the study of risk management and the factors of credit default
TRANSCRIPT
-
7/28/2019 THE STUDY OF RISK MANAGEMENT AND THE FACTORS OF CREDIT DEFAULT
1/76
-
7/28/2019 THE STUDY OF RISK MANAGEMENT AND THE FACTORS OF CREDIT DEFAULT
2/76
PREFACE
MBA is a stepping-stone to the management carrier and to develop goodmanager. It is
necessary that the theoretical must be supplemented with exposure to the
real environment.Theoretical knowledge just provides the base and its not sufficient
to produce a good manager thats why practical knowledge is needed.Therefore the
research product is an essential requirement for the student of MBA. This research
project not only helps the student to utilize his skills properly learn field realities but also
provides a chance to the organization tofind out talent among the budding managers inthe very beginning.
Working on a relevant and particular project is a part of parcel of any specialized courses
of MBA to fulfill this requirement as a student of M.B.A.. I have chosen the project of
the study as Risk management and factors of credit defaults by analyzing the results of
logistic regression model using SPSS in Canara bank
Banks have long stood as the repository of the funds to be made available to the needy.
Of late, retail lending process has helped the mass in distress, support and venture out
their dreams. Hence, the banks and other financial institutions have assumed the role of a
money lender over the years. However this blessing has also its shortfalls. The
multitudes of retail lending schemes have also ushered in the pitfalls of defaults. Many a
times, banks do not carefully evaluate the borrowers credit worthiness before granting
loans. This has often resulted in the creation of NPAs or Non-Performing Assets which
are a major liability and set back to the banks. The occurrence of NPA harms the capital
adequacy of banks and hence affects the further lending processes
I hope my effort to shape this project work will yield best possible result and will go a
long way in this direction.
2
-
7/28/2019 THE STUDY OF RISK MANAGEMENT AND THE FACTORS OF CREDIT DEFAULT
3/76
ACKNOWLEDGEMENT
It was indeed a pleasure for me to work in a prestigious organisation like Canara Bank. It
was a golden chance to have a summer internship in a bank like Canara and Im
thoroughly grateful to Jaipuria Institute of Management for giving me such an
opportunity.
I would also like to express my profound gratitude to Mr.A.K Sachdeva (Senior
Manager.) and the Mr.Y.K Gupta(Manager) Canara Bank Mahanagar Branch, for
providing me with their expert guidance and help wherever needed and for clarifying the
doubts however small it maybe.
Also, I am highly grateful & indebted to staff members of the Canara Bank. I would like
to extent my deep gratitude for their constant supervision, expert guidance, enthusiasm,
continuous encouragement, sharp observation and suggestions. Their keen interest and
support was the driving element in this project report.
I would also like to thank my mentor Dr.Masood Siddiqui for his constant support and
valuable suggestions throughout internship period and in the completion of the project
report. Also, Im thankful to our Dean, Prof. Dheeraj Mishra and all the other facultymembers at JIM,Lucknow who corrected and provided help and assistance at every step.
Lastly, I am highly indebted to my family, without their moral support this project could
not have been possible.
3
-
7/28/2019 THE STUDY OF RISK MANAGEMENT AND THE FACTORS OF CREDIT DEFAULT
4/76
-
7/28/2019 THE STUDY OF RISK MANAGEMENT AND THE FACTORS OF CREDIT DEFAULT
5/76
easy to implement but also does not require additional staff. There are various limitation
of the method suggested because of various constraints I had, like data availability, as an
intern but if implemented will reduce the work load of a manager and henceforth,
promote creation of further standard assets.
The aim of this study is to develop an understanding of the Risk management with
special focus on Credit Risk management and gather knowledge about the various risks
that stand afore the banks in the lending process and the evaluation and possible reasons
for the occurrences of non-performance assets. This is being critically analyzed through
SPSS.
TABLE OF CONTENTS
Chapter IIntroduction
1
Banking System in
India2
About Canara
Bank10
Scope & Importance of
study....17
Objectives.
..18
Chapter II
Evolution, Origin & Development of Risk
management...19
5
-
7/28/2019 THE STUDY OF RISK MANAGEMENT AND THE FACTORS OF CREDIT DEFAULT
6/76
-
7/28/2019 THE STUDY OF RISK MANAGEMENT AND THE FACTORS OF CREDIT DEFAULT
7/76
Risk management underscores the fact that the survival of an organization depends
heavily on its capabilities to anticipate and prepare for the change rather than just
waiting for the change and react to it. The objective of risk management is not to prohibit
or prevent risk taking activity, but to ensure that the risks are consciously taken with full
knowledge, clear purpose and understanding so that it can be measured and mitigated. It
also prevents an institution from suffering unacceptable loss causing an institution to fail
or materially damage its competitive position. Functions of risk management is bank
specific dictated by the size and quality of balance sheet, complexity of functions,
technical/ professional manpower and the status of MIS in place in that bank. Therefore,
banking practices, which continue to be deep routed in the philosophy of securities,
based lending and investment policies, need to change the approach and mind-set, rather
radically, to manage and mitigate the perceived risks, so as to ultimately improve the
quality of the asset portfolio.
To the extent the bank can take risk more consciously, anticipates adverse changes and
hedges accordingly, it becomes a source of competitive advantage, as it can offer its
products at a better price than its competitors.
Although Banks and FIs have the freedom to design and implement their own policies
for recovery and write-off incorporating compromise and negotiated settlements, still itbecomes extremely essential for a bank to avoid giving credit to potential defaulters.
Occurrence of NPA can lead to problems like restriction on flow of cash done by bank
due to the provisions of fund made against NPA, draining of profit, bad effect on
goodwill and on equity value etc.
Non-performing loans epitomize bad investment. They misallocate credit from good
projects, which do not receive funding, to failed projects. Bad investment ends up in
misallocation of capital, and by extension, labour and natural resources. Banks
redistribute losses to other borrowers by charging higher interest rates, lower deposit
rates and higher lending rates repress saving and financial market, which hamper
economic growth.
7
-
7/28/2019 THE STUDY OF RISK MANAGEMENT AND THE FACTORS OF CREDIT DEFAULT
8/76
The recovery of loan has always been problem for banks and financial institution. To
come out of these first we need to think is it possible to avoid NPA. There may not be
one-size-fits-all risk management module for all the banks to be made applicable
uniformly. Balancing risk and return is not an easy task as risk is subjective and not
quantifiable whereas return is objective and measurable. If there exist a way of
converting the subjectivity of the risk into a number then the balancing exercise would
be meaningful and much easier. Hence, the predictive analysis regarding the default has
a huge scope and is of utmost relevance and importance to the banks.
Banking in India:-
Banking in India originated in the last decades of the 18th century. The first banks were
The General Bank of India, which started in 1786, and Bank of Hindustan, which started
in 1790; both are now defunct. The oldest bank in existence in India is the State Bank of
India, which originated in the Bank of Calcutta in June 1806, which almost immediately
became the Bank of Bengal. This was one of the three presidency banks, the other two
being the Bank of Bombay and the Bank of Madras, all three of which were established
under charters from the British East India Company. For many years the Presidency
banks acted as quasi-central banks, as did their successors. The three banks merged in
1921 to form the Imperial Bank of India, which, upon India's independence, became the
State Bank of India in 1955.
History
8
http://en.wikipedia.org/w/index.php?title=Bank_of_Hindustan&action=edit&redlink=1http://en.wikipedia.org/wiki/State_Bank_of_Indiahttp://en.wikipedia.org/wiki/State_Bank_of_Indiahttp://en.wikipedia.org/wiki/Bank_of_Calcuttahttp://en.wikipedia.org/wiki/Bank_of_Bengalhttp://en.wikipedia.org/wiki/Bank_of_Bombayhttp://en.wikipedia.org/wiki/Bank_of_Madrashttp://en.wikipedia.org/wiki/Imperial_Bank_of_Indiahttp://en.wikipedia.org/wiki/Imperial_Bank_of_Indiahttp://en.wikipedia.org/wiki/State_Bank_of_Indiahttp://en.wikipedia.org/wiki/State_Bank_of_Indiahttp://en.wikipedia.org/wiki/State_Bank_of_Indiahttp://en.wikipedia.org/wiki/Bank_of_Calcuttahttp://en.wikipedia.org/wiki/Bank_of_Bengalhttp://en.wikipedia.org/wiki/Bank_of_Bombayhttp://en.wikipedia.org/wiki/Bank_of_Madrashttp://en.wikipedia.org/wiki/Imperial_Bank_of_Indiahttp://en.wikipedia.org/wiki/State_Bank_of_Indiahttp://en.wikipedia.org/w/index.php?title=Bank_of_Hindustan&action=edit&redlink=1 -
7/28/2019 THE STUDY OF RISK MANAGEMENT AND THE FACTORS OF CREDIT DEFAULT
9/76
Indian merchants in Calcuttaestablished the Union Bank in 1839, but it failed in 1848 as
a consequence of the economic crisis of 1848-49. The Allahabad Bank, established in
1865 and still functioning today, is the oldest Joint Stock bank in India.(Joint Stock
Bank: A company that issues stock and requires shareholders to be held liable for the
company's debt) It was not the first though. That honor belongs to the Bank of Upper
India, which was established in 1863, and which survived until 1913, when it failed, with
some of its assets and liabilities being transferred to the Alliance Bank of Simla.
