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Credit Risk Management Essay

4703 words - 19 pages

Banks are in the business of risk management and, hence, are incentivized to develop sophisticated risk management systems. The basic components of risk management system are identifying the risks the bank is exposed to, assessing their magnitude, monitoring them, controlling/mitigating them using a variety of procedures and setting aside capital for potential losses.
RBI prescribed risk management framework in terms of:
a) Asset-Liability Management practices.
b) Credit Risk Management.
c) Operational Risk Management.
d) Stress testing by Indian Banks in the perspective of international practices.
It can be categorized into:
i) ...view middle of the document...

As regard risk related to the business activity financed, these may include obsolescence of technology/products design, competition, in adequate supply of inputs, lack of infrastructural facilities, government rules/regulations and so on.
In addition, banks may also face risks caused by a concentration of their portfolio in certain types of loan facilities like overdrafts, cash credit, term loans, lease/hire- purchase finance and so on. Further , the concentration risk may caused duo to high exposure in a single/group of borrowers or in a specific economic/industrial sector.
As a step towards enhancing and fine-tuning their existing risk management practices, the RBI has prescribed effective 2001, a comprehensive risk management framework for banks.

Credit Risk Management focuses on three main elements of the frame work:
(i) Credit Risk Policies and Procedures.
(ii) Organizational structure for effective credit administration and risk management functions.
(iii) Credit risk rating framework.
(i) Credit Risk Policies and Procedures:
As per RBI guidelines, bank should prepare a comprehensive and well articulated , written credit policy document, with the approval of their Boards of Directors, highlighting the strategy, policies and procedures for effective management of credit and mitigation of risks. The credit policies and procedures should have the following features:
* Based on studies of industries/business activities, bank should identify those which are doing well and have encouraging outlook/potential for growth. Such activities should be placed under target/preferred credits while others which are not doing well and have uncertain prospects/default risk may be kept under a watch list where in exposures are increased –contained/reduced.
* Delegation of loan approving/sanctioning powers of officials, linking the same with the risk rating of the borrowers. The level of loan sanctioning authority may increase as the risk rating worsens.
* Linking credit risk scoring and rating system and risk acceptance criteria with the risk rating of the borrowers so that no loan proposal below a certain cutoff level is entertained. The conditions under which deviations can be made by the sanctioning authority required to ratify the deviations should also be specified.
* The credit policies and procedures should lay down prudential exposure limits for loans to individuals and groups of borrowers, as also for different industries/sensitive sectors, as a proportion of the bank’s capital funds.
* They should discuss concentration risk in terms of industry, sector exposures or regional exposures as also the steps that need to be taken for credit dispersion as to mitigate concentration risk. Bank should lay down a system of regular analysis of the credit portfolio for an ongoing control of risk concentration.
* They should discuss the loan review mechanism and renewal system and may relate their frequency with risk...

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