GUIDANCE NOTE ON CREDIT RISK MANAGEMENT

GUIDANCE NOTE ON CREDIT RISK MANAGEMENT

Chapter 1 - Policy Framework

1.1 Credit risk is defined as the possibility of losses associated with diminution in the credit quality of borrowers or counterparties. In a bank’s portfolio, losses stem from outright default due to inability or unwillingness of a customer or counterparty to meet commitments in relation to lending, trading, settlement and other financial transactions. Alternatively, losses result from reduction in portfolio value arising from actual or perceived deterioration in credit quality. Credit risk emanates

from a bank’s dealings with an individual, corporate, bank, financial institution or a sovereign. Credit risk may take the following forms:

Þ        in the case of direct lending: principal/and or interest amount may not be repaid;

Þ        in the case of guarantees or letters of credit: funds may not be forthcoming from the constituents upon crystallization of the liability;

Þ        in the case of treasury operations: the payment or series of payments due from the counter parties under the respective contracts may not be forthcoming or ceases;

Þ        in the case of securities trading businesses: funds/ securities settlement may not be effected;

Þ        in the case of cross-border exposure: the availability and free transfer of foreign currency funds may either cease or restrictions may be imposed by the sovereign.

1.2 In this backdrop, it is imperative that banks have a robust credit risk

management system which is sensitive and responsive to these factors.

The  effective   management  of   credit   risk   is  a  critical   component    of

comprehensive  risk  management   and   is  essential  for   the  long    term

success    of    any    banking   organisation.    Credit    risk    management

encompasses identification, measurement, monitoring and control of the

credit risk exposures.

1.3 Building Blocks of Credit Risk Management:

In a bank, an effective credit risk management framework would comprise

of the following distinct building blocks:

a)    Policy and Strategy

b)   Organisational Structure

c)    Operations/ Systems

1.4  Policy and Strategy

The Board of Directors of each bank shall be responsible for approving

and periodically reviewing the credit risk strategy and significant credit

risk policies.

1.4.1 Credit Risk Policy

v  Every bank should have a credit risk policy document approved by the Board. The document should include risk identification, risk measurement, risk grading/ aggregation techniques, reporting and risk control/ mitigation techniques, documentation, legal issues and management of problem loans.

v  Credit risk policies should also define target markets, risk acceptance criteria, credit approval authority, credit origination/ maintenance procedures and guidelines for portfolio management.

v  The credit risk policies approved by the Board should be communicated to branches/controlling offices. All dealing officials should clearly understand the bank’s approach for credit sanction and should be held accountable for complying with established policies and procedures.

v  Senior management of a bank shall be responsible for implementing the credit risk policy approved by the Board.

1.4.2 Credit Risk Strategy

v  Each bank should develop, with the approval of its Board, its own credit risk strategy or plan that establishes the objectives guiding the bank’s credit-granting activities and adopt necessary policies/ procedures for conducting such activities. This strategy should spell out clearly the organisation’s credit appetite and the acceptable level of risk-reward trade-off for its activities.

v  The strategy would, therefore, include a statement of the bank’s willingness to grant loans based on the type of economic activity, geographical location, currency, market, maturity and anticipated profitability. This would necessarily translate into the identification of target markets and business sectors, preferred levels of diversification

and concentration, the cost of capital in granting credit and the cost of bad debts.

v  The credit risk strategy should provide continuity in approach as also take into account the cyclical aspects of the economy and the resulting shifts in the composition/ quality of the overall credit portfolio. This strategy should be viable in the long run and through various credit cycles.

v  Senior management of a bank shall be responsible for implementing the credit risk strategy approved by the Board.

1.5 Organisational Structure

Sound organizational structure is sine qua non for successful implementation of an effective credit risk management system. The organizational structure for credit risk management should have the following basic features:

The Board of Directors should have the overall responsibility for management of risks. The Board should decide the risk management policy of the bank and set limits for liquidity, interest rate, foreign exchange and equity price risks.

