A PROJECT REPORT ON CREDIT RISK MANAGEMNT AT SARASWAT BANK LTD A detailed study done in Submitted in partial fulfillment of the

requirement for the award of degree of Master of Management (MMS) under Mumbai University Submitted by Sudhir K Tardekar ROLL NO: 19 BATCH: 20011 2012 Under the guidance of NAME OF THE GUIDE Prof. Sadhana Ogale

C.K.Thakur Institute of Management Studies & Research

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New Panvel, Khanda Colony

ABSTRACT
The project entitled CREDIT RISK MANAGEMENT only with the intension of understanding how bank manages the credit risk. Credit risk is the potential that borrower or counter parties will fails to meet its obligations in accordance with agreed terms. Credit risk usually arises from lending activities of a bank. It is observe that loans are the largest and most obvious source of credit risk. Banks are increasingly facing credit risk in various instruments others than loans, including acceptance, interbank transactions, trade financing, foreign exchange transactions, financial futures, swaps, bonds, equities, options and in the extension of commitments and guarantees and the settlement of transactions. Credit risk consists of various components, objectives, types, credit risk management framework, etc. My project report consists of all the above points in brief about how to manage credit risk in banks. My project specifically concentrates on credit risk management includes credit derivates and credit insurance and also credit risk mitigates as per Basel II Accord and various mitigates used by different banks. I am thankful to our internal guide Prof.Sadhana Ogale who has also helped me in preparation of my project report. I feel that the college has provided adequate facility to develop my vision and also enrich my knowledge.

ACKNOWLEDGEMENT

A work is never a work of an individual. I owe a sense of gratitude to the intelligence and co-operation of those people who had been so easy to let me understand what I needed from time to time for completion of this exclusive project. I am greatly indebted to my guides Prof. Sadhana Ogale, faculty guide for Finance (summer internship), C.K.Thakur Institute of Management Studies & Research. K. S. Pawar, Dy. General Manager, Saraswat Co-operative Bank Ltd., Ghatkopar for their constant guidance, advice and help which enabled me to finish this project report properly in time. I am also grateful to Dr.S. T. Gadade Principal and Prof. Niesh Manore, HOD of MMS, C.K.Thakur Institute of Management Studies & Research, for permitting me to undertake this study. Last but not the least, I would like to forward my gratitude to my friends & other faculty members who always endured me and stood with me and without whom I could not have completed the project.

Sudhir Tardekar
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DECLARATION
I do hereby declare that this piece of project report entitled CREDIT RISK MANAGEMENT at Saraswat Co-op. Bank for partial fulfillment of the requirements for the award of the degree of MASTER OF MANAGEMENT STUDIES is a record of original work done by me under the supervision and guidance of Prof. Sadhana Ogale,C.K.Thakur Institute of Management Studies & Research. This project work is my own and has neither been submitted nor published elsewhere.

PLACE: DATE:

SIGNATURE OF THE STUDENT

CERTIFICATE
This is to certify that the summer project work of Mr. SUDHIR K.TARDEKAR titled Credit Risk Management is an original work and this work has not been submitted elsewhere in any form. The indebtness to other works/publications has been duly acknowledged at the relevant places. The project work was carried out during 21.05.2011 to 21.07.2011 in SARASWAT CO-OPERATIVE BANK LTD.

Mr. K. S. Pawar, Dy. Gen. Manager, Saraswat Co-operative Bank Ltd., Ghatkopar, Mumbai.

Date:

Sr no. Topics
01 02 03 04 05 I) II) III) VI) 06 I) II) III) VI) Abstract Acknowledgement Declaration Certificate Introduction Of Study Objective Of The Study need & importance of the study Research Methodology Limitation Of The Study About Saraswat Co-operative Bank Company Profile & features Milestones Growth and Strength Financial position And NPAs Risk in Banking business Origin & Evolution of Credit Risk Management Types of Credit Risk Components of Credit Risk Objectives of Credit Risk Management Credit Risk Management framework : Policy Framework

Page No.
02 03 04 05 08-10

11-18

22 24 28 30 31 33-53 34
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 Credit risk rating framework Credit risk limits Credit Risk Modeling RAROC Pricing Risk Mitigants Loan Review Mechanism/credit audit 07 08 09 10 Credit Risk Mitigants as per Basel II Accord Credit risk mitigants used by different banks New Capital Accord : Implications for Credit Risk Management Case Study Conclusion Biblograph/Weblograph

37 43 44 50 52 53 54 60 72 77 84 85

INTRODUCTION:7

Risk is inhisent in all aspects of a commercial operation and covers areas such as customer services, reputation, technology, security, human resources, market price, funding, legal, regulatory fraud and strategy. However, for banks and financial institutions credit risk is the most important factor to be managed. The term credit risk is defined, as the potential that a borrower or counter-party will fail to meet its obligations in accordance with agreed terms. In simple terms, it is the probability of loss from a credit transaction. Loans are the largest and most obvious source of credit risk. Loans are given by banks in the form of corporate lending, sovereign lending, project financing and retail lending. However this sources of credit risk exists throughout the activities of banks, including in the banking book and in the trading book and both on and off the balance heet. Banks are increasingly facing credit risk in various instruments other than loans, including acceptances, interbank transactions, trade financing, foreign exchange transactions, financial futures, swaps, bonds, equities, options and in the extension of commitments and guarantees, and the settlement of transactions. Credit risk encompasses both default risk and market risk. Default risk is the objective assessment of the likelihood that counterparty will default. Market risk measures the financial loss that will be experienced should the client default. Credit risk includes not only the current replacement value but also the potential loss from default. OBJECTIVES OF THE STUDY:
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The main objectives of the study are: 1 To study the effectiveness of credit process. 2 To know and analyze the procedure of loan disbursement and its evaluation criteria. 3 To study and analyze the factors contributing to default rate and their interrelations. 4 To suggest suitable strategies for improving credit and risk management. NEED & IMPORTANCE OF THE STUDY: In todays market scenario, one of the most critical areas to focus on is to protect the bank from bankruptcy. In such conditions Credit and Risk Department plays a key role in growth of banks. Any delay in realizing the receivables would adversely affect the working capital, which in turn effects the overall financial management of a firm. No firm can be successful if its over dues are not collected, monitored and managed carefully in time. Thus Risk management is important in sustaining the bank and its growth.

RESEARCH METHODOLOGY:
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To fulfill the objectives of the study both primary and secondary data are used. The primary data was collected through interviewing all the executives and officials of the of SARASWAT CO-OPERATIVE BANK LTD. The secondary data was collected from published records, website and reports of the Bank. Mainly the data relating to credit procedures followed by the bank and risk management was obtained through manager from bank database .The data for this purpose was obtained from bank for a period of 3 years that is from. Based on the availability of the data, the analysis was made from different angles to assess the credit and risk management of SARASWAT CO-OPERATIVE BANK LTD.

LIMITATIONS OF THE STUDY:

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The study is limited to Mumbai city only.

2 The study has been done according to bank point of view. 3 The study has been done without meeting the defaulters due to constraints of time.

Place of study:The project study is carried out at the Loan Department of Saraswat Cooperative Bank Ltd. Central Zonal office Situated at Ghatkopar, Mumbai. The study is undertaken as a part of the MMS curriculum from 21.05.2011 to 21.07.2011 in the form of summer placement.

THE SARASWAT CO-OPERATIVE BANK LIMITED

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The Bank has a very humble but a very inspiring beginning. On 14th September 1918 , "The Saraswat Co-operative Banking Society" was founded. Mr. J.K. Parulkar became its first Chairman, Mr. N.B. Thakur, the first Vice-Chairman, Mr. P.N. Warde, the first Secretary and Mr. Shivram Gopal Rajadhyaksha, the first Treasurer. These were the people with deep and abiding ideals, faith, vision, optimism and entrepreneurial skills. These dedicated men in charge of the Society had a commendable sense of service and duty imbibed in them. Even today, our honorable founders inspire a sense of awe and respect in the Bank and amongst the shareholders. The Society was initially set up to help families in distress. Its objective was to provide temporary accommodation to its members in eventualities such as weddings of dependent members of the family, repayment of debt and expenses of medical treatment etc. The Society was converted into a fullfledged Urban Co-operative Bank in the year 1933. The Bank has the unique distinction of being a witness to History. The Bank, which was originally founded in 1918, i.e. close on the heels of the Russian Revolution, also witnessed as a Society and as Bank-the First World War, the Second World War, India's freedom Movement and the glorious chapter of post-independence India. During this cataclysmic cavalcade of history, the Bank as a financial institution and its members could not of course remain unaffected by the economic consequences of the major events.

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The two wars in particular brought in their wake, paucities of all kinds and realities and stand by its members in distress as a solid bulwark of strength. The Founder Members and the later-day management's of the Bank continued to demonstrate their unwavering faith in the destiny of the common man and the co-operative movement and they encouraged the shareholders to save despite all odds.

COMPANY PROFILE
"Service to the Common Man" has been the motto of Saraswat Bank for the last 91 years. Bank inspite of its growth in size has been able to offer to the customers the dual advantage of "Ability of Big Banks and Agility of Small Banks" The Bank still continues to function with the glorious tradition in public services besides being the largest Urban Co-operative Bank in India, Saraswat Bank has now become the largest in Asia. Saraswat Bank has now 217 fully computerised branches, 15 Zonal Offices and departments located across 6 States viz. Maharashtra, Goa, Gujarat, Madhya Pradesh, Karnataka and Delhi. Saraswat Bank attributes this success to its undying spirit to serve the common man and to the sharpening of its competitive edge by constantly upgrading technology to match international standards. The Bank is fully computerised and offers convenient working hours. Saraswat Bank has introduced a wide range of credit schemes at attractive interest rates, which has become very popular, especially among the middle12

class in view of the easy repayment plans. Bank offers attractive interest rates on deposits and also various add on features at very market competitive rate. The Beginning of the 21st Century has been a giant leap forward for the Bank. Bank chose a path of organic/inorganic growth and our pace of growth accelerated .Bank's total business which was around Rs 4000 Crore in 2000 almost tripled to Rs 15295 Crore in 2007. The Business of the Bank as on 31st March 2009 had crossed Rs 21000 Crores.