Foreign banks too started to app, particularly in Calcutta, in the 1860s. The Comptoire
d'Escompte de Paris opened a branch in Calcutta in 1860, and another in Bombay in
1862; branches in Madras and Pondicherry, then a French colony, followed. HSBC
established itself in Bengalin 1869. Calcutta was the most active trading port in India,mainly due to the trade of the British Empire, and so became a banking center.
The first entirely Indian joint stock bank was the Oudh Commercial Bank, established in
1881 in Faizabad. It failed in 1958. The next was the Punjab National Bank, established
in Lahorein 1895, which has survived to the present and is now one of the largest banks
in India.
Around the turn of the 20th Century, the Indian economy was passing through a relativeperiod of stability. Around five decades had elapsed since the Indian Mutiny, and the
social, industrial and other infrastructure had improved. Indians had established small
banks, most of which served particular ethnic and religious communities.
The presidency banks dominated banking in India but there were also some exchange
banks and a number of Indian joint stockbanks. All these banks operated in different
segments of the economy. The exchange banks, mostly owned by Europeans,
concentrated on financing foreign trade. Indian joint stock banks were generally
undercapitalized and lacked the experience and maturity to compete with the presidency
and exchange banks. This segmentation let Lord Curzon to observe, "In respect of
banking it seems we are behind the times. We are like some old fashioned sailing ship,
divided by solid wooden bulkheads into separate and cumbersome compartments."
9
http://en.wikipedia.org/wiki/Calcuttahttp://en.wikipedia.org/wiki/Calcuttahttp://en.wikipedia.org/wiki/Allahabad_Bankhttp://en.wikipedia.org/wiki/Alliance_Bank_of_Simlahttp://en.wikipedia.org/wiki/Kolkatahttp://en.wikipedia.org/wiki/Kolkatahttp://en.wikipedia.org/w/index.php?title=Comptoire_d%27Escompte_de_Paris&action=edit&redlink=1http://en.wikipedia.org/w/index.php?title=Comptoire_d%27Escompte_de_Paris&action=edit&redlink=1http://en.wikipedia.org/wiki/Mumbaihttp://en.wikipedia.org/wiki/Chennaihttp://en.wikipedia.org/wiki/Pondicherryhttp://en.wikipedia.org/wiki/Pondicherryhttp://en.wikipedia.org/wiki/HSBChttp://en.wikipedia.org/wiki/Bengalhttp://en.wikipedia.org/wiki/Bengalhttp://en.wikipedia.org/wiki/British_Rajhttp://en.wikipedia.org/wiki/Faizabadhttp://en.wikipedia.org/wiki/Faizabadhttp://en.wikipedia.org/wiki/Punjab_National_Bankhttp://en.wikipedia.org/wiki/Lahorehttp://en.wikipedia.org/wiki/Lahorehttp://en.wikipedia.org/wiki/Indian_rebellion_of_1857http://en.wikipedia.org/wiki/Indian_rebellion_of_1857http://en.wikipedia.org/wiki/Joint_stock_companyhttp://en.wikipedia.org/wiki/Joint_stock_companyhttp://en.wikipedia.org/wiki/Calcuttahttp://en.wikipedia.org/wiki/Allahabad_Bankhttp://en.wikipedia.org/wiki/Alliance_Bank_of_Simlahttp://en.wikipedia.org/wiki/Kolkatahttp://en.wikipedia.org/w/index.php?title=Comptoire_d%27Escompte_de_Paris&action=edit&redlink=1http://en.wikipedia.org/w/index.php?title=Comptoire_d%27Escompte_de_Paris&action=edit&redlink=1http://en.wikipedia.org/wiki/Mumbaihttp://en.wikipedia.org/wiki/Chennaihttp://en.wikipedia.org/wiki/Pondicherryhttp://en.wikipedia.org/wiki/HSBChttp://en.wikipedia.org/wiki/Bengalhttp://en.wikipedia.org/wiki/British_Rajhttp://en.wikipedia.org/wiki/Faizabadhttp://en.wikipedia.org/wiki/Punjab_National_Bankhttp://en.wikipedia.org/wiki/Lahorehttp://en.wikipedia.org/wiki/Indian_rebellion_of_1857http://en.wikipedia.org/wiki/Joint_stock_company -
7/28/2019 THE STUDY OF RISK MANAGEMENT AND THE FACTORS OF CREDIT DEFAULT
10/76
The period between 1906 and 1911, saw the establishment of banks inspired by the
Swadeshi movement. The Swadeshi movement inspired local businessmen and political
figures to found banks of and for the Indian community. A number of banks established
then have survived to the present such as Bank of India,Corporation Bank, Indian Bank,
Bank of Baroda,Canara Bankand Central Bank of India.
The fervour of Swadeshi movement lead to establishing of many private banks in
Dakshina Kannada and Udupi district which were unified earlier and known by the name
South Canara ( South Kanara ) district. Four nationalised banks started in this district
and also a leading private sector bank. Hence undivided Dakshina Kannada district is
known as "Cradle of Indian Banking".
During the First World War (19141918) through the end of the Second World War
(19391945), and two years thereafter until the independence of India were challenging
for Indian banking. The years of the First World War were turbulent, and it took its toll
with banks simply collapsing despite the Indian economy gaining indirect boost due to
war-related economic activities. At least 94 banks in India failed between 1913 and 1918
as indicated in the following table:
YearsNumber of banks
that failed
Authorised capital
(Rs. Lakhs)
Paid-upCapital
(Rs. Lakhs)
1913 12 274 35
1914 42 710 109
1915 11 56 5
1916 13 231 4
1917 9 76 25
1918 7 209 1
Post-Independence
The partition of India in 1947 adversely impacted the economies of Punjab and West
Bengal, paralyzing banking activities for months. India's independence marked the end
10
http://en.wikipedia.org/wiki/Swadeshihttp://en.wikipedia.org/wiki/Bank_of_Indiahttp://en.wikipedia.org/wiki/Bank_of_Indiahttp://en.wikipedia.org/wiki/Corporation_Bankhttp://en.wikipedia.org/wiki/Corporation_Bankhttp://en.wikipedia.org/wiki/Indian_Bankhttp://en.wikipedia.org/wiki/Bank_of_Barodahttp://en.wikipedia.org/wiki/Canara_Bankhttp://en.wikipedia.org/wiki/Canara_Bankhttp://en.wikipedia.org/wiki/Central_Bank_of_Indiahttp://en.wikipedia.org/wiki/Dakshina_Kannadahttp://en.wikipedia.org/wiki/Udupi_districthttp://en.wikipedia.org/wiki/First_World_Warhttp://en.wikipedia.org/wiki/First_World_Warhttp://en.wikipedia.org/wiki/Second_World_Warhttp://en.wikipedia.org/wiki/Indian_independence_movementhttp://en.wikipedia.org/wiki/Economy_of_Indiahttp://en.wikipedia.org/wiki/Partition_of_Indiahttp://en.wikipedia.org/wiki/Punjab,_Indiahttp://en.wikipedia.org/wiki/Punjab,_Indiahttp://en.wikipedia.org/wiki/West_Bengalhttp://en.wikipedia.org/wiki/West_Bengalhttp://en.wikipedia.org/w/index.php?title=Indian_independence_goverment&action=edit&redlink=1http://en.wikipedia.org/wiki/Swadeshihttp://en.wikipedia.org/wiki/Bank_of_Indiahttp://en.wikipedia.org/wiki/Corporation_Bankhttp://en.wikipedia.org/wiki/Indian_Bankhttp://en.wikipedia.org/wiki/Bank_of_Barodahttp://en.wikipedia.org/wiki/Canara_Bankhttp://en.wikipedia.org/wiki/Central_Bank_of_Indiahttp://en.wikipedia.org/wiki/Dakshina_Kannadahttp://en.wikipedia.org/wiki/Udupi_districthttp://en.wikipedia.org/wiki/First_World_Warhttp://en.wikipedia.org/wiki/Second_World_Warhttp://en.wikipedia.org/wiki/Indian_independence_movementhttp://en.wikipedia.org/wiki/Economy_of_Indiahttp://en.wikipedia.org/wiki/Partition_of_Indiahttp://en.wikipedia.org/wiki/Punjab,_Indiahttp://en.wikipedia.org/wiki/West_Bengalhttp://en.wikipedia.org/wiki/West_Bengalhttp://en.wikipedia.org/w/index.php?title=Indian_independence_goverment&action=edit&redlink=1 -
7/28/2019 THE STUDY OF RISK MANAGEMENT AND THE FACTORS OF CREDIT DEFAULT
11/76
of a regime of the Laissez-faire for the Indian banking. The Government of India
initiated measures to play an active role in the economic life of the nation, and the
Industrial Policy Resolution adopted by the government in 1948 envisaged a mixed
economy. This resulted into greater involvement of the state in different segments of the
economy including banking and finance. The major steps to regulate banking included:
The Reserve Bank of India, India's central banking authority, was established in
April 1934, but was nationalized on January 1, 1949 under the terms of the
Reserve Bank of India (Transfer to Public Ownership) Act, 1948 (RBI, 2005b).[1]
In 1949, the Banking Regulation Act was enacted which empowered the Reserve
Bank of India (RBI) "to regulate, control, and inspect the banks in India".
The Banking Regulation Act also provided that no new bank or branch of anexisting bank could be opened without a license from the RBI, and no two banks
could have common directors.
