Jntu credit risk-management

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What is Credit Risk?

The risk that a counterparty to a transaction will fail to perform according to

the terms and conditions of the contract due to

•Problems such as•Bankruptcy•Illiquidity ,etc.

Lenders, Depositors, Borrowers and Suppliers - all face credit risk

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A More Formal Definition

Credit Risk is defined as the possibility

that a borrower or counterparty will fail

to meet its obligations in accordance with

the agreed terms

Default triggers

a total or partial loss of any amount lent

to the counterparty

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Credit Risk Components “Quantity” of Risk

Outstanding balance lent to the borrower

“Quality” of Risk Dependant on

Chances that the default occurs Guarantees that reduce the loss in the

event of default

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Credit Risk Components Cont.. Credit Risk or Loss Given Default

(LGD) Composed of Default Risk Exposure Risk Recovery Risk

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Default Risk Possible definitions

Missing a payment obligation- usually three months

Breaking a covenant – financial ratios bands

Entering a legal procedure Economic default- market value of

assets drops below that of liabilities

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Exposure Risk Amortised debt- no exposure risk

As repayment schedule known hence no exposure risk

Committed lines of credit like Overdraft All off balance sheet items like third

party guarantees Derivatives- if liquidation value is

positive then it remains if the counterparty defaults

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Recovery Risk Dependent upon

Collateral security

Third party guarantee

Legal framework

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Credit Risk Management’s Importance for Banks cont..

New forms of financial transactions emerging Securitisation Credit Derivatives

CRAR( Capital to Risk-weighted Assets Ratio) Framework

Decreasing Govt. Support for bail outs

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Traditional Approach in Credit Approval System 5 “C” principles

Character (of Borrower) Capital (Borrower’s risk-bearing

commitment) Capacity (to provide adequate cash

flows) Collateral (Priority of charge and value) Condition- (of business of borrower and

industry he belongs to ) Level of interest rates

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Evolution of Credit Risk Rating Systems - India

Position in India Regulatory Health-Code System

(1980s) Internal Credit Rating Systems of

banks In both cases , no explicit linkages

with capital requirements

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Five Eternal Principles of Credit Risk Management Selection Limitation Diversification Provision Capitalisation Quantitative Approach attempts to

optimise all the above

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Credit Risk Management Limit systems and Credit screening Risk quality and ratings Credit enhancements

Covenants- diversification, ratios Securitisation Guarantees Letters of credit

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Industry Ratings-Risk Evaluation

Cash Flows Debt Repayment Ability Time Horizon- 3 to 5 years Parameters

Demand –Supply outlook Cost Structures Competition Govt Policies Financial performance-Historical

+Projected

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Company Ratings Industry Prospects Operating Efficiency

Capacity utilisation levels Input-output norms Power consumption Gross margins Working capital management

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Company Ratings cont. Market Position

Current and expected Likely growth rate for the company Current market share and its stability Barriers to entry Basis of competition Diversity of markets Product profile

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Company Ratings cont.

Business Risk

Accounting Quality

Financial Performance

Past 3-5 years

Future 2-3 years

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Company Ratings cont.

Financial Flexibility Company’s need for funds Ability to raise it through

Debt Equity GDR’s, ADR’s Internal accruals Liquidation of marketable securities Support from group companies

Financial Risk Financial performance Ability to fund capital commitments Service debt obligations

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RBI Guidelines on Risk Management

RBI issued Guidelines to banks on Risk Management in October, 1999.

The Guidelines are aimed to make banks aware of the risks and put in place proper risk management system

Emphasis placed on Board level overview and an organisational structure and practices which would enable proactive risk management

Guidance Paper dated Sept.20, 2001 issued by RBI on Credit Risk Management

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Integrated Management

Inter-relationships between risk categoriesCapital Adequacy NormsCapital Adequacy for Market RiskBasle Committee’s proposal to prescribe explicit capital charge for Operational Risk also

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Risk Management Structure

Risk Mgt. Committee

Credit Policy Committee

BOARD

*Asset-Liability Management Committee

ALCO *

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Organisational Scheme for Credit Risk Management

R isk M an ag em en t C om m ittee

C red it R isk M an ag em en tF u n c tion

C red it A d m in is tra tionF u n c tion

L oan R eviewF u n c tion

C red it P o lic y C om m ittee

T.V.RAOTHANK YOU

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