Bank in the year 2008 launched the Branding Initiative .The purpose of such an exercise was to reconfirm the thrust of Bank on its core values ,which can be summed up as "Sense of Belonging ".The name of the Bank should always inspire the Sense of Belonging in all its stakeholders and that Bank continues to fulfill the changing needs and expectations of the customer with unflinching gusto and aplomb. As on 31st March, 2010 Bank had surpassed the business level of Rs 23000 crore businesses. Bank by 1st November, 2010 has already surpassed the business level of Rs 25000 crore .As on 31st March, 2011 Bank's business had crossed Rs 26000 crore. It is a matter of immense pride for the Bank that Bank's new Corporate Office at Prabhadevi -Mumbai has recently become operational.The office reverberates our strong presence in the financial capital of the country. The massive edifice in crystal glass in heart of Mumbai gently reminds everyone of the numero -uno position which the Bank holds in the Cooperative Sector. The usage of state of art technology coupled with
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personal ambience's to make everybody comfortable once again reiterates Bank's adherence to "Think Global, Act Local". The address of our new corporate office is as under: Our features: 1. Attractive Interest Rates on Deposits. 2. 0.50% additional interest on Deposits for Co-operative Society.
3. 1.00% additional interests on Deposits for Senior Citizens.

4. Various Loan Facilities to fulfill your needs. 5. We have cheque drawing and cheque collection faculty on major cities all over India. 6. Electricity bills of B.E.S.T., M.S.E.B. etc. accepted. 7. NO TDS to our shareholders. 8. Lockers available at lowest rates.

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Milestones:
1918 1933 1942 1977-78 1988 2008 2009 Established as Co-operative Credit Society. Converted into a Urban Co-operative Bank. The Bank had gained Strong foundation in terms of its membership, resources, assets and profits. the Bank's gross income crossed the Rs.3.00 crore mark for the first time. Became Scheduled Bank. Bank launched the Branding Initiative. Bank's website: www.saraswatbank.com launched. Decision to set up "Development Reserve Fund" to undertake special schemes. 2010 All Branches fully computerized.

Growth and Strength:

MAJOR ACHIEVEMENTS DURING FY 2009-10: As you are aware, this year has proved to be a daunting year for your Bank. However, inspite of the challenges posed, your Bank marched forward in
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pursuance of our goal under Dr. Adarkar Mission-II, of achieving a business goal of ` 25,000 crore by March 31, 2011. The progress is as follows: (A) Total business of the Bank (i.e. deposits plus advances) grew to ` 23,517.08 crore as on 31st March, 2010 from ` 21,029.26 crore as on 31st March, 2009 i.e. a growth of ` 2,487.82 crore in absolute terms and of 11.83 per cent, on a y-o-y basis. (B) The deposits grew from ` 12,918.85 crore as on 31st March, 2009 to ` 14,266.73 crore as on 31st March, 2010 i.e. a rise of 10.43 per cent, while advances increased from ` 8,110.41 crore as on 31st March, 2009 to ` 9,250.35 crore as on 31st March, 2010 i.e. a rise of 14.06 per cent. (C) Within the overall deposits, your Bank has successfully increased the low-cost deposit base. The CASA deposits increased by 31.98 per cent on a y-o-y basis i.e. a rise of ` 1,029.32 crore in absolute terms. The ratio of CASA deposits to total deposits thus increased from 24.91 per cent as on 31st March, 2009 to 29.77 per cent as on 31st March, 2010. (D) On the backdrop of the scenario depicted hereinabove, the profit of the Bank (before tax and exceptional items) has decelerated from ` 315.61 crore in FY 2008-09 to ` 179.16 crore in FY 2009-10. The net profit after tax also slid lower at ` 119.67 crore in FY 2009-10 vis--vis ` 210.79 crore for the preceding financial year.

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(E) The foreign exchange turnover of your Bank remained above ` 50,000 crore for second successive year in spite of global financial turmoil, which had affected countrys exports. (F) The number of branch licences of your bank reached the magical figure of 200. Accepting that these were tough times, no new mergers have been carried out during financial year 2009-10. The 200th branch of your Bank was opened at Dindoshi , Goregoan (E), Mumbai, on 16th March, 2010 on the auspicious occasion of Gudhi Padva at the hands of Smt. Mrinal Gore, the well-known socialist leader.10 Annual Report 2009-10 (G) A total of twenty-eight new branches were opened during the year. Of these, four new branches were opened at Mangalore on a single day and two branches were opened at Bengaluru on a single day, strengthening Banks base in the Southern region. (H) RBI allowed your Bank to raise Long Term Subordinated Deposits (LTSD) of ` 300 crore to strengthen the capital adequacy. Your Bank accordingly completed issuance of ` 300 crore LTSD by March, 2010. In pursuance of the instructions from RBI, LTSD issue carried stiff conditions. LTSD investments are not protected by deposit insurance, no loans can be availed against such deposits and they cannot be withdrawn before their long maturity. And yet depositors entrusted their funds of the order of ` 300 crore to your Bank, to support the Banks TierII capital, which demonstrates the deep and abiding trust the members of public have in your Bank and in the brand Saraswat Bank.

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(I) Your Banks capital adequacy ratio has always been well above the RBI stipulation of 9 per cent. With the issuance of LTSD this year and mainly placing market value on the capital asset of new Corporate Center The Saraswat Bank Bhavan at Prabhadevi, Mumbai, your Bank has further strengthened its capital base and reserves. The Capital Adequacy Ratio (CRAR), which stood at 10.92 per cent as on 31st March, 2009 has moved up to 14.63 per cent as on 31st March, 2010 which in effect has enabled us to emerge stronger from the recession. SARASWAT CO-OPERATIVE BANK

FINANCIAL POSITION (LAST 2YEARS)

Particulars Total Income Total Expenditure Gross Profit Less: Provisions Net Profit Before Tax and Exceptional Items Less: Income Tax Net Profit after Tax and before Exceptional items Less: Exceptional Items Net Profit AT THE YEAR END Own Funds Share Capital Reserves and Surplus Deposits Current Savings Term Advances Secured Unsecured Priority Sector

FOR THE YEAR ENDED 31-Mar-09 31-Mar-10 % Change 1,499.92 1,458.20 -2.78% 1,174.56 1,242.36 5.77% 325.36 215.84 -33.66% 9.75 36.68 276.21% 315.61 179.16 -43.23% 74.32 241.29 30.50 210.79 1,174.21 77.50 1,096.71 12,918.85 916.22 2,302.13 9,700.50 8,110.41 7,995.04 115.37 4,940.81 40.00 139.16 19.49 119.67 1,270.37 86.23 1,184.14 14,266.73 1,244.30 3,003.37 10,019.06 9,250.35 9,151.61 98.74 5,300.48 -46.18% -42.33% -36.10% -43.23% 8.19% 11.26% 7.97% 10.43% 35.81% 30.46% 3.28% 14.06% 14.47% -14.41% 7.28%

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% to Advances 60.92% Small Scale Industries 2,454.11 Small Businessmen and Traders 556.78 Other Priority Sectors 1,929.92 Working Capital 15,622.82 Investments 4,791.51 Borrowings and Refinance 664.00 Net NPAs (%) 0.00 Capital Adequacy (%) 10.92 Number of Members Regular * 1,29,741 Nominal 4,67,644 Number of Branch Licences 175 Number of Employees 2,904 * Shareholders holding fifty shares and above

57.30% 2,946.54 689.47 1,664.47 17,071.06 5,321.39 562.00 0.00 14.63 1,34,417 4,94,292 200 2,911

20.07% 23.83% -13.75% 9.27% 11.06% -15.36% 0.00

The Deposits have grown by Rs. 14266.73 crores at the previous year end and registered growth of 10.43%. Advanced have growth by 14.06% and gone up by Rs. 9250.35 crores. As a result bank has achieved a CD ratio 58.47 %. Paid Up Capital of the bank increased form Rs. 40.46 crores to Rs. 45.77 crores, registering growth of 13 % over the previous year. The reserves and other funds have increased from Rs. 1096.71 crores to Rs. 1184.14 crores in the previous year. The Working Capital have grown by Rs. 17071.06 crores at the previous year end and registered a growth of 9.27%. The Net Profit has decreased from Rs. 210.79 to Rs. 119.67 crores.