Nationalisation
Despite the provisions, control and regulations ofReserve Bank of India, banks in India
except the State Bank of India or SBI, continued to be owned and operated by private
persons. By the 1960s, the Indian banking industry had become an important tool to
facilitate the development of the Indian economy. At the same time, it had emerged as a
large employer, and a debate had ensued about the nationalization of the banking
industry. Indira Gandhi, then Prime Minister of India, expressed the intention of the
Government of India in the annual conference of the All India Congress Meeting in a
paper entitled "Stray thoughts on Bank Nationalisation."The meeting received the paper
with enthusiasm.
Thereafter, her move was swift and sudden. The Government of India issued an
ordinance ('Banking Companies (Acquisition and Transfer of Undertakings) Ordinance,
1969')) and nationalised the 14 largest commercial banks with effect from the midnight
of July 19, 1969. These banks contained 85 percent of bank deposits in the country [2].
11
http://en.wikipedia.org/wiki/Laissez-fairehttp://en.wikipedia.org/wiki/Laissez-fairehttp://en.wikipedia.org/wiki/Government_of_Indiahttp://en.wikipedia.org/wiki/Government_of_Indiahttp://en.wikipedia.org/wiki/Mixed_economyhttp://en.wikipedia.org/wiki/Mixed_economyhttp://en.wikipedia.org/wiki/Reserve_Bank_of_Indiahttp://en.wikipedia.org/wiki/Reserve_Bank_of_Indiahttp://en.wikipedia.org/wiki/Indian_banking#cite_note-0http://en.wikipedia.org/wiki/Reserve_Bank_of_Indiahttp://en.wikipedia.org/wiki/State_Bank_of_Indiahttp://en.wikipedia.org/wiki/Indian_economyhttp://en.wikipedia.org/wiki/Indian_economyhttp://en.wikipedia.org/wiki/Indira_Gandhihttp://en.wikipedia.org/wiki/Indira_Gandhihttp://en.wikipedia.org/wiki/Prime_Minister_of_Indiahttp://en.wikipedia.org/wiki/Government_of_Indiahttp://en.wikipedia.org/wiki/Nationalisationhttp://en.wikipedia.org/wiki/Indian_banking#cite_note-Austin-1http://en.wikipedia.org/wiki/Laissez-fairehttp://en.wikipedia.org/wiki/Government_of_Indiahttp://en.wikipedia.org/wiki/Mixed_economyhttp://en.wikipedia.org/wiki/Mixed_economyhttp://en.wikipedia.org/wiki/Reserve_Bank_of_Indiahttp://en.wikipedia.org/wiki/Indian_banking#cite_note-0http://en.wikipedia.org/wiki/Reserve_Bank_of_Indiahttp://en.wikipedia.org/wiki/State_Bank_of_Indiahttp://en.wikipedia.org/wiki/Indian_economyhttp://en.wikipedia.org/wiki/Indira_Gandhihttp://en.wikipedia.org/wiki/Prime_Minister_of_Indiahttp://en.wikipedia.org/wiki/Government_of_Indiahttp://en.wikipedia.org/wiki/Nationalisationhttp://en.wikipedia.org/wiki/Indian_banking#cite_note-Austin-1 -
7/28/2019 THE STUDY OF RISK MANAGEMENT AND THE FACTORS OF CREDIT DEFAULT
12/76
Jayaprakash Narayan, a national leader of India, described the step as a "masterstroke of
political sagacity." Within two weeks of the issue of the ordinance, the Parliament
passed the Banking Companies (Acquisition and Transfer of Undertaking) Bill, and it
received thepresidential approval on 9 August 1969.
A second dose of nationalization of 6 more commercial banks followed in 1980. The
stated reason for the nationalization was to give the government more control of credit
delivery. With the second dose of nationalization, the Government of India controlled
around 91% of the banking business of India. Later on, in the year 1993, the government
mergedNew Bank of India with Punjab National Bank. It was the only merger between
nationalized banks and resulted in the reduction of the number of nationalised banks
from 20 to 19. After this, until the 1990s, the nationalised banks grew at a pace of around4%, closer to the average growth rate of the Indian economy.
Liberalisation
In the early 1990s, the then Narasimha Rao government embarked on a policy of
liberalization, licensing a small number of private banks. These came to be known as
New Generation tech-savvy banks, and included Global Trust Bank (the first of such new
generation banks to be set up), which later amalgamated with Oriental Bank of
Commerce, Axis Bank(earlier as UTI Bank), ICICI BankandHDFC Bank. This move,
along with the rapid growth in the economy of India, revitalized the banking sector in
India, which has seen rapid growth with strong contribution from all the three sectors of
banks, namely, government banks, private banks and foreign banks.
The next stage for the Indian banking has been set up with the proposed relaxation in thenorms for Foreign Direct Investment, where all Foreign Investors in banks may be given
voting rights which could exceed the present cap of 10%, at present it has gone up to
74% with some restrictions.
12
http://en.wikipedia.org/wiki/Jayaprakash_Narayanhttp://en.wikipedia.org/wiki/Parliament_of_Indiahttp://en.wikipedia.org/wiki/President_of_Indiahttp://en.wikipedia.org/w/index.php?title=New_Bank_of_India&action=edit&redlink=1http://en.wikipedia.org/wiki/Punjab_National_Bankhttp://en.wikipedia.org/wiki/Narasimha_Raohttp://en.wikipedia.org/wiki/Liberalizationhttp://en.wikipedia.org/wiki/Axis_Bankhttp://en.wikipedia.org/wiki/UTI_Bankhttp://en.wikipedia.org/wiki/ICICI_Bankhttp://en.wikipedia.org/wiki/HDFC_Bankhttp://en.wikipedia.org/wiki/HDFC_Bankhttp://en.wikipedia.org/wiki/Economy_of_Indiahttp://en.wikipedia.org/wiki/Jayaprakash_Narayanhttp://en.wikipedia.org/wiki/Parliament_of_Indiahttp://en.wikipedia.org/wiki/President_of_Indiahttp://en.wikipedia.org/w/index.php?title=New_Bank_of_India&action=edit&redlink=1http://en.wikipedia.org/wiki/Punjab_National_Bankhttp://en.wikipedia.org/wiki/Narasimha_Raohttp://en.wikipedia.org/wiki/Liberalizationhttp://en.wikipedia.org/wiki/Axis_Bankhttp://en.wikipedia.org/wiki/UTI_Bankhttp://en.wikipedia.org/wiki/ICICI_Bankhttp://en.wikipedia.org/wiki/HDFC_Bankhttp://en.wikipedia.org/wiki/Economy_of_India -
7/28/2019 THE STUDY OF RISK MANAGEMENT AND THE FACTORS OF CREDIT DEFAULT
13/76
The new policy shook the Banking sector in India completely. Bankers, till this time,
were used to the 4-6-4 method (Borrow at 4%; Lend at 6%; Go home at 4) of
functioning. The new wave ushered in a modern outlook and tech-savvy methods of
working for traditional banks. All this led to the retail boom in India. People not just
demanded more from their banks but also received more.
In 2010, banking in India is generally fairly mature in terms of supply, product range and
reach-even though reach in rural India still remains a challenge for the private sector and
foreign banks. In terms of quality of assets and capital adequacy, Indian banks are
considered to have clean, strong and transparent balance sheets relative to other banks in
comparable economies in its region. The Reserve Bank of India is an autonomous body,
with minimal pressure from the government. The stated policy of the Bank on the IndianRupee is to manage volatility but without any fixed exchange rate-and this has mostly
been true.
With the growth in the Indian economy expected to be strong for quite some time-
especially in its services sector-the demand for banking services, especially retail
banking, mortgages and investment services are expected to be strong. One may also
expect M&As, takeovers, and asset sales.
In March 2006, the Reserve Bank of India allowed Warburg Pincus to increase its stake
in Kotak Mahindra Bank (a private sector bank) to 10%. This is the first time an investor
has been allowed to hold more than 5% in a private sector bank since the RBI announced
norms in 2005 that any stake exceeding 5% in the private sector banks would need to be
vetted by them.
In recent years critics have charged that the non-government owned banks are too
aggressive in their loan recovery efforts in connection with housing, vehicle and personal
loans. There are press reports that the banks' loan recovery efforts have driven defaulting
borrowers to suicide.
Adoption of banking technology
13
http://en.wikipedia.org/wiki/Indiahttp://en.wikipedia.org/wiki/Retail_bankinghttp://en.wikipedia.org/wiki/Retail_bankinghttp://en.wikipedia.org/wiki/Indiahttp://en.wikipedia.org/wiki/Retail_bankinghttp://en.wikipedia.org/wiki/Retail_banking -
7/28/2019 THE STUDY OF RISK MANAGEMENT AND THE FACTORS OF CREDIT DEFAULT
14/76
The IT revolution had a great impact in the Indian banking system. The use of computers
had led to introduction of online banking in India. The use of the modern innovation and
computerisation of the banking sector of India has increased many folds after the
economic liberalisation of 1991 as the country's banking sector has been exposed to the
world's market. The Indian banks were finding it difficult to compete with the
international banks in terms of the customer service without the use of the information
technology and computers.
The RBI in 1984 formed Committee on Mechanisation in the Banking Industry (1984)
whose chairman was Dr C Rangarajan, Deputy Governor, Reserve Bank of India. The
major recommendations of this committee was introducing MICR Technology in all the
banks in the metropolis in India. This provided use of standardized cheque forms andencoders.
In 1988, the RBI set up Committee on Computerisation in Banks (1988) headed by Dr.