The Risk Management Committee will be a Board level Sub committee including CEO and heads of Credit, Market and Operational Risk Management Committees. It will devise the policy and strategy for integrated risk management containing various risk exposures of the bank including the credit risk. For this purpose, this Committee should effectively coordinate between the Credit Risk Management Committee (CRMC), the Asset Liability Management Committee and other risk committees of the bank, if any. It is imperative that the independence of this Committee is preserved. The Board should, therefore, ensure that this is not compromised at any cost. In the event of the Board not accepting any recommendation of this Committee, systems should be put in place to spell out the rationale for such an action and should be properly documented. This document should be made available to the internal and external auditors for their scrutiny and comments. The credit risk strategy and policies adopted by the committee should be effectively communicated throughout the organisation.

1.5.1 Each bank may, depending on the size of the organization or loan/

investment  book,   constitute   a  high  level     Credit   Risk  Management

Committee   (CRMC).      The   Committee   should   be    headed   by      the

Chairman/CEO/ED, and should comprise of heads of Credit Department,

Treasury, Credit Risk Management Department (CRMD) and the Chief

Economist.  The  functions  of  the  Credit  Risk  Management  Committee

should be as under:

v  Be responsible for the implementation of the credit risk policy/ strategy approved by the Board.

v  Monitor credit risk on a bank wide basis and ensure compliance with limits approved by the Board.

v  Recommend to the Board, for its approval, clear policies on standards for presentation of credit proposals, financial covenants, rating standards and benchmarks,

v  Decide delegation of credit approving powers, prudential limits on large credit exposures, standards for loan collateral, portfolio management, loan review mechanism, risk concentrations, risk monitoring and evaluation, pricing of loans, provisioning, regulatory/legal compliance, etc.

1.5.2   Concurrently,   each   bank   should   also   set   up     Credit   Risk

Management    Department       (CRMD),    independent    of    the       Credit

Administration Department. The CRMD should:

v  Measure, control and manage credit risk on a bank-wide basis within the limits set by the Board/ CRMC

v  Enforce compliance with the risk parameters and prudential limits set by the Board/ CRMC.

v  Lay down risk assessment systems, develop MIS, monitor quality of loan/ investment portfolio, identify problems, correct deficiencies and undertake loan review/audit. Large banks could consider separate set up for loan review/audit.

v  Be accountable for protecting the quality of the entire loan/ investment portfolio. The Department should undertake portfolio evaluations and conduct comprehensive studies on the environment to test the resilience of the loan portfolio.

1.6 Operations / Systems

Banks should have in place an appropriate credit administration, credit risk

measurement and monitoring processes. The credit administration process

typically involves the following phases:

v  Relationship management phase i.e. business development.

v  Transaction management phase covers risk assessment, loan pricing, structuring the facilities, internal approvals, documentation, loan administration, on going monitoring and risk measurement.

v  Portfolio management phase entails monitoring of the portfolio at a macro level and the management of problem loans.

On the basis of the broad management framework stated above, the banks

should  have   the   following  credit   risk  measurement   and    monitoring

procedures:

·         Banks should establish proactive credit risk management practices like annual / half yearly industry studies and individual obligor reviews, periodic credit calls that are documented, periodic visits of plant and business site, and at least quarterly management reviews of troubled exposures/weak credits.

·         Banks should have a system of checks and balances in place for extension of credit viz.:

-        Separation of credit risk management from credit sanction

-        Multiple credit approvers making financial sanction subject to approvals at various stages viz. credit ratings, risk approvals, credit approval grid, etc.

-        An independent audit and risk review function.

·         The level of authority required to approve credit will increase as amounts and transaction risks increase and as risk ratings worsen.

·         Every obligor and facility must be assigned a risk rating.

·         Mechanism to price facilities depending on the risk grading of the customer, and to attribute accurately the associated risk weightings to the facilities.

·         Banks should ensure that there are consistent standards for the origination, documentation and maintenance for extensions of credit.

