Credit Risk Managment

CREDIT RISK MANAGEMENT

"Ships are safe in harbour

but they are not meant for that

banking is business of taking

informed and calculated risk"

The business of banking means

"accepting of deposit for the purpose of onward lending"

Risks in Business

Risk can be defined as any uncertainty about a future event that threatens the organisation's ability to accomplish its mission. Business is a trade off between risk and return. There can be no risk-free or zero risk oriented business. Risk in its pragmatic sense, therefore, involves both threats that may be materialised and opportunities which can be exploited.

Credit Risk and Default

Credit Risk is the risk of loss to the Bank in the event of Default.

Default arises due to counterparty's inability and/or unwillingness to meet commitments in relation to lending.

Credit risk is the potential loss that a bank borrower or counter party will fail to meet its obligation in accordance with the agreed terms

TYPES OF THE CREDIT RISK

A) Transaction risk B) Portfolio risk

a) Grade risk a) concentration risk

b) default risk b) intrinsic risk

1) non payment

2) delayed payment

Credit risk may be in the following forms:

* In case of the direct lending

* In case of the guarantees and the letter of the credit

* In case of the treasury operations

* In case of the securities trading businesses

* In case of the cross border exposure

Traditionally credit risk has 2 components

a) Solvency aspects of the credit risk-the risk borrower is unable to pay

b) Liquidity aspects of the risk-the risk that arise due to the delay in the repayment by the borrower leading to the cash flow problems for the leader

The need for Credit Risk Rating

The need for Credit Risk Rating has arisen due to the following:

1. With dismantling of State control, deregulation, globalisation and allowing things to shape on the basis of market conditions, Indian Industry and Indian Banking face new risks and challenges. Competition results in the survival of the fittest. It is therefore necessary to identify these risks, measure them, monitor and control them.

2. It provides a basis for Credit Risk Pricing i.e. fixation of rate of interest on lending to different borrowers based on their credit risk rating thereby balancing Risk & Reward for the Bank.

3. The Basel Accord and consequent Reserve Bank of India guidelines requires that the level of capital required to be maintained by the Bank will be in proportion to the risk of the loan in Bank's Books for measurement of which proper Credit Risk Rating system is necessary.

4. The credit risk rating can be a Risk Management tool for prospecting fresh borrowers in addition to monitoring the weaker parameters and taking remedial action.

The Credit Risk Rating method is used by Bank's Credit officers,

* To gather key information about risk areas of a borrower and

* To arrive at a risk score that would reflect the borrower's creditworthiness/degree of risk.

The types of Risks Captured in the Bank's Credit Risk Rating Model

The Credit Risk Rating Model provides a framework to evaluate the risk emanating from following main risk categorizes/risk areas:

* Industry risk

* Business risk

* Financial risk

* Management risk

* Facility risk

* Project risk

The Overall Rating is assigned on a 'A++' to 'C' scale presented below along with its meaning: