jntu credit risk-management
DESCRIPTION
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What is Credit Risk?
The risk that a counterparty to a transaction will fail to perform according to
the terms and conditions of the contract due to
•Problems such as•Bankruptcy•Illiquidity ,etc.
Lenders, Depositors, Borrowers and Suppliers - all face credit risk
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A More Formal Definition
Credit Risk is defined as the possibility
that a borrower or counterparty will fail
to meet its obligations in accordance with
the agreed terms
Default triggers
a total or partial loss of any amount lent
to the counterparty
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Credit Risk Components “Quantity” of Risk
Outstanding balance lent to the borrower
“Quality” of Risk Dependant on
Chances that the default occurs Guarantees that reduce the loss in the
event of default
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Credit Risk Components Cont.. Credit Risk or Loss Given Default
(LGD) Composed of Default Risk Exposure Risk Recovery Risk
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Default Risk Possible definitions
Missing a payment obligation- usually three months
Breaking a covenant – financial ratios bands
Entering a legal procedure Economic default- market value of
assets drops below that of liabilities
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Exposure Risk Amortised debt- no exposure risk
As repayment schedule known hence no exposure risk
Committed lines of credit like Overdraft All off balance sheet items like third
party guarantees Derivatives- if liquidation value is
positive then it remains if the counterparty defaults
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Recovery Risk Dependent upon
Collateral security
Third party guarantee
Legal framework
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Credit Risk Management’s Importance for Banks cont..
New forms of financial transactions emerging Securitisation Credit Derivatives
CRAR( Capital to Risk-weighted Assets Ratio) Framework
Decreasing Govt. Support for bail outs
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Traditional Approach in Credit Approval System 5 “C” principles
Character (of Borrower) Capital (Borrower’s risk-bearing
commitment) Capacity (to provide adequate cash
flows) Collateral (Priority of charge and value) Condition- (of business of borrower and
industry he belongs to ) Level of interest rates
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Evolution of Credit Risk Rating Systems - India
Position in India Regulatory Health-Code System
(1980s) Internal Credit Rating Systems of
banks In both cases , no explicit linkages
with capital requirements
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Five Eternal Principles of Credit Risk Management Selection Limitation Diversification Provision Capitalisation Quantitative Approach attempts to
optimise all the above
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Credit Risk Management Limit systems and Credit screening Risk quality and ratings Credit enhancements
Covenants- diversification, ratios Securitisation Guarantees Letters of credit
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Industry Ratings-Risk Evaluation
Cash Flows Debt Repayment Ability Time Horizon- 3 to 5 years Parameters
Demand –Supply outlook Cost Structures Competition Govt Policies Financial performance-Historical
+Projected
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Company Ratings Industry Prospects Operating Efficiency
Capacity utilisation levels Input-output norms Power consumption Gross margins Working capital management
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Company Ratings cont. Market Position
Current and expected Likely growth rate for the company Current market share and its stability Barriers to entry Basis of competition Diversity of markets Product profile
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Company Ratings cont.
Business Risk
Accounting Quality
Financial Performance
Past 3-5 years
Future 2-3 years
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Company Ratings cont.
Financial Flexibility Company’s need for funds Ability to raise it through
Debt Equity GDR’s, ADR’s Internal accruals Liquidation of marketable securities Support from group companies
Financial Risk Financial performance Ability to fund capital commitments Service debt obligations
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RBI Guidelines on Risk Management
RBI issued Guidelines to banks on Risk Management in October, 1999.
The Guidelines are aimed to make banks aware of the risks and put in place proper risk management system
Emphasis placed on Board level overview and an organisational structure and practices which would enable proactive risk management
Guidance Paper dated Sept.20, 2001 issued by RBI on Credit Risk Management
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Integrated Management
Inter-relationships between risk categoriesCapital Adequacy NormsCapital Adequacy for Market RiskBasle Committee’s proposal to prescribe explicit capital charge for Operational Risk also
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Risk Management Structure
Risk Mgt. Committee
Credit Policy Committee
BOARD
*Asset-Liability Management Committee
ALCO *
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Organisational Scheme for Credit Risk Management
R isk M an ag em en t C om m ittee
C red it R isk M an ag em en tF u n c tion
C red it A d m in is tra tionF u n c tion
L oan R eviewF u n c tion
C red it P o lic y C om m ittee
T.V.RAOTHANK YOU
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