·         Banks should have a consistent approach towards early problem recognition, the classification of problem exposures, and remedial action.

·         Banks should maintain a diversified portfolio of risk assets; have a system to conduct regular analysis of the portfolio and to ensure on-going control of risk concentrations.

·         Credit risk limits include, obligor limits and concentration limits by industry or geography. The Boards should authorize efficient and effective credit approval processes for operating within the approval limits.

·         In order to ensure transparency of risks taken, it is the responsibility of banks to accurately, completely and in a timely fashion, report the comprehensive set of credit risk data into the independent risk system.

·         Banks should have systems and procedures for monitoring financial performance of customers and for controlling outstanding within limits.

·         A conservative policy for provisioning in respect of non-performing advances may be adopted.

·         Successful credit management requires experience, judgement and commitment to technical development. Banks should have a clear, well-documented scheme of delegation of powers for credit sanction.

Banks must have a Management Information System (MIS), which should

enable them to manage and measure the credit risk inherent in all on- and

off-balance sheet activities.   The MIS should provide adequate information

on the composition of the credit portfolio, including identification of any

concentration of risk. Banks should price their loans according to the risk

profile of the borrower and the risks associated with the loans.

TYPICAL ORGANISATIONAL STRUCTURE FOR RISK MANAGEMENT

BOARD OF DIRECTORS

RISK MANAGEMENT COMMITTEE

(BOARD SUBCOMMITTEE INCLUDING CEO AND HEADS OF CREDIT, MARKET AND

OPERATIONAL RISK MANAGEMENT COMMITTEES)

CORE FUNCTION: POLICY AND STRATEGY FOR INTEGRATED RISK MANAGEMENT

CREDIT RISK MANAGEMENT COMMITTEE (COMMITTEE OF TOP EXECUTIVES INCLUDING CEO, HEADS OF CREDIT & TREASURY, AND CHIEF ECONOMIST)

ALCO/  MARKET	OPERATIONAL
RISK	RISK
MANAGEMENT	MANAGEMENT
COMMITTEE	COMMITTEE

CREDIT RISK MANAGEMENT DEPARTMENT (CRMD)

CREDIT        ADMINISTRATION

DEPARTMENT (CAD)

Risk Planning

Risk

Assessment

Risk Analytics

- Definition of

and Monitoring

- Credit Risk and

procedures

- Sector review

pricing models’

- Credit Rating

design &

- Design of

- Review of Credit

maintenance

credit

Proposals (new)

processes

- Asset review

- Portfolio analysis

(existing)

and reporting

Credit Risk –Systems

-  Integration of risk Procedures with credit systems

-  Design and development of support systems for risk assessment & monitoring

Chapter 2 - Credit Rating Framework

2.1 Background

A   Credit-risk   Rating   Framework   (CRF)   is   necessary   to   avoid     the

limitations  associated   with   a   simplistic   and   broad   classification   of

loans/exposures into a “good” or a “bad” category. The CRF deploys a

number/  alphabet/  symbol  as  a  primary  summary  indicator  of  risks

associated with a credit exposure. Such a rating framework is the basic

module for developing a credit risk management system and all advanced

models/approaches   are   based   on   this   structure.   In   spite   of   the

advancement in risk management techniques, CRF is continued to be

used to a great extent. These frameworks have been primarily driven by a

need to standardise and uniformly communicate the “judgement” in credit

selection  procedures   and  are   not  a   substitute   to   the  vast     lending

experience accumulated by the banks' professional staff.

2.2 End Use of Risk-Ratings made on the CRF Broadly, CRF can be used for the following purposes:

a.    Individual credit selection, wherein either a borrower or a particular exposure/ facility is rated on the CRF.

b.   Pricing (credit spread) and specific features of the loan facility. This would largely constitute transaction-level analysis.

c.    Portfolio-level analysis.

d.   Surveillance, monitoring and internal MIS

e.    Assessing the aggregate risk profile of bank/ lender. These would be relevant for portfolio-level analysis. For instance, the spread of credit exposures across various CRF categories, the mean and the standard deviation of losses occurring in each CRF category and the overall migration of exposures would highlight the aggregated credit-risk for the entire portfolio of the bank.