Capital to Risk Asset Ratio:

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NPAs: Movement of NPAs: During the year under Report, which was characterized by acute recession in the world economy, there was an addition of ` 107.84 crore to the Gross NPAs, as against the last year additions amounting to ` 110.95 crore. The NPA Management Dept of your Bank has been able to recover/reduce the Gross NPAs by ` 110.72 crore to bring down the Gross NPA level to 3.92 per cent from the last years level of 4.50 per cent, which constitutes an improvement. The recoveries and provisions however helped the Bank to maintain the Net NPA level to zero percent for the sixth consecutive year.
Movement of NPAs and Provision for the year 2009-2010. (` in crore)
GROSS NPAs As on 31st March, 2009 Addition during the year. Reduction during the year. As on 31st March, 2010 PROVISIONS: As on 31st March, 2009 Addition during the year. Reduction during the year. As on 31st March, 2010 NET NPAs As on 31st March, 2009 As on 31st March, 2010 0.00 0.00 370.24 35.57 41.58 364.23 365.26 107.84 110.72 362.38

It is worth mentioning that after the remnant Gross NPAs of the order of 144.26 crore of the seven merged banks (now Gandhakosh) are excluded from the total Gross NPAs of ` 362.38 crore of your Bank, ` 218.12 crore would be Gross NPAs of your legacy Saraswat Bank, which stand at 2.36 per cent of the total advances of your Bank. They include some
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of the stubborn NPAs prior to April 2001. We are endeavouring to bring your Banks Gross NPAs down to around 1 per cent by FY 2013-14. During the year under Report, your Bank could recover ` 3.70 crore from the written-off accounts. A special strategy has been worked out under a project christened as Phoenix during the year 2010-11 to make aggressive recoveries from written off accounts.

Risk in Banking business:Banking business lines are many and varied. Commercial banking, corporate finance, retail banking, trading and investment banking and various financial services form the main business lines of Banks. Within
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each lines of business these are sub-groups and each sub-group contains variety of financial activities. Banks clients may very from retail consumers to mid-market corporate to large corporate to financial institutions. Banking may differ appreciably for each segment even for the similar services for example; lending activities may extend from retail banking to specialized finance. Again specialized finance may extend from specific fields with standard practice, such as exports and commodities financing to structure financing implying specific structuring and customization for making large and risky transactions feasible, such as project financing or corporate acquisitions. Banks also assemble financial products and derivatives and deliver them as a package to its clients as a part of specialized financing commensurate with the needs of clients. Product lines also vary across client segments. Standard lending products include short-term and long term loans with specified repayments, demand loans and various othis lines of credit such as bill purchase and bills discounting facilities, as auto loans, house building loans etc. banks also offer guarantees, letters of credit etc. which are in the nature of off- balance heet transactions. These are various deposits products that vary for different segments and different needs. Banks also offer market products such as fixed income security shares, foreign exchange trading and derivates like standard swaps and options. The key driver in managing all the business lines are enhancing risk adjusted expected returns. This is the common factor for all business lines. But management practices vary across business lines, activities differ, and so does the risk factors associated with them.
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Types of banking Risks:These are major 5 types of banking risk. They are 1) Liquidity risk. 2) Interest rate risk.
3) Market risks

4) Credit risk ( Default risk ) 5) Operational risk. Each of above risk is the risk which every bank faces and each risk is having sub-risk. Each of above risk is unique & has huge depth & my project is concerned about only credit risk. Thus, my focus hereafter will be exclusively on credit risk

1. THE ORIGINS AND EVOLUTION OF CREDIT RISK

MANAGEMENT

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Credit is much older than writing. Hammurabis code, which codified legal thinking since 4000 years ago in Mesopotamia, didnt outline the basic rules of borrowing and didnt address concept such as interest, collateral and default. These concepts appear to have been too well known to have required explanation. However, the code did emphasize that failure to pay a debt is a crime that should be treated identically to theft and fraud. The code also set some limits to penalties. For example, a defaulter could be seized by his creditors and sold into slavery, but his wife and children could only be sold for a three-year term. Similarly, the Bible records enslavement for debt without disapproval; for example, the story of Elisha and the widows oil concern the threatened enslavement of two children because their faiths died without paying his debts. But the Bible also goes further than Hammurabi in limiting the collection rights of creditors purely a matter of mercy. The modern bankruptcy concepts of protection from creditors and extinguishment of debt are entirely absent from both Hammurabi and the bible. Historically, credit default was a crime. At various places and times, it was punishable by death, mutilation, torture, imprisonment or enslavementpunishment that could be visited upon debtors and their dependents.

Unpaid debts could sometimes be transferred to relatives or political entities. But that does not mean that the law was creditors friendly. The Bible prohibits charging interest [usury], which removes any incentives to

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lend. It also specified general releases from debt. Aristocrats, especially sovereigns, would frequently repudiate their and sometimes debts in general. Considering the potential consequences, one has to wonder why anyone borrowed or lent money in ancient times. Borrowers risked horrendous consequences from default, while lenders faced legal obstacles to collecting money owed-and to making a profit. Both sides also risked strong social disapproval if money was not repaid. Moreover, moralists and lawmakers favored equity financing over credit. Under an equity financing arrangement, both successful and unsuccessful outcomes could be resolved without expensive legal proceedings. Documentation and oversight was also much simpler. Even the equity financing language was, and remains, biased with words like equity [which means fair] as opposed to negative words like debts and liability. To answer the question about why people engaged in credit agreements, we must go even far this back in history and replace written sources with guesswork. Credit risk arose before financing of business ventures. This is credit risk, for example, when a farmer says to a stranger, help me harvest my crop, and Ill give you two baskets of grain.

The Bible is hostile even to this form of credit, saying you should not let the sun go down on an unpaid wage. Surprisingly, this belief even has

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supported today, as some fundamentalists insist on paying all employees in cash every day before sundown. The trouble with this approach, of course, is that it requires the farmer to have cash or goods to spare before the harvest is in. More generally, in any economy; you need money supply, at least equal to the total value of all goods and services in the process of production.

Back To Basic:
The work on exposure at default and loss given default has highlighted deficiencies in understanding of probability of default. Early research defined default as Mr.ing a payment or filing for bankruptcy. These events are easy to determine and thus convenient for early progress in estimating probabilities. As the market place evolved, probability was defined over fixed time intervals. Lenders sometime restructure rather than default. Restructuring form a continuum from those that involve no loss of economic value to creditors to those that make creditors claim almost worthless. These clearly contribute to creditors losses and thus should be included in loss given default. If we do this, its easier to measure the loss given default but harder to define default and hence harder to estimates probability of default.

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To estimates exposure at default, we need to know the future time series of probability of default, not just the cumulative probability over specific intervals. Even the probability over every interval is not enough; we need to know the dynamics of the process. This has been quite a bit of work done on this problem for the purpose of pricing credit derivatives, but unfortunately it has proven hisd to reconcile with risk management default probability models. This has been a dilemma in the past and will continue to be a major challenge in the future, especially as active credit risk management strategies gain popularity. Credit risk has been around for millennia. Good qualitative credit ratings have been around for century. Serious quantitative credit risk estimates have a 40-years history. Quantitative progress was slowed by confusion within the profession, but regulators, rating agencies, practitioners and academics have been working togethis for at least last five years. Consequently, for the first time in history, it seems likely that the problem of credit risk can be solved.

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Types Of Credit Risk

Credit risk arises from potential changes in the credit quality of a borrower. It has two components: default risk and credit spread risk or downgrade risk. 1. DEFAULT RISK:Default risk is driven by the potential failure of a borrower to make promised payment, either party or wholly. In the event of default, a fraction of the obligation will normally be paid. This is known as the recovery rate. 2. CREDIT SPREAD RISK OR DOWNGRADE RISK:If a borrower does not default, this is still risk due to worsening in credit quality. This results in the possible widening of the credit-spreads. This is credit spread risk. These may arise from a rating change {i.e., an upgrade or a downgrade}. It will usually be firm specific. Loans are not usually marketed to market. Consequently, the only important factor is whether or not the loan is in default today [since this is the only credit event that can lead to an immediate loss]. Capital market portfolios are marketed to market. They have in addition credit spread volatility [continuous changes in the credit-spread]. This is more likely to be driven by the markets appetite for certain levels of risk. For example, the spreads on high-grade bonds may widen or tighten, although this need not necessarily be taken as an indication that they are more or less likely to default.

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Default risk and downgrade risk are transaction level risks. Risks associated with credit portfolio as a whole is termed portfolio risk. Portfolio risk has two components Systemic or intrinsic risk. Concentration risk. 1. Systemic risk:As we have seen, portfolio risk is reduced due to diversification. If a portfolio is fully diversified, i.e. diversified across geographies, industries, borrowers markets, etc., equitably, then the portfolio risk is reduced to a minimum level. This minimum level corresponds to the risks in the economy in which it is operating. This is systemic or intrinsic risk. 2. Concentration risk:If the portfolio is not diversified that is to say that it has highis weight in respect of a borrower or geography or industry etc., the portfolio gets concentration risk. The following chart outlines financial risk in lending:CREDIT RISK

PORTFOLIO RISK

TRANSACTION RISK

CONCENTRATION RISK

SYSTEMIC RISK

DEFAULT RISK

DOWNGRADE RISK

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A variant of credit risk is counterparty risk. The counterparty risk arises from non-performance of the trading partners. The non-performance may arise from counterpartys refusal/inability to perform. The counterparty risk is generally viewed as a transient financial risk associated with trading rathis than standard credit risk.

.The

components of credit risk are:

Credit growth in the organization and composition of the

credit folio in terms of sectors, centers and size of borrowing activities so as to assess the extent of credit concentration. Credit quality in terms of standard, sub-standard, doubtful and loss-making assets. Extent of the provisions made towards poor quality credits. Volume of off-balance-heet exposures having a bearing on the credit portfolio. Thus credit involves not only funds outgo by way of loans and advances and investments, but also contingent liabilities. Thisefore, credit risk should cover the entire gamut of an organizations operations whose ultimate loss factor is quantifiable in terms of money. According to Reserve Bank of India, the following are the forms of credit risk: Non-repayment of the principal of the loan and/or the interest on it.

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 Contingent liabilities like letters of credit/guarantees issued by the bank on behalf of the client and upon crystallization amount not deposited by the customer. In the case of treasury operations, default by the counter-parties in meeting the obligations. In the case of securities trading, settlement not taking place when it is due. In the case of cross-border obligations, any default arising from the flow of foreign exchange and/or due to restrictions imposed on remittances out of the country.

OBJECTIVES OF CREDIT RISK MANAGAMENT:Credit risk management can have different objectives at two levels namely transaction level & Portfolio level. At the transaction level, the objectives of credit risk management ideally should be: Setting an appropriate credit risk environment. Framing a sound credit approval process.
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 Maintaining an appropriate credit administration, measurement and monitoring process. Employing sophisticated tools/techniques to enable continuous risk evaluation on a scientific basis. Ensuring adequate pricing formula to optimize risk return relationship At the Portfolio level, the objectives of credit risk management should be: Development and Monitoring of methodologies and norms to evaluate and mitigate risks arising from concentrating by industry, group, product, etc.
Ensuring adherence to regulatory guidelines.

Driving asset growth strategy. If we closely analyze the above, we can observe that the transaction level pursues value creation and portfolio level pursues value preservation.

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CREDIT RISK MANAGEMENT FRAMEWORK

Banks need to manage credit risk inherent in the entire portfolio as well as risk in individual credits or transactions. The effective management of credit risk is a critical component of a comprehensive approach of risk management and essential to long term of any banking organization. Banks for this purpose incorporates proper framework for credit risk management (CRM), which includes,

Policy framework

Credit risk rating framework

Credit risk limits

Credit risk modeling

RAROC pricing

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 Risk mitigates

Loan review mechanism/credit audit

POLICY FRAMEWORK:Given the fast changing, dynamic world scenario experiencing the pressure of globalization, liberalization, consolidation and disintermediation, it is important that banks must have robust credit risk management policies (CRMPs) and procedures, which are sensitive and responsive to these changes. In any bank, the corporate goals and credit culture are closely linked and an effective CRM framework requires the following distinct building blocks: (1) Strategy and policy, (2) Organization, and (3) operations/systems.

1. Strategy and policy:

Strategy and policies includes defining credit limits, the development of credit guidelines and the identification and assessment of credit risk. Banks should develop its own credit risk strategy defining the objectives for
34

the credit granting function. This strategy should spell out clearly the organisations credit limits and acceptable level of risk-reward trade-off at both macro and micro levels. The credit risk strategy should provide continuity in approach, and take into account the cyclical aspects of any economy and the resulting shifts in the composition and quality of the overall credit portfolio. This strategy should be viable in the long run and through various credit cycles. Credit policies and procedures should necessarily have the following elements: Banks should have written policies that define target markets, risk acceptance criteria, credit approval authority, credit origination and maintenance procedures and guidelines for portfolio management and remedial management. Sound procedures to ensure that all risks associated with requested credit facilities are promptly and fully evaluated by the relevant lending and credit officers. Banks should establish proactive CRM practices like annual/half yearly industry studies and individual obligor reviews, periodic credit calls that are documented, periodic plant visits, and at least quarterly management reviews of troubled exposures/weak credits. Procedures and systems, which allow for monitoring financial performance of customers and for controlling outstanding within limits. Systems to manage problem loans to ensure appropriate restructuring
35

schemes. A conservative policy for the provisioning of non-performing advances should be followed. Banks should have a consistent approach towards early problem recognition, the classification of problem exposures, and remedial action and maintain a diversified portfolio of risk assets in line with the capital desired to support such a po
2.

Organizational structure:
Banks should have an independent group responsible for the CRM.

The responsibilities of this team are the formulation of credit policies, procedures and controls extending to all of its credit risk arising from corporate banking, treasury, credit cards, personal banking, trade finance, securities processing, payments and settlement systems.

3. Operations/systems:
Banks should have in place an appropriate credit administration, measurement and monitoring process. The credit process typically involves the following phases: Relationship management phase, that is, business development, Transaction management phase to cover risk assessment, pricing, structuring of the facilities, obtaining internal approvals, documentation, loan administration and routine monitoring and measurement, and Portfolio
36

management phase to entail the monitoring of portfolio at a macro level and the management of problem loans. The banks should have systems in place for reporting and evaluating the quality of the credit decisions taken by the various officers. Banks must have a MIS to enable them to manage and measure the credit risk inhisent in all on and off-balance heet activities. It should provide adequate information on the composition of the credit portfolio, including identification of any concentration of risk.

CREDIT RISK RATING FRAMEWORK:A credit risk-rating framework deploys a number/alphabet/symbol as a primary summary indicator of risks associated with a credit exposure. These rating frameworks are logic-based, utilize responses made on a specified scale and promote the accuracy and consistency of the judgment exercised by the banks. For loans to individuals or small businesses, credit quality is typically assessed through a process of credit scoring. Prior to extending credit, a bank or this lender will obtain information about the party requesting a loan. In the case of a bank issuing credit cards, this might include the party's annual income, existing debts, whether they rent or own a home, etc. A standard formula is applied to the information to produce a number, which is called a credit score. Based upon the credit score, the lending institution

37

decides whethis or not to extend credit. The process is formulaic and highly standardized. Many forms of credit riskespecially those associated with larger institutional counterpartiesare complicated, unique or are of such a nature that that it is worth assessing them in a less formulaic manner. The term credit analysis is used to describe any process for assessing the credit quality of counterparty. While the term can encompass credit scoring, it is more commonly used to refer to processes that entail human judgement. One or more people, called credit analysts, review information about the counterparty. This might include its balance heet, income statement, recent trends in its industry, the current economic environment, etc. They may also assess the exact nature of an obligation. For example, secured debt generally has high is credit quality than does subordinated debt of the same issuer. Based upon their analysis, they assign the counterparty (or the specific obligation) a credit rating, which can be used for making credit decisions. Many banks, investment managers and insurance companies hire their own credit analysts who prepare credit ratings for internal use. These firms including Standard & Poor's, Moody's and Fitchare in the business of developing credit ratings for use by investors or third parties. Institutions that have publicly traded debt hire one or more of them to prepare credit ratings for their debt. In the United States, the National Association of Insurance Com Mr.ioners publihes credit ratings that are used for calculating capital charges for bond portfolios held by insurance companies.
38

Exhibit 1 indicates the system of credit ratings employed by Standard & Poor's. Other systems are similar. Standard & Poor's Credit Ratings Exhibit 1

AAA --- Best credit qualityextremely reliable with regard to financial obligations. AA --- Very good credit qualityVery reliable. A --- More susceptible to economic conditionsstill good credit quality. BBB --- Lowest rating in investment grade. BB --- Caution is necessarybest sub-investment credit quality. B --- Vulnerable to changes in economic conditions currently showing the ability to meet its financial obligations. CCC --- Currently vulnerable to nonpaymentDependent on favorable economic Conditions. CC --- Highly vulnerable to a payment default.

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C --- Close to or already bankruptpayment on the obligation currently continued. D --- Payment default on some financial obligation has actually occurred. This is the system of credit ratings Standard & Poor's applies to bonds. Other credit rating systems are similar. Credit Rating Model:The customer rating model is being developed by me for solving the problem of nonpayment of loan. This model helps to determine the repayment capacity of the customer at the initial level. This model is applicable only for personal and housing loan. The system of customer rating would involve allocating marks for various parameters of the prospective customers profile and his repayment capacity such as his personal details, financial status, repayment capacity and past relation with the bank. A format of the rating heet is being introduced hise. It may be observed that thise are 15 parameters for which a maximum of 100 marks are allotted. The loan request of applicants securing marks of 60 and above {i.e. credit rating of A and above} may be considered by the branch manager. The applicant getting marks between 50 to 60{credit rating B} will not be considered by branch manager but it will be submitted to credit committee. In considering such request, the sanctioning authority may take into consideration othis relevant facts into consideration and also stipulate a highis rate of interest, if warranted; commensurate with the high

40

is risk perception. An applicant scoring less than 50 marks will not be eligible for being considered for loan.

Customer Rating (For personal and housing loans) Name: Address: Phone No. 01 Age(Yea rs) Up to 25 3 02 : Residence Office : Mobile : Score 25 to 35 7 35 to 45 10 45 to 55 7 Over 55 3 Over 65 Not Eligible Max. 10 All

Education Up to Metric

Graduate

03

1 3 Occupation 1. ( Business or Profession ) Practicing CA/ Other professional Other Doctor Architect Business Engineer 10 7 5 3 II ( Service ) Govt. Semi Govt. Corporate Small Others Enterprises 10 10 7 5 3

Post Graduate or Professional 5

10 41

04

05 06 07 08

09

Period of Service / Business Upto 2 2 to 5 5 to 10 10 to 20 20 to 30 Above Years years years years yeas 30 years 0 3 7 10 7 3 10 No of Dependents Upto 2 2 to 4 Above 4 5 3 1 5 Yearly Income Upto 50000 50001 to 1 lakh >1 lakh to 2 lakh 2 lakh 4 6 8 10 10 Income of Spouse < 30000 30000 to 1 lakh > 1 lakh to 2 lakh > 2 lakh 2 3 4 5 5 Stay in the present house Family owned over Family owned over 3 years or Othis 5 rented over 5 years Years 5 3 0 Ownership of following items Colo 2 Refrig Credit Washing Tel PC at Car None ur wheeler eration Card Machine Mobile home TV Non Any 1 Any 2 Any 3 Any 4 Any 5 Any 6 Any 7 All 8 e 0 1 2 3 4 5 6 7 10 Account well operated with our Bank for 1-3 Years Over 3 to 5 years Over 5 years 3 4 5 Whethis income / salary credited to account Directly credited Cheque regularly Not Satisfactory to account received credited business 5 3 0 3 Average balance in Savings / Current for last for one year Below Rs. 1000 Rs. 1000 to Rs. Rs.5001 to Over Rs. 5000 Rs. 15000 15000 0 2 3 5 Othis Deposits , if any, with our Bank Below Rs. Rs. 5-15000 Rs. 30-50000 Over Rs. 5000 50000 0 2 3 5 Whethis any loan taken earlier Whethis any loan taken earlier? If Yes

10

10 11

12

13

14

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Purpose : Amount : From which branch Repayment of earlier Loan : No Loan Timely taken Repayment

15

Paid under Not compromise Repaid Settlement 3 5 3 Not Eligible 5 Present monthly repayment obligations, if any (as % of salary or monthly income Over 50% 30% - 50% < 30% 0 3 5 5 Total 100 Score (%) Rating 81% and above A+ + 71-80% A+ 61-70% A 51-60% B 50% or below C Branch Manager

Fully repaid but with some delay

CREDIT RISK LIMITS:-

For managing credit risk, a bank generally sets an exposure credit limit for each counter party to which it has credit exposure. This is standard procedure in many contexts. It could be a corporate loan, individual loan or a derivative dealer transacting with counterparties. All entail credit risk. All are contexts wise credit exposure limits are used. A bank may also use aggregate credit exposure limits. A bank might set credit exposure limits by industry. It might also set a total exposure credit limit for all its corporate lending activities. Exposures are calculated with the help of credit risk models.

