Loan policy credit risk management
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Loan Policy- Credit Risk Management
N.GopalDeputy General Manager/MOF
CAB Pune
July 5, 2010 1RBI CAB Pune
July 5, 2010RBI CAB Pune 2
Loan policy- Genesis, Importance- Credit risk Management
Need for loan policy Ingredients of a good loan policy Loan Policy and risk Management Prudential ceilings and loan policy Final Analysis
July 5, 2010 3RBI CAB Pune
July 5, 2010RBI CAB Pune 4
July 5, 2010RBI CAB Pune 5
Credit sanctioning guidelines, and the written documentation setting forth standards as determined by a bank's senior management. A bank's loan policy also establishes minimum credit standards for taking on loans. It sets policies and procedures in treatment of delinquent loans, and the type of customer a bank wants as a borrower.
July 5, 2010RBI CAB Pune 6
July 5, 2010RBI CAB Pune 7
1980sThe world and the way of banking changed American banking history witnessed several credit induced
bank disasters E.g. Continental, Sea First and Texan Banks
1990s Credit freeze due to East Asian Crisis 2000 GTB’s credit induced problems Lessons
The common “triggers of crisis” Aggressive and unplanned lending
Credit concentration failure to diversify, Risky practices, inadequate monitoring
Result Poor credit culture
Credit culture is largely dependent on the loan policies pursued by a bank
July 5, 2010 8RBI CAB Pune
First six years of the millennium saw paradigms shifts in bank lending India became more closely integrated to the global economy Interest rates moved both ways Traditional avenues for lending slowed down Competition
Policies responses had to become dynamic outward and forward looking to meet challenges
July 5, 2010 9RBI CAB Pune
1. Board & Management Oversight2. Portfolio Management3. Management Information Systems4. Market Analysis5. Credit Underwriting Standards6. Portfolio Stress Testing & Sensitivity Analysis7. Credit Risk Review Function
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TheoryBroadly defining the credit cultureBroadly laying out the external-internal environment
Lookups Statutory issues & RegulatoryMarket, present environment
Studies Industry, survey etc
Setting up Risk AppetiteFixation of internal norms & prudential ceilingsDeciding on risk rating
ImplementationLaying out procedures, appraisal standards, schematic
issuesJuly 5, 2010 16RBI CAB Pune
Credit Culture “This is the way we handle credit”
Establish BusinessEstablish Business Priorities Priorities
Choose Credit Choose Credit Culture Culture
StrategiesStrategies
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Credit Policy determines the credit culture
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Based on Corporate prioritiesBased on Corporate priorities
Credit Culture could be one of four Credit Culture could be one of four typestypes
CORPORATE PRIORITY CORPORATE PRIORITY CULTURECULTURE
Emphasis on asset quality , long term Emphasis on asset quality , long term growthgrowth
Values Driven (Conservative, Values Driven (Conservative, Prudent)Prudent)
Short term gains Short term gains Earnings Driven (Regardless Earnings Driven (Regardless of risk)of risk)
Market share, Size Market share, Size Volume Driven /AggressiveVolume Driven /Aggressive
No clear priorities No clear priorities UnfocussedUnfocussed
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Overriding objective of credit policy
Healthy Balance between
Credit Volumes, Earnings & Asset Quality
Within the framework of
Regulatory prescriptions,
Corporate goals - social responsibilities
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Credit expansionSteady expansion, sustained, continuous & prudent growthSteady rise in profits but emphasis on
Quality Assets Profitable Relationships
Statutory and Regulatory line
This philosophy seeks to instill a value driven credit culture
July 5, 2010 21RBI CAB Pune
July 5, 2010 22RBI CAB Pune
RBI’s Guidelines on Risk Management Systems in Banks require a typical Credit Policy to cover:
Standards of presentation of credit proposals, financial covenants
Rating standards and benchmarks
Prudential limits on large credits and asset concentrations
Standards for Loan collateral, Loan Review Mechanism
Pricing of loans, risk monitoring and evaluation
Legal and regulatory compliances
Delegation of credit sanctioning powers
Prohibition on lending
July 5, 2010 23RBI CAB Pune
No ambiguity in postulations- chance for different understanding interpretations
Loan policy must clearly mark the boundaries Government RBI Bank
Loan policy should ideally list out restrictions that credit grantors can refer
Loan policy must provide for exceptions- list out if possible
Loan policy must also lay down the levels of authority for certain credit decisions
Regulatory reviews, inspections also provide opportunities for aligning loan policy to regulatory thinking
July 5, 2010 24RBI CAB Pune
Sector specific guidelines should also contain Do’s and Don’ts based on present environment, statutory and regulatory guidelines
e.g. Financing Real Estate, Capital Markets, bill discounting,
NBFC lending etc Ban on lending to units producing ozone depleting
substances is an instance of statutory restriction
While assessing the adequacy of a loan policy these Do’s and Don’ts should be weighed by the credit grantor
Deterrents to non compliance to these do’s and don’ts
July 5, 2010 25RBI CAB Pune
July 5, 2010 26RBI CAB Pune
Target markets, industry and business sectors are identified
Sectoral study Trends in consumption, impact on a sector Growth potential, capital investment, Delinquencies Conclusions Translating experiences into policy
Industry Study Products, Capital investment, Sunrise/sunset Turnover, Labour, locational concentration Market, fashion trends etc Seasonality Regulatory environment
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July 5, 2010 28RBI CAB Pune
Policy not to stop with managing transaction risks
Has to address intrinsic risk also Portfolio perspective The risk inherent in certain lines of business is known
through industry analysis
Industry analysis to look at three vital factors Historic elements Predictive elements Lending elements
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Historic Risk Elements should look at:
Financials: capital, cash flows, w.c. cycle
Stability: demand, growth
Longevity of the industry: demand, trend need etc
Predictive Risk Elements would include:
Structure: constitution
Diversity: concentration
Entry barriers- political, financial, feasibility
Product Life cycle- ever in demand, seasonal etc
Economic Vulnerability, Political / Regulatory risks, Environmental issues and Covariance factors
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Lending elements Collaterals-availability, acceptability Security- legal issues, Valuation – Delivery – Loan or an advance
Industry study should be periodically reviewed and factored into the policy
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In real life policy setting industry analysis may or may not be documented on these rigorous lines
In any case a careful consideration of all three risk elements go into the industry limits fixed by each bank
This is based on the lending experience and business expectations that the bank has
It is intrinsic risks in sectors like real estate and capital markets that explains the regulatory concern about build up of asset concentrations in these areas
Inspection and Audit to help verification/validation whether the intrinsic risk in industries with higher exposure limits have been assessed by the bank
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Identify focus areas broad confines of strategy, study, restrictions etc.
