining an e2posure arising out o% risk rating! keeping in #ie& t"e macro5le#el ma $e #ie&ed %rom t"e

27

Credit Risk Management *onitoring e2posure alread appropriate cases! +llocation o% risk capital %or poor graded credits! +#oiding o#er5concentration o% e2posure in speci%ic risk grades1 &"ic" ma not $e o% ma0or concern at a particular point o% time1 $ut ma in %uture pose pro$lems i% t"e concentration continues! Clarit and consistenc 1 toget"er &it" transparenc in rating a particular $orro&er/e2posure1 ena$ling a proper control mec"anism to c"eck risks associated in t"e e2posure! Basel5II "as summed up t"e utilit o% credit rating in t"is &a 4 'Internal risk ratings are an important tool in monitoring credit risk! Internal risk ratings s"ould $e ade>uate to support t"e identi%ication and measurement o% risk %rom all credit risk e2posures and s"ould $e integrated into an institution?s o#erall anal sis o% credit risk and capital ade>uac ! T"e ratings s stem s"ould pro#ide detailed ratings %or all assets1 not onl %or critici<ed or pro$lem assets! 3oan loss reser#es s"ould $e included in t"e credit risk assessment %or capital ade>uac !. METHODS OF CREDIT RATING B! T"roug" t"e c cle4 In t"is met"od o% credit rating1 t"e condition o% t"e o$ligor and/or position o% e2posure are assessed assuming t"e '&orst point in $usiness c cle.! T"ere ma $e a strong element o% su$0ecti#it on t"e e#aluator?s part &"ile grading a particular case! It is also di%%icult to implement t"e met"od &"en t"e num$er o% $orro&ers/e2posures is large and #aried! C! 7oint5in5time4 + rating sc"eme $ased on t"e 65''#%$ 6 %&i$i % o% t"e $orro&er/e2posure! T"e inputs %or t"is met"od are pro#ided $ %inancial statements1 current market position o% t"e trade / $usiness1 corporate go#ernance1 o#erall management e2pertise1 etc! In India $anks usuall adopt t"e point5in5time met"od $ecause4 in t"e $ooks and deciding e2it strategies in

28

Credit Risk Management It is relati#el simple to operate &"ile at t"e same time

pro#iding a %air estimate o% t"e risk grade o% an o$ligor/e2posure! It can $e applied consistentl and o$0ecti#el ! 7eriodical re#ie& and do&ngrading are possi$le depending upon t"e position! T"e point5in @time %ull ser#es t"e purpose o% credit rating o% a $ank! SCORES / GRADES IN CREDIT RATING: T"e main aim o% t"e credit rating s stem is t"e measurement or >uanti%ication o% credit risk so as to speci%icall identi% t"e pro$a$ilit o% de%ault :7D;1 e2posure at de%ault :E+D; and loss gi#en de%ault :3-D;!Hence it needs a tool to implement t"e credit rating met"od :generall t"e point in time met"od;!T"e agenc also needs to design appropriate measures %or #arious grades o% credit at an indi#idual le#el or at a port%olio le#el! T"ese grades ma generall $e an o% t"e %ollo&ing %orms4 B! +lp"a$et4 +++1 ++1 BBB1 etc! C! ,um$er4 I1 II1 III1 IV1 etc! T"e %undamental reasons %or #arious grades are as %ollo&s4 Signaling de%ault risks o% an e2posure! Facilitating comparison o% risks to aid decision making! Compliance &it" regulator e2posures! 7ro#iding a %le2i$le means to ultimatel measure t"e credit risk o% an e2posure! COMPONENTS OF SCORES/GRADES: Scores are mere num$ers allotted %or eac" >uantitati#e and >ualitati#e parameter555out o% t"e ma2imum allo&a$le %or eac" parameter as ma $e %i2ed $ an organi<ation 555o% an e2posure! T"e issue o% identi%ication o% speci%ic parameters1 its o#erall marks and %inall relating aggregate marks :%or all >uantitati#e and >ualitati#e 29 o% asset classi%ication $ased on risk

Credit Risk Management parameters; to #arious grades is a matter o% management polic and discretion5555 t"ere is no statutor or regulator compulsion! Ho&e#er t"e management is usuall guided in its e%%orts $ t"e %ollo&ing %actors4 Si<e and comple2it o% operations! Varieties o% its credit products and speed! T"e $anks credit p"ilosop" and credit appetite! Commitment o% t"e top management to assume risks on a calculated $asis &it"out $eing risk5a#erse! FUNDAMENTAL PRINCIPLE OF RATING AND GRADING + $asic re>uirement in risk grading is t"at it s"ould re%lect a clear and %ine distinction $et&een credit grades co#ering de%ault risks and sa%e risks in t"e s"ort run! 9"ile t"ere is no i&#"l num$er o% grades t"at &ould %acilitate ac"ie#ing t"is o$0ecti#e1 it is e2pected t"at 3 '# 4'"%5l"'i$! ma ser#e t"e %ollo&ing purposes4 O$0ecti#e anal sis o% port%olio risk! +ppropriate pricing o% #arious risk grade $orro&er?s1 &it" a %ocus on lo&5 risk $orro&ers in terms o% lo&er pricing! +llocation o% risk capital %or "ig" risk graded e2posures! +c"ie#ing accurac and consistenc ! +ccording to t"e (BI1 t"ere s"ould $e an ideal $alance $et&een 'accepta$le credit risk and unaccepta$le credit risk. in a grading s stem! It is suggested t"at4 + rating scale ma consist o% K5F le#els! O% t"e a$o#e t"e %irst %i#e le#els ma represent accepta$le credit risks! T"e remaining %our le#els ma represent unaccepta$le credit risks! T"e a$o#e scales ma $e denoted $ num$ers :B1 C1 D etc!; or alp"a$ets :+++1 ++1 BBB1 etc!;

30

Credit Risk Management

TYPES OF CREDIT RATING -enerall speaking credit rating is done %or an t pe o% e2posure irrespecti#e o% t"e nature o% an o$ligor?s acti#it 1 status :go#ernment or non5go#ernment; etc! Broadl 1 "o&e#er1 credit rating done on t"e %ollo&ing t pes o% e2posures! 9"olesale sector:COI;! (etail e2posure4 Consumer lending1 like "ousing %inance1 car %inance1 etc! T"e parameters %or rating t"e risks o% &"olesale and retail e2posures are di%%erent! Here are some o% t"em4 In t"e &"olesale sector1 repa ment is e2pected %rom t"e $usiness %or &"ic" t"e %inance is $eing e2tended! But in t"e case o% t"e retail sector1 repa ment is done %rom t"e mont"l /periodical income o% an indi#idual %rom "is salar / occupation! In t"e &"olesale sector1 apart %rom assets %inanced %rom $ank %unds1 ot"er $usiness assets/personal assets o% t"e o&ner ma $e a#aila$le as securit ! In case o% retail e2posure1 t"e assets t"at are %inanced generall constitute t"e sole securit ! Since &"olesale e2posure is %or $usiness purposes1 en"ancement lasts :especiall %or &orking capital %inance; as long as t"e $usiness operates! In t"e retail sector1 "o&e#er1 e2posure is limited to appoint o% time agreed to at t"e time o% dis$ursement! 'Unit. e2posure in t"e retail categor is >uite small generall compared to t"at o% &"olesale e2posure! T"e %re>uenc o% credit rating in t"e case o% &"olesale e2posure is generall annual1 e2cept in cases &"ere more %re>uent : sa "al% earl ; rating is &arranted due to certain speci%ic reasons : %or e2ample1 declining trend o% asset >ualit ! Ho&e#er retail credit ma $e su$0ected to a lo&er %re>uenc e2posure4 E2posed to t"e commercial and institutional

31

Credit Risk Management :sa once in t&o ears; o% rating as long as e2posure continues to $e under t"e standard asset categor ! USUAL PARAMETERS FOR CREDIT RATING +! Wh l#s"l# #7p s5'#: For &"olesale e2posures1 &"ic" are generall meant %or t"e $usiness acti#ities o% t"e o$ligor1 t"e %ollo&ing parameters are usuall important4 8uantitati#e %actors as on t"e last date o% $orro&er?s accounting ear4 B! -ro&t" in sales/main income! C! -ro&t" in operating pro%it and net pro%it! D! (eturn on capital emplo ed! M! Total de$t5e>uit ratio! G! Current ratio! N! 3e#el o% contingent lia$ilities! H! Speed o% de$t collection! K! Holding period o% in#entories/%inis"ed goods! F! Speed o% pa ment to trade creditors! BL! De$t5ser#ice co#erage ratio :DSC(;! BB! Cas" %lo& DSC(! BC! Stress test ratio :#ariance o% cas" %lo&/DSC( compared &it" t"e preceding ear;! 8ualitati#e %actors are ad0uncts to t"e >uantitati#e %actors1 alt"oug" t"e cannot $e measured accuratel Sonl complete! T"ese %actors usuall include4 B! Ho& t"e particular $usiness complies &it" t"e regulator %rame&ork1 standard and norms1 i% laid do&n! C! E2perience o% t"e top management in t"e #arious acti#ities o% t"e $usiness! an o$0ecti#e opinion can $e %ormed! ,e#ert"eless1 &it"out assessing >uantitati#e %actors1 credit rating &ould not $e

32

Credit Risk Management D! 9"et"er t"ere is a clear cut succession plan %or ke personnel in t"e organi<ation! M! Initiati#es s"o&n $ t"e top management in sta ing a"ead o% competitors! G! Corporate go#ernance initiati#e! N! Honoring %inancial commitments! H! Ensuring end5use o% e2ternal %unds! K! 7er%ormance o% a%%iliate concerns1 i% an ! F! T"e organi<ation?s a$ilit to cope &it" an ma0or &ere tec"nological1 regulator 1 legal c"anges1 etc! BL! C clical %actors1 i% an 1 t"e $usiness and "o& t"e industr /trade anal sis! BB! 7roduct c"aracteristics5555scope %or di#ersi%ication! BC! +pproac" to %acing t"e t"reat o% su$stitutes! B/ R#$"il E7p s5'#: In undertaking credit rating %or retail e2posures5555&"ic" consists mainl o% lending %or consumer dura$les and "ousing %inance1 or an ot"er %orm o% need $ased %inancial re>uirement o% indi#iduals/groups in t"e %orm o% educational loansSt"e t&o #ital issues need to $e addressed4 B! Borro&er?s a$ilit to ser#ice t"e loan! C! Borro&er?s &illingness at an point o% time to ser#ice t"e loan and / or compl &it" t"e lenders re>uirement! T"e parameters %or rating retail e2posures are an admi2ture o% >uantitati#e and >ualitati#e %actors! In $ot" situations1 t"e e#aluator?s o$0ecti#it in assessment is considered crucial %or 0udging t"e >ualit parameters ma $e grouped into %our categories4 ./ PERSONAL DETAILS: a! A4#4 Economic li%e1 producti#e ears o% li%e! o% e2posure! T"e "andled $ t"e management in t"e past ear5555macro le#el

33

Credit Risk Management $! E&56"$i % 85"li9i6"$i %s4 7ro$a$ilit tendenc to ser#ice and repa t"e loan! c! M"'i$"l s$"$5s4 -reater need o% a permanent settlement1 lesser tendenc to de%ault! d! N53:#' 9 &#p#%&#%$s4 Impact on mont"l out%lo&1 reduced a$ilit to repa ! e! M :ili$! 9 $h# i%&i;i&5"l< l 6"$i %4 +%%ects t"e $orro&er?s repa ment capacit and also "is &illingness to repa ! 0/ EMPLOYMENT DETAILS: a! E3pl !3#%$ s$"$5s4 Income o% t"e sel%5emplo ed is not as sta$le as t"at o% a salaried person! $! D#si4%"$i %: 7eople at middle management and senior management le#els tend to "a#e "ig"er income and sta$ilit ! c! -ross 3 %$hl! i%6 3#1 a$ilit to repa ! d! N53:#' 9 !#"'s in current emplo ment / $usiness1 sta$le income! o% "ig"er income and greater

1/ FINANCIAL DETAILS: a! M"'4i%/p#'6#%$"4# 9 9i%"%6i%4 9 : '' =#'s4 more t"e $orro&er?s

in#ol#ement1 less t"e amount o% t"e loan! $! D#$"ils 9 : '' =#'>s "ss$s4 land O $uilding1 &ort" o% t"e $orro&er or securit ! c! D#$"ils 9 " : '' =#'>s "ss#$s4 $ank $alances and ot"er securities1 &ort" o% t"e $orro&er or securit ! ?/ OTHER DETAILS A)OUT THE LOAN AND )ORROWER: a! 7resence and percentage o% collateral555additional securit ! $! 7resence o% grantor555additional securit !

34

Credit Risk Management c! Status s m$ol/li%est le :telep"one1 tele#ision1 re%rigerator1 &as"ing mac"ine1 t&o &"eeler1 car1 cellular p"one;! d! +ccount relations"ip! +s per (BI guidelines1 all e2posure :&it"out an cut o%% limit; are to $e rated!

CREDIT AUDIT Credit also kno&n as loan re#ie& mec"anism is t"e outcome o% modern commerce1 a result o% proli%eration o% credit/loan institutions t"e &orld o#er &it" sop"isticated loan products on one "and and t"e gro&ing concern a$out asset >ualit on t"e ot"er! T"e core emp"asis is on compliance &it" credit polic 1 procedures1 documentation process and a$o#e all1 ad"erence to stipulated terms and conditions %or sanction1 dis$ursements and monitoring!

CREDIT AUDIT DEFINED Credit audit is concerned &it" t"e #eri%ication o% credit :loan; accounts1 including t"e in#estment port%olio! +lt"oug" t"e $usiness o% credit/loans is predominantl t"e domain o% $anks1 "o&e#er an commercial institution can $e in#ol#ed in it as &ell %or e2ample1 credit sales creating accounts recei#a$les! Credit audit ma $e de%ined as t"e process o% e2amining and #eri% ing credit records %rom t"e #ie&point o% compliance &it" laid do&n policies1 s stem procedures %or t"e dis$ursement o% credit and t"eir monitoring! T"e (BI "as de%ined credit audit as a mec"anism to e2amine 'compliance &it" e2tant sanction and post sanction processes/procedures laid do&n $ t"e $ank %rom time to time.!