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Depending on the assessment of the borrower (commercial as well as retail) a credit exposure limit is decided for the customer, however, within the framework of a total credit limit for the individual divisions and for the company as a whole. Also within the limit as per RBI, i.e. not more than 20% of capital to individual borrower and not more than 40% of capital to a group borrower.

Threshold limit is set depending on the: Credit rating of the borrower Past financial records Willingness and ability to repay Borrowers future cash flow projections.

CREDIT RISK MODELLING:-

A credit risk model seeks to determine, directly or indirectly, the answer to the following question: Given our past experience and our assumptions about the future, what is the present value of a given loan or fixed income security? A credit risk model would also seek to determine the (quantifiable) risk that the promised cash flows will not be forthcoming. The techniques for measuring credit risk that have evolved over the last twenty years are prompted by these questions and dynamic changes in the loan market.
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The increasing importance of credit risk modeling should be seen as the consequence of the following three factors:

Banks are becoming increasingly quantitative in their treatment of credit risk. New markets are emerging in credit derivatives and the marketability of existing loans is increasing through securitization/ loan sales market. Regulators are concerned to improve the current system of bank capital requirements especially as it relates to credit risk. Credit Risk Models have assumed importance because they provide

the decision maker with insight or knowledge that would not otherwise be readily available or that could be marshaled at prohibitive cost. In a marketplace wise margins are fast disappearing and the pressure to lower pricing is unrelenting, models give their users a competitive edge. The credit risk models are intended to aid banks in quantifying, aggregating and managing risk across geographical and product lines. The outputs of these models also play increasingly important roles in banks risk management and performance measurement processes, customer profitability analysis, risk-based pricing, active portfolio management and capital structure decisions. Credit risk modeling may result in better internal risk management and may have the potential to be used in the supervisory oversight of banking organizations. In the measurement of credit risk, models may be classified along three different dimensions: the techniques employed the domain of applications in the credit process and the products to which they are applied.
45

Techniques: The following are the more commonly used techniques:

a. Econometric Techniques such as linear and multiple discriminate

analyses, multiple regression, logic analysis and probability of default, etc.

b. Neural networks are computer-based systems that use the same data

employed in the econometric techniques but arrive at the decision model using alternative implementations of a trial and error method.
c. Optimization models are mathematical programming techniques that

discover the optimum weights for borrower and loan attributes that minimize lender error and maximise profits.
d. Rule-based or expert systems are characterised by a set of decision

rules, a knowledge base consisting of data such as industry financial ratios, and a structured inquiry process to be used by the analyst in obtaining the data on a particular borrower.
e. Hybrid Systems In these systems simulation are driven in part by a

direct causal relationship, the parameters of which are determined through estimation techniques.

Domain of application: These models are used in a variety of domains:

a. Credit approval: Models are used on a standalone basis or in

conjunction with a judgmental override system for approving credit in the consumer lending business. The use of such models has expanded to include small business lending. They are generally not used in
46

approving large corporate loans, but they may be one of the inputs to a decision.
b. Credit rating determination: Quantitative models are used in

deriving shadow bond rating for unrated securities and commercial loans. These ratings in turn influence portfolio limits and othis lending limits used by the institution. In some instances, the credit rating predicted by the model is used within an institution to challenge the rating assigned by the traditional credit analysis process.
c. Credit risk models may be used to suggest the risk premier that

should be charged in view of the probability of loss and the size of the loss given default. Using a mark-to-market model, an institution may evaluate the costs and benefits of holding a financial asset. Unexpected losses implied by a credit model may be used to set the capital charge in pricing.
d. Early warning: Credit models are used to flag potential problems in

the portfolio to facilitate early corrective action.

e. Common credit language: Credit models may be used to select

assets from a pool to construct a portfolio acceptable to investors at the time of asset securitisation or to achieve the minimum credit quality needed to obtain the desired credit rating. Underwriters may use such models for due diligence on the portfolio (such as a collateralized pool of commercial loans).
f. Collection strategies: Credit models may be used in deciding on the

best collection or workout strategy to pursue. If, for example, a credit model indicates that a borrower is experiencing short-term liquidity problems rather than a decline in credit fundamentals, then an appropriate workout may be devised.
47

g. Credit Risk Models: Approaches The literature on quantitative risk modeling has two different approaches to credit risk measurement. The first approach is the development of statistical models through analysis of historical data. This approach was frequently used in the last two decades. The second type of modeling approach tries to capture distribution of the firm's asset-value over a period of time. The statistical approach tries to rate the firms on a discrete or continuous scale. The linear model introduced by Altman (1967), also known as the Z-score Model, separates defaulting firms from non-defaulting ones on the basis of certain financial ratios. Altman, Hartzell, and Peck (1995, 1996) have modified the original Z-score model to develop a model specific to emerging markets. This model is known as the Emerging Market Scoring (EMS) model. The second type of modeling approach tries to capture distribution of the firm's asset-value over a period of time. This model is based on the expected default frequency (EDF) model. It calculates the asset value of a firm from the market value of its equity using an option pricing based approach that recognizes equity as a call option on the underlying asset of the firm. It tries to estimate the asset value path of the firm over a time horizon. The default risk is the probability of the estimated asset value falling below a pre-specified default point. This model is based conceptually on Merton's (1974) contingent claim framework and has been working very well for estimating default risk in a liquid market.

48

Closely related to credit risk models are portfolio risk models. In the last three years, important advances have been made in modeling credit risk in lending portfolios. The new models are designed to quantify credit risk on a portfolio basis, and thus are applied at the time of diversification as well as portfolio based pricing. These models estimate the loss distribution associated with the portfolio and identify the risky components by assessing the risk contribution of each member in the portfolio. Banks may adopt any model depending on their size, complexity, risk bearing capacity and risk appetite, etc. However, the credit risk models followed by banks should, at the least, achieve the following:

Result in differentiating the degree of credit risk in different credit exposures of a bank. The system could provide for transaction-based or borrower-based rating or both. It is recommended that all exposures are to be rated. Restricting risk measurement to only large sized exposures may fail to capture the portfolio risk in entirety for variety of reasons. For instance, a large sized exposure for a short time may be less risky than a small sized exposure for a long time Identify concentration in the portfolios Identify problem credits before they become NPAs Identify adequacy/ inadequacy of loan provisions Help in pricing of credit Recognize variations in macro-economic factors and a possible impact under alternative scenarios Determine the impact on profitability of transactions and relationship.

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RISK ADJUSTED RETURN ON CAPITAL (RAROC) :As it became clearer that banks needed to add an appropriate capital charge in the pricing process, the concept of risk adjusting the return or risk adjusting capital was born. RAROC is based on a market-to market concept. As defined by Bankers Trust, RAROC allocates a capital charge to a transaction or a line of business at an amount equal to the maximum expected loss (at a 99 percent confidence level) over one year on an after-tax basis. As may be expected, the highs volatility of the returns, the more the capital allocated. The highest capital allocation means that the transaction has to generate cash flows larger enough to offset the volatility of returns, which results from the credit risk, material risk, and others risks taken. The RAROC process estimates the asset value that may prevail in the worst case scenario and then equates the capital cushion to be provided for the potential loss. These are four basic steps in this process:
Analyze the activity or product.

Determine the basic risk categories that it contains, for example, interest rate (country, directional, basis, yield curve, optionality), foreign exchange, equity, commodity, and credit. Operating risks.

50

 Quantify the risk in each category by a market proxy. Using the historical price movements of the market proxy over the past three years, compute a market risk factor, given by the following equation: RAROC risk factor = 2.33 * weekly volatility * square root of 52 * (I tax rate) In this equation, the multiplier 2.33 gives the volatility (expressed as per cent) at the 99 percent confidence level. The term 52 converts the weekly price movement into an amount movement. The term (I tax rate) converts the calculated value to an after-tax basis. Compute the rupee amount of capital required for each category by multiplying the risk factor by the size of the position. Establishing the maximum expected loss in each product line and linking the capital to this loss makes it possible to compare products of different risk levels by stating the risk side of the risk-reward equation in a consistent manner. The risk-toreward ratio becomes comparable.

The RAROC is an improvement over the traditional approach in that it allows one to compare two businesses with different risk (volatility of returns) profiles. Using a hurdle rate, a lender can also use the RAROC principle to set the target pricing on a relationship or a transaction. Although not all assets have market price distribution, RAROC is a first step towards
51

examining an institutions entire balance heet on a mark-to-market basis if only to understand the risk-return tradeoffs that have been made.