2.3       Basic Architecture of CRFs

The following elements outline the basic architecture and the operating

principles of any CRF.

2.3.1 Grading system for calibration of credit risk

§  Nature of grading system

§  Number of grades used

§  Key outputs of CRF

2.3.2 Operating design of CRF

§  Which exposures are rated?

§  The risk rating process

§  Assigning and monitoring risk ratings

§  The mechanism of arriving at risk ratings

§  Standardisation and benchmark for risk ratings

§  Written communications and formality of procedures

2.3.3 CRFs and Portfolio Credit Risk

§  Portfolio surveillance and reporting

§  Adequate levels of provisioning for credit events

§  Guidelines for asset build up, aggregate profitability and pricing

§  Interaction with external credit assessment institutions

The architecture and operating principles are discussed in detail in the ensuing paragraphs.

2.4 Grading System for Calibration of Credit Risk

The grades (symbols, numbers, alphabets, descriptive terms) used in the

internal   credit-risk   grading   system   should   represent,   without     any

ambiguity, the default risks associated with an exposure. The grading

system should enable comparisons of risks for purposes of analysis and

top  management  decision-making.        It   should  also   reflect   regulatory

requirements of the supervisor on asset classification (e.g. the RBI asset

classification). It is anticipated that, over a period of time, the process of

risk  identification  and  risk  assessment  will  be  further  refined.          The

grading system should, therefore, be flexible and should accommodate the

refinements in risk categorisation.

2.4.1 Nature of Grading System for the CRF

The grading system adopted in a CRF could be an alphabetic or numeric

or an alpha-numeric scale. Since rating agencies follow a particular scale

Guidance Note _ Credit Risk _ October_ 2002

12

(AAA, AA+, BBB etc.), it would be prudent to adopt a different rating scale to avoid confusion in internal communications. Besides, adoption of a different rating scale would permit comparable benchmarking between the two mechanisms. Several banks utilise a numeric rating scale. The number of grades for the “acceptable” and the “unacceptable” credit risk categories would depend on the finesse of risk gradation. Normally, numeric scales developed for CRFs are such that the lower the credit-risk, the lower is the calibration on the scale.

Illustration

A rating scale could consist of 9 levels, of which levels 1 to 5 represent various grades of acceptable credit risk and levels 6 to 9 represent various grades of unacceptable credit risk associated with an exposure.

The scale, starting from “1” (which would represent lowest level credit risk and highest level of safety/ comfort) and ending at “9” (which would represent the highest level of credit risk and lowest level of safety/ comfort), could be deployed to calibrate, benchmark, compare and monitor credit risk associated with the bank’s exposures and give indicative guidelines for credit risk management activities. Each bank may consider adopting suitable alphabetic prefix to their rating scales, which would make their individual ratings scale distinct and unique.

2.4.2 Number of Grades Used in the CRF

The number of grades used in the CRF depends on the anticipated spread in credit quality of the exposures taken by the bank. This, in turn, is dependent on the present and the future business profile of the bank and the anticipated level of specialisation/ diversification in the credit portfolio. CRFs with a large number of levels/ grades on the rating scale are, as evident, more expensive to operate as the costs of additional information for (very) fine gradation of credit-quality increase sharply. A bank can initiate the risk-grading activity on a relative smaller/ narrower scale and introduce new categories as the risk-gradation improves.