C.R. Rangarajan which emphasized that settlement operation must be computerized in
the clearing houses of RBI in Bhubaneshwar, Guwahati, Jaipur, Patna and
Thiruvananthapuram.It further stated that there should be National Clearing of inter-city
cheques at Kolkata,Mumbai,Delhi,Chennai and MICR should be made Operational.It
also focused on computerisation of branches and increasing connectivity among
branches through computers.It also suggested modalities for implementing on-line
banking.The committee submitted its reports in 1989 and computerisation began form
1993 with the settlement between IBA and bank employees' association.
In 1994, Committee on Technology Issues relating to Payments System, Cheque
Clearing and Securities Settlement in the Banking Industry (1994) was set up with
chairman Shri WS Saraf, Executive Director, Reserve Bank of India. It emphasized on
Electronic Funds Transfer (EFT) system, with the BANKNET communications network
as its carrier. It also said that MICR clearing should be set up in all branches of all banks
with more than 100 branches.
Committee for proposing Legislation On Electronic Funds Transfer and other Electronic
Payments (1995)[11] emphasized on EFT system. Electronic banking refers to DOING
BANKING by using technologies like computers, internet and networking, MICR,EFT
14
http://en.wikipedia.org/wiki/Indian_banking#cite_note-10http://en.wikipedia.org/wiki/Indian_banking#cite_note-10 -
7/28/2019 THE STUDY OF RISK MANAGEMENT AND THE FACTORS OF CREDIT DEFAULT
15/76
so as to increase efficiency, quick service, productivity and transparency in the
transaction.
Apart from the above mentioned innovations the banks have been selling the third party
products like Mutual Funds, insurances to its clients. Total numbers of ATMs installed in
India by various banks as on end March 2005 is 17,642.The New Private Sector Banks in
India is having the largest numbers of ATMs which is fol off site ATM is highest for the
SBI and its subsidiaries and then it is followed by New Private Banks, Nationalised
banks and Foreign banks. While on site is highest for the Nationalised banks of India.
BANK GROUPNUMBER OF
BRANCHES
ON SITE
ATM
OFF
SITE
ATM
TOTAL
ATM
NATIONALISED BANKS 33627 3205 1567 4772
STATE BANK OF INDIA 13661 1548 3672 5220
OLD PRIVATE SECTOR
BANKS4511 800 441 1241
NEW PRIVATE SECTOR
BANKS1685 1883 3729 5612
FOREIGN BANKS 242 218 579 797
CANARA BANK
HISTORY
Canara Bank (Canara), one of the biggest commercial banks in India, was established in
1906 atMangalore, Karnataka by Mr.AmmembalSubbaRaoPai. He had envisioned the
bank to not only offer financial services but also fulfill social causes such as removal of
15
-
7/28/2019 THE STUDY OF RISK MANAGEMENT AND THE FACTORS OF CREDIT DEFAULT
16/76
superstitions and ignorance, promotion of habit of saving, providing assistance to the
people in need and develop a sense of humanity among the people. The Bank has gone
through the various phases of its growth trajectory over hundred years of its existence.
Growth of Canara Bank was phenomenal, especially after nationalization in the year
1969, attaining the status of a national level player in terms of geographical reach and
clientele segments. Eighties was characterized by business diversification for the Bank.
In June 2006, the Bank completed a century of operation in the Indian banking industry.
The eventful journey of the Bank has been characterized by several memorable
milestones. Canara has a panIndia presence with a network of 3,046 branches as on
March 31, 2010. Thebanks branches are wellspread across metropolitan, urban, semi
urban and rural areas.
The bank boasts of having the maximum number of ATM installations among all the
nationalized banks summing up to more than 2000 of them at 698 centres. Also, 1351
branches of the bank provide Internet and Mobile Banking (IMB) services, while
Anywhere Banking services are being provided at 2027 of its branches. All the
branches of Canara Bank are enabled with Real Time Gross Settlement (RTGS) and
National Electronic Fund Transfer (NEFT) transaction facilities, insuring smooth and
swift money transfer from any corner of the nation to another corner.Apart from setting other benchmarks in the field of providing comprehensive banking
services to the consumers, Canara Bank has a number of achievements to its credit,
which include being the first bank in India to have launched Inter-City ATM network,
being the first bank to have been awarded ISO Certification for one of its branches,
providing credit card for farmers for the first time in India along with offering
Agricultural Consultancy Services
Significant milestones
1st July 1906 Canara Hindu Permanent Fund Ltd. formally registered with a capital of
2000 shares of 50/- each, with 4 employees.
1910 Canara Hindu Permanent Fund renamed as Canara Bank Limited
16
-
7/28/2019 THE STUDY OF RISK MANAGEMENT AND THE FACTORS OF CREDIT DEFAULT
17/76
1969 14 major banks in the country, including Canara Bank, nationalized on July 19
1976 1000th branch inaugurated
1983 Overseas branch at London inaugurated
Cancard (the Banks credit card) launched
1984 Merger with the Laksmi Commercial Bank Limited
1985 Commissioning of Indo Hong Kong International Finance Limited
1987 Canbank Mutual Fund &Canfin Homes launched
1989 Canbank Venture Capital Fund started
1989-90 Canbank Factors Limited, the factoring subsidiary launched
1992-93Became the first Bank to articulate and adopt the directive principles of Good
Banking.
1995-96 Became the first Bank to be conferred with ISO 9002 certification for one of its
branches in Bangalore
2001-02Opened a 'Mahila Banking Branch', first of its kind at Bangalore, for catering
exclusively to the financial requirements of women clientele.
2002-03Maiden IPO of the Bank
2003-04 Launched Internet Banking Services
2004-05 100% Branch computerization
2005-06Entered 100th Year in Banking Service. Launched Core Banking Solution inselect branches. Number One Position in Aggregate Business among Nationalized
Banks.
2006-07 Retained Number One Position in Aggregate Business among Nationalized
Banks. Signed MoUs for Commissioning Two JVs in Insurance and Asset Management
with international majors viz., HSBC (Asia Pacific) Holding and RobecoGroep N.V
respectively.
2007-08 Launching of New Brand Identity.Incorporation of Insurance and Asset
Management JVs. Launching of 'Online Trading' portal. Launching of a Call Centre.
Switchover to Basel II New Capital Adequacy Framework.
2008-09The Bank crossed the coveted 3 lakh crore in aggregate business. The Banks
3rd foreign branch at Shanghai commissioned.
17
-
7/28/2019 THE STUDY OF RISK MANAGEMENT AND THE FACTORS OF CREDIT DEFAULT
18/76
2009-10 The Banks aggregate business crossed 4 lakh croremark.
Net profit of the Bank crossed 3000 crore. The Banks branch network crossed the 3000
mark.
2010-11 The Banks aggregate business crossed 5 lakh croremark. Net profit of the
Bank crossed 4000 crore. 100% coverage under Core Banking Solution. The Banks 4th
foreign branch at Leicester and a Representative office at Sharjah, UAE, opened. The
Bank raised 1993 crore under QIP. Govt. holding reduced to 67.72% post QIP.
2011-12 Total number of branches reached 3600. The Banks 5th foreign branch at
Manama, Bahrain opened. .
Canara Banks rating reflects its strong market position, adequate capitalization levels,
and comfortable liquidity profile. The rating also factors the banks business profile that
is supported by a good resources position, as well as its better asset quality as compared
to its peers. Crisil also considers the Government of Indias (GoI) majority ownership of
Canara Bank to be a positive rating factor. The banks earnings profile is characterized
by moderate although improving profitability.
Among the Top 5 banks in India
Canara is Indias fifth largest bank in terms of asset size; as on March 31, 2010, it had an
asset base ofaround Rs 2.6 trillion. It is one of the few national players in the bankingindustry with a network of more than 3000 branches spread all across the country.
Canara Banks strong market position is underpinned by its nationwide presence and its
large and diversified balance sheet. This strong market position gives Canara Bank
significant advantages in raising resources, besides bringing in diversity of assets.
The banks strong market position is underpinned by its market share of over4.8% in
deposits and advances, and its panIndia branch network. The banks advances and
depositsregistered a compound annual growth rate (CAGR) of 20% and 18%,
respectively, over the past threeyears. Deposits and advances grew 25.5% and 22.5%,
respectively, yearonyear in FY10. Canara'srevenue profile is diversified across
businesses, products, and geographies. As on March 31, 2010,retail advances constituted
15% of the bank's total advances, against an industry average of around20%. Housing
18
-
7/28/2019 THE STUDY OF RISK MANAGEMENT AND THE FACTORS OF CREDIT DEFAULT
19/76
loans (direct) accounted for 42% of the retail portfolio as compared to 37% on March
31,2009.
Support from majority owner, Government of India
The Government of India (GoI) is the majority owner of Canara, with ~73.2% stake as
on March 31,2010. This gives the bank stability both on an ongoing basis and in the
event of distress. The flexibility provided by GoIs additional stake over the minimum
required holding of 51% and the banks strong
TierI base provides it with sufficient ability to absorb assetside risks. Canara's stated
posture is tomaintain a capital adequacy ratio (CAR) of above 12%. Further, GoI has
reiterated that it will takemeasures to maintain public sector banks' (PSBs) overall CAR
at around 12%, so that these banks cangrow their balance sheets and remain competitive.
Strategic tieups with international players
In 2007, Canara formed a joint venture with M/s RobecoGroep NV, for managing assets
of CanbankMutual Fund (since renamed as Canara Robeco Mutual Fund). The joint
venture gets sales support fromthe vast network of the bank. Canara also floated an
insurance JV along with HSBC Insurance (AsiaPacific) Holding Ltd and Oriental Bank
of Commerce, another nationalised bank. The company wasincorporated in September2007. Canara holds 51% stake in the insurance JV.