35

Credit Risk Management Credit audit is not a statutor regulator port%olios! re>uirement! Ho&e#er %rom t"e

angle o% credit risk management1 t"e (BI "as asked $anks to

implement an appropriate credit audit s stem %or t"eir loan / in#estment

O)@ECTIVES Credit audit acts as an ena$ler in $uilding up and monitoring asset >ualit &it"out compromising on policies1 norms and procedure! Its $asic o$0ecti#e is implanted in t"e independent #eri%ication process1 co#ering4 B! T"e sanction process! C! T"e modalities o% dis$ursement! D! Compliance &it" regulator e2isting in "ouse policies! M! T"e monitoring mec"anism and "o& it is suited to stop a possi$le decline in asset >ualit ! T"us an independent assessment :&it"out $eing carried a&a $ t"e 0udgment o% t"ose in#ol#ed in sanctioning1 dis$ursing and monitoring credit; is t"e &"ole and sole o% credit audit! T"e %indings o% t"e credit audit process &it" t"e suggested course o% action %or impro#ements operate as a sa%et #al#e %or t"e organi<ation! SCOPE Credit audit must co#er not onl %unded credit/loans 55555555including accounts recei#a$le555555$ut also t"e in#estment port%olio1 o% $ot" go#ernment and corporate securities! It s"ould also co#er non5%unded commitments :letter o% credit1 guarantees1 $id $onds1 etc;!indi#idual account #eri%ication s"ould $e %ollo&ed up $ port%olio #eri%ication :%or e2ample1 loan/credit port%olio on t"e &"ole1 sectoral position1 etc!; prescriptions $esides ad"erence to

36

Credit Risk Management T"e scope and co#erage o% suc" an audit depends on t"e si<e and comple2it o% operations o% an organi<ation and past trends :sa a period o% t"ree5%i#e ears; re%lected in t"e indi#idual / port%olio >ualit o% accounts! DISTINCTION )ETWEEN CREDIT AUDIT AND ACCOUNTS AUDIT +lt"oug" t"e $asic element o% $ot" credit audit and accounts audit is #eri%ication/e2amination1 t"e %ollo&ing points o% distinction $et&een t"e t&o are important4

CREDIT AUDIT

ACCOUNTS AUDIT

B! Concerned &it" loan /in#estment assets o% an Concerned &it" all t pes o% assets and lia$ilities organi<ation like a $ank! limited compan :pri#ate/pu$lic;! o% an organi<ation! %or all t pes o% limited companies :no statutor C! T"is is not a statutor re>uirement e#en %or a It is a statutor re>uirement :at least once a ear; re>uirement %or ot"ers;! D! T"e scope o% credit audit :ot"er&ise kno&n as T"e scope o% accounts audit co#ers all assets loan re#ie& mec"anism; &it" respect and is restricted to to /lia$ilities &it"out an restrictions1 $ut &it"in t"e compliance sanction %rame&ork o% t"e +ccounting Standards o% t"e

:loan/in#estment;

post5sanction Institute o% C"artered +ccountants! o% audit rests &it" t"e auditor

processes/procedures as ma e2ist in a $ank! M! modalit /periodicit ma $e decided $ t"e *odalit %inancing institution su$0ect to t"e regulator guidelines o% t"e (BI!

concerned1 &"o "as to %ollo& accepted %inancial practices/standards! For a limited compan

:pu$lic / pri#ate;1 an audit once a ear is a must! G! T"e audit ma $e undertaken in5"ouse $ an +udit o% limited companies :pri#ate/pu$lic; can organi<ation1 and t"e auditor need not $e a $e undertaken onl >uali%ied c"artered account! accountants! $ >uali%ied c"artered

37

Credit Risk Management N! Credit auditor is not re>uired to #isit I% need $e1 an auditor ma not onl #eri% t"e $orro&er?s %actor /o%%ice1 $ut %rames "is opinion $ooks o% accounts1 "e ma onl on t"e $asis o% records! also p" sicall inspect %actor /place o% storage o% assets!

COMPONENTS OF CREDIT AUDIT S"%6$i % p' 6#ss4 In a $ank/%inancial institution1 t"e sanction o% a credit %acilit :%unded loan as &ell as non5%unded %acilit 5%or e2ample1 guarantees1 letters o% credit etc!;+s &ell as in#estment in marketa$le securities "a#e to go t"roug" c"annels %i2ed $ t"e institution according to its needs and s stems and procedures! -enerall 1 t"e process goes t"roug" t"e %ollo&ing steps4 a; (eceipt o% credit application %rom t"e client at t"e operating unit1 like t"e $ranc" o% t"e $ank concerned! $; Scrutin o% t"e application in t"e lig"t o% t"e $ank?s norms and guidelines as &ell as speci%ic directi#es o% t"e (BI! c; 7reparation o% an assessment note :credit proposal; a%ter #eri% ing t"e necessar aspects o% t"e $orro&ers and guarantors1 i% an terms and conditions o% securities! d; E2ercise o% t"e %inancial po&ers o% t"e delegated aut"orities %or sanction! Dis:5's#3#%$ 3 &"li$!4 T"is is t"e conse>uence o% t"e sanction process and includes4 a;Securit documentation as per t"e terms and conditions o% sanction! $; 7re5dis$ursement p" sical inspection o% t"e $usiness site/place %or $usiness lending! c; In t"e case o% ac>uisition o% capital assets/in#estment in securities1 direct pa ment to t"e seller/insurer concerned is to $e made to ensure proper end5use! :t"is includes credentials stud 1 p" sical inspection o% t"e $usiness site/securities1 t"is in#ol#es details o% t"e issuer1

38

Credit Risk Management C 3pli"%6#4 It is necessar t"at t"e $ank/%inancial institution compl &it" regulator guidelines and its internal norms/s stems during t"e sanction process1 t"e dis$ursement stage and t"e post5dis$ursement stage/In %act1 t"roug"out t"e tenure o% an credit/in#estment asset in t"e $ooks1 t"e $ank/%inancial institution must ensure t"at no guidelines are $reac"ed! T"e (BI?S ne& (isk Based Super#ision S stem &ill %ocus1 inter alia1 on t"e Tcompliance? angle o% t"e $ank/%inancial institution! ,on5 compliance ma in#ite penal measures! M %i$ 'i%44 T"e credit audit process ensures t"at t"e $ank/%inancial institution concerned %ollo&s necessar monitoring measures so t"at t"e asset >ualit :loan/in#estment;remains at an accepta$le le#el1 and in cases o% signs o% deterioration1 necessar recti%ication measures are initiated! *onitoring is an ongoing mec"anism and in realit a sa%et #al#e %or a $ank/%inancial institution! T"ere%ore1 a credit audit is complementar s stem! to t"e entire credit risk management

HOW CREDIT AUDITS ARE TO )E CONDUCTED B; +n in5"ouse department ma e2perienced people! C; In t"e alternati#e1 an arrangement ma $e made &it" pro%essionals? institutions to undertake suc" an audit :$usiness process outsourcing; D; Credit audit is to $e restricted to t"e records mentioned &it" respect to appraisal1 post5sanction super#ision and %ollo& up! M; Credit audit does not usuall in#ol#e t"e p" sical #eri%ication o% securities/#isit $orro&er?s %actor /premises! G; T"e credit audit process ma co#er all credit records/documents or a statistical sampling o% a $atc" o% records! +ccording to (BI guidelines1 in $anks/%inancial institutions1 all %res" credit decisions and rene&al cases in t"e past t"ree5si2 mont"s :preceding t"e date o% commencement o% t"e credit; s"ould $e su$0ected to t"e credit $e set up &it" pro%essionall >uali%ied and

39

Credit Risk Management audit process! + random selection o% G5BLRma port%olio! N; Credit audit is an ongoing process! Ho&e#er1 %or indi#idual accounts1 t"e %re>uenc depends upon t"e >ualit o% t"e accounts! T"e audit ma e#en $e on a >uarterl $asis in t"e case o% "ig"5risk accounts! H; 3arge $anks/%inancial institutions usuall pre%er to co#er credit audit &it" a cut5o%% si<e :sa 1 indi#idual e2posures o% (s D5G crores and o#er;on a "al%5 earl $asis t"roug" t"eir in5"ouse o%%icials! $e made %rom t"e rest o% t"e

R)I G5i&#li%#s % C'#&i$ A5&i$ Credit audit e2amines compliance &it" e2tant sanctions and post5sanction processes/procedures laid do&n $ t"e $ank %rom time to time and is concerned &it" t"e %ollo&ing aspects45 O)@ECTIVES OF CREDIT AUDIT: 5Impro#ement in t"e >ualit o% t"e credit port%olio 5(e#ie&ing t"e sanction process and compliance status o% large loans! 5Feed$ack on regulator compliance! 5Independent re#ie& o% credit risk assessment! 57icking up earl &arning signals and suggesting remedial measures! 5(ecommending correcti#e action to impro#e credit >ualit 1 credit administration and credit skills o% sta%%1 etc! STRUCTURE OF THE CREDIT AUDIT DEPARTMENT: T"e credit audit/loan re#ie& mec"anism ma department or t"e inspection and audit department! F5%6$i %s 9 $h# 6'#&i$ "5&i$ &#p"'$3#%$: 5To process credit audit reports! $e assigned to a speci%ic

40

Credit Risk Management 5To anal <e credit audit %indings and ad#ise t"e departments/%unctionaries concerned! 5To %ollo& up &it" t"e controlling mac"ines! 5To apprise t"e top management! 5To process t"e responses recei#ed and arrange %or t"e closure o% t"e relati#e credit audit reports! 5To maintain a data$ase o% ad#ances su$0ected to credit audit! S6 p# "%& 6 ;#'"4#: T"e %ocus o% credit audit needs to $e $roadened %rom t"e account le#el to kook at t"e o#erall port%olio and t"e credit process $eing %ollo&ed! T"e important areas are4 P '$9 li '#;i#=4 E2amining t"e >ualit o% credit and in#estment :>uasi5control; port%olio and suggesting measures %or impro#ement1 including t"e reduction o% concentrations in certain sectors to le#els indicated in t"e loan polic and prudential limits suggested $ t"e (BI! L "% '#;i#=: (e#ie& o% t"e sanction process and status o% post5sanction process/procedures :not 0ust restricted to large accounts;! T"ese include4 5+ll proposals and proposals %or rene&al o% limits :&it"in t"ree5si2 mont"s %rom t"e date o% sanction;! 5+ll e2isting accounts &it" sanction limits e>ual to or a$o#e a cut5o%% point1 depending upon t"e si<e o% acti#it ! 5(andoml selected :sa G5BLR; proposals %rom t"e rest o% t"e port%olio! 5+ccounts o% sister concerns/groups/associate concerns o% t"e a$o#e accounts1 e#en i% t"e limit is less t"an t"e cut5o%% point! A6$i % p i%$s 9 ' '#;i#=: 5Veri% ing compliance &it" t"e $ank?s policies and regulator regard to sanction! 5E2amining t"e ade>uac o% documentation! 5Conducting t"e credit risk assessment! 5E2amining t"e conduct o% account and %ollo&5up looked at $ line %unctionaries! 5O#erseeing action taken $ line %unctionaries on serious irregularities! 5Detecting earl &arning signals and suggesting remedial measures! F'#85#%6! 9 '#;i#=: compliance &it"

41

Credit Risk Management T"e %re>uenc o% re#ie& #aries depending on t"e magnitude o% risk :sa 1 t"ree mont"s %or "ig" risk accounts1 and si2 mont"s %or a#erage risk accounts1 one ear %or lo&5risk accounts;! 5Feed$ack on general regulator compliance! 5E2amining ade>uac o% policies1 procedures and practices! 5(e#ie&ing t"e credit risk assessment met"odolog ! 5E2amining t"e reporting s stem and e2ceptions to t"em! 5(ecommending correcti#e action %or credit administration and credit skills o% sta%%! 5Forecasting likel "appenings in t"e near %uture!

PROCEDURE TO )E FOLLOWED FOR CREDIT AUDIT: 5+ credit audit is conducted on5site1 i!e! at t"e $ranc" &"ic" "as appraised t"e ad#ance and &"ere t"e main operati#e credit limits are made a#aila$le! 5(eports on t"e conduct o% accounts o% allocated limits are to $e called %rom t"e corresponding $ranc"es! 5Credit auditors are not re>uired to #isit $orro&er?s %actor /o%%ice premises! MODEL FORMAT OF CREDIT AUDIT REPORT :(BI "as not speci%icall prescri$ed an %ormat; Here?s a model report %or t"e credit audit %or $ank credit/loan accounts! T"e %ormat ma $e modi%ied to meet organi<ation5speci%ic re>uirements! -OOD B+,) 3TD! C(EDIT +UDIT S7ECI*E, (E7O(T FO(*+T :+CCOU,T59ISE; 7eriod co#ered in t"e report :%rom6666666to66666666; Credit audit report as on66666666666666666666

42

Credit Risk Management

5,ame o% t"e $orro&er and group a%%iliation1 i% an 4 5*ain place o% $usiness/registered o%%ice4 5Date o% esta$lis"ment/incorporation4 53ine o% acti#it /$usiness segment4 5Financing pattern Sole/multiple/consortium S"are :percentage and amount o% credit limit %or suc" a lender;4 5Date and aut"orit o% last sanction/rene&al4 5Credit rating $ t"e $ank/rating agenc and &"at it indicates4 5Total e2posure :%unded and non5%unded; To t"e part 4 To t"e group :i% an ;4 To state speci%icall i% t"ere is an %oreign currenc loan/commitment4 Credit arrangement &it" t"e $ank/%inancial institution4 since &"en; Facilit 3imit/line Outstanding +mount o% O#erdues1 i% an 5Comments4 59"et"er guidelines laid do&n "a#e $een ad"ered to &"ile appraising/assessing4 5Comments on industr a#erages %or in#entor 1 recei#ea$les1creditors etc! taken into account4 :(s! In lak"s1 O#erdue

43

Credit Risk Management 5Comments on %inancial per%ormance o% t"e part #is5 a5#is estimates and industr position1i% a#aila$le4 59"et"er management >uail5 ties &ere anal <ed at sanc5 tion/rene&al stage4 5+n ot"er important issues4 59"et"er all t"e terms and conditions o% t"e sanction &ere complied &it"1 i% not details and reasons and &"en t"e same is e2pected to $e done4 5Comments on %irst dis$urse5 ment o% %acilities:applica$le %or %res" sanctions!; 5Sanctions co#er stipulated as per sanction4 Securities 5Securit documentation4 5Date o% document4 5Details o% unrecti%ied irregula5 rities1i% an 4 59"et"er c"arge %iled &it" (OC :(egistrar o% Comp5 De%iciencies1 i% an

44

Credit Risk Management +nies; %or primar as &ell as Collateral securities in case o% + compan 1 i% not details &it" 7resent status4 5Conduct o% t"e account4 5Interest ser#iced up to :*ont"/ ear;4 5Su$mission o% return/state5 ment $ t"e part 4 Stock statement/statement o% $ook5 de$ts su$mitted up to :mont"/ ear;4 5Insurance %or securities4 +ggregate amount insured! Date up to &"ic" insurance polic &ill remain #alid4 57rimar securities4 5Collateral securities4 5 7" sical inspection o% securities4

5 9"et"er pre5sanction inspection carried out and %ound in order!