Identify macro economic trends, regulatory stance bank’s own experience core competencies
Retail for instance became a focus area for banks after the interest rate deregulation and the slow down in corporate borrowings
SMEs, Agriculture and Micro Finance are today perceived to be major business opportunities
July 5, 2010 33RBI CAB Pune
Each bank has its strong points and core competencies
Public sector banks have a strong rural and semi urban presence and a history of success in agricultural and rural credit
Banks in Western India have a predominant presence in sugar sector
Credit Policy to draw on such strengths It should also leverage on sector specific regulatory
incentives and relaxations extended from time to time
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July 5, 2010 35RBI CAB Pune
Prudential limits
limiting magnitude of credit risk
Dispersion of credit risk- prevents concentration
Determinants-
Credit culture
Risk appetite
Regulatory dictates
Prevailing Industry and Economic Conditions
Loan policy should articulate the rationale behind the limits, for better appreciation and understanding
July 5, 2010 36RBI CAB Pune
Financial Limits
Single & Group
Substantial Exposure
Maximum limit Aggregate limit Industry wise Sector specific
Individual Corporate Partnership Proprietorship
Aggregate linked to capital funds
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Financial benchmarks with conditions under which deviations can be permitted
Single and Group borrower limits not exceeding what is prescribed by RBI- permissible deviations
Substantial Exposure limit (10% borrowers < 600% of capital)
Industry and sector wise ceilings Limits on sensitive sectors subject to asset price
volatility High risk and low priority sectors Maturity profile of the loan book
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Limit setting is unique to each bank
It has to balance risk control against growth imperatives
The limits set should reflect the legacy issues in the portfolio
There should be higher limits for areas where Bank has a natural advantage
Lower limits and ban in sectors where the Bank’s prior experience has been adverse
Limit setting is dynamic and on-going
July 5, 2010 39RBI CAB Pune
July 5, 2010 40RBI CAB Pune
Tool for the measurement of credit risk To enable an informed and considered credit
decision as ‘good ‘ or ‘bad’To appropriately price loan products
“BCBS defines credit rating as summary indicator of risk inherent in individual credit signifying the risk of loss due to default of a counterparty by considering qualitative and quantitative information
Policy should provide for rating of all loan accounts- very little exceptions
The rating should consist of 8-9 parameters (minimum) Policy to specify minimum entry rating i.e. Hurdle Rate
Policy to lay down exceptions to Hurdle ratePolicy to lay down procedures to handle accounts which fall below
hurdle rating Annual review of ratings- Quarterly, half yearly updates Study of Rating migration Pricing linked to Rating Mapping of external ratings to internal ratings
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A good loan policy to provide leeway for
It should balance the risk and returns on the retail front
Schematic LendingDirected credit flow to certain sectors
Housing, farming, SME, retail, personal loans, special tie-ups etc
Retail loans under various products and schemes designed by the Bank
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Returns from retail/schematic lending commensurate with risks?
Schemes to match customer expectations?Standard of Due Diligence and KYC?Outsourcing risks adequately addressed?Delinquencies under control in specific product
categories?What is the growth in terms of size, earnings and
quality?
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July 5, 2010 46RBI CAB Pune
Take over route to grow businessPolicy to clearly lay down ground rules
What type of borrower accountsWhat level of exposuresTake over from whomTake over standardsPricing
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July 5, 2010 48RBI CAB Pune
Profitability, Customer Friendliness/service, ComplianceCapital Conversation
Challenges arise when what the customer needs are not provided for in the policy
Trade off business considerations, social responsibility,
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Area of potential conflict in perceptions differences between regulator and banks
Every policy has to provide for exceptions RBI the regulator also recognizes this But question is how far and how much
Deviations/ exceptions dictated by business needs
Extent of their impact on risk profile to be seen
Within the overall credit culture of the bank
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July 5, 2010 51RBI CAB Pune
Credit Policy serves a ‘Gate Keeping’ function Defines thrust areas in relation to credit culture,
profit objectives and regulatory directionsDefines acceptable levels of risk by identifying
industry segments for fresh exposures Prevents risk concentrations and ensures
diversification by setting limits on sectors and individual transactions
It provides pricing strategies through the use of Credit Risk Rating framework
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Knowledge is the most potent of risk mitigant
Does the policy provide for dissemination of knowledge on credit?
Is the policy in itself, - Comprehensive,
Articulate, accurate and
User friendly?
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An ideal loan policy should Create right for business growthMaintain quality of assets Provide platform for good procedures/processEnsure regulatory and statutory compliances Be the platform for Credit Risk Management
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July 5, 2010 55RBI CAB Pune
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