Adequate capitalisation levels
Canara Banks capital position is characterised by a moderate Tier I capital ratio,
reasonably large capital base, and comfortable networth coverage of net non-performing
assets (NPAs). At 7.85 per cent as at March 31, 2003, Canara Banks Tier I capital
adequacy ratio is moderate and is comparable with that of the better public sector banks.
Canara Banks reasonably large capital base of Rs 41.49 billion as at March 31, 2003
provides comfort against large asset-related shocks. The net worth coverage for net
NPAs at 2.85 times provides substantial comfort to its existing capital position.
Good resource and liquidity profile
19
-
7/28/2019 THE STUDY OF RISK MANAGEMENT AND THE FACTORS OF CREDIT DEFAULT
20/76
Canara Banks good resource profile accrues from its large and geographically well-
diversified deposit base (which emanates from its national presence), healthy resource
mix, and steady growth in deposits. Further, a significant proportion of the banks
branches (42 per cent) are in the semi-urban and rural areas, which provides it with a
relatively stable source of funds, given the limited presence of the new private sector
banks in these areas.
Canara provides various banking products and services, primarily in India and the
overseas market. In FY10, treasury operations contributed ~25% of total revenue,
retailbanking ~26%, corporate/ wholesale banking ~46% and others ~3%. Apart from
banking operations, Canara also offers factoring, insurance asset management, and retail
institutional broking services through subsidiaries and associates. In addition to overseas
branches in London, Leicester, Shangai and Hong Kong, the bank has operations
inRussia in partnership with State Bank of India. Further, the bank offers NRI services
such as deposits, loans and advances, remittance facilities, and consultancy services,
aswell as safe custody, nomination facility, attorney ship services, facilities for returning
Indians, safe deposit lockers, and investment products.
The bank provides a range of alternative delivery channels, which includes over 2,000
automated teller machines (ATMs) covering 728 centres, 1,959 branchesprovidingInternet and mobile banking (IMB) services and 2,091 branches offering
anywhere banking services. Canara was the first Indian bank to launch an intercity
ATM network. As onMarch 31, 2010, the bank had 3,046 branches well spread across
metropolitan, urban, semiurban and rural areas. The bank's international operations are
supported by 395correspondent banks spread across 80 countries. As of March 31, 2010,
Canara had 43,380 employees.
Canara Banks liquidity position continues to be comfortable, and is supported by a
steady growth in deposits, access to the inter-bank call money market, and investments
above regulatory requirements in highly liquid Government Securities. Canara Bank
made a net profit of Rs.3,283crore in 2011-12, a decline of 23 per cent over the previous
year. The growth of deposits and advances during the past year was in low double-
20
-
7/28/2019 THE STUDY OF RISK MANAGEMENT AND THE FACTORS OF CREDIT DEFAULT
21/76
digits.Total provisions amounted to Rs.2,660crore, of which NPAs accounted for
Rs.1,294 crore.
The bank had a net interest margin of 2.50 per cent in 2012, as compared to 3.12 per
cent, a year earlier. The board has maintained the dividend at Rs.11 per share for 2011-
12.
Today, Canara Bank occupies a premier position in the comity of Indian banks. With an
unbroken record of profits since its inception, Canara Bank has several firsts to its credit.
These include:
Launching of Inter-City ATM Network
Obtaining ISO Certification for a Branch
Articulation of Good Banking Banks Citizen Charter
Commissioning of Exclusive Mahila Banking Branch
Launching of Exclusive Subsidiary for IT Consultancy
Issuing credit card for farmers
Providing Agricultural Consultancy Services
Over the years, the Bank has been scaling up its market position to emerge as a major
'Financial Conglomerate' with as many as nine subsidiaries/sponsored institutions/joint
ventures in India and abroad. As at March 2010, the Bank has further expanded its
domestic presence, with 3043 branches spread across all geographical segments.
Not just in commercial banking, the Bank has also carved a distinctive mark, in various
corporate social responsibilities, namely, serving national priorities, promoting rural
development, enhancing rural self-employment through several training institutes and
spearheading financial inclusion objective. Promoting an inclusive growth strategy,
which has been formed as the basic plank of national policy agenda today, is in fact
deeply rooted in the Bank's founding principles. "A good bank is not only the financial
heart of the community, but also one with an obligation of helping in every possible
21
-
7/28/2019 THE STUDY OF RISK MANAGEMENT AND THE FACTORS OF CREDIT DEFAULT
22/76
manner to improve the economic conditions of the common people". These insightful
words of Canara bank founder continue to resonate even today in serving the society
with a purpose. The growth story of Canara Bank in its first century was due, among
others, to the continued patronage of its valued customers, stakeholders, committed staff
and uncanny leadership ability demonstrated by its leaders at the helm of affairs. The
bank strongly believes that the next century is going to be equally rewarding and
eventful not only in service of the nation but also in helping the Bank emerge as a
"Global Bank with Best Practices". This justifiablebelief is founded on strong
fundamentals, customer centricity, enlightened leadership and a family like work culture.
22
-
7/28/2019 THE STUDY OF RISK MANAGEMENT AND THE FACTORS OF CREDIT DEFAULT
23/76
Scope Importance and Objective of Study
During the last decade, importance of risk management in credit has increased for both
borrowers and lenders, especially, in the developing countries. For this reason, banks and
financial institutions started to revise their lending policies. There are basically six
functional responsibilities associated with credit lending activities;
(1)Assessment of the customers credit risk,
(2) Making the credit granting decision with regard to credit terms and, where relevant,
credit limits,
(3) Collecting receivables (debts) as the fall due and taking action against defaulters,(4) Monitoring customer behavior and compiling management information,
(5) Bearing the risk of default or bad debt,
The study focuses on collecting statistical data on consumer behavior, evaluating the
collected data and trying to find managerial outcomes. These outcomes enable financial
institutions to evaluate alternative lending policies and minimize their credit default risks
in credit types such as home loans, car loans, and personal loans. More specifically, this
study aims to examine the relationship between the consumer credit payment
performance and some demographic variables (such as marital status, sex, residential
status, occupation, Education) and some financial variables (such as income, loan size,
interest rate, credit category).
The present study is important for two reasons. First, many previous studies and
financial institutions have focused on the relationship between lenders decision and the
characteristics of the consumer credit applicants rather than the relationship between
payment performance of the consumer credit and their characteristics. It is, of course,
important to get some information about the relationship between characteristics of
people apply for consumer credit (applicants) and to whom the credit will be given.
However, it is equally beneficial to have an idea about the relationship between the
23
-
7/28/2019 THE STUDY OF RISK MANAGEMENT AND THE FACTORS OF CREDIT DEFAULT
24/76
characteristics of people that are already accepted (clients) and whether they are paying
back their loans on time or not i.e. payment performance.
To some extent, this kind of testing whether the decision of accepting/rejecting (or the
decision criteria) the applicants is the right one or not we dont know correctly.
Therefore, investigating the effects of some characteristics of credit clients on clients
payment performance becomes crucial.
Second, by ranking customers according to predicted default probabilities, a bank will
have a chance to minimize the expected default or misclassification.
As a reaction to an increasing competition and bankruptcies, banks all over the world
are trying hard to improve the process of loan origination in corporate banking.
Practitioners estimate that improvements in risk management can decrease credit losses
by 20 to 40%.
OBJECTIVES:-
To formulate a method so as to identify the potential NPAs and the factors
responsible loan defaults with the help of logistic regression model
To have in-depth understanding of the different type of risks that pose threat to
banks.
To have profound understanding existing system of risk management prevailing
in the bank.
Getting a real time exposure of the corporate world and the processes in the
company which will help me in relating the classroom teaching with the practical
world for the better understanding of things.
Having an experience in a Banking company will help me in pursuing a career in
this industry which has a very high growth potential and an immense career
opportunities in the near future.
24
-
7/28/2019 THE STUDY OF RISK MANAGEMENT AND THE FACTORS OF CREDIT DEFAULT
25/76
EVOLUTION, ORIGIN & DEVELOPMENT OF
RISK MANAGEMENT
The word risk is derived from an Italian word risicare which means, "to dare". This
means that risk is more a choice than a fate. Extending this analogy further we can
say that risk is not something to be faced but a set of opportunities open to choice.
There is no single definition that captures the entire spectra of what constitutes risk. The
Bank for International Settlement (BIS) definition, which is widely accepted, reads thus
"Risk is the threat that an event or action will adversely affect an organizations ability to
achieve its objectives and successfully execute its strategies".
A very wider definition of risk is Risk is nothing but the certainty of anexposure to
uncertainty.
Risk Management:-
Managing the risks commences with the task of identifying all the possible risks in our
activities. The next task would be to list out the controls in place against each of the
identified risks. Making an assessment of the controls in place versus the identified risks
for adequacy follows this.
The risk identification and assessment is a dynamic exercise and must be carried out at
regular intervals aiming at continuous refinement of our procedures in tune with the risks
perceived. Risks also need to be measured to not only ascertain their financial impact on
25
-
7/28/2019 THE STUDY OF RISK MANAGEMENT AND THE FACTORS OF CREDIT DEFAULT
26/76
our resources but also to aid in pricing our products. Finally a system should be in place
to monitor/review the above processes.