45

Credit Risk Management 59"et"er post5dis$ursement inspection is regularl carried out and %ound in order4 5Date o% last inspection4 5+ccounts o% sister concerns4 5 Suggestions o% credit audit %or remedial measures1 &"ere asset >ualit is s"o&ing signs o% concern!

CREDIT RISK MODEL

+ credit risk model is a >uantitati#e stud o% credit risk1 co#ering $ot" good $orro&ers and $ad $orro&ers! + risk model is a mat"ematical model containing t"e loan applicants? c"aracteristics eit"er to calculate a score representing t"e applicant?s pro$a$ilit o% de%ault or to sort $orro&ers into di%%erent de%ault classes! + model is considered e%%ecti#e i% a suita$le T#alidation? process is also $uilt in &it" ade>uate po&er and cali$ration! +s a matter o% %act1 a model &it"out t"e necessar appropriate #alidation is onl a " pot"esis! UTILITY Banks ma deri#e t"e %ollo&ing $ene%its i% t"e install an appropriate credit risk model4 It &ill ena$le t"em to compute t"e present #alue o% a loan asset o% %i2ed income securit 1 taking into account t"e organi<ations past e2perience and assessment o% %uture scenario! It %acilitates t"e measurement o% credit risk in >uantitati#e terms1 especiall in cases &"ere promised cas" %lo&s ma not materiali<e! and

46

Credit Risk Management It &ould ena$le an organi<ation to compute its regulator capital re>uirement $ased on an internal ratings approac"! +n appropriate credit risk model &ill %acilitate an impact stud deri#ati#es and loan sales/securiti<ation initiati#es! It %acilitates t"e pricing o% loans and pro#ides a competiti#e edge to t"e pla ers! It "elps t"e top management in an organi<ation in %inancial planning1 customer pro%ita$ilit anal sis1 port%olio management1 and capital structuring/restructuring1 managing risk across t"e geograp"ical and product segments o% t"e enterprise! (egulator aut"orities %ind it easier to e#aluate $anks t"at "a#e suita$le credit risk model in place! +$o#e all1 a credit risk model ena$les ac"ie#ing t"e o$0ecti#es o% &"at to measure1 "o& to measure and "o& to interpret t"e results! o% credit

DISTINCTION )ETWEEN CREDIT RATING AND CREDIT RISK MODEL Bot" credit rating and a credit risk model ser#er t"e common purpose o% e#aluating t"e >ualit o% an e2posure! Ho&e#er %rom t"e risk management angle1 t"ere is a su$tle distinction $et&een t"e t&o4 C'#&i$ '"$i%4 +pplies to all t pes o% e2posures so as to identi% poor >ualit "ig" >ualit 1 medium >ualit 1 lo& >ualit and e2posures using a on t"e $enc"mark process! Focus is mainl C'#&i$ 'isk 3 &#l +pplies predominantl to lo& and poor >ualit e2posures to ascertain Tpresent #alue?1 especiall in cases &"ere t"e promised cas" %lo& ma not materiali<e! Focus is mainl on t"e Tpro$a$ilit o% de%ault?! Sop"isticated statistical tec"ni>ues like linear and multiple discriminant anal sis1 etc are used 47

Tpro$a$ilit o% repa ment?! Financial parameters and state o% e2posures o#er a s"ort period55555 usuall o% one ear55555%orm t"e

Credit Risk Management core o% credit rating e2ercise! Facilitates grading e2posures to an ideal range o% K5F grades comprising $ot" o% good and $ad e2posures! as tools %or anal sis o#er t"e long term! Facilitates computation o%

Te2posure o% de%ault?1 Tpro$a$ilit o% de%ault?1 loss gi#en de%ault? to&ards risk capital re>uirement!

CREDIT RISK MANAGEMENT TECHNI*UES Tec"ni>ues are met"ods to accomplis" a desired aim! In credit risk modeling1 t"e aim is essentiall to compute t"e pro$a$ilit o% de%ault o% an asset/loan! Broadl t"e %ollo&ing range is a#aila$le to an organi<ation going in %or a credit risk model4 Econometric tec"ni>ue4 Statistical models suc" as linear pro$a$ilit and logit model1 linear discriminant model1 (+(UC model1 etc! ,eural net&orks4 Computer $ased s stems using economic tec"ni>ues on an alternati#e implementation $asis! Optimi<ation model4 *at"ematical process o% identi% ing optimum &eig"ts o% $orro&er and loan assets! H $rid s stem4 simulation $ direct casual relations"ip o% t"e parameters!

FOCAL POINTS OF APPLICATION OF MODELS In all lending decisions1 especiall in t"e retail lending segment1 models are #er use%ul since in t"e ordinar course o% t"e lending $usiness1 t"e pro$a$ilit decisions! It acts as an instrument to #alidate :or in#alidate; t"e credit rating process in an organi<ation! It?s possi$le to &ork out reasona$l t"e >uantum o% risk premium t"at is loaded in pricing credit &it" t"e $acking o% an appropriate credit risk model! Credit risk models "elp in diagnosing potential pro$lems in a credit/allied $usiness proposition and at t"e same time %acilitate prompt correcti#e action! o% de%ault "as an o#erriding implication on credit appraisal

48

Credit Risk Management In t"e securiti<ation process1 credit risk models ena$le t"e construction o% a pool o% assets t"at ma $e accepta$le to in#estors! +ppropriate strategies can $e designed to monitor $orro&al accounts &it" t"e aid o% credit risk models! PRERE*UISITES FOR ADOPTING A MODEL T"e adoption o% an statistical/mat"ematical model $ an organi<ation depends upon t"e compan ?s si<e and comple2it o% operations1 risk $earing capacit 1 risk appetite1 o#erall risk e#aluation and t"e control en#ironment! Ho&e#er1 &"ile adopting an particular %orm o% t"e credit risk model1 t"e %ollo&ing prere>uisites s"ould $e satis%ied4 + &ide range o% "istorical data must $e used! T"ere must $e assistance %rom a compact *anagement In%ormation S stem :*IS;! T"e data must $e relia$le and aut"entic! +ll t"e signi%icant risk elements depending on t"e organi<ation?s range o% acti#ities must $e $uilt into t"e model! T"e model?s assumptions must $e realistic! T"e model s"ould $e capa$le o% di%%erentiating t"e element and intensit o% risk in #arious categories o% e2posures! T"e model s"ould $e in a position to identi% o#er5 concentration5555555"ence "ig"er order risk555555555555in t"e port%olio! T"e model s"ould pro#ide clear signals o% incipient sickness and pro$lems in e2posures! It s"ould %acilitate &orking out ade>uac pro#isions %or non per%orming e2posures! It s"ould "a#e room %or making impact anal sis o% macro situations on #arious e2posures o% t"e organi<ation! It s"ould $e in a position to "elp t"e management determine t"e likel e%%ect on pro%ita$ilit o% t"e #arious risk contents in t"e e2posures! / inade>uac in t"e

49

Credit Risk Management T"ere s"ould $e periodical #alidation o% t"e model! T"ere s"ould $e an ongoing s stem o% re#ie& %or t"e model to 0udge its e%%icac !

CREDIT RISK PORTFOLIO MANAGEMENT

Banks e2tend credit to indi#idual $orro&ers! T"e lending / e2tension o% credit ma stretc" to a num$er o% $orro&ers &"o ma "a#e a common linkage! T"is linage ma $e t"e result o%4 In#ol#ement in t"e same trade or $usiness! 3ocated in t"e same geograp"ical setting or in close pro2imit ! Common o&ners/management! + credit port%olio t"ere%ore consists o% indi#idual $orro&ers in a pool &"o are connected to eac" ot"er in some &a or t"e ot"er! %rom t"e #ie& point o% enterprise5&ide risk management1 credit risk port%olio management is t"e process o% identi%ication1 measurement1 monitoring and control o% concentration risk arising out o% t"e common link $et&een t"e $orro&ers555555&"et"er tec"nical1 economical1 %inancial or in an ot"er $usiness manner! O)@ECTIVE OF CREDIT RISK PORTFOLIO MANAGEMENT To identi% 1 measure1 monitor and control not onl e2pected losses %rom eac" credit transaction $ut also une2pected losses %rom t"e entire port%olio! To ac"ie#e an Toptimum port%olio?1 &it" t"e lo&est risk content %or a gi#en le#el o% income or "ig"est income &it" a speci%ied risk content!

50

Credit Risk Management To o$tain ma2imum $ene%it o% di#ersi%ication and to reduce likel losses o&ing to credit concentration to parties &it" some %orm o% common linkage! To act as a re%ined su$stitute to t"e %or&ard5looking approac" in"erent in t"e asset/e2posure relations"ip $ pro#iding &ide5ranging inputs o% correlation and #olatilit ! To reduce i% not eliminate t"e risks o% une2pected "appenings to a port%olio $ecause o% t"e occurrence o% e#ents arising out o% t"e linkage 5555 like $eing in t"e same industr /trade1 same o&ner management1 etc! To %acilitate credit decisions and risk5mitigating steps in an integrated manner keeping in #ie& t"e intimate relations"ip in a credit port%olio o% correlation and #olatilit !

ADVANTAGES OF CREDIT RISK PORTFOLIO MANAGEMENT It is rig"tl said t"at de%aults and credit migration are directl linked to t"e macroeconomic situation! Credit c cles mo#e in tandem &it" $usiness c cles in an econom ! + credit port%olio stud $rings out t"e actual situation on an ongoing $asis1 ena$ling t"e management to initiate risk5 mitigating actions >uickl ! 7ort%olio management ena$les t"e measurement o% credit concentration risk in an dimension "a#ing a direct e%%ect on one or t"e ot"er! For e2ample industr /trade grouping1 location closeness1 and instrument $ased relations"ip! + s stematic approac" to port%olio anal sis ena$les t"e di#ersi%ication o% risk e2posures1 going $ t"e age old principle t"at +33 E--S SHOU3D ,OT BE 7UT I, THE S+*E B+S)ET! + clear cut and rational capital allocation process is possi$le $ ensuring regular anal sis o% di#ersi%ication $ene%its and concentration risks! (isk 51

Credit Risk Management increases &it" a decline in credit >ualit impro#ement in credit >ualit ! Credit deri#ati#es can $e managed $etter &it" port%olio management $ecause t"eir risk contents are more intensi%ied and "a#e a more crucial e%%ect on an organi<ation! *ore rational pricing o% credit e2posure is possi$le &"en an organi<ation "as an appropriate credit risk management s stem in place! )ASIC PRINCIPLES OF CREDIT RISK PORTFOLIO MANAGEMENT Indi#idual $orro&er/e2posure le#el is t"e %oundation o% t"e port%olio stud ! + %rame&ork is to $e designed depending on t"e si<e and comple2it o% t"e $ank in &"ic" t"ere is aggregation o% all credit risk e2posures and &a s and means to compare products and sectoral risks! + s stem to measure #arious t pes o% credit e2posures s"ould $e put in place keeping in #ie& t"e element o% correlation and #olatilit ! )ASIC ATTRI)UTES OF CREDIT RISK PORTFOLIO MANAGEMENT +ccording to t"e (eser#e Bank o% India1 port%olio credit risk measurement and management depends on t&o ke attri$utes4 correlation and #olatilit ! Correlation indicates a relation $et&een t&o or more t"ings1 impl ing an intimate or necessar connection! T"ese ma $e mat"ematical1 statistical or an ot"er #aria$les t"at tend to $e associated or occur toget"er in an une2pected &a ! In ot"er &ords1 i% t"ere is interdependence $et&een t&o or more #aria$le >uantities in suc" a manner t"at a c"ange in t"e #alue or e2pectation o% t"e ot"er1 t"en t"e are said to $e correlated %rom a statistical angle! T"e (BI guidelines state 'Credit port%olio correlation &ould means num$er o% times companies/counterparties in a port%olio de%aulted simultaneousl ! Volatilit 1 on t"e ot"er "and1 means rapid or une2pected c"ange &"ic" ma $e di%%icult to capture or "old permanentl !. T"e main purpose o% port%olio management &ould $e to e2amine t"e correlation $et&een t"e de%aulting o% a pool o% e2posure :port%olio; to t"e #olatilit o% a particular industr / sector acti#it ! T"is is done so as to measure and manage t"e 52 and goes do&n &it" an

Credit Risk Management non5di#ersi%ia$le risk in a port%olio as distinguis"ed %rom di#ersi%ia$le risk! + lo& de%ault correlation &ould mean t"at non5di#ersi%ia$le risk content in a port%olio "as little signi%icance! + "ig" de%ault correlation1 on t"e ot"er "and1 means more risk! T"e implication o% correlation and #olatilit in a port%olio stud "as $een succinctl e2plained $ t"e (BI guidelines4 'consider t&o companiesE one operates in large capacities in t"e steel sector1 promoted $ t&o entirel unrelated promoters! T"oug" t"ese &ould classi% as t&o separate counter parties1 $ot" o% t"em &ould $e "ig"l sensiti#e to go#ernment?s e2penditure in ne& pro0ects/in#estments! T"us1 :correlation;1 impacting t"e credit >ualit o% suc" a port%olio reduction in go#ernment?s in#estments could impact t"ese t&o companies simultaneousl :#olatilit ;1 e#en t"oug" %rom a regulator or con#entional perspecti#e1 t"e risk "as $een di#ersi%ied :t&o separate promoters1 t&o separate industries;! T"us t"oug" t"e credit port%olio ma $e &ell di#ersi%ied and %ul%ills t"e prescri$ed criteria %or counter part e2posure limits1 "e "ig" correlation in potential per%ormance $et&een t&o counter parties ma impact t"e port%olio >ualit under stress conditions.! CONSTRAINTS IN PORTFOLIO MANAGEMENT T"oug" credit risk port%olio management5555&it" t"e aid o% concepts like correlation and #olatilit 55555 is #er use%ul1 it does su%%er %rom some constraints! Here are some4 T"ere are a num$er o% #aria$les like correlation o% returns1 correlation o% %actors e2plaining returns1 correlation o% de%ault pro$a$ilit 1 correlation o% rating categor 1 correlation o% spreads1 etc! Depending on t"e si<e1 comple2it and co#erage o% t"e port%olio1 it "as to $e decided &"ic" o% t"ese #aria$les need to $e considered1 and is a constraint in computing t"e coe%%icient o% correlation! Distri$ution o% returns contains T%at tails? &"ic" ma indicate t"at1 in t"e region o% loan loss1 t"e pro$a$ilit is more t"an t"at dictated $ t"e normal distri$ution cur#e!