RISK MITIGANTS:Credit risk mitigation means reduction of credit risk in an exposure by a safety net of tangible and realizable securities including third-party approved guarantees/insurance. Banks use a number of techniques to mitigate the credit risks to which they are exposed. Exposures may be collaterised by first priority claims, in whole or in part with cash or securities, a loan exposure may be guaranteed by a third-party, or a bank may buy a credit derivative to offset various forms of credit risk. Additionally banks may also net the loans owned to them against deposits from the same counter-party. The various credit risk mitigants laid down by Basel Committee are as follows: 1. Collateral (tangible, marketable) securities 2. Guarantees 3. Credit derivatives 4. On-balance-sheet netting The extent to which a particular credit risk mitigant helps depends on the quantum of exposure, or the strength of the mitigant.

52

These are certain conditions to be met for the use of credit risk mitigants, which are as follows: All documentation used in collateralized transactions and for documenting on-balance-heet netting, guarantees, and credit derivative must be binding on all parties and must be legally enforceable in all relevant jurisdictions. Banks must have properly reviewed all the documents and should have appropriate legal opinions to verify such, and ensure its enforceability.

LOAN REVIEW MECHANISM / CREDIT AUDIT :Credit audit examines the compliance with extant sanction and post-sanction processes and procedures laid down by the bank from time to time. The objectives of credit audit are: Improvement in the quality of credit portfolio, Review of sanction process and compliance status of large loans, Feedback on regulatory compliance, Independent review of credit risk assessment, Pick-up of early warning signals and suggest remedial measures, and

53

 Recommend corrective actions to improve credit quality, credit administration, and credit skills of staff. CREDIT RISK MITIGANTS AS PER BASEL 2 ACCORD Recommendations of BASEL II The Basel II principles are intended to achieve an ongoing improvement of risk management procedures in the loan business. The regulatory treatment of credit risk mitigation has widely been acknowledged as needing substantial updating. Basel establishes a framework for recognizing the various mitigation techniques of collateral, netting, guarantees and credit derivatives. As per BASEL committee any valid hedge should attract regulatory capital relief. However, hedges are rarely perfect: this will generally be a residual risk element, including an element of operational risk, which will attract a regulatory capital charge. The various credit risk mitigants laid down by Basel Committee are as follows: 1. Collateral (tangible, marketable) securities 2. Guarantees 3. Credit derivative 4. On-balance-Sheet netting.
54

1. Collateral:A collateralised transaction is one in which banks have a credit exposure or potential credit exposure in the form of loan of cash or securities, securities posted as collateral or the exposure under the over-the counter derivative contract, to a counter-party; and that credit exposure is hedged in whole or in part by collateral posted by the counter-party or by a third-party on behalf of the counter-party. The following requirements must be met: The collateral must be pledged for at least the life of exposure and it must be marked to market and revalued with a minimum frequency of six months. The banks must have clear and robust procedures for the timely liquidation of collateral. Whise the custodian holds the collateral; banks must take reasonable steps to ensure that the custodian segregates the collateral from its own assets. The various collateral instruments eligible for recognition are as follows: Cash on deposit with bank including certificates of deposit or comparable instruments issued by the lending bank, Gold,
55

 Debt securities issued by sovereigns and public-sector enterprises that are treated as sovereigns by the national supervisor,

And also debt securities listed on the recognized exchange, which are issued by banks.

Equities. Mutual funds. The amount of credit exposure of the bank to the counter-party will be reduced to the extent of market value of the collateral posted by the counter-party.

2. Guarantees:A guarantee given on behalf of counter-party must represent a direct claim on protection provider and must be explicitly referenced to specific exposures. In the case of default on part of counter-party, the guarantor shall be bound to pay the amount of credit exposure. In order for a guarantee to be recognized, following must be satisfied: On the qualifying default/non-payment of the counter-party, the bank may in a timely manner pursue the guarantor for the credit outstanding under the documentation governing the transaction. The guarantee is explicitly documented obligation assumed by the guarantor.

56

 The guarantor covers all types of payments the underlying obligor is expected to make under the documentation governing the transaction, for example, notional amount, margin payments, etc. Credit protection given by the following entities is recognized: Sovereign entities, public-sector enterprises, banks and securities firms, having risk weight lower than that of counter-party,

Othis entities like parent, subsidiary or affiliated companies, which have risk weight lower than that of counter-party.

3. Credit derivative
Credit derivative is an instrument designed to segregate market risk from credit risk and to allow the separate trading of credit risk. Credit derivatives allow a more efficient allocation and pricing of credit risk. Credit derivatives are privately negotiated bilateral contracts that allow users to manage their exposure to credit risk. For example, a bank concerned that one of its customers may not be able to repay a loan can protect itself against loss by transferring the credit risk to another party while keeping the loan on its books. This mechanism can be used for any debt instrument or a basket of instruments for which an objective default price can be determined. Credit derivatives are traded over-the-counter (OTC) in developed markets. OTC trades are contracts negotiated between counterparties that
57

take place outside the regulated exchanges. This permits maximum flexibility in structuring a contract that meets the needs of both parties.

Types of Credit Derivative:The product menu in the credit derivatives market is changing every day, but these are four major instruments that make up the bulk of the trading volume today: Total Return Swaps Credit Default Swap Credit Spread Options and Credit Linked Notes. Terminology varies among market participants, sometimes based on geography. For example, Credit Default Swaps are sometimes called Credit Swaps. Banks involved in swap derivatives can reduce risks by netting agreements. Closeout netting is now a standard provision in the legal documentation of the over-the-counter derivative contract.

58

Bilateral closeout netting agreements cover a set of N derivatives contracts between two parties. In case of default, counter-party cannot stop payments on contracts that have negative value while demanding payment on positively valued contracts. Net loss in case of default is the positive sum of the market value of all the contracts in the agreement: Net loss = max (Vi, 0) i = 1 to N In contrast without a netting agreement, the potential loss is the sum of all positive value contracts. On-balance heet netting will be fully recognized for the first time, subject to the following operational conditions: An enforceable legal agreement is in place; All assets and liabilities subject to the netting agreement can be precisely determined at any time; Exposures are monitored and controlled on a net basis; Roll-off risk is monitored and controlled; and Assets and liabilities are maturity matched and hedges meet the minimum 1-year residual maturity requirement.

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CREDIT RISK MITIGANTS USED BY DIFFERENT BANKS:-

For decades mitigation of credit risk has been mainly achieved through selecting and monitoring borrowers and through creating a welldiversified loan portfolio. More recently, new financial instruments and risk sharing markets have evolved, in particular, markets for credit derivatives virtually exploded during the 1990s. The Bank for International Settlements in its annual report said that in the early 1990s, the market for credit-risk transfer from banks on to the buyers of securities and loans involved a few billion dollars worth of loans; by 2002, that figure had grown to more than $2 trillion. The different mitigation techniques used by banks are as under: 1. Collateralization 2. Guarantees 3. Escrow account 4. Break trade laws 5. Insurance 6. Securitisation 7. Equator principle 8. Settlement through Clearing Corporation of India Limited (CCIL) 9. Netting

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1. COLLATERALISATION:-

Collateral is asset provided to secure an obligation. Traditionally, banks might require corporate borrowers to commit company assets as security for loans. Today, this practice is called secured lending or asset-based lending. Collateral can take many forms: cash deposits, property, equipment, receivables, oil reserves, marketable securities, bonds, national saving certificates, etc. Collateral levels may be fixed or vary over time to reflect the market value of the deal. A more recent development is collateralization arrangements used to secure repo securities lending and derivatives transactions. Under such arrangement, a party who owes an obligation to another party posts collateraltypically consisting of cash or securitiesto secure the obligation. In the event that the party defaults on the obligation, the secured party may seize the collateral. In this context, collateral is sometimes called margin. An arrangement can be unilateral with just one party posting collateral. With two-sided obligations, such as a swap or foreign exchange forward, bilateral collateralization may be used. In that situation, both parties may post collateral for the value of their total obligation to the others. Alternatively, the net obligation may be collateralizedat any point in time; the party who is the net obligator posts collateral for the value of the net obligation.

61

In a typical collateral arrangement, the secured obligation is periodically marked-to-market, and the collateral is adjusted to reflect changes in value. The securing party posts additional collateral when the market value has risen, or removes collateral when it has fallen. The Collateral agreement may specify: Acceptable collateral. Frequency of Margin calls. Valuation. Lien on Collateral. Closeout & Termination clauses. Types of Collateral Amount of Collateral & Margin requirement:Sr. No. 1. Nature of Collateral Sub Nature of Collateral Same Currency Different Currency Plant & Machinery Land & Building Vehicle With Banks National Saving Certificates Government Bonds --Exposure against collateral (%) 100% 90% to 95% 75% to 80% 70% to 80% 70% to 75% 80% to 85% 75% to 85% 80% 50% Margin requirement (%) NIL 10% to5% 25% to 20% 30% to 20% 30% to 25% 20% to 15% 25% to 15% 20% 50%

Cash Deposits

2.

Fixed Assets

3.

Fixed Deposits

4.

Marketable Securities

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2. GUARANTEES:Banks take guarantee on behalf of their customer as a credit risk mitigation technique. Guarantees of following entities are approved by the banks:
Guarantees from this banks including central bank

Guarantees from government Guarantees from parent/associate of that company having stronger entity Guarantees from the director/trustees of the company Guarantees from inter-bank/ inter-branch Guarantee from a third party The conditions to be met, when issues of loans against guarantees are as follows: All the terms and conditions for a guarantee must be clearly documented and made available to all parties involved in processing loans

63

Care should be taken while guarantees are time bound that the expiry date of the guarantee does not pass without a new guarantee or an extension of the old one is received.