History of Risk Management in Banks: The origin and development of risk
management in Banks in a chronological order. For this purpose the subject is divided
into the following periods,
1970s and BCBS, Basel Accord I, Events of 1990s, Basel Accord II
1970s and BCBS:: The first major Bank event that opened the eyes of financial sector
was that of Bank Herstatt of Germany, which was forced by German regulators intoliquidation. The G-10 countries and Luxembourg formed a committee under the auspices
of Bank for International Settlements (BIS), called Basel Committee on Banking
Supervision (BCBS) to promote stability in the global banking system. The committee
meets regularly four times a year. It has about thirty technical working groups and task
forces, which also meet regularly. The two main objectives of the committee at the time
of its formation were
No foreign Banking system should escape supervision
Supervision must be adequate for all Banks operating internationally
BCBS engaged itself in formulating standards, guidelines and best practices with the
expectation that respective central banks will implement them to best suit their national
systems.
Basel Accord I:: Pursuing the goal of creating a level competitive field for all Banks,BCBS published a credit risk framework to guide the allocation of capital reserves for all
internationally active Banks. This popularly came to be known as Basel I accord. The
Basle I framework defined two minimum standards for acceptable Capital adequacy
requirements.
26
-
7/28/2019 THE STUDY OF RISK MANAGEMENT AND THE FACTORS OF CREDIT DEFAULT
27/76
Risk based capital ratio & Asset to capital multiple
Risk based capital ratio is defined as the ratio of capital to risk weighted assets. Assets
means both on balance sheet items(Loans, advances and investments etc) and off balance
sheet exposures(Guarantees and Letters of credit etc).As per the accord Banks had to
hold a minimum capital of 8% over the risk weighted assets. Out of the minimum capital
to be held at least 4% of it should be in the form of Tier I capital. The asset to capital
multiple was set at 12.5.Tier II capital is limited to 100% of Tier I capital
Capital Adequacy Ratio(CAR) = Capital divided by Credit risk
Capital = Tier I Capital + Tier II Capital
Credit risk = Sum of Risk Weighted Assets (RWA)
Risk Weighted assets = Exposure X Supervisor determined risk weights.
Capital ratio Minimum 8% as per Basel. and 9% as per RBI
In India Basel I accord, was implemented through the Narasimham Committee
Recommendations introducing Prudential Norms such as Asset Classification, Income
Recognition & Capital Adequacy Ratio. CAR of 9 % was stipulated by Reserve Bank of
India. Basel I met the following objectives:
o Strengthened the capital base of Banks
o Created clear and uniform guidelines for all Banks world over
o Reduced competitive distortion among banks
Capital brought in by the above formula is known as Regulated Capital as risk weights
are prescribed by the regulator of the respective countries ( In India RBI)
Events of 1990s:: In the 1990s many loss incidents were witnessed in the financial
sector. Failure of Barings Bank, BCCI, Sumitomo Bank and Daiwa Bank are some of the
27
-
7/28/2019 THE STUDY OF RISK MANAGEMENT AND THE FACTORS OF CREDIT DEFAULT
28/76
examples. BCBS continued its efforts to suggest measures and remedies to strengthen
the Banking system world over. In January 1996 BCBS came out with amendment to the
1988 accord to incorporate Market risks.
Accordingly RBI introduced Asset Liability Management for Banks in India to address
Liquidity and Interest rate risks with effect from 1.04.1999.
Basel New Accord:: Towards the end of 20th century banking operations witnessed
significant changes like::
Deregulated environment
Liberalization, Privatization and Globalization
Technology boost leading to introduction of sophisticated and complex products
Expansion and foray into new types of activities
Basel I though a revolutionary move of earlier times, it suffered from many
shortcomings which have ignored the above changes. The short comings of Basel I
are:
Non-recognition of Operational risk
Ignoring of the Risk management advancements
Capital reserve inaccuracies
In 1999 BCBS came out with fresh proposals to align the capital held by banks more
closely with the risks faced by them. This is popularly known as Basel New Accord. The
proposals had three stages of consultation and have finally found approval on
26.06.2004.The proposals of the new accord have to be implemented by 01 04 2007.
These proposals stand on three reinforcing pillars namely
28
-
7/28/2019 THE STUDY OF RISK MANAGEMENT AND THE FACTORS OF CREDIT DEFAULT
29/76
Minimum Capital Requirements
Supervisory Review
Market Discipline
Pillar I Minimum Capital Requirements:: Prescribes the various approaches in the
order of risk sensitivity for measuring credit and operational risk, thus enabling banks to
move from Regulated Capital to Economic Capital.
Pillar II Supervisory Review:: This pillar of the Accord aims at not only ensuring
that Banks are capital adequate in terms of risks faced but also encourages them to use
better risk management techniques in monitoring and managing their risks. Another
important aspect of pillar II is the assessment of compliance with the minimum standards
and disclosure requirements for pursuing advanced measurement approaches as
mentioned above. National supervisor i.e., Reserve Bank of India will ensure that these
requirements are met both as qualifying criteria and on a continuous basis.
29
-
7/28/2019 THE STUDY OF RISK MANAGEMENT AND THE FACTORS OF CREDIT DEFAULT
30/76
-
7/28/2019 THE STUDY OF RISK MANAGEMENT AND THE FACTORS OF CREDIT DEFAULT
31/76
RISK MANAGEMENT IN BANKS
Operating in a liberalized & globalized environment banks are exposed to various kinds
of risks that can emanate from financial & non-financial factors. Generally risks faced by
banks are grouped in clearly identifiable categories which include
a) credit risk b) market risk and c) operational risk.
With progressive de-regulation, cross border dealings, globalization, introduction of
wide range of products & services, improvement in technology & communications,
significant changes have occurred in the balance sheets of banks. Risks faced by banks
have now increased manifold posing significant challenges to both banks & supervisors.
To respond to these challenges there have been various supervisory initiatives to
introduce better operating standards in banks, greater transparency & sensitivity towards
risk management by banks.
The risks faced by banks can be categorized under two risk groups:
1) Business risks which are inherent in the activities that banks undertake.
2) Control risks that arise out of inadequacy, break down or absence of variouscontrols that are used to mitigate business risks.
Inherent business risks include credit risk, market risk, liquidity risk, operational risk,
strategy & business environment risk, group risk etc.
Control risks include breakdown of internal controls & risk related to organization
structure & management.
The impact of losses on account of various risks get reflected in a banks earnings &
capital. As such, while earnings & capital do not represent risk per se, since they bear the
impact of various risks their assessment in relation to risk management is important.
Hence capital & earnings have been included under business risks.
31
-
7/28/2019 THE STUDY OF RISK MANAGEMENT AND THE FACTORS OF CREDIT DEFAULT
32/76
i) CREDIT RISK:: Credit risk represents the major risk faced by banks
on account of nature of their business activity, which includes dealing with or lending to
a corporate, another bank, financial institution or a country. Credit risk may be carried in
banking book or the trading book or in the off balance sheet items. Credit risk includes:
a) COUNTER PARTY RISK- The possibility that a borrower or counter party will
fail to meet obligations in accordance with agreed terms. It may also be reflected in
the down grading of the standing of the counter party making him more vulnerable to
possibility of defaults.
b) PORTFOLIO RISK Due to adverse credit distribution, credit Concentration /
investment concentration .
c) COUNTRY RISK The possibility that a country will be unable to service or repay
its debts to foreign lenders in a timely manner.
ii) MARKET RISK:: Market risk is the potential of erosion of income or market
value of an asset arising due to changes in market variables such as interest rate, foreignexchange rate, equity prices & commodity prices.
a) Interest rate risk The risk in the erosion of earnings due to variation in
the interest rate with in a given time zone. Interest rate risk may arise on account of gap
or mismatch risk, basis risk, embedded options risk, yield curve risk etc.
b) Foreign exchange risk The holdings of foreign exchange assets or
liabilities, not been hedged against movement in exchange rates. This position is
referred to as open position. Forex risk affects both spot & forward positions of the bank.
Forex risk includes settlement risk, time zone risk & translation risk.
32
-
7/28/2019 THE STUDY OF RISK MANAGEMENT AND THE FACTORS OF CREDIT DEFAULT
33/76
c) Equity price risk- Potential of an institution to suffer losses on its exposure to
capital markets, from adverse movements in the prices of equity.
d) Commodity price risk The potential of adverse movements in prices of physical
products, which are or can be traded in the secondary markets like agricultural
products, minerals & oils, precious metal.
iii). LIQUIDITY RISK Possibility that a bank may be unable to meet its liabilities as
they become due for payment or may be able to fund the liabilities at a cost much higher
than the normal cost. The risk arises due to mismatch in the timing if inflows & outflows
of funds, and from funding of long term assets from short term liabilities. Surplus
liquidity could also represent a loss to the bank in terms of earnings missed & hence an
earning risk.
iv). STRATEGY & BUSINESS ENVIRONMENT RISK May arise due to
inappropriate or non-viable business strategy adopted by the bank/ its absence altogether
& the business environment that the bank operates in, including the business cycle that
the economy may be passing through. A dynamic & viable medium term strategy
formulated on the basis of proper research & planning, identifying target areas, markets,products, customer base etc is necessary for effective risk management. Lack of the same
may pose a significant risk to the earnings & viability of the bank.
v). OPERATIONAL RISK May arise due to inadequate or failed internal processes,
people & systems or from external events. It includes People risk ( incompetence, frauds,
work environment, motivation ), Operational control risk ( failure of operational
controls, volumes ),Model risk ( model application error, methodology error ). Apart
from the above the following are also covered under operational risk.