53

Credit Risk Management + multi5period model to address t"e issue o% transaction costs o% credit risk needs to $e put in place as against t"e eas solution o% t"e single period approac"! T"e a$sence o% price disco#er in a port%olio o% de$t securiti<ation taking into account seniorit 1 co#enants1 call options1 etc! pose pro$lems! Data limitation1 &it" t"e %ocus on geograp" reduces t"e e%%icac o% port%olio management! CREDIT PARADO+ T"e attri$utes o% correlation and #olatilit in port%olio management %acilitate di#ersi%ication o% credit risks! But o%ten in t"e process a parado2 emergesE &"et"er to e2pand a particular port%olio &it" a "ig"er order o% risk $ut &it" lo&er transaction costs and / or "ig"er spreads or could $e content &it" lo& risk and lo& earning e2posures! Furt"ermore1 increasing e2posure to t"e same part / group t"at is kno& to an organi<ation %or a long time and pro#ides a good source o% income ma apparentl $e in its interests $ut ma lead to concentration o% risks! T"is in turn ma lead to une2pected losses! T"is kind o% situation is called C(EDIT 7+(+DOP! TECHNI*UES OF PORTFOLIO CREDIT RISK CONTROL +n e%%ort at credit risk control555555$e it at t"e indi#idual credit or port%olio le#els55555"as t"e %ollo&ing main ingredients! E2pected and une2pected losses are estimated on a consistent $asis &it" relia$le data $ack5up! T"ere must $e a $alance $et&een income and risk le#el! +de>uate sa%et nets must $e $uilt in s"ould estimates and actuals at an time #ar 1 putting t"e organi<ation in peril! T"e %ollo&ing t&o tec"ni>ues aimed at controlling e2posure at t"e port%olio le#el ma $e adopted simultaneousl $ut not in isolation4 and industr identi%ication1

54

Credit Risk Management B! -roup e2posure ceilings4 T"e (BI "as prescri$ed t"at $anks/%inancial institutions limit t"eir e2posures5555$ot" %unded and non5%unded 55555555 to a certain portion o% t"eir capital %und! T"is is applica$le %or $ot" single e2posure and group e2posure! From t"e #ie&point o% port%olio e2posure control1 t"e pre#ailing guideline suggests t"at a $ank must place a ceiling on group e2posure :$e ond &"ic" no group e2posure can $e taken up &it"out (BI?s appro#al;! T"e ceilings are4 Single e2posure4 ceiling o% BGR o% t"e $anks capital %und :additional GR in case o% in%rastructure e2posure;! -roup e2posure4 ceiling o% MLR o% t"e $ank?s capital %und :additional GR %or in%rastructure e2posure;! T"is tec"ni>ue aims at port%olio control1 at $ot" t"e indi#idual and group :i!e! $orro&ers interlinked t"roug" s"are"olding1 commonalit o% management1 etc!; le#els! +s a result o% correlating t"e o#erall single/group e2posure ceiling &it" its capital %und1 a $ank ensures 55555%rom t"e credit risk angle55555t"at its o&n stake in an une2pected situation does not go out o% gear! T"is mec"anism ma $e treated as Trisk limits?! C! Industr /sectoral ceiling4 +longside t"e a$o#e measure it ma $e use%ul to "a#e an industr ceiling as a part o% port%olio management! In t"is respect1 a $ank ma %ollo& t"ese rules4 Fi2 an a$solute amount as a ceiling %or a particular industr :like te2tiles1 p"armaceuticals1 etc!; or sectoral :real estate1 etc!; In doing so t"e organi<ation ma go $ t"e position o% a particular industr /sector! For e2ample1 i% a particular place/state is considered unsuita$le %or a particular line o% acti#it it s"ould $e kept in #ie& &"ile e2amining t"e e2posure ceiling! Industr /sectoral anal sis/stud s"ould not $e a one5time a%%air $ut $e on an ongoing $asis! T"e %eed$ack %rom suc" anal sis/stud ceiling desired %or a particular industr /sector! &ill determine t"e

55

Credit Risk Management CONDUCTING INDUSTRY/SECTORAL ANALYSIS T"is t pe o% anal sis/stud is $est per%ormed $ e2perts like tec"nocrats and economists! T"ere are organi<ations in India t"at do suc" studies and sell t"eir reports! C(IS5I,F+C :a C(ISI3 concern;1 IC(+1 C+(E and C*IE "a#e skilled sta%% t"at prepares t"eir reports on a continuing $asis $ased on market sur#e and inputs %rom #arious sources! -enerall 1 t"e %ollo&ing aspects "a#e to $e taken into account &"ile preparing industr /sectoral reports4 O#erall position o% t"e domestic econom as per -D7 gro&t"! O#erall consumption gro&t"55555domestic and o#erseas! + particular industr /sector?s position in t"e econom as a &"ole! E%%ect o% go#ernment policies on t"e industr /sector! +#aila$ilit o% inputs55555ra& materials1 la$or1 po&er1 transportation1 etc! Scope %or di#ersi%ication! Demand suppl gap! 7ossi$ilities o% t"reats %rom su$stitutes/ne& parties! Signi%icant %actors like c clicalit and seasonalit ! Industr sector %inancials in terms o% return on capital emplo ed :(OCE;1 operating pro%it gro&t"1 de$t5e>uit ratio1 current ratio1 etc! Capacit utili<ation! (a& material consumption in relation to sales! +#erage de$tors collection in relation to sales! +#erage creditors pa ment in relation to purc"ases! +#erage in#entor "olding!

)RIEF SPECIMEN OF INDUSTRY/SECTORAL REPORT 9"ile t"e structure and content o% report ma #ar %rom industr to industr according to t"e purpose %or &"ic" t"e anal sis/stud is undertaken1 a $rie% specimen report on t"e 9 & p' 6#ssi%4 i%&5s$'! is presented $elo& %or credit risk port%olio monitoring purposes!

56

Credit Risk Management

INTRODUCTION T"e %ood processing sector consists o% t"e %ollo&ing sectors4 Food grains! *ilk products! Fruits! Vegeta$les! Ot"er agro5$ased items! T"e acti#it in#ol#es lo& capital e2penditure and t"e re>uirement o% tec"nical kno&ledge and e2pertise is %airl small! PRODUCTION PROCESS Depending on t"e end process1 t"e production process ma $e o% t"e %ollo&ing t pes4 7rimar processing! Secondar processing! Tertiar processing! 7rimar processing co#ers cleaning1 po&dering and re%ining agricultural produce! Secondar processing is a #alue5addition process suc" as making tomato puree1 processing meat products1 etc! Tertiar processing on t"e ot"er "and co#ers %ood items t"at "a#e gone t"roug" t"e tertiar process and are read %or consumption at t"e point o% sale1 like $aker products1 0ams1 sauces1 etc! CHARACTERISTICS OF THE FOOD PROCESSING )USINESS

57

Credit Risk Management Fragmented1 &it" #arious small units as against t"e glo$al situation o% massi#e scales o% operation! Hig" le#els o% &astage! 3o& %arm met"ods! Hig" emplo ment potential:it is estimated t"at an in#estment o% (s BLL crores creates around GM1LLL 0o$s as compared to CG1LLL in a mass consumption item like paper;! MA@OR CONSTRAINTS Inade>uate in%rastructure! T"e %ood processing industr deals in items t"at are #er peris"a$le! 3ack o% dependa$le storage and transportation %acilities "inders its gro&t"! 3a&s/directi#es on pre#ention o% %ood adulteration are not su%%icientl stringent! DEMAND AND SUPPLY POSITION It is reported t"at t"e Indian %ood processing market is &ort" around (s CG1LLL crores! In #ie& o% t"e peris"a$le nature o% t"e items1 t"e industr concentrates on local operations! 9it" a gro&ing population t"e industr potential! "as "ig" gro&t" ield mainl due to t"e lack o% moderni<ation o% agricultural

COMPANY Hindustan 3e#er 3imited

PRODUCTS Ice creams1 packaged &"eat %lour1 salt1 tea1 $read1 oils1 %ats and diar products!

Haldirams *T( Foods

Snack %ood1 traditional Indian s&eets! Con#enience %ood1 ice creams1 snack %ood!

58

Credit Risk Management Cad$ur India (uc"i group C"ocolates1 sugar con%ectionar 1 malt drinks! So a products1 palmolein oil1 sun%lo&er oil1 " drogenated #egeta$le %at and oil! Da$ur -la2oSmit" )line -u0arat Co5operati#e Fruit 0uices1 cooking paste and sauces! *alt drinks *ilk Ice creams1 $utter1 c"eese1 milk po&der1 traditional Indian s&eets1 c"ocolates! Fruit 0uices1 tomato puree1 nuts1 groundnut oil1 re%ined palmolein oil and " drogenated oil! 7epsi Foods India So%t drinks $ut also a large consumer o% tomatoes and c"ilies %or preparing pastes %or e2ports! Britannia Industries s 7arle Foods *ot"er Diar Biscuit1 milk products like c"eese and $utter! Biscuits and ot"er related products! Ice creams1 $utter1 c"eese1 milk po&der1 traditional Indian s&eets1 c"ocolates! ,estle India C"ocolates1 sugar con%ectioner 1 malt drinks1 milk po&der! E+PORT SCENARIO 7rocessed %ood accounts %or around CGR o% our countr ?s total agro e2ports! Fruits1 spices1 #egeta$les1 rice and #arious animal products are t"e main items e2ported! GOVERNMENT POLICY CONTROLS

*arketing Federation -odre0 %oods

59

Credit Risk Management ,o industrial license is generall necessar %or %ood processing! Ho&e#er1 a license is needed %or industries engaged in $eer1 pota$le alco"ol1 &ines1 sugar cane1 " drogenated animal %ats and oils! O$taining ISI mark is relati#el eas and carries a good #alue in $randed processed items! IMPORTANT OVERALL INFORMATION )ASE OF THE FOOD

PROCESSING INDUSTRY

(eturn on capital emplo ed Operating pro%it gro&t" De$t5e>uit (atio Current (atio Capacit Utili<ation (a& material consumption +#erage de$tors collection +#erage creditors pa ment +#erage in#entor "olding period

DK!MMR F!MDR L!M4B B!G4B 3o& HLR o% sales CGda s NBda s CCda s

CONCLUSION
T"e %ood processing industr in India "as ample opportunities %or gro&t"555555nationall and internationall ! T"e industr "as t"e uni>ue ad#antage o% lo& capital in#estment1 lo&er gestation periods and operating c cles and to top it all1 an industr %riendl en#ironment %rom industr point o% #ie&! +t t"e same time it "as t"e potential to en"ance agricultural acti#it and emplo ment! In sum1 t"e gro&t" o% t"is industr needs to $e encouraged &it" a pro#ision %or an ongoing re#ie& mec"anism! 60

Credit Risk Management

CREDIT IN NON(PERFORMING ASSETS

,on5per%orming ad#ances :,7+?s; 5555 kno&n as non5per%orming loans :,73?s; in man countries 555555 are generall t"e outcome o% ine%%ecti#e or %ault credit risk management $ a $ank! *ore o%ten t"an not1 t"e pro$lem is not recogni<ed at an earl stage and "ence remedial action is not initiated on time! T"is is precisel &" t"e (BI "as ad#ised t"e $anks to undertake credit risk management! WHY NPA IS A MATTER OF CONCERN TO )ANKS? ,7+ management in $anks is a #er crucial %unction $ecause o% t"e %ollo&ing4 Funds remain sunk &it"out an returns in terms o% cas" %lo&s!

61

Credit Risk Management B; C; T"e credit c cle o% $anks gets c"ocked up causing li>uidit constraints! (ec cling o% %unds is a%%ected! 7ro%ita$ilit is a%%ected t&o5%old On t"e pro#isioning %or principal/interest c"arged! ,il income %rom e2posure!

WHY AN ACCOUNT )ECOME NPA? T"ere is an emp"asis on credit gro&t" especiall to t"e priorit sector and small $orro&ers! +s a result t"ere is $ot" credit and ,7+ gro&t" in t"e s stem! It is estimated t"at during t"e past decade1 t"e credit gro&t" &as around FLR1 o% &"ic" contaminated credit :,7+; accounted %or one5t"ird s"are! Broadl t&o %actors are responsi$le %or t"e increase in ,7+?s1 &"ic" are as %ollo&s4 A/ ,on5pa ment $ $orro&ers due to #arious internal and e2ternal %actors and in ,on5initiation o% e%%ecti#e reco#er steps $ $anks! REASONS FOR NON(PAYMENT )Y )ORROWERS: some e2treme cases &ill%ul de%ault!

+ccording to (BI1 t"e %ollo&ing are t"e main reasons %or non pa ment $ $orro&ers4 INTERNAL REASONS: $; Di#ersion o% %unds to&ards e2pansion1 di#ersi%ication1 modi%ication1 ne& pro0ect and in some cases pro#iding %unds to associates/sister concerns &it"/&it"out an interest! c; Time/cost o#erruns o% pro0ects! d; Business %ailure :product1 marketing1 etc;! e; Strained la$or relations! %; Inappropriate tec"nolog /recurrent tec"nical pro$lems! 62

Credit Risk Management g; 7roduct o$solescence1 &"ic" again is a ma0or %actor! E+TERNAL REASONS: a; (ecession! $; ,on5pa ment $ $orro&er?s customers 555555$ot" a$road and local! c; Inputs/po&er s"ortage! d; 7rice escalation :especiall $orro&er?s product &it"out t"e a$ilit to pass on %ull >uantum o% increase to t"eir $u ers! e; +ccidents and massi#e eart">uakes! %; C"anges in go#ernment policies regarding e2cise dut /import dut /pollution control orders! WILFUL DEFAULT: So %ar t"ere "as $een no standard de%inition o% &ill%ul de%ault! T"e (BI "as stated t"e %ollo&ing e2amples o% &ill%ul de%ault! a; De%ault occurs &"en t"e unit "as t"e capacit to "onor its o$ligations! $; 9"en t"e unit "as not used t"e %unds %or t"e speci%ic purposes and di#erted t"em %or ot"er purposes! c; T"e unit "as sip"oned o%% t"e %unds in $reac" o% t"e speci%ic purposes o% t"e %inanceE t"e %unds are not a#aila$le &it" t"e unit in t"e %orm o% ot"er assets! In essence1 &ill%ul de%ault ma $e de%ined as an non pa ment o% commitment $ an o$ligator 555e#en &"en t"ere is no cas" / asset crunc" 5555 &it" t"e sole intent o% causing "arm to a lender! + &ill%ul de%ault is generall t"e conse>uence o% sip"oning o%% %unds $ means o% misappropriation / %raud! Cases o% &ill%ul de%ault need stern action including %iling o% a criminal suit &"en so ad#ised! )! LACK OF EFFECTIVE STEPS )Y )ANKS:

63

Credit Risk Management Banks "a#e to accept t"eir s"are o% $lame in ,7+?s $ $eing ine%%ecti#e in dealing &it" $orro&ers?! T"e %ollo&ing are t"e main points t"at need to $e mentioned4 Inordinate dela in sanction and dis$ursement o% need $ased %inance! +s a result1 t"e $orro&ing units ma $e star#ed o% re>uisite %inance at t"e rig"t time1 %orcing t"em to %ace %inancial losses! It is e2pected t"at $anks s"ould decide on a credit proposal generall &it"in D5M mont"s %rom t"e date o% application! 3ack o% coordination $et&een t"e %inancing institution speci%icall in t"e case o% s ndicate %unding and e2c"ange o% necessar in%ormation! Ine%%ecti#e credit management1 especiall at t"e post @ dis$ursement stage and ina$ilit to detect and pre#ent unaut"ori<ed deplo ment or di#ersion o% %unds! Timel reco#er steps in#ol#ing cr stalli<ation o% securities and / or legal action not initiated!