3. ESCROW ACCOUNT:Escrow account is one of the techniques used by the banks to recover their repayment from the borrower, thiseby reducing their loan exposure. Escrow account is an amount set aside to keep the money that is owed by one party to another. Bank asks the borrower to open an escrow account with the trustee bank for repayment in the event of default. Both the parties decide when the money is to be transferred in the escrow account, depending on that the borrower puts the money in such account and the escrow agent pays the part of the money to the lending bank in charge of loan. Escrow account is also maintained by the borrower to pay the lending bank at the expiry of their loan contract. This technique enables bank to recover loan from the escrow account. 4. BREAK TRADE LAWS:Banks use technique such as break trade laws/termination clause, i.e. they have a mutual contract whereby they can exit from the trade in the event of any type of default on the part of borrower. 5. INSURANCE :64

Banks lending against collateral, such as lending for housing property, insure such property with the insurance company. Insurance enables banks to recover their loss in the case of uncertain event. Thus, an insurance policy may provide for compensation in the event that a party defaults. 6. SECURITISATION:The Securitization and Reconstruction of Financial Assets Act enables bank and FIs to recover some of the amounts from the existing NPAs. Securitization involves the pooling or repackaging of asset (e.g. a portfolio of loans or a group of accounts) for sale to an entity that then sells securities backed by the assets to the investors. A service is retained by the entity to service the loans or work the accounts, thus providing the entity with the projected and necessary cash flow to pay back the investors within the appropriate time frame. Banks package and sell large corporate loans to the institutional and individual investors. Thus, securitization enables banks to transfer its loan exposure to this entity. This is also one of the techniques used by banks to reduce their loan exposure.

7. EQUATOR PRINCIPLE:The Equator Principles - a voluntary set of guidelines developed for managing social and environmental issues related to the financing
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development projects - apply only to projects which cost $50 million or more, as those costing less represent only 3 per cent of the market. Banks adopting the Equator Principles undertake to provide loans only to projects whose sponsors can demonstrate their ability and willingness to comply with comprehensive processes aimed at ensuring that projects are developed in a socially responsible manner and according to sound environmental management practices. Equator principle involves following steps: The banks, to begin with, agree upon a common terminology in categorizing projects into high, medium and low environmental and social risk, based on the International Finance Corporations (IFC) categorization process. They apply this to projects globally and to all industry sectors such as mining, oil and gas and forestry, so as to ensure consistent approaches in their dealings with high- and medium-risk projects. Banks ask their customers to demonstrate in their environmental and social reviews, and in their environmental and social management plans, the extent to which they have met the applicable World IFC safeguard policies, or to justify exceptions to them. This practice allows them to secure information of the quality required for them to make judgments. And then again, the banks insert into the loan documentation for high- and mediumrisk projects covenants for borrowers to comply with their environmental and social management plans.

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The Equator Principles enables banks to better assess, mitigate, document and monitor the credit risk and reputation risk associated with financing development projects. 8. CLEARING CORPORATION OF INDIA LIMITED:Clearing Corporation of India Limited (CCIL) has been promoted by leading banks and financial institutions (SBI, IDBI, LIC, ICICI, Bank of Baroda and HDFC Bank) operating in India to address the need for an integrated clearing and settlement system for debt and forex transactions. For participants in the forex market, CCIL's intermediation provides a structure to mitigate, and manage, the risks associated with the settlement of these high-value transactions. Since the foreign currency leg has necessarily to be settled overseas while the rupee leg gets settled locally, time-zone differences come into the picture, adding to the settlement risk. Besides bringing tangible benefits in the form of improved efficiency and easier reconciliation of accounts with their correspondent banks, CCIL's intermediation in the settlement process brings the benefit of lower cost to the participating banks. CCIL at present guarantees settlement of trades of its members concluded in the debt and forex market. The debt market trades are the ones that are carried out on the NDS (Negotiated Dealing System) and come to CCIL for settlement. The forex trades carried out by the dealers on their respective trading system are sent to CCIL for settlement.
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CCIL clears and settles trades of its members transacted on Reserve Bank of India's NDS. The trades include normal outright trades, forward outright trades, normal repo / reverse repo trades (other than RBI-repo) and forward repo / reverse repo trades for government securities and Treasury Bills. The settlement of these trades is guaranteed by CCIL through a process called novation whiseby CCIL becomes central counterparty for each trade. CCIL also clears and settles inter-bank forex trades in India. These are initially rupee-based US dollar spot and forward trades, later cash and trades would also get settled through CCIL. In future, CCIL also proposes to handle trades in other currencies. The settlement of these trades will be guaranteed by CCIL through the legal process called novation. Collateralized borrowing and lending obligation (CBLO) trading system To expand the depth of the debt market in India, CCIL has provided a trading platform to the market participants for undertaking collateralised borrowing and lending by offering repoable securities and bonds as collateral. By providing the CBLO trading system, CCIL has achieved the following objectives: Facilitating easy liquidity in the repo market
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 Enhancing the depth of the market through wider participation by corporate, MFs, trusts etc
Providing non-bank entities suitable opportunities for short-term

investment (other than call money market) Reducing the counter-party and default risk by ensuring suitable settlement mechanism Elimination of market inefficiency in short-term borrowing and lending Development of market-oriented short-term reference rate for inter-bank transactions.

9. NETTING:Netting is one of the techniques considered by Basel 2 accord for reduction of credit exposure to counterparties. Netting means the occurrence of any or all of the followings: 1. The termination or acceleration of payment or delivery obligations or entitlement under one or more qualified financial contracts entered into under netting agreement;
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2. the calculation or estimation of a closeout value, market value, liquidation value, or replacement value in respect of each obligation or entitlement terminated and/or accelerated; 3. The conversion of any values calculated under (2) into a single currency; 4. The offset of any values calculated under (2), as converted under (3); Netting arrangement means: Any agreement between two parties that provides for netting of present or future payment or delivery obligations or entitlements arising under or in connection with one or more qualified financial contracts entered into these under by the parties to the agreement, and, Any collateral arrangement related to one or more of the foregoing. Qualified financial contract means any financial contract, including any terms and conditions incorporated by reference in any such financial contract, pursuant to which payment or delivery obligations that have a market or an exchange price are due to be performed at a certain time or within a certain period of time. Qualified financial contract include:

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 A currency, cross-currency or interest rate swap agreement; A basis swap agreement;

A spot, future, forward or this foreign exchange agreement;

A cap, collar or floor transaction; A commodity swap; A forward rate agreement; A currency or interest rate future; A currency or interest rate option Equity derivatives; Credit derivatives;

Spot, future, forward or others commodity contract;

A repurchase agreement; An agreement to buy, sell, borrow or lend securities, such as a securities lending transaction; A title collateral arrangement; An agreement to clear or settle securities transaction s or to act as depository for securities; Any agreement or contract designated as such by the Bank under this Act

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NEW CAPITAL ACCORD: IMPLICATIONS FOR CREDIT RISK MANAGEMENT

The Basel Committee on Banking Supervision had released in June 1999 the first Consultative Paper on a New Capital Adequacy Framework with the intention of replacing the current broad-brush 1988 Accord. The Basel Committee has released a Second Consultative Document in January 2001, which contains refined proposals for the three pillars of the New Accord Minimum Capital Requirements, Supervisory Review and Market Discipline. The Committee proposes two approaches, viz., Standardised and Internal Rating Based (IRB) for estimating regulatory capital. Under the standardised approach, the Committee desires to produce neither a net increase nor a net decrease, on an average, in minimum regulatory capital, even after accounting for operational risk. Under the IRB approach, the Committees ultimate goals are to ensure that the overall level of regulatory capital is sufficient to address the underlying credit risks and also provides capital incentives relative to the standardised approach, i.e., a reduction in the risk weighted assets of 2% to 3% (foundation IRB approach) and 90% of the capital requirement under foundation approach for advanced IRB approach to encourage banks to adopt IRB approach for providing capital. The minimum capital adequacy ratio would continue to be 8% of the risk-weighted assets, which cover capital requirements for market (trading book), credit and operational risks. For credit risk, the range of options to estimate capital extends to include a standardised, a foundation IRB and an advanced IRB approaches.
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Standardized Approach Under the standardized approach, preferential risk weights in the range of 0%, 20%, 50%, 100% and 150% would be assigned on the basis of ratings given by external credit assessment institutions. Orientation of the IRB Approach Banks internal measures of credit risk are based on assessments of the risk characteristics of both the borrower and the specific type of transaction. The probability of default (PD) of a borrower or group of borrowers is the central measurable concept on which the IRB approach is built. The PD of a borrower does not, however, provide the complete picture of the potential credit loss. Banks should also seek to measure how much they will lose should a borrower default on an obligation. This is contingent upon two elements. First, the magnitude of likely loss on the exposure: this is termed the Loss Given Default (LGD), and is expressed as a percentage of the exposure. Secondly, the loss is contingent upon the amount to which the bank was exposed to the borrower at the time of default, commonly expressed as Exposure at Default (EAD). These three components (PD, LGD, EAD) combine to provide a measure of expected intrinsic, or economic, loss. The IRB approach also takes into account the maturity (M) of exposures. Thus, the derivation of risk weights is dependent on estimates of the PD, LGD and, in some cases, M, that are attached to an exposure. These components (PD, LGD, EAD, M) form the basic inputs to the IRB approach, and consequently the capital requirements derived from it.