2.4.3 Key Outputs of the CRF

a.    The calibration on the rating scale is expected to define the pricing and related terms and conditions for the accepted credit exposures. It is possible to define broad pricing bands and directly link the band with the calibration on the rating scale. Further refinement in the pricing proposal would be based on the bank’s judgement of the prominent elements of the loan proposal and the relationship with the borrower.

b.   In addition to the pricing related decisions, the calibration on the rating scale would allow prescription of limits on the maximum quantum of exposure permissible for any credit proposal. The quantum (or amount of facility sanctioned) would depend on the credit-score on the CRF. These limits could be linked to an internal parameter (viz. a certain percentage of bank’s capital funds) or could be linked to an external parameter (viz. a certain percentage of the total debt required by the borrower). This would help in a larger dispersion of risk amongst lenders and limit risk concentration in moderate credit-quality projects.

c.    The rating scale could also be used for deciding on the tenure of the proposed assistance.

d.   The  rating  scale  could  also  be  used  to  decide  on  the  frequency/

intensity of monitoring of the exposure. Banks may also use the rating scale to keep a close track of deteriorating credit quality and decide on the remedial measures which the deterioration may warrant. For instance, the frequency of surveillance on category 5 exposures could be kept at quarterly intervals, while those on category 3 loans could be half-yearly. More importantly, movement of an existing exposure to the “unacceptable” category of credit risk (grades 6 to 9) should directly identify the extent of provisioning (loan loss reserves) that need to be earmarked for expected losses.

e.    Though loss-provisions are often specified by the regulator (e.g. the RBI provisioning norms), banks should develop their own internal norms and maintain certain level of “reasonable over-provisioning” as a best practice. Specifically, while the credit exposure/ asset is clearly facing rapid/ steady erosion and is on the downhill transition path, anticipatory provisioning can be done based on the calibrations on the risk-rating scale. These provisions could be in the nature of general provisions.

2.5       Operating Design of the CRF

2.5.1 Which Exposures are Rated?

The first element of the operating design is to determine which exposures are required to be rated through the CRF. There may be a case for size-based classification of exposures and linking the risk-rating process to these size-based categories. The shortcoming of this arrangement is that though significant credit migration/deterioration/erosion occurs in the smaller sized exposures, these are not captured by the CRF. In addition, the size-criteria are also linked with the tenure-criteria for an exposure. In several instances, large-sized exposures over a short tenure may not require the extent of surveillance and credit monitoring that is required for a smaller sized long-tenure exposure. Given this apparent lack of clarity, a policy of ‘all exposures are to be rated’ should be followed.

2.5.2 The Risk-Rating Process

The credit approval process within the bank is expected to replicate the flow of analysis/ appraisal of credit-risk calibration on the CRF. As indicated above the CRF may be designed in such a way that the risk rating has certain linkages with the amount, tenure and pricing of exposure. These default linkages may be either specified upfront or may be developed with empirical details over a period of time. The risk rating assigned to each credit proposal would thus directly lead into the related decisions of acceptance (or rejection), amount, tenure and pricing of the (accepted) proposal.

For each proposal, the credit/ risk staff would assign a rating and forward the recommendation to the higher level of credit selection process. The proposed risk rating is either reaffirmed or re-calibrated at the time of final credit approval and sanction. Any revisions that may become necessary in the risk-ratings are utilised to upgrade the CRF system and the operating guidelines. In this manner, the CRF maintains its “incremental upgradation” feature and changes in the lending environment are captured by the system. The risk-rating process would be equally relevant in the credit-monitoring/ surveillance stage. All changes in the underlying credit-quality are calibrated on the risk-scale and corresponding remedial actions are initiated.

2.5.3 Assigning & Monitoring Risk-Ratings

In conventional banks, the practice of segregating the “relationship management” and the “credit appraisal” functions is quite prevalent. One of the variants of this arrangement is that responsibilities for calibration on the risk-rating scale are divided between the “relationship” and the “credit” groups. All large sized exposures (above a limit) are appraised independently by the “credit” group. Generally, the activities of assigning and approving risk-ratings need to be segregated. Though the front-office or conventional relationship staff can assign the risk-ratings, the responsibilities of final approval and monitoring should be vested with a separate credit staff.