64

Credit Risk Management

ICICI )ANK

ICICI Bank is India=s second5largest $ank &it" total assets o% a$out (s!B1NHN!GF $n:USU DK!G $n; at *arc" DB1 CLLG and pro%it a%ter ta2 o% (s! CL!LG $n:USU MNB mn; %or t"e ear ended *arc" DB1 CLLG :(s! BN!DH $n:USU DHN mn; in %iscal CLLM;! ICICI Bank "as a net&ork o% a$out GHD $ranc"es and e2tension counters and o#er C1LLL +T*s! ICICI Bank o%%ers a &ide range o% $anking products and %inancial ser#ices to corporate and retail customers t"roug" a #ariet o% deli#er c"annels and t"roug" its speciali<ed su$sidiaries and a%%iliates in t"e areas o% in#estment $anking1 li%e and non5li%e insurance1 #enture capital and asset management! ICICI Bank set up its international $anking group in %iscal CLLC to cater to t"e cross $order needs o% clients and le#erage on its domestic $anking strengt"s to o%%er products internationall ! ICICI Bank currentl "as su$sidiaries in t"e United )ingdom1 Canada and (ussia1 $ranc"es in Singapore and Ba"rain and representati#e o%%ices in t"e United States1 C"ina1 United +ra$ Emirates1 Banglades" and Sout" +%rica! ICICI Bank=s e>uit s"ares are listed in India on t"e Bom$a Stock E2c"ange and t"e ,ational Stock E2c"ange o% India 3imited and its +merican Depositar (eceipts :+D(s; are listed on t"e ,e& York Stock E2c"ange :,YSE;! ICICI Bank "as %ormulated a Code o% Business Conduct and Et"ics %or its directors and emplo ees! A$ S#p$#3:#' 0A< 0AAB< ICICI )"%k< =i$h 9'## 9l "$ 3"'k#$ 6"pi$"liC"$i %D 9 ": 5$ Rs/ ?AA/AA :illi % ,USE F/AA :illi %- '"%k#& $hi'& "3 %4s$ "ll $h# 6 3p"%i#s lis$#& % $h# I%&i"% s$ 6k #76h"%4#s/ ICICI Bank &as originall promoted in BFFM $ ICICI 3imited1 an Indian %inancial institution1 and &as its &"oll 5o&ned su$sidiar ! ICICI=s s"are"olding in

65

Credit Risk Management ICICI Bank &as reduced to MNR t"roug" a pu$lic o%%ering o% s"ares in India in %iscal BFFK1 an e>uit o%%ering in t"e %orm o% +D(s listed on t"e ,YSE in %iscal CLLL1 ICICI Bank=s ac>uisition o% Bank o% *adura 3imited in an all5stock amalgamation in %iscal CLLB1 and secondar market sales $ ICICI to institutional in#estors in %iscal CLLB and %iscal CLLC! ICICI &as %ormed in BFGG at t"e initiati#e o% t"e 9orld Bank1 t"e -o#ernment o% India and representati#es o% Indian industr ! T"e principal o$0ecti#e &as to create a de#elopment %inancial institution %or pro#iding medium5 term and long5term pro0ect %inancing to Indian $usinesses! In t"e BFFLs1 ICICI trans%ormed its $usiness %rom a de#elopment %inancial institution o%%ering onl pro0ect %inance to a di#ersi%ied %inancial ser#ices group o%%ering a &ide #ariet o% products and ser#ices1 $ot" directl and t"roug" a num$er o% su$sidiaries and a%%iliates like ICICI Bank! In BFFF1 ICICI $ecome t"e %irst Indian compan and t"e %irst $ank or %inancial institution %rom non5Japan +sia to $e listed on t"e ,YSE! +%ter consideration o% #arious corporate structuring alternati#es in t"e conte2t o% t"e emerging competiti#e scenario in t"e Indian $anking industr 1 and t"e mo#e to&ards uni#ersal $anking1 t"e managements o% ICICI and ICICI Bank %ormed t"e #ie& t"at t"e merger o% ICICI &it" ICICI Bank &ould $e t"e optimal strategic alternati#e %or $ot" entities1 and &ould create t"e optimal legal structure %or t"e ICICI group=s uni#ersal $anking strateg ! T"e merger &ould en"ance #alue %or ICICI s"are"olders t"roug" t"e merged entit =s access to lo&5cost deposits1 greater opportunities %or earning %ee5$ased income and t"e a$ilit to participate in t"e pa ments s stem and pro#ide transaction5$anking ser#ices! T"e merger &ould en"ance #alue %or ICICI Bank s"are"olders t"roug" a large capital $ase and scale o% operations1 seamless access to ICICI=s strong corporate relations"ips $uilt up o#er %i#e decades1 entr into ne& $usiness segments1 "ig"er market s"are in #arious $usiness segments1 particularl %ee5$ased ser#ices1 and access to t"e #ast talent pool o% ICICI and its su$sidiaries! In Octo$er CLLB1 t"e Boards o% Directors o% ICICI and ICICI Bank appro#ed t"e merger o% ICICI and t&o o% its &"oll 5o&ned retail %inance su$sidiaries1 ICICI 7ersonal Financial Ser#ices 3imited and ICICI Capital Ser#ices 3imited1 &it" ICICI Bank! T"e merger &as appro#ed $ s"are"olders o% ICICI and ICICI Bank in Januar CLLC1 $ t"e Hig" Court o% -u0arat at +"meda$ad in *arc"

66

Credit Risk Management CLLC1 and $ t"e Hig" Court o% Judicature at *um$ai and t"e (eser#e Bank o% India in +pril CLLC! Conse>uent to t"e merger1 t"e ICICI group=s %inancing and $anking operations1 $ot" &"olesale and retail1 "a#e $een integrated in a single entit ! RISK MANAGEMENT AT ICICI (isk is an in"erent part o% ICICI Bank?s $usiness1 and e%%ecti#e (isk Compliance O +udit -roup is critical to ac"ie#ing %inancial soundness and pro%ita$ilit ! ICICI Bank "as identi%ied (isk Compliance O +udit -roup as one o% t"e core competencies %or t"e ne2t millennium! T"e Risk C 3pli"%6# 2 A5&i$ G' 5p ,RC 2 AG- at ICICI Bank $enc"marks itsel% to international $est practices so as to optimi<e capital utili<ation and ma2imi<e s"are"older #alue! 9it" &ell de%ined policies and procedures in place1 ICICI Bank identi%ies1 assesses1 monitors and manages t"e principal risks4 Credit risk :t"e possi$ilit counterparties; *arket (isk :t"e possi$ilit o% loss due to c"anges in market prices and rates o% securities and t"eir le#els o% #olatilit ; Operational risk :t"e potential %or loss arising %rom $reakdo&ns in policies and controls1 "uman error1 contracts1 s stems and %acilities; T"e a$ilit to implement anal tical and statistical models is t"e true test o% a risk met"odolog ! In addition to t"ree departments &it"in t"e (isk Compliance O +udit -roup "andling t"e a$o#e risks1 an A%"l!$i6s U%i$ de#elops >uantitati#e tec"ni>ues and models %or risk measurement! Credit risk1 t"e most signi%icant risk %aced $ ICICI Bank1 is managed $ t"e C'#&i$ Risk C 3pli"%6# 2 A5&i$ D#p"'$3#%$ ,CRC 2 AD- &"ic" e#aluates risk at t"e transaction le#el as &ell as in t"e port%olio conte2t! T"e industr anal sts o% t"e department monitor all ma0or sectors and e#ol#e a sectoral outlook1 &"ic" is an important input to t"e port%olio planning process! T"e department "as done detailed studies on de%ault patterns o% loans and prediction o% de%aults in t"e Indian conte2t! (isk5$ased pricing o% loans "as $een introduced! o% loss due to c"anges in t"e >ualit o%

67

Credit Risk Management T"e %unctions o% t"is department include4 ./ R#;i#= 9 C'#&i$ O'i4i%"$i % 2 M %i$ 'i%4 Credit rating o% companies! De%ault risk O loan pricing! (e#ie& o% industr sectors! (e#ie& o% large e2posures in industries/ corporate groups/ companies! Ensure *onitoring and %ollo&5up $ $uilding appropriate s stems suc" as C+S C! D! Design appropriate credit processes1 operating policies O procedures! 7ort%olio monitoring M! *et"odolog to measure port%olio risk! Credit (isk In%ormation S stem :C(IS;!

Focused attention to structured %inancing deals! 7ricing1 ,e& 7roduct +ppro#al 7olic 1 *onitoring!

G!

*onitor ad"erence to credit policies o% (BI! During t"e ear1 t"e department "as $een instrumental in reorienting t"e

credit processes1 including delegation o% po&ers and creation o% suita$le control points in t"e credit deli#er acti#ities! +#aila$ilit o% in%ormation on a real time $asis is an important re>uisite %or sound risk management! To aid its interaction &it" t"e strategic $usiness units1 and pro#ide real time in%ormation on credit risk1 t"e C(C O +D "as implemented a 68 process &it" t"e o$0ecti#e o% impro#ing customer response time and en"ancing t"e e%%ecti#eness o% t"e asset creation and monitoring

Credit Risk Management sop"isticated in%ormation s stem1 namel t"e C'#&i$ Risk I%9 '3"$i % S!s$#3/ In addition1 t"e C(C O +D "as designed a &e$5$ased s stem to render in%ormation on #arious aspects o% t"e credit port%olio o% ICICI Bank!

INTERVIEW In relation to m pro0ect1 I decided to meet someone %rom t"e credit department %rom t"e #er &ell kno& ICICI Bank! T"ere%ore1 I met *r! Vi#ek 7al1 manager1 (+7- 7ersonal loans at ICICI Bank 3imited1 &"ic" is situated at (7To&ers1 J!B!,agar1 +nd"eri1 *um$ai5MLL LGF! T"e >uestions put %ort" to "im and t"e ans&ers gi#en $ "im are as %ollo&s4 ./ Wh"$ is 6'#&i$ 'isk 3"%"4#3#%$? +! Credit risk management is a #er important %unction o% $anks toda ! In a %inancial institute like ours credit risk management is o% utmost importance as t"e #olumes t"at &e deal in on a dail $asis are enormous1 $ot" in retail as &ell as corporate $anking! 9e pro#ide ou &it" all kinds o% loans1 ou name it and &e "a#e it1 $e it personal loan1 car loan or pro0ect %inancing taken $ corporates! T"ere%ore &e la a lot o% emp"asis on credit risk management! 0/ D #s $h# :"%k h";# " s#p"'"$# 6'#&i$ 'isk &#p"'$3#%$? Wh"$ "'# i$s 95%6$i %s? / D #s $h# :"%k h";# &i99#'#%$ &#p"'$3#%$s 9 ' h"%&li%4 6 'p '"$# 6'#&i$ 'isk "%& R#$"il 6'#&i$ 'isk? +! Yes1 &e do! In%act t"ere is a separate %loor %or t"e loans department1 &"erein t"ere are credit managers1 &"o take care o% t"e #arious aspects o% credit1 rig"t %rom gi#ing credit to a customer till reco#ering t"e E*I?s %rom t"em! T"e "ierarc" at ICICI in t"e credit department is as %ollo&s4 ,ational Credit *anager

69

Credit Risk Management

Vonal Credit *anager

(egional Credit manager :Eac" o% t"e regional credit managers "as M5G area credit managers under t"em!; ICICI in%act "as separate $ranc"es %or retail $anking and corporate $anking and eac" $ranc" "as separate credit departments! D/ Is s 3# i%s5'"%6# $h#'# 9 ' 6 ;#'i%4 6'#&i$ 'isk? H"s $h# :"%k $"k#% :5si%#ss 6'#&i$ i%s5'"%6#? +! 9ell1 I am not sure i% suc" a t"ing e2ists! Ho&e#er &e pro#ide insurance co#er &it" t"e loans t"at &e gi#e! +t present1 ICICI pro#ides insurance &it" Home 3oan $ut t"at is $uilt5in and is optional! M! Is l "% "l="!s 4i;#% % s#65'i$!? Wh"$ "'# $h# li3i$s 5%$il =hi6h $h# :"%k 4i;#s l "% =i$h 5$ s#65'i$! "%& =i$h s#65'i$!? $e gi#en on securit ! 7ersonal 3oans are +! ,o1 loans need not necessaril

completel unsecured! In case o% +uto loan t"e #e"icle?s papers are mortgaged &it" t"e $ank1 same is t"e case %or "ome loan! So in suc" a case t"e car or t"e "ouse $ecomes t"e securit ! G/ N =( "( &"!s "l3 s$ "ll $h# :"%ks h";# 6 3# 5p =i$h s 3"%! s6h#3#s "%& "'# 4i;i%4 "="! " l $ 9 6'#&i$/ H = p' 9i$":l# is $his $ $h# :"%k? C"% "ll $his :# 3"%"4#& =i$h 5$ " p' p#' 6'#&i$ 'isk &#p"'$3#%$ i% pl"6#? +! T"at?s true1 t"ere are a lot o% sc"emes in t"e market toda and is primaril t"ere to attract t"e customer! +nd es t"e credit risk management is #er important and no %inancial institution1 or e#en an organi<ation %or t"at matter can do &it"out one! N/ Th# R#45l"$ '! ) &! =hi6h '#45l"$#s $h# 6'#&i$ 4i;#% :! :"%ks?

70

Credit Risk Management +! 9e %ollo& our compan guidelines &"ic" are inline &it" t"e (BI! T"e (BI is t"e regulator $od %or all %unctions carried on $ t"e $anks!