a) Legal risk May arise due to the possibility of actions of a bank not being in
conformity with the laws of a country or being in violation thereof. The bank can also
experience legal risk when customers approach court of law for redressal of their
33
-
7/28/2019 THE STUDY OF RISK MANAGEMENT AND THE FACTORS OF CREDIT DEFAULT
34/76
grievances where transactions with its counter parties are not supported by proper
documents or the terms of the contract are unclear or even due to lack of well established
legal pronouncements in cases where issues involved are nebulous.
b) Reputational risk The financial implications of a moral obligation cast on
a bank in the environment it is functioning or by virtue of its association with another
organization is called reputational risk. Reputational risk is the potential of suffering loss
due to significant negative public opinion, bad or wrong publicity.
c) Technological risk Arising out of IT related factors like validity of IT
systems, back up & disaster recovery systems, failure of systems, security of systems,
programming errors etc. It can also arise due to obsolescence of technology being used,
technology not being in alignment with business needs or adoption of untried & untested
technology, inability of the staff to respond to new technology etc.
vi). GROUP RISK Arising on account of financial implications being cast on the bank
due to its obligations to other entities in the group or due to contagion effect. A bank
may have various domestic/over seas subsidiaries dealing in mutual funds, merchant
banking services, housing finance, gilt securities, banking services etc. Since there are,as yet, no rigorous capital adequacy norms & prudential regulations governing
subsidiaries, the parent bank is exposed to the risk of rescue operations whenever a
subsidiary runs in to losses/ needs fresh injection of funds.
vii). EARNINGS RISK It can be assessed through assessment of fund cost & return,
assessment of earnings & expenses and assessment of earnings quality & stability.
viii). CAPITAL INADEQUACY RISK Capital of bank is a cushion against
unexpected losses. The volume of capital determines the direction & magnitude of future
growth of business of a bank. Though capital does not represent business risk, since it
bears the impact of other risks its adequacy or inadequacy is a material in the risk
assessment of a bank.
34
-
7/28/2019 THE STUDY OF RISK MANAGEMENT AND THE FACTORS OF CREDIT DEFAULT
35/76
CONTROL RISKS.
i) Internal control risk Arising on account of failure of internal control system
of the bank. Weakness in internal controls have been historically recognized as a high
risk factor. It requires special attention due to its high potential to inflict heavy losses on
a bank on account of failure of various control systems.
ii) Organization risk Arising on account of organizational bottlenecks in the form
of inadequate or inappropriate structure in relation to its business and the quality of its
external & internal relationships. The organization structure needs to be clear and in tune
with the legal & business requirements of the bank .The organization should be flexible
to meet the challenges.
iii) Management risk Arising out of poor quality and lack of integrity of
management. It is reflected in quality of senior management personnel, their leadership,
competence, integrity and their effectiveness in strategizing, delivering & dealing with
the problems.
iv) Compliance risk Arising out of non-compliance with various requirements onaccount of authorisation, statutory requirements, prudential operations & supervisory
directives/guidance.
RISK MANAGEMENT ARCHITECTURE:
The effectiveness of risk management systems depends to a large extent on having in
place appropriate and effective risk management architecture. It should at the minimum
include the following:
i) Risk management policies.
ii) Board of directors & Senior management commitment.
iii) Effective organization structure for risk management.
iv) Effective risk management processes & systems.
35
-
7/28/2019 THE STUDY OF RISK MANAGEMENT AND THE FACTORS OF CREDIT DEFAULT
36/76
v) Human resources & training.
vi) In-house monitoring.
RISK MANAGEMENT POLICIES: Bank should have appropriate risk management
policies in place. The risk management policy document should broadly cover the
followings:
a) Identify the risks that are to be measured & monitored.
b) Define risk tolerance level for the bank.
c) Specify the methodology for measuring the various risks and specifically approve the
methodology or models to be used.
d) Provide for exception reporting to top management when the allocated limits are
breached.
e) Indicate the process to be adopted for immediate corrective action.
f) Set up an organizational structure for risk management including delegation of
powers & responsibilities for risk monitoring & control.
g) Provide detailed guidelines for proper data collection, collation & updating.
h) Specify a separate organizational unit for validation & review of the risk monitoring
techniques used.
i) Specify system for comprehensive review of risk management & risk control &
report to the board.
36
-
7/28/2019 THE STUDY OF RISK MANAGEMENT AND THE FACTORS OF CREDIT DEFAULT
37/76
BOARD OF DIRECTORS AND SENIOR MANAGEMENT COMMITMENT: The
Board should set various risk limits by assessing the banks risk appetite, skills available
& risk bearing capacity represented by capital. It should also set up appropriate
procedures for management of the risks. This calls for clear lines of responsibility for
managing risk, adequate systems for measuring risk, appropriately structured limits on
risk taking, effective internal controls & a comprehensive risk reporting process.
The Board should ensure that senior management attends to its responsibilities
concerning risk management & internal control and frequently reviews the effectiveness
of the system. It also needs to make a periodical review of risk management policies,
control systems in place, clarity of various reporting lines, adequacy of monitoring
mechanisms, adherence to policies, procedures & limits by operational departments and
adequacy of management responses on identified weaknesses.
RISK MANAGEMENT ORGANIZATION : At the apex of the risk management
organization of a bank should be the Risk Management Committee, which generally
comprises the Managing Director, Heads of business units of the bank and Head of Risk
Management. It can also include some members of the Board. The RMC is responsible
for supervising the activities & operations of all committees entrusted with riskmanagement functions with in the bank. These committees include Credit Risk
Management Committee, Asset Liability Management Committee and the Operational
Risk Control Function.
The Risk Management Department supports the activities of Risk Management
Committee through research on & analysis of risks, reporting risk positions & making
recommendations as to the level & degree of risk to be assumed. RMD has the
responsibility to identify, measure & monitor the risks faced by the bank, develop &
issue policies and procedures, verify the models that are to be used for risk measurement
& pricing complex products and identify new risks as a result of emerging markets &
new products.
37
-
7/28/2019 THE STUDY OF RISK MANAGEMENT AND THE FACTORS OF CREDIT DEFAULT
38/76
Under RMD, there may be independent groups/departments for supporting the
committees for specific risks ie. Credit risk, Market risk and Operational risk.
The Credit Risk Management Department may be supported by Risk Planning Cell,
Risk Assessment & Monitoring Cell, Risk Analytic Cell & Credit Risk Systems Cell.
RISK MANAGEMENT PROCESSES & SYSTEMS:
a) Risk Identification: The first step for risk management process is to identify all risks
to which the bank is exposed. The activities undertaken by the bank as well as the new
activities that the bank proposes to enter in to as observed from the balance sheet & other
records should be systematically examined to identify all kinds of risks faced by the
bank. The bank will have to proceed in systematic manner across all its activities both
on assets and liabilities, including off balance-sheet items to ensure that there is no
activity of the bank omitted from risk management.
b) Risk measurement: Banks should have proper systems in place to measure the risks
identified as arising from various activities. For this, banks may develop risk
management techniques that are appropriate to the size & complexities of theirportfolios, resources & data availability. The methodologies of risk measurement may
range from a simple assessment on the basis of certain qualitative & quantitative criteria
compared with certain pre-set standards/bench marks to sophisticated
statistical/mathematical models.
c) For measuring credit risk traditional methods involve financial analysis in
conjunction with credit rating framework to arrive at risk aggregation, pricing & other
decisions. On the other hand there are several other new techniques in the nature of
quantitative models using econometric, mathematical programming or simulation
methodologies for decision making.
38
-
7/28/2019 THE STUDY OF RISK MANAGEMENT AND THE FACTORS OF CREDIT DEFAULT
39/76
d) For interest rate/forex/market risk measurement, some of the standard techniques
used are maturity gap analysis, duration gap analysis, value-at-risk approach etc.
e) Risk monitoring & control: Controlling the risk with in the parameters & limits set
by the Competent Authority is the ultimate objective of the risk management exercise.
Risk monitoring & control involves
i) Limit setting each bank should determine for itself what is the maximum level of
risk it can face given the level of its capital. Fixation of risk level has a great
significance since capital is subject to erosion if risks actually materialise. The limits
could be fixed in terms portfolio standards for credit risk or setting limit for value at risk
in respect of credit risk, earning risk & market risk.
ii).Monitoring once limits are fixed, the actual performance/utilization needs to be
compared against the limits for risk monitoring. The results of such comparisons will
reveal the exceptions, which may be investigated for reasons of material deviations and
reported to the proper authority for remedial action. Tracking of risk migrations upward
or downward is another aspect of risk mitigation.
iii).Reporting & MIS the existence of strong MIS that captures relevant information
and data is an important pre-requisite for effective risk control. However, the accuracy of
data, the frequency of revision of data/information and its timely availability are
important factors that determine the efficacy of the risk monitoring & control process.
iv). Risk mitigation the essential aspect of risk monitoring & control is to take
corrective action for bringing down risk to manageable levels if it is considered high.
The various ways of risk mitigation are reduction in exposure to a particular industry,
stepping up of recoveries to bring down NPAs, acceptance of collaterals, reducing open
positions in foreign currencies .etc.
39
-
7/28/2019 THE STUDY OF RISK MANAGEMENT AND THE FACTORS OF CREDIT DEFAULT
40/76
HUMAN RESOURCES & TRAINING:: with banks gradually refining their risk
management systems & the impending introduction of risk based supervision of banks
by RBI, the need of understanding the risks m the process of their management &
control and the increasing use of sophisticated tools for measuring & managing the
risks, bank should have specialised staff adequately trained to discharged various risk
management functions.