2.5.4 Mechanism of Arriving at Risk-Ratings

The risk ratings, as specified above, are collective readings on the pre-specified scale and reflect the underlying credit-risk for a prospective exposure. The CRF could be separate for relatively peculiar businesses like banking, finance companies, real-estate developers, etc. For all industries (manufacturing sector), a common CRF may be used. The peculiarity of a particular industry can be captured by assigning different weights to aspects like entry barriers, access to technology, ability of new

entrants to access raw materials, etc. The following step-wise activities outline the indicative process for arriving at risk-ratings.

Step I	Identify all the principal business and financial risk
	elements
Step II	Allocate weights to principal risk components
Step III	Compare with weights given in similar sectors and
	check for consistency
Step IV	Establish the key parameters (sub-components of the
	principal risk elements)
Step V	Assign weights to each of the key parameters
Step VI	Rank the key parameters on the specified scale
Step VII	Arrive at the credit-risk rating on the CRF
Step VIII	Compare   with   previous   risk-ratings   of   similar
	exposures and check for consistency
Step IX	Conclude the credit-risk calibration on the CRF

The risk-rating process would represent collective decision making principles and as indicated above, would involve some in-built arrangements for ensuring the consistency of the output. The rankings would be largely comparative. As a bank’s perception of the exposure improves/changes during the course of the appraisal, it may be necessary to adjust the weights and the rankings given to specific risk-parameters in the CRF. Such changes would be deliberated and the arguments for substantiating these adjustments would be clearly communicated in the appraisal documents.

2.5.5 Standardisation and Benchmarks for Risk-Ratings

In a lending environment dominated by industrial and corporate credits, the assignors of risk-ratings utilise benchmarks or pre-specified standards for assessing the risk profile of a potential borrower. These standards usually consist of financial ratios and credit-migration statistics, which capture the financial risks faced by the potential borrower (e.g. operating and financial leverage, profitability, liquidity, debt-servicing ability, etc.). The business risks associated with an exposure (e.g. cyclicality of industry, threats of product or technology substitution etc.) are also addressed in the CRF. The output of the credit-

appraisal process, specifically the financial ratios, is directly compared

with the specified benchmarks for a particular risk category. In these

cases, the risk rating is fairly standardised and CRF allocates a grade or a

numeric value for the overall risk profile of the proposed exposure.

Illustration

The CRF may specify that for the risk-rating exercise:

If Gross Revenues are between Rs.800 to Rs.1000 crore	assign a score of 2
If Operating Margin is 20% or more	assign a score of 2
If Return on Capital Employed (ROCE) is 25% or more	assign a score of 1
If Debt : Equity is between 0.60 and 0.80	assign a score of 2
If interest cover is 3.50 or more	assign a score of 1
If Debt Service Coverage Ratio (DSCR) is 1.80 or more	assign a score of 1

The next step would be to assign weights to these risk-parameters. In an industrial credit environment, the CRF may place higher weights on size (as captured in gross revenues), profitability of operations (operating margins), financial leverage (debt: equity) and debt-servicing ability (interest cover). Assume that the CRF assigns a 20% weightage to each of these four parameters and the ROCE and DSCR are given a 10% weightage each. The weighted-average score for the financial risk of the proposed exposure is 1.40, which would correspond with the extremely low risk/highest safety level-category of the CRF (category 1). Similarly, the business and the management risk of the proposed exposure are assessed and an overall/ comprehensive risk rating is assigned.

The industrial credit environment permits a significantly higher level of

benchmarking and standardisation, specifically in reference to calibration

of  financial  risks  associated  with  credit  exposures.  For  all  prominent

industry-categories,  any  lender  can  compile  profitability,  leverage  and

debt-servicing details and utilise these to develop internal benchmarks for

the CRF. As evident, developing such benchmarks and risk-standards for

a portfolio of project finance exposures, as in the case of the bank, would

be an altogether diverse exercise.

The  CRF  may  also  use   qualitative/   subjective   factors   in  the    credit

decisions. Such factors are both internal and external to the company.