H! Wh"$ i%9 '3"$i % & #s " :"%k 6 ll#6$ ": 5$ i$s : '' =#'s? Wh 6 ll#6$s i$? +! 9"ile granting credit to an indi#idual &"o is a salaried person1 &e consider last t"ree mont"s Salar slip and/or last t"ree mont"s $ank statement! 9"ile in t"e case o% a sel% emplo ed person!9e take into consideration "is last t&o ears IT( :Income Ta2 (eturn;! Our DS+?s :Direct Selling +gents; and DST?s :Direct Selling Teams; collect t"e in%ormation a$out people &"om t"e $orro&ers is stored in t"e compan ?s *IS! K/ D #s $h# :"%k 4i;# "="! " l $ 9 6'#&i$ &5# $ 6 3p#$i$i;# p'#ss5'#? This 6 5l& $5'% 5$ $ 'isk!< s h = & #s $h# :"%k s$'ik# " :"l"%6# :#$=##% p' 9i$":ili$! "%& ; l53# 9 :5si%#ss? +! Frankl 1 competition does not $ot"er ICICI! ICICI "as a #er strong $rand name! T"e statistics speak %or t"em sel#es! ICICI does a $usiness o% KLL crores per mont" &"ere as our nearest competitor HDFC does a $usiness o% CLL crores per mont"! Ho&e#er &e keep on pus"ing our DS+?s to o$tain a greater market s"are! Ho&e#er to keep a"ead o% competition &e do gi#e attracti#e sc"emes to t"e masses1 %or e2ample i% an HDFC account "older comes to ICICI %or a loan t"en "e "as to pa CR less interest and "e need not gi#e "is $ank statements1 "o&e#er "e must "a#e a &ell maintained $alance! F! H = l %4 & #s " p#'s % $"k# $ account &it" ICICI can also a#ail o% loan %rom t"e $ank! 9"ile sanctioning t"e loan &e take into consideration :$"i% 6'#&i$ 9' 3 ! 5' :"%k? approac" and &"o ma $e prospecti#e $orro&ers $ut once t"e loan is granted t"e in%ormation a$out t"e

+! 9it"in a &eeks time t"e loans are sanctioned! + person &"o does not "a#e an

71

Credit Risk Management #arious %actors like sta$ilit 1 a$ilit and intent! For e2ample in case o% personal loans t"e minimum age limit is CG ears1 minimum &ork e2perience is B ear1 sta$ilit is B ear and t"e minimum net income must $e K t"ousand rupees per mont"! .A/ Wh#% $"lki%4 ": 5$ 6'#&i$< is i$ li3i$#& $ G5s$ l "%s $"k#% :! i%&i;i&5"ls ' i$ "ls i%6l5&#s L#$$#' 9 C'#&i$s< #$6? +! In t"e case o% lending to indi#iduals it is 7ersonal loans1 +uto loan and Home loan and in t"e case o% corporate loan t"e letter o% credit is included! ../ Wh"$ & #s Ass#$ *5"li$! 3#"%? H = is i$ 3"%"4#&? +! 9"en a $ank gi#es a loan it appears on t"e asset side o% t"e $alance s"eet! T"e >ualit o% t"e loan is credi$ilit o% t"e person and "is a$ilit and &illingness to pa $ack! 9"ile determining t"e asset >ualit a lot o% ratios are considered! .0/ A'# $h#'# &i99#'#%$ R5l#s "%& P' 6#&5'#s 9 ' C 'p '"$# 6'#&i$ 'isk 3"%"4#3#%$ "%& 9 ' R#$"il C'#&i$ 'isk 3"%"4#3#%$? +! Yes t"ere are di%%erences primaril due to t"e #olume o% $usiness!

.1/ Wh"$ is $h# )"s#l R#p '$? D #s $h# :"%k 9 ll = i$? +! I t"ink Basel (eport "as 0ust guidelines! It talks a$out t"e $est practices! For us t"e go#erning $od is t"e (BI and &e %ollo& our compan guidelines1 &"ic" are %le2i$le enoug" so as to ser#e customers $etter!

72

Credit Risk Management .?/ Wh"$ is $h# '#6 ;#'! p' 6#&5'# i% 6"s# 9 " &#9"5l$#'? Is $h#'# " p' p#' p' 6#&5'# p'#s6'i:#& :! $h# R)I? +! It depends on a num$er o% %actors1 like &"o is t"e person1 is it a genuine reason or not1 etc :%or pa ing t"e E*I;! In case o% +uto 3oan &e take a&a t"e #e"icle and it is t"e easiest loan to reco#er1 "ome loan "as its limitations $ecause "ome is one o% t"e $asic necessities o% man and t"ere are some Hig" Court speci%ications! 7ersonal loan is t"e most risk loan as in case o% personal loan t"ere is no securit ! Ho&e#er in a cit like *um$ai1 t"e de%ault rate is #er good1 as in less t"an CR o% t"e $orro&ers de%ault1 an t"ing $elo& GR is considered good! T"is is "o&e#er t"e case &it" *um$ai it is di%%erent %or di%%erent cities! In ot"er cases &e %ollo& t"e compan guidelines &"ic" are in lieu &it" t"e (BI speci%ications! .B/ H = 9$#% & #s $h# :"%k 9 ll =(5p "%& k##p % 6h#6ki%4 $h# 6"p"6i$! 9 $h# : '' =#'s "%& is i$ & %# 9 ' "ll $h# 6"s#s? +! Once t"e loan is gi#en at least in case o% retail $anking &e do not %ollo& up t"e customer as long as "e is pa ing t"e E*I?s regularl 1 it?s onl i% "e approac"es %or anot"er loan t"at #arious t"ings &ill $e c"ecked! In t"e corporate $anking t"ings are a slig"tl di%%erent! .H/ H = & #s $h# :"%k $"k# % i$s &#9"5l$#'s? Wh"$ & #s $h# :"%k & =h#% $h# : '' =#' :#6 3#s :"%k'5p$? a! In case o% t"e E*I?s not paid on time &e generall rela2 t"e procedure i% it is a case o%

73

Credit Risk Management genuine de%ault! Ho&e#er i% t"e person is in no position to pa at all in case o% +uto loan 1 Home loan 1 etc t"e securit t"at is t"e #e"icle or "ome &ill $e taken a&a as t"e last resort!

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Credit Risk Management

THE INDUSTRIAL AND DEVELOPMENT )ANK OF INDIA LIMITED ID)I

@5l! .FH?: Set up under an +ct o% 7arliament as a &"oll 5o&ned su$sidiar o% (eser#e Bank o% India! F#:'5"'! .FIH: O&ners"ip trans%erred to -o#ernment o% India! Designated 7rincipal Financial Institution %or co5ordinating t"e &orking o% institutions at national and State le#els engaged in %inancing1 promoting and de#eloping industr !

M"'6h .FJ0: International Finance Di#ision o% IDBI trans%erred to E2port5 Import Bank o% India1 esta$lis"ed as a &"oll 5o&ned corporation o% -o#ernment o% India1 under an +ct o% 7arliament!

Ap'il .FFA: Set up Small Industries De#elopment Bank o% India :SIDBI; under SIDBI +ct as a &"oll 5o&ned su$sidiar to cater to speci%ic needs o% small5scale sector! In terms o% an amendment to SIDBI +ct in Septem$er CLLL1 IDBI di#ested GBR o% its s"are"olding in SIDBI in %a#or o% $anks and ot"er institutions in t"e %irst p"ase! IDBI "as su$se>uentl di#ested HF!BDR o% its stake in its erst&"ile su$sidiar to date!

@"%5"'! .FF0: +ccessed domestic retail de$t market %or t"e %irst time &it" inno#ati#e Deep Discount BondsE registered pat"5$reaking success! D#6#3:#' .FF1: Set up IDBI Capital *arket Ser#ices 3td! as a &"oll 5 o&ned su$sidiar to o%%er a $road range o% %inancial ser#ices1 including Bond 75

Credit Risk Management Trading1 E>uit Broking1 Client +sset *anagement and Depositor Ser#ices! IDBI Capital is currentl a leading 7rimar Dealer in t"e countr !

S#p$#3:#' .FF?: Set up IDBI Bank 3td! in association &it" SIDBI as a pri#ate sector commercial $ank su$sidiar 1 a se>uel to (BI=s polic %inancial sector re%orms! o% opening up domestic $anking sector to pri#ate participation as part o% o#erall

O6$ :#' .FF?: IDBI +ct amended to permit pu$lic o&ners"ip upto MFR! @5l! .FFB: *ade Initial 7u$lic O%%er o% E>uit and raised o#er (s!CLLL crores1 t"ere$ reducing -o#ernment stake to HC!BMR!

M"'6h 0AAA: Entered into a JV agreement &it" 7rincipal Financial -roup1 US+ %or participation in e>uit and management o% IDBI In#estment *anagement Compan 3td!1 erst&"ile a BLLR su$sidiar ! IDBI di#ested its entire s"are"olding in its asset management #enture in *arc" CLLD as part o% o#erall corporate strateg !

M"'6h 0AAA: Set up IDBI Intec" 3td! as a &"oll 5o&ned su$sidiar undertake IT5related acti#ities!

to

@5%# 0AAA: + part o% -o#ernment s"are"olding con#erted to pre%erence capital1 since redeemed in *arc" CLLBE -o#ernment stake currentl GK!MHR! A545s$ 0AAA: Became t"e %irst +ll5India Financial Institution to o$tain ISO FLLC4BFFM Certi%ication %or its treasur %or its %ore2 ser#ices! operations! +lso $ecame t"e %irst organi<ation in Indian %inancial sector to o$tain ISO FLLB4CLLL Certi%ication

M"'6h 0AA.: Set up IDBI Trustees"ip Ser#ices 3td! to pro#ide tec"nolog 5 dri#en in%ormation and pro%essional ser#ices to su$scri$ers and issuers o% de$entures!

F#:'5"'! 0AA0: +ssociated &it" select $anks/institutions in setting up +sset (econstruction Compan :India; 3imited :+(CI3;1 &"ic" &ill $e in#ol#ed &it" t"e strategic management o% non5per%orming and stressed assets o% Financial Institutions and Banks!

S#p$#3:#' 0AA1: IDBI ac>uired t"e entire s"are"olding o% Tata Finance 3imited in Tata Home %inance 3td1 signaling IDBI=s %ora into t"e retail

76

Credit Risk Management %inance sector! T"e "ousing %inance su$sidiar "as since $een renamed =IDBI Home %inance 3imited=!

D#6#3:#' 0AA1: On Decem$er BN1 CLLD1 t"e 7arliament appro#ed T"e Industrial De#elopment Bank :Trans%er o% Undertaking and (epeal Bill; CLLC to repeal IDBI +ct BFNM! T"e 7resident=s assent %or t"e same &as o$tained on Decem$er DL1 CLLD! T"e (epeal +ct is aimed at $ringing IDBI under t"e Companies +ct %or in#esting it &it" t"e re>uisite operational %le2i$ilit to undertake commercial $anking $usiness under t"e Banking (egulation +ct BFMF in addition to t"e $usiness carried on and transacted $ it under t"e IDBI +ct1 BFNM!

@5l! 0AA?: T"e Industrial De#elopment Bank :Trans%er o% Undertaking and (epeal; +ct CLLD came into %orce %rom Jul C1 CLLM! @5l! 0AA?: T"e Boards o% IDBI and IDBI Bank 3td! take in5principle decision regarding merger o% IDBI Bank 3td! &it" proposed Industrial De#elopment Bank o% India 3td! in t"eir respecti#e meetings on Jul CF1 CLLM!

S#p$#3:#' 0AA?: T"e Trust Deed %or Stressed +ssets Sta$ilisation Fund :S+SF; e2ecuted $ its Trustees on Septem$er CM1 CLLM and t"e %irst meeting o% t"e Trustees &as "eld on Septem$er CH1 CLLM!

S#p$#3:#' 0AA?: T"e ne& entit WIndustrial De#elopment Bank o% IndiaW &as incorporated on Septem$er CH1 CLLM and Certi%icate o% commencement o% $usiness &as issued $ t"e (egistrar o% Companies on Septem$er CK1 CLLM!

S#p$#3:#' 0AA?:,oti%ication issued $ *inistr o% Finance speci% ing S+SF as a %inancial institution under Section C:";:ii; o% (eco#er o% De$ts due to Banks O Financial Institutions +ct1 BFFD!

S#p$#3:#' 0AA?: ,oti%ication issued $ *inistr o% Finance on Septem$er CF1 CLLM %or issue o% non5interest $earing -oI IDBI Special Securit 1 CLCM1 aggregating (s!FLLL crores1 o% CL5 ear tenure!

S#p$#3:#' 0AA?: ,oti%ication %or appointed da as Octo$er B1 CLLM1 issued $ *inistr o% Finance on Septem$er CF1 CLLM!

77

Credit Risk Management

S#p$#3:#' 0AA?: (BI issues noti%ication %or inclusion o% Industrial De#elopment Bank o% India 3td! in Sc"edule II o% (BI +ct1 BFDM on Septem$er DL1 CLLM!

O6$ :#' 0AA?: +ppointed da 5 Octo$er LB1 CLLM 5 Trans%er o% undertaking o% IDBI to IDBI 3td! IDBI 3td! commences operations as a $anking compan ! IDBI +ct1 BFNM stands repealed!

@"%5"'! 0AAB: T"e Board o% Directors o% IDBI 3td!1 at its meeting "eld on Januar CL1 CLLG1 appro#ed t"e Sc"eme o% +malgamation1 en#isaging merging o% IDBI Bank 3td! &it" IDBI 3td! 7ursuant to t"e sc"eme appro#ed $ t"e Boards o% $ot" t"e $anks1 IDBI 3td! &ill issue BLL e>uit s"ares %or BMC e>uit s"ares "eld $ s"are"olders in IDBI Bank 3td! E-* "as $een con#ened on Fe$ruar CD1 CLLG %or seeking s"are"older appro#al %or t"e sc"eme!

78

Credit Risk Management

INTERVIEW
9it" regard to m pro0ect Credit (isk *anagement1 I met *r! Bilal +n&ar1 Credit +nal st1 at IDBI Bank 3TD! at "is o%%ice in ,ariman 7oint1 *um$ai5MLL LCB! T"e %ollo&ing are t"e >uestions asked to *r! Bilal and t"e ans&ers gi#en $ "im! ./ Wh"$ is 6'#&i$ 'isk 3"%"4#3#%$? +! Credit risk *anagement is managing credit gi#en $ t"e $ank to its $orro&ers1 suc" t"at t"e $ank does not lose its mone ! 0/ D #s $h# :"%k h";# " s#p"'"$# 6'#&i$ 'isk &#p"'$3#%$? Wh"$ "'# i$s 95%6$i %s? Wh"$ is $h# hi#'"'6h! i% $h# 6'#&i$ 'isk &#p"'$3#%$? +! Yes1 t"e $ank "as a separate credit risk department! T"e "ierarc" department is as %ollo&s4 o% t"e

HE+D (IS)

HE+D C(EDIT (IS)

C(EDIT *+,+-E(S 1/ Is s 3# i%s5'"%6# $h#'# 9 ' 6 ;#'i%4 6'#&i$ 'isk? H"s $h# :"%k $"k#% :5si%#ss 6'#&i$ i%s5'"%6#?