Since specialization develops over time, identification and positioning core staff for risk
management as well as availability of second line of support are crucial for effective risk
management.
IN-HOUSE MONITORING:: The risk management process needs to be reviewed
periodically by an independent group of executives to ensure that all important elements
of risk management process are functioning effectively/efficiently and the risk as
measure through the process is the actual risk/close to the actual risks faced by Bank.
40
-
7/28/2019 THE STUDY OF RISK MANAGEMENT AND THE FACTORS OF CREDIT DEFAULT
41/76
CREDIT RISK
The banks and financial institution have faced difficulties over the years for several
reasons. The major causes continue to be directly related to the low quality of credit,poor portfolio risk management besides insensitivity to changes in economic and other
circumstances. Loans and Advances are the most obvious source of Credit Risk.
Focused attention on credit delivery, recovery and review are pre requisite for effective
Credit Management. Therefore Credit Risk is the critical component of Integrated Risk
Management. The success of integrated Risk Management largely depends on effective
handling of Credit Risk.
Definition of Credit Risk: Credit Risk is defined as The inability or unwilling ness
of the customer or counter party to meet commitments in relation to lending,
hedging, settlement and other financial transactions.
Hence credit risk emanates when the counter party is unwilling or unable to meet or
fulfill the contractual obligations/ commitments thereby leading to defaults. Credit Risk
of a Bank depends upon several External and Internal factors. These External or Internal
factors are related both to the borrower & the bank.
Internal factors (Applicable to Banks):: Deficient loan policies, Inadequately defined
powers for sanction of loans, Absence of prudential credit concentration limits, Absence
of credit committees, Deficiency in credit appraisal systems, Excessive dependence on
collaterals, Inadequate/lack of risk pricing, Absence of loan review mechanism and post
sanction surveillance
External factors (Applicable to Borrowers) :: Inadequate technical know-how,
Locational disadvantages, Outdated production process, High input costs, Break Even
Point being very high, Uneconomic size of plant, Large investment in Fixed Assets,
Over estimation of demand, wide swings in commodity or equity prices.
41
-
7/28/2019 THE STUDY OF RISK MANAGEMENT AND THE FACTORS OF CREDIT DEFAULT
42/76
-
7/28/2019 THE STUDY OF RISK MANAGEMENT AND THE FACTORS OF CREDIT DEFAULT
43/76
-
7/28/2019 THE STUDY OF RISK MANAGEMENT AND THE FACTORS OF CREDIT DEFAULT
44/76
8. Transaction Risk: The very nature of transaction some times has an intrinsic
risk like:
Granting of clean or unsecured loan
Discounting of a supply bill
Book debt finance to individuals & proprietary concerns
9. Economic Scenario /Government Policies/ Trade Restrictions: The changes in
economic scenario or the Government policies or the trade restrictions imposed by
different countries which are beyond the control of either the Bank or the Borrower may
adversely affect the business or activity which might cause default leading to Credit
Risk.
Credit risk is having two components. The first is the solvency aspect of credit risk,
which relates to the risk that the borrower is unable to repay in full the sum outstanding.
The second is the liquidity aspect of credit risk that arises when the payment due from
the borrower are delayed leading to cash flow problems for the lender. The liquidity and
solvency risks are closely related.
In order to meet the short liquidity needs, a firm may have to undertake fire-sale of
assets which might fetch a lower amount for the assets sold as compared to the sale of
assets under normal circumstances. This could lead to a situation of technical
insolvency where the realizable value of assets may be less than the value of liabilities.
This problem is more pronounced in case of banks as their balance sheet contains assets (
like loans and investment etc ) which fluctuate in value where as the value of deposits
remains constant and in fact might grow on account of interest element. Thus what may
appear to be liquidity risk in the beginning may turn in to solvency risk over a period of
time.
44
-
7/28/2019 THE STUDY OF RISK MANAGEMENT AND THE FACTORS OF CREDIT DEFAULT
45/76
-
7/28/2019 THE STUDY OF RISK MANAGEMENT AND THE FACTORS OF CREDIT DEFAULT
46/76
of Expected Losses and Unexpected Losses. In turn these are calculated by Probability
of Default (PD), Loss Given Default(LGD) and Exposure at Default (EAD)
Banks which comply with certain minimum requirements like Comprehensive Credit
rating system shall be permitted to adopt the Foundation Approach. Under this approach,
the rating system adopted by the banks shall be capable of quantifying the Probability of
Default, whereas the LGD and EAD are provided by RBI.
Under Advanced Measurement Approach, banks will be allowed to use the internal for
calculation of PD, EAD, LGD for assigning the risk weights and they will be validated
by RBI.
However for adopting the IRB Approach, banks should build up historical data base on
the Portfolio quality/Provisioning/Write offs etc.
46
-
7/28/2019 THE STUDY OF RISK MANAGEMENT AND THE FACTORS OF CREDIT DEFAULT
47/76
NON-PERFORMING ASSETSAll the risk management activities are done in order to avoid the occurrence of potential
default or occurrence of Non-performing Assets. A Non-performing asset (NPA) is
defined as a credit facility in respect of which the interest and/or instalment of principal
has remained past due for a specified period of time. For the identification of NPA
and with a view to moving towards international best practices and to ensure greater
transparency, it has been decided to adopt the 90 days overdue norm for identification,
from the year ending March 31, 2004. Accordingly, with effect from March 31, 2004, a
non-performing asset (NPA) shall be a loan or an advance where;
Interest and/or installment of principal remain overdue for a period of more than
90 days in respect of a term loan,
The account remains out of order for a period of more than 90 days, in respect
of an Overdraft/Cash Credit (OD/CC),
The bill remains overdue for a period of more than 90 days in the case of bills
purchased and discounted,
Interest and/or installment of principal remains overdue for two harvest seasons
but for a period not exceeding two half years in the case of an advance granted for
agricultural purposes, and
Any amount to be received remains overdue for a period of more than 90 days in
respect of other accounts.
The banking industry has undergone a sea change after the first phase of economicliberalization in 1991 and hence credit management. While the primary function of
banks is to lend funds as loans to various sectors such as agriculture, industry, personal
loans, housing loans etc., in recent times the banks have become very cautious in
extending loans. An NPA is defined as a loan asset, which has ceased to generate any
income for a bank whether in the form of interest or principal repayment. As per the
47
-
7/28/2019 THE STUDY OF RISK MANAGEMENT AND THE FACTORS OF CREDIT DEFAULT
48/76
prudential norms suggested by the Reserve Bank of India (RBI), a bank cannot book
interest on an NPA on accrual basis. In other words, such interests can be booked only
when it has been actually received. Therefore, this has become what is called as a
critical performance area of the banking sector as the level of NPAs affects
theprofitability of a bank.
Therefore, an NPA account not only reduces profitability of banks by provisioning in the
profit and loss account, but their carrying cost is also increased which results in excess
&avoidable management attention. Apart from this, a high level of NPA also puts strain
on the banks net worth because banks are under pressure to maintain a desired level of
Capital Adequacy and in the absence of comfortable profit level; banks eventually look
towards their internal financial strength to fulfill the norms thereby slowly eroding the
net worth.
Today the Net NPAs of Indian PSBs (which account for around three-fourths of the total
assets of Indian banking industry) are as low as 0.72 per cent and gross NPAs are at 2.5
per cent. However, NITSURE (2007) contends that once there is a slowdown in private
expenditure and corporate earnings growth, companies on these banks books will not be
in a position to service their debts on time and there is a strong likelihood of generation
of new NPAs. Moreover, he also suggests that with rising interest rates in the
government bond market, the banks treasury incomes have declined considerably. Sobanks will not have enough profits to make provisions for NPAs. Under these
circumstances, management of NPAs is a difficult task.
Classification
Banks are required to classify non-performing assets further into the following three
categories based on the period for which the asset has remained non-performing and the
realisability of the dues:
Sub-standard Assets
Doubtful Assets
Loss Assets
48
-
7/28/2019 THE STUDY OF RISK MANAGEMENT AND THE FACTORS OF CREDIT DEFAULT
49/76
Sub-standard: The account holder comes in this category when they dont pay three
installment continuously after 90 days and upto 1year. for this category bank has
made 10% provision of funds from their profit(10% of its reserves.) to meet the
losses generated from NPA.In the case of term loan, if installments of principal are
overdue for more than one year but not exceeding two years, it is to be treated as
sub-standard asset. An asset where the terms of the loan agreement regarding interest
and principal have been re-negotiated or re-scheduled should be classified as sub-
standard and should remain in such category for at least two years of satisfactory
performance under the re-negotiated or rescheduled terms. In other words, the
classification of assets should not be upgraded merely as a result of re-scheduling
unless there is satisfactory compliance of the above condition.
Doubtful NPA: An asset, which remains NPA for more than two years. Here too,
rescheduling does not entitle a bank to upgrade the quality of an advance
automatically.In the case of a term loan, if installments of principal are overdue for more
than two years, it is to be treated as doubtful.Under doubtful NPA there are three sub
categories :
D1 i.e. up to 1 year : 20% provision is made by the banks
D2 i.e. up to 2 year: 30% provision is made by the bank
D3 i.e. up to 3 year : 100% provision is made by the bank.
Loss Assets: Under this 100% provision is made. When account holder comes in this
category their account can be written off by the banks. After this the assets are handed
over to recovery agents for sale. An asset where loss has been identified by the bank or
internal/