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IRB Approach The Committee proposes two approaches foundation and advanced - as an alternative to standardized approach for assigning preferential risk weights. Under the foundation approach, banks, which comply with certain minimum requirements viz. comprehensive credit rating system with capability to quantify Probability of Default (PD) could assign preferential risk weights, with the data on Loss Given Default (LGD) and Exposure at Default (EAD) provided by the national supervisors. In order to qualify for adopting the foundation approach, the internal credit rating system should have the following parameters/conditions:

Each borrower within a portfolio must be assigned the rating before a loan is originated. Minimum of 6 to 9 borrower grades for performing loans and a minimum of 2 grades for non-performing loans. Meaningful distribution of exposure across grades and not more than 30% of the gross exposures in any one borrower grade. Each individual rating assignment must be subject to an independent review or approval by the Loan Review Department. Rating must be updated at least on annual basis. The Board of Directors must approve all material aspects of the rating and PD estimation. Internal and External audit must review annually, the banks rating system including the quantification of internal ratings. Banks should have individual credit risk control units that are responsible for the design, implementation and performance of
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internal rating systems. These units should be functionally independent.

Members of staff responsible for rating process should be adequately qualified and trained. Internal rating must be explicitly linked with the banks internal assessment of capital adequacy in line with requirements of Pillar 2. Banks must have in place sound stress testing process for the assessment of capital adequacy. Banks must have a credible track record in the use of internal ratings at least for the last 3 years. Banks must have robust systems in place to evaluate the accuracy and consistency with regard to the system, processing and the estimation of PDs. Banks must disclose in greater detail the rating process, risk factors, and validation etc. of the rating system.

Under the advanced approach, banks would be allowed to use their own estimates of PD, LGD and EAD, which could be validated by the supervisors. Under both the approaches, risk weights would be expressed as a single continuous function of the PD, LGD and EAD. The IRB approach, therefore, does not rely on supervisory determined risk buckets as in the case of standardized approach. The Committee has proposed an IRB approach for retail loan portfolio, having homogenous characteristics distinct from that for the corporate portfolio. The Committee is also working towards developing an appropriate IRB approach relating to project finance.

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The adoption of the New Accord, in the proposed format, requires substantial up gradation of the existing credit risk management systems. The New Accord also provided in-built capital incentives for banks, which are equipped to adopt foundation or advanced IRB approach. Banks may, therefore, upgrade the credit risk management systems for optimising capital.

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Case Study
M/S SB MANDIES M/S Quality Crafts Store Proprietor Mr. RAHIT SHARMA, N.M. Nagar, Kherwadi Road, established in the year 2006, is engaged in retail business of Local distribution of Goods. The party has been in connection with and dealing with the Saraswat Co-op. Bank, Ghatkopar branch since year 2008 with satisfactory dealings and good conduct. The turnover of account is encouraging. The party has established good trade connections and is involved in related trade. No negative complaints has been registered or found against the party ever since the opening of account with the bank branch. The amount is frequently routed through the account and the performance of account is good. Borrowers Information Name of Applicant Borrower Address of the Head/Regd. Office Constitution Date of Establishment Period since dealing with branch Net worth as on 31.10.2009 : Mr. AJAY KAWADE : Amrut Nagar, Kherwadi Road : Individual : Year 2006 : Year 2008 : Rs. 9.00 lacs

General Information of the Proposal Existing Banking Arrangements Proposed Banking Arrangements Sanction Comes Under Powers of Activity Sector : Sole Banking : Sole Banking : Branch Head : Trading of Goods etc. : Trading
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Present Facilities by the Applicant Facility Requested by the Applicant Purpose of Borrowing Amount Requested Securities Proposed for the Facility: Primary Security

: Nil : Cash Credit : For Expansion of Existing Business : Rs. 5.00 Lacs.

Hypothecation of stocks and Book Debts Collateral Security Third Party Guarantee of two persons: 1. Mr. XYZ S/o Mr. XYZ 2. Mr XYZ S/o Mr. XYZ Both the guarantors are dealing with the Saraswat Co-op. Bank Branches. As reported both are availing cash credit facility with their respective branches and with a satisfactory performance. Financial Indicators has been calculated as follows:
a) Net Working Capital: Total Current Assets less Total Current

Liabilities.
b) Current Ratio: Total Current Assets divided by Total Current

Liabilities.
c) Stocking Velocity: Stock for the year divided by Cost of Goods Sold

or Credit Purchase during the year multiplied by 360 days.

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d) Debtors Velocity: Average Receivables or Debtors for the year

divided by Credit Sales during the year multiplied by 360 days.

e) Creditors Velocity: Average Payables or Creditors for the year

divided by Credit Purchase during the year multiplied by 360 days. Financials of the Firm (Amt. in Rs. Lacs) Particulars Sales Purchases % of Sales Growth Net Profit Liabilities Share Capital Total Term Liabilities Current Liabilities Working Capital Sundry Creditors Expenses Payable Borrowings Other liabilities Total Current Liabilities Tolal Liabilities Assets Investments Fixed Assets Total Fixed Assets Current Assets Stocks Sundry Debtors Cash in hand/Bank Balance Loans/Advances Total Current Assets Total Assets 31/03/2009 7.12 6.12 1.42 2.64 2.64 1.00 0.38 0.23 0.00 0.00 1.61 4.25 0.00 0.24 0.24 2.24 0.52 1.25 0.00 3.01 4.25 31/03/2010 Projected 19.00 17.53 325.00 2.23 3.30 3.30 8.00 1.20 0.65 0.00 0.00 9.85 13.15 0.00 0.72 0.72 8.50 3.16 0.77 0.00 12.43 13.15
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Financial Indicators Particulars Net Working Capital (In Rs. Lacs) Current Ratio Stocking Velocity ( Days) Debtors Velocity (Days) Creditors Velocity (Days) 31/03/2009 1.40 1.86 108 26.29 22.35 31/03/2010 2.58 1.26 175 59.87 24.64

Apart from the above financials of the party, the account statement reveals the following transactions of the party with the Bank Branch (Amt. in Rs. Lacs):

Debit Summation From 01/04/2008 to 31/03/2009 (1 6.52 year) From 01/04/2008 to 31/10/2009 (7 11.62 months)

Credit Summation 6.50 11.10

Comments and Observations: f) The party has projected to achieve a sales target of Rs. 19.00 Lacs over previous year achievement of Rs. 7.12 Lacs. The projected sales target seems to be achievable owing to the fact that up to 31/10/2008
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(7 months) the party has a sales turnover of Rs. 11.62 lacs through the account. g) Stock Velocity reveals the part of sales always invested in stock during the year or in other words it refers to the period of sales sans obstacles out of the current stock in case the production halts due to strike or other reason. The stocking period of 175 days is on higher side hence its been accepted at 90 days level. h) Debtors Velocity reveals the duration within the debtors are expected to be realized. The projected debtors period seems reasonable hence accepted for assessment as projected. i) Creditors Velocity reveals the duration within the creditors are expected to be paid. Lesser the days better is the position of the firm. The projected creditors velocity is at a lower level, keeping the kind of stocks in trade into consideration, the velocity has been accepted at 50 days level. Assessment of MPBF (Amt. in Rs. Lacs) Particulars Accepted Sales Accepted Purchase Current Assets Stock (17.53*90360) Debtors (19*60360 Cash in hand Loans & advances Total Current Assets (a) Current Liabilities Creditors (17.53*50360) Amount 19.00 17.53 90 days 60 days 4.38 3.16 0.54 0.00 8.08 2.50
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50 days

Other liabilities Total Current liabilities (b) Working Capital Gap (a-b) Margin (as projected by the party) MPBF Recommendations of Bank Branch

0.00 2.50 5.58 2.58 3.00

In view of above, it is proposed, if agreed, to allow Cash Credit Facility of Rs. 3 Lacs (Rupees three lacs only) in favor of M/S Quality Crafts Store Prop. Mr. Shah Alam Mateen for a period of one year subject to renewal after review against securities as discussed. Rate of Interest: PLR presently 13 % with monthly rests or any other rate. This may be prescribed by the Bank from time to time. Margin: 40% on Stocks 50% on Book-Debts (excluding book debts older than 6 months).

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CONCLUSION Banks are the major money lenders in todays growing market. Banks plays a very important role in today fast increasing economy. Private Banks have increased competition in market and more and more banks want to increase their business by giving larger amount of and more number of loans. Every loan carries certain risk and when banks are giving loans on such a large scale they need a perfect technique to minimize the risk and decrease the percentage of NPAs. Credit risk management provides that technique to the bank to stay ahead in business. Credit Risk Management is a part of banks day to day activity which is not going to end. Credit risk arises from lending activity of a Bank. Credit risk also arises from potential changes in the credit quality of a borrower. It has two components: default risk and credit spread risk. Credit risk measurement is based on Credit Rating. Credit rating of an account is done with primary objective to determine whethis the account, after the expiry of a given period, would remain a performing asset.

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It must be noted that while the use of Credit Risk Management techniques reduces or transfers credit risk, it simultaneously may increase othis risks such as legal, operational, liquidity and market risk. This fore, it is imperative that banks employ robust procedure and process to control these risks as well. In fact, advantages of risk mitigation must be weighed against the risks acquired and its integration with the banks overall risk profile.
CREDIT RISK MANAGEMENT IS THE HEART OF TODAYS BANKS RISK TAKING BUSINESS.

BIBLOGRAPH

Risk Management by Macmillan. Bank Financial Management by taxman.

Saraswat Bank manuals and circulars

www.Saraswatbank.com www.google.co.in www.rbi.org.in

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www.wikipedia.org www.investopedia.com

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