79

Credit Risk Management +! Yes1 e#en I "a#e "eard o% it $ut it is still in its nascent stage and caug"t up in India as o% no&! ?/ H = & #s $h# :"%k 4 ": 5$ 6 ll#6$i%4 i%9 '3"$i % ": 5$ i$s : '' =#'s? Wh & #s i$? +! Be%ore gi#ing loan to t"e $orro&ers &e take in to account #arious %actors in order to a#oid risk n loss! Various %actors like age o% t"e person1 e2isting commitments1 %inancial conditions o% t"e person1 annual report in case o% corporate loan and salar in case o% personal loan is taken into consideration! B/ Is l "% "l="!s 4i;#% % s#65'i$!? Wh"$ "'# $h# li3i$s 5%$il =hi6h $h# :"%k 4i;#s l "% =i$h 5$ s#65'i$! "%& =i$h s#65'i$!? +! In t"e corporate $anking sector mostl loans are gi#en on securit $asis $ut a lot o% $usiness is done on t"e $asis o% trust also and so is t"e case in retail $anking! H/ D #s $h# :"%k 4i;# "="! " l $ 9 6'#&i$ &5# $ 6 3p#$i$i;# p'#ss5'#? This 6 5l& $5'% 5$ $ 'isk!< s h = & #s $h# :"%k s$'ik# " :"l"%6# :#$=##% p' 9i$":ili$! "%& ; l53# 9 :5si%#ss? +! Competition is "ealt" E &e al&a s tr to $e a"ead o% competition! Ho&e#er1 at all times &e do not mindlessl gi#e a&a loans to gain market s"are! 9e see to it t"at t"ere is a "ealt" $alance $et&een (isk and (eturn! I/ Th# R#45l"$ '! ) &! =hi6h '#45l"$#s $h# 6'#&i$ 4i;#% :! :"%ks/ +! T"ere is onl one regulator $od &"ic" go#erns t"e &orkings o% t"e $anks1 t"e (BI! J/ D #s $h# :"%k h";# &i99#'#%$ &#p"'$3#%$s 9 ' h"%&li%4 6 'p '"$# 6'#&i$ 'isk "%& R#$"il 6'#&i$ 'isk? +! Yes1 t"e $ank "as di%%erent departments %or "andling corporate $usiness and retail $usiness!

80

Credit Risk Management F/ A'# $h#'# &i99#'#%$ R5l#s "%& P' 6#&5'#s 9 ' C 'p '"$# 6'#&i$ 'isk

3"%"4#3#%$ "%& 9 ' R#$"il C'#&i$ 'isk 3"%"4#3#%$? +! ,ot reall 1 t"e #olume o% $usiness di%%ers "o&e#er some $asic rules remain t"e same! .A/ H = l %4 & #s " p#'s % $"k# $ t"e loan is granted almost immediatel ! ../ Wh#% $"lki%4 ": 5$ 6'#&i$< is i$ li3i$#& $ G5s$ l "%s $"k#% :! i%&i;i&5"ls ' i$ "ls i%6l5&#s L#$$#' 9 C'#&i$s< #$6/? +! Yes1 it is $ot"! In case o% retail $anking t"e loans are gi#en to indi#iduals and rest comes under corporate $anking! .0/ Wh"$ & #s Ass#$ *5"li$! 3#"%? +! 9"en a $ank gi#es a loan to an indi#idual or a compan 1 it comes on t"e asset side o% t"e $alance s"eet! It is an asset $ecause it earns an income %or t"e $ank! +sset >ualit means t"e (IS) 7E(CE7TIO, t"at t"e $ank associates &it" a particular $orro&er! For e2ample1 i% *r! +<im 7rem0i approac"es t"e $ank %or an amount o% sa 1 one lak" rupees1 t"e $ank &ill gi#e "im t"e mone &it"out an securit 1 $ecause o% risk perception $eing lo&! T"at is $ecauseE *r! 7rem0i &ill not de%ault in pa ment! Ho&e#er a certain procedure &ill "a#e to $e %ollo&ed i% an common man comes to t"e $ank %or a loan o% t"e same amount $ecause t"e risk perception di%%ers! .1/ Wh"$ is $h# )"s#l R#p '$? +! +s %ar as I kno& T"e Basel (eport1 is an international set o% rules and regulations! .?/ H = 9$#% & #s $h# :"%k 9 ll =(5p "%& k##p % 6h#6ki%4 $h# 6"p"6i$! 9 $h# : '' =#'s "%& is i$ & %# 9 ' "ll $h# 6"s#s? +! Yes %ollo& ups are done in some cases and t"at too in t"e corporate sector $ut in most cases &e need not do a %ollo&5up1 0ust $eing a&are as to &"at is going on in t"e market $ updating oursel% &it" t"e latest ne&s is su%%icient! :$"i% 6'#&i$ 9' 3 ! 5' :"%k?

+! +s soon as t"e in%ormation recei#ed %rom t"e &ould5$e $orro&er is aut"enticated1

81

Credit Risk Management .B/ Wh"$ is p '$9 li 3"%"4#3#%$? +! In case o% corporate $anking1 7ort%olio management is t"e di%%erent companies in &"ic" t"e $ank puts or &ants to put t"eir mone in! t"is depends on t&o criterias4 -ro&t" o% a particular industr ! T"e le#el o% e2posure t"e $ank &ants in a particular industr !

+s o% no& t"e entire econom is $ooming and I,DI+ is SHI,I,- as %ar as t"e $usiness scenario is concerned! +n $ank &ill not t"ink t&ice $e%ore in#esting in construction1 auto components1 IT1 etc! .H/ H = & #s $h# :"%k $"k# % i$s &#9"5l$#'s? Is $h#'# " p' p#' p' 6#&5'# p'#s6'i:#& :! $h# R)I? +! It depends %rom case to case! I% t"e de%ault is a case o% &ill%ul de%ault1 t"en t"e $ank is compelled to take legal action! Ho&e#er i% t"e de%ault is a genuine $usiness de%ault1 t"en t"e $ank goes in %or one time settlement! T"ere are (BI regulations in case o% OTS! .I/ Wh"$ is $h# '#6 ;#'! p' 6#&5'# i% 6"s# 9 " &#9"5l$#'? +! +s mentioned a$o#e i% t"e de%ault is due to &ill%ul de%ault &e tr to reco#er it $ legal proceedings! Ho&e#er in case o% genuine de%ault1 t"e $ank goes in %or O,E TI*E SETT3E*E,T! OTS ma $e done $ taking mone %rom t"e persons Fi2ed Deposits1 S"ares1 7ropert 1 etc!

82

Credit Risk Management

)USINESS OVERVIEW OF FEDERAL )ANK

F#&#'"l )"%k 1 one o% t"e leading pri#ate sector $anks in India &it" a "istor o% HG ears o% pu$lic con%idence and trust1 "as also $uilt up a reputation o% $eing an agile1 IT sa## and customer %riendl Bank! T"e Bank "as a #er &ide net&ork o% more t"an GLL o%%ices co#ering almost all t"e important cities in t"e countr &it" a dominant presence in t"e State o% )erala &it" more t"an DLL $ranc"es! Business Figures as on DB5LD5CLLG :(s Crores; Deposits +d#ances In#estments BGBFD KKCD GHFF

S$' %4 Fi%"%6i"ls T"e Bank1 "a#ing a net &ort" o% o#er (s!HBG crores and a $usiness turno#er e2ceeding (s!CMLLL crores1 "as turned in an e2cellent per%ormance in t"e current %inancial ear &it" a net pro%it o% o#er FL crores! +s on *arc" LG1 t"e Bank=s s"are :%ace #alue (s BL/5; "as a Book Value o% (s BBL/5 and an Earnings per S"are :E7S; o% (s BD!HD!

83

Credit Risk Management Pi %##'s i% E%h"%6i%4 C5s$ 3#' C %;#%i#%6# Federal Bank "as pla ed a pioneer role in de#eloping and deplo ing ne& tec"nolog assisted customer %riendl products and ser#ices! + %e& o% its earl mo#es are Ser#ice cited t"roug" $elo&4 Fed,et X First1 among t"e traditional $anks in t"e countr to introduce Internet Banking X First among t"e traditional $anks to "a#e all its $ranc"es automated! X First and onl Bank among t"e traditional Banks in India to "a#e all its $ranc"es inter5connected X First Electronic Telep"one Bill 7a ment in t"e countr &as done t"roug" Federal Bank! X First and onl $ank among t"e older Banks to "a#e an e5s"opping pa ment gate&a ! X First traditional Bank to introduce *o$ile +lerts and *o$ile Banking ser#ice! X First Bank to implement an E2press (emittance Facilit %rom +$road T"e Bank "as also t"e distinction o% $eing one o% t"e %irst $anks in t"e countr to deplo most o% t"ese tec"nolog ena$led ser#ices at t"e smaller $ranc"es including rural and semi5ur$an areas! A%!Ti3#(A%!Wh#'#(A%!W"! )"%ki%4 T"e Bank "as t"e %ull range o% deli#er c"annels including1 Internet Banking1 *o$ile Banking and +lerts1 +n 9"ere :Branc"; Banking1 Interconnected Visa ena$led +T* net&ork1 E5mail +lerts1 Telep"one Banking and a Centrali<ed customer Call Centre &it" toll %ree num$er! Customers t"us "a#e t"e a$ilit to a#ail CM "our $anking ser#ice %rom t"e c"annel o% "is c"oice1 according to "is con#enience! T"e Bank is currentl in t"e process o% $uilding a net&ork o% +T*s1 across t"e countr to supplement its deli#er options! Its current net&ork o% CHG plus +T*s is $eing e2panded aggressi#el ! Federal Bank alread "as t"e largest num$er o% +T*s in )erala1 taking round5t"e5clock $anking con#enience to e#en man rural areas! T"e

84

Credit Risk Management Bank "as launc"ed its an &"ere $anking ser#ice1 ena$ling customers to $ranc" at an $ranc" o% "is c"oice regardless o% t"e place &"ere t"e account is maintained! Fi%"%6i"l S5p#' M"'k#$ T"e Bank "as no& emerged into a %inancial supermarket gi#ing t"e customers a range o% products and ser#ices! +part %rom t"e entire sle& o% Banking products and deli#er X X X X X X X X X X X X X Utilit Bill E BS,3 On5line 7a ment 3IC t"roug" 3i%e E2port E2press Cas" 3ock Insurance Credit c"annels &e Credit 7roducts Insurance 3ine Ser#ice in association in also pro#ide t"e %ollo&ing Ser#ices Cards &it" ICICI 7rudential EC-C %acilities4 Depositor

X -eneral Insurance 7roducts in association &it" United India Insurance 7roducts association +$road Cas" in 5 &it" (emittance 5On5 Bo2 Cas" *erc"ant s"opping Bill Insurance Tele$anking C"annel Facilit %or *anagement Banking 7a ment %rom E2press ,(I=s FEDF+ST (emittance t"e Ser#ices Ser#ices gate&a 7a ment 7a ment 5 Fed e57a US

X Eas 7a 5 On5line %ee pa ment s stem U%i85# T#6h% l 4! &'i;#% s#';i6#s T"e Bank=s *o$ile Banking Ser#ices ena$les customers to access t"eir account details o#er t"e mo$ile p"one! T"e Bank also "as t"e *o$ile +lert %acilit 1 &"ic" ena$les customers in an part o% t"e &orld to recei#e instant alerts on transactions in t"eir account in India on t"eir mo$ile! + note&ort" %eature o% t"e %acilit is t"at it is "ig"l %le2i$le and can $e personali<ed according to t"e needs o% t"e customer at an time! E#en &"ile le#eraging on tec"nolog to impro#e

85

Credit Risk Management con#enience1 &e "a#e al&a s stri#ed to ensure t"at our product and ser#ices are simple1 eas to use and most a%%orda$le! P'#9#''#& )"%ki%4 P"'$%#' 9 NRI s Federal Bank continues to $e t"e %a#orite c"oice %or ,(Is as is e#idenced %rom t"e %act t"at a$out MLR o% our deposits come %rom t"e ,(I segment! Our s"ort term deposit "as $een rated $ C(ISI3 and a&arded a "ig" score o% 7BQ t"e Bank "as correspondent Bank arrangements &it" Banks in most o% t"e ma0or cities in t"e &orld! S9IFT connecti#it ensures speed trans%er o% %unds to accounts maintained &it" t"e Bank! In addition1 t"e Bank "as an E2press (emittance Facilit :FEDF+ST; ena$ling ,on (esident Indians in t"e -ul% to e%%ect >uick trans%er o% %unds to t"eir accounts! FedFast &"en com$ined &it" t"e *o$ile +lert %acilit ena$les t"e customer to not onl recei#e >uick credit o% "is remittance in t"e account $ut also to recei#e instant con%irmation o% t"e credit on t"eir mo$ile p"one an &"ere in t"e &orld1 t"roug" S*S!

INTERVIEW 9it" regard to m pro0ect1 I met *r! S"a"0i Jaco$1 C"ie% *anager o% Federal Bank?s Fort $ranc"! T"e >uestions asked to "im and t"e ans&ers gi#en $ "im are as %ollo&s4 ./ Wh"$ "66 '&i%4 $ ! 5 is 6'#&i$ 'isk 3"%"4#3#%$?