Internal factors could include integrity and quality of management of the

borrower, quality of inventories/ receivables and the ability of borrowers

to raise finance from other sources. External factors would include views on the economy and industry such as growth prospects, technological change and options.

2.5.6 Written Communications and Formality of Procedure

The two critical aspects of the formality of procedure in the risk-rating process are

(i)           the process-flow through which a credit-transaction would flow across various units and

(ii)          the written communication on the risk-ratings assigned to a particular proposal.

The process-flow required for the credit appraisal exercise, may be explicitly drafted and communicated. It may clearly identify the transactions and linkages between various operating units of the bank.

The above discussion broadly presents some of the essential dimensions in the design of a CRF by banks. These details are indicative of the scope of work required for the CRF. Banks may make appropriate modifications to suit their requirements.

2.6 CRFs and aggregation of Credit-Risk

Analysing exposures using the CRF technique would highlight the spread (or frequency-distribution) of the credit-risk in the bank’s asset portfolio and would give an indication for its future asset build-up efforts. This section briefly covers some aspects of portfolio credit-risk management, a process which would possibly be facilitated by implementing the CRF.

2.6.1 Portfolio Surveillance and Reporting

The conventional internal MIS of a bank would identify the problem-loans in the asset portfolio, as per the guidelines given by the regulator (i.e. the asset-classification guidelines of RBI). These details, however, represent only a component of the credit-risks accumulated in the asset portfolio of a bank. The CRF can be used for informing the top management on the

frequency distribution of assets across risk-rating scale, the extent of migration in the past (e.g. movement of exposures from higher to lower risk-categories or vice-versa) and the anticipated developments in the aggregated credit portfolio. The senior management may benefit from such outputs in terms of steering the organisation through various risk-cycles (e.g. initial low-risk low-return phase to consolidation and further to an incremental rise in relatively high-risk high-return exposures).

2.6.2 Adequate Levels of Provisioning for Credit Events

The spread of the asset portfolio across the risk-rating scale and the trends in rating migration would allow the bank management to determine the level of provisioning required, in addition to the regulatory minimum, to absorb unanticipated erosions in the credit quality of the assets. In most cases, provisions for loan-losses are based on the prevailing regulatory and accounting directives. However, the management may find merit in certain prudent level of “over-provisioning”. This exercise may add stability and resilience to the capital adequacy and profitability of the bank.

The extent of provisioning required could be estimated from the Expected Loss on Default (which is a product of the Probability of Default (PD) and Loss Given Default (LGD). Since these probabilities can be assigned only after significant empirical details are available, an alternative would be to adopt a policy of allocating/ provisioning an amount which may be a proportion of the aggregate exposures in the risk-rating scale which reflect the likelihood of the assets slipping into the NPA category.

2.6.3 Guidelines for Asset Build-up, Aggregate Profitability and Pricing

As discussed earlier, a clear analysis of the prevailing risk-posture of the bank, facilitated by the CRF, would give strong recommendations for future asset build-up and business development activities. The extent of provisioning would be based on actual and anticipated erosion in credit quality and would define the “cost” of maintaining an exposure in the

Guidance Note _ Credit Risk _ October_ 2002

20

bank’s credit portfolio. A similar analysis could be undertaken for a specific credit-product and the risk-adjusted return can be assessed. This will involve an analysis of the pricing-decisions, provisioning requirements, loss on default and the incremental impact on bank’s profitability.

2.6.4 Interaction with External Credit Assessment Institutions (ECAI) The benefits of such a CRF system, in addition to those described above, could include a more amenable interaction with rating agencies and regulatory bodies. As regards investment ratings the parameters laid down in para 4.1 of the Risk Management Guidelines issued by RBI in October, 1999 may be followed, i.e., the proposals for investments should also be subjected to the same degree of credit risk analysis, as any loan proposals. The proposals should be subjected to detailed appraisal and rating framework that factors in financial and non-financial parameters of issuers, sensitivity to external