86

Credit Risk Management +! Credit risk management is Dou$le C"ecking! It is risk a#oidance! 0/ D #s $h# :"%k h";# " s#p"'"$# 6'#&i$ 'isk &#p"'$3#%$? +! T"e $ank "as a separate (isk Department1 called t"e Integrated (isk *anagement Department! T"is department "as &it"in it sel% Credit (isk Di#ision1 *arket (isk Di#ision1 Etc! t"ere%ore it is called I,TE-(+TED (IS) *+,+-E*E,T DE7+(T*E,T! T"us1 &it"in t"e (isk Department t"ere is a Credit 7rocessing Department! 1/ Is s 3# i%s5'"%6# $h#'# 9 ' 6 ;#'i%4 6'#&i$ 'isk? +! T"ere is an EC-C co#er %or loans taken &"ile doing e2port! ?/ Is l "% "l="!s 4i;#% % s#65'i$!? Wh"$ "'# $h# li3i$s 5%$il =hi6h $h# :"%k 4i;#s l "% =i$h 5$ s#65'i$! "%& =i$h s#65'i$!? +! *ostl loan is al&a s gi#en on securit ! 9e gi#e loans on collateral securit and primar securit ! Ho&e#er as a part o% social responsi$ilit loans are gi#en to t"e &eaker sections &it"out an securit ! B/ N =("(&"!s "l3 s$ "ll $h# :"%ks h";# 6 3# 5p =i$h s 3"%! s6h#3#s "%& "'# 4i;i%4 "="! " l $ 9 6'#&i$/ H = p' 9i$":l# is $his $ $h# :"%k? C"% "ll $his :# 3"%"4#& =i$h 5$ " p' p#' 6'#&i$ 'isk &#p"'$3#%$ i% pl"6#? +! It is purel a marketing gimmick! ,o $ank compromises on pro%ita$ilit 1 it is all to attract customers! It goes &it"out sa ing t"ere are "idden costs in#ol#ed! H/ Th# R#45l"$ '! ) &! =hi6h '#45l"$#s $h# 6'#&i$ 4i;#% :! :"%ks? +!T"e (BI is t"e regulator $od in all cases! I/ H = l %4 & #s " p#'s % $"k# $ :$"i% 6'#&i$ 9' 3 ! 5' :"%k? +! On an a#erage it takes C5D da s! T"e $ranc" sanction mig"t take place on t"e same da ! Depending on t"e amount t"e loan sanction ma e#en take C5D &eeks! J/ D #s $h# :"%k 4i;# "="! " l $ 9 6'#&i$ &5# $ 6 3p#$i$i;# p'#ss5'#? This 6 5l& $5'% 5$ $ 'isk!< s h = & #s $h# :"%k s$'ik# " :"l"%6# :#$=##% p' 9i$":ili$! "%& ; l53# 9 :5si%#ss? +! ,o1 &e do not gi#e in due to competition! I% &e t"ink t"e $orro&er does not "a#e t"e capacit to pa $ack i!e! it is a pro$a$le ,7+ and &e &ill "a#e to make e%%orts to make reco#er &e do not grant t"e loan!

87

Credit Risk Management F/ Wh#% $"lki%4 ": 5$ 6'#&i$< is i$ li3i$#& $ G5s$ l "%s $"k#% :! i%&i;i&5"ls ' i$ "ls i%6l5&#s L#$$#' 9 C'#&i$s< #$6/? +! Yes1 it includes e#er t"ing &"ere in t"e $ank gi#es a&a loan or guarantees! .A/ H = & #s $h# :"%k 4 ": 5$ 6 ll#6$i%4 i%9 '3"$i % ": 5$ i$s : '' =#'s? Wh & #s i$? +! T"e personnel %rom t"e credit department collect in%ormation a$out t"e $orro&ers! T"e in%ormation is stored in t"e $anks data$ase! ../ A'# $h#'# &i99#'#%$ R5l#s "%& P' 6#&5'#s 9 ' C 'p '"$# 6'#&i$ 'isk 3"%"4#3#%$ "%& 9 ' R#$"il C'#&i$ 'isk 3"%"4#3#%$? +! Yes1 t"e procedures are di%%erent $ut t"e $asic rules remain t"e same! In simple terms1t"e #olume o% $usiness c"anges! .0/ D #s $h# :"%k h";# &i99#'#%$ &#p"'$3#%$s 9 ' h"%&li%4 6 'p '"$# 6'#&i$ 'isk "%& R#$"il 6'#&i$ 'isk? +! ,o1 t"ere are no separate departments %or "andling corporate credit risk and retail credit risk! .1/ Wh"$ is $h# )"s#l R#p '$? +! I do not "a#e an idea a$out it! .?/ H = 9$#% & #s $h# :"%k 9 ll =(5p "%& k##p % 6h#6ki%4 $h# 6"p"6i$! 9 $h# : '' =#'s "%& is i$ & %# 9 ' "ll $h# 6"s#s? +! 9e %ollo& a Tracking S stem $ut it is %ollo&ed onl in t"e case o% de%ault o% pa ment $ t"e $orro&er! .B/ D #s $h# :"%k '"$# i$s : '' =#'s? +! Yes1 rating is done on t"e $asis o% integrit 1 past per%ormance1 %inancial standing and strengt"! .H/ H = & #s $h# :"%k 4 ": 5$ P '$9 li 3"%"4#3#%$? +! T"e %ollo&ing are t"e criterias t"at are kept in mind &"ile managing t"e port%olio! T"e are E2posure to t"e compan ! :In case o% corporate;! E2posure to t"e group! :In case o% corporate;! E2posure to t"e industr ! :In case o% corporate;! E2posure to t"e indi#idual! :In case o% retail;! 88

Credit Risk Management E2posure to t"e countr ! :In case o% e2port;!

.I/ Wh"$ is $h# '#6 ;#'! p' 6#&5'# i% 6"s# 9 " &#9"5l$#'? Wh"$ & #s $h# :"%k & =h#% $h# : '' =#' :#6 3#s :"%k'5p$? +! + $orro&er does not $ecome $ankrupt1 all o% a sudden! 9e "a#e an e2cellent tracking s stem! +n asset $ecomes a ,7+ :dou$t%ul asset1 not repa a$le; i% t"e amount due :E*I; is not paid &it"in FL da s! T"en &e make e%%orts %or reco#er ! One &a is taking possession o% t"eir securities!

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ANALYSIS
For m pro0ect I #isited t"ree pri#ate $anks555 ICICI Bank1 IDBI Bank 3td and T"e Federal Bank 3imited! T"e #isits &ere e2tremel kno&ledgea$le and "elped me to gain an insig"t into t"e practical &orld! T"e importance o% credit risk management is clearl e#ident a%ter t"e %ield inter#ie&s! I %ound out t"at t"oug" t"e names o% t"e designations are di%%erent %or di%%erent $anks1 t"e core %unction remains remain t"e same! Furt"er more t"e di%%erence $et&een credit risk managers in t"e corporate department and retail credit risk is $asicall t"e #olume o% $usinesses! T"e process o% credit risk management remains t"e same in all t"e companies and is carried out $ all t"e companies o% course &it" a %e& c"anges in terms o% &"o collects and stores t"e data1 etc a$out t"e $orro&ers! T"e %ield #isits ga#e me a clear cut idea a$out t"e importance laid $ t"e $anks on credit risk management! *anaging credit risk is o% utmost importance as it "elps t"e $anks to reduce t"e risk o% ,7+?s :,on 7er%orming +ssets;! +n #enture taken $ an $od toda in#ol#es a certain amount o% risk toda ! 9it"out risk t"ere can $e no gain! +s %ar as t"e $anking industr goes1 one o% t"eir main aims is gi#ing loans

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Credit Risk Management :credit; to indi#iduals and corporates %or personal as &ell as personal needs! Credit risk is closel related &it" t"e $usiness o% lending! T"is comprises a "uge percentage o% t"eir $usiness! Credit risk reduces t"e 7ro$a$ilit o% loss %rom a credit transaction! T"us it is needed to meet t"e goals and o$0ecti#es o% t"e $anks! It aims to strengt"en and increase t"e e%%icac o% t"e organi<ation1 &"ile maintaining consistenc and transparenc ! It is predominantl concerned &it" pro$a$ilit o% de%ault! It is %or&ard looking in its assessment1 looking1 %or instance1 at a likel scenario o% an ad#erse outcome in t"e $usiness! T"e credit risk management %unction "as $ecome t"e centre o% gra#it 1 especiall in a %inanciall in ser#ices industr like $anking! *oreo#er t"e are no& using it as a tool to succeed o#er t"eir competition $ecause credit risk management practices reduce risk and impro#e return on capital! In t"e terminolog o% %inance1 t"e term credit "as an omni$us connotation! It not onl includes all t pes o% loans and ad#ances :kno&n as %unded %acilities; $ut also contingent items like letter o% credit1 guarantees and deri#ati#es :also kno&n as non5 %unded/non5credit %acilities;! In#estment in securities is also treated as credit e2posure! Furt"er I %ound out t"at t"e met"od o% o$taining t"e $usiness %or t"e $anks :loans in t"is case; is outsourced $ ICICI! T"e "a#e a lot o% DS+?s :Direct selling +gents; and DST?s :Direct Selling Teams; &orking %or t"em1 &"o get t"em $usiness! T"us t"e credit managers at ICICI do not meet t"eir clients in person as per popular perceptionE it is onl t"e DS+ t"at t"e customers come in contact &it"! Ho&e#er t"eir counterparts at IDBI Bank 3td and T"e Federal Bank 3imited meet t"eir clients %ace to %ace and act as relations"ip managers! +not"er %act I %ound out %rom all t"e inter#ie&s &as t"at appro2imatel in a$out KLR o% t"e cases o% corporate loans t"e $anks do not sanction t"e entire amount asked %or $ t"e $orro&ers e#en i% t"e are %ull con#inced t"at t"e $orro&er is in a position to pa $ack t"e loan! T"is is done to reduce t"eir credit risk in un%oreseen circumstances! In credit risk management perception o% t"e $ank a$out t"e $orro&er also pla s a #er important role1 i% t"e manager %eels t"at t"e person is not an "onest

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Credit Risk Management person and is capa$le o% de%ault :in t"is case it is called 9ill%ul de%ault; t"e $ank does not sanction t"e loan amount at all! Furt"er a %act t"at &as $roug"t out and discussed in all t"e inter#ie&s &as t"at in t"e corporate loans t"e $anks &ere not #er "esitant to gi#e loans to most o% t"e companies $ecause t"e econom as a &"ole is doing &ell and t"us all t"e sectors and industries also!

R#6 33#%&"$i %s
Esta$lis"ment o% an appropriate credit risk en#ironment / culture! T"is s"ould operate under a sound and independent credit appro#al process! *aintaining appropriate credit administration1 measurement and monitoring processes! Ensuring ade>uate controls o#er credit risk! +&areness o% t"e implications o% ot"er %orms o% risk1 suc" as market risk and operational risk! Instilling risk5return discipline keeping in #ie& t"e sop"istication o% a particular t pe o% $usiness acti#it o% $anking!

)ENEFITS
T"e stake"olders5555especiall s"are"olders1 depositors :in t"e case o% $anks; and t"e go#ernment5555 are t"e $ene%iciaries since t"e economic and social costs o%

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Credit Risk Management poor credit risk practices strengt"ens t"e con%idence in t"e operation o% t"e organi<ation concerned1 $esides ena$ling s stematic peer5le#el anal sis and comparison! It is also a %act t"at suc" practices %acilitate %or&ard5looking assessment1 aided $ t"e tools o% stress testing1 credit Va(1 etc! T"e end result is certainl en"anced in#estor con%idence and returns!

CONCLUSION
T"e aim o% credit risk management is to reduce t"e 7ro$a$ilit o% loss %rom a credit transaction! T"us it is needed to meet t"e goals and o$0ecti#es o% t"e $anks! It aims to strengt"en and increase t"e e%%icac o% t"e organi<ation1 &"ile maintaining consistenc and transparenc ! It is predominantl concerned &it" pro$a$ilit o% de%ault! It is %or&ard looking in its assessment1 looking1 %or instance1 at a likel scenario o% an ad#erse outcome in t"e $usiness! T"us &e conclude t"at Credit risk management is not 0ust a process or procedure! It is a %undamental component o% t"e $anking %unction! T"e management o% credit risk must $e incorporated into t"e %i$er o% $anks! Credit risk s stems are currentl e2periencing one o% t"e "ig"est gro&t" rates o% an s stems area in

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Credit Risk Management %inancial ser#ices! T"ere is a direct correlation $et&een market risk and credit risk and credit risk "as an impact on t"e operational market! In m opinion credit risk management is an important %unction o% $anns toda ! +ll $anks need to practice it in some %orm or t"e ot"er! T"e need to understand t"e importance o% credit risk management and t"ink o% it as a ladder to gro&t" $ reducing t"eir ,7+?s! *oreo#er t"e must use it as a tool to succeed o#er t"eir competition $ecause credit risk management practices reduce risk and impro#e return on capital!

ANNE+URES

*5#s$i %%"i'# B! 9"at is credit risk managementJ C! Does t"e $ank "a#e a separate credit risk departmentJ 9"at are its %unctionsJ D! Is some insurance t"ere %or co#ering credit riskJ Has t"e $ank taken $usiness credit insuranceJ M! Ho& does t"e $ank go a$out collecting in%ormation a$out its $orro&ersJ 9"o does itJ

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Credit Risk Management G! Is loan al&a s gi#en on securit J 9"at are t"e limits until &"ic" t"e $ank gi#es loan &it"out securit and &it" securit J N! ,o&5a5da s almost all t"e $anks "a#e come up &it" so man sc"emes and are gi#ing a&a a lot o% credit! Ho& pro%ita$le is t"is to t"e $ankJ Can all t"is $e managed &it"out a proper credit risk department in placeJ H! Does t"e $ank gi#e a&a a lot o% credit due to competiti#e pressureJ T"is could turn out to risk 1 so "o& does t"e $ank strike a $alance $et&een pro%ita$ilit and #olume o% $usinessJ K! T"e (egulator Bod &"ic" regulates t"e credit gi#en $ $anks! F! Ho& does t"e $ank take on its de%aultersJ Is t"ere a proper procedure prescri$ed $ t"e (BIJ BL! Ho& long does a person take to o$tain credit %rom our $ankJ BB! 9"en talking a$out credit1 is it limited to 0ust loans taken $ indi#iduals or it also includes 3etter o% Credits1 BC! +re t"ere di%%erent (ules and 7rocedures %or Corporate credit risk management and %or (etail Credit risk managementJ BD! Does t"e $ank "a#e di%%erent departments %or "andling corporate credit risk and (etail credit riskJ BM! 9"at does +sset 8ualit meanJ Ho& is it managedJ BG! 9"at is t"e Basel (eportJ BN! Ho& o%ten does t"e $ank %ollo&5up and keep on c"ecking t"e capacit o% t"e $orro&ers and is it done %or all t"e casesJ BH! 9"at is t"e reco#er procedure in case o% a de%aulterJ BK! 9"at does t"e $ank do &"en t"e $orro&er $ecomes $ankruptJ BF! Does t"e $ank rate its $orro&ersJ Does t"e $ank %ollo& a credit rating mec"anismJ CL! Ho& does t"e $ank go a$out credit risk port%olio managementJ

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Credit Risk Management

)I)LIOGRAPHY

ks '#9#''#&:

C(EDIT (IS) *+,+-E*E,T $ S!)! Bagc"i N#=sl#$$#' "%& M"%5"ls: Bank 8uest (BI Bulletin W#:si$#s Visi$#&: &&&!icici$ank!com &&&!id$i$ank!com 96

Credit Risk Management &&&!t"e%ederal$ank!com &&&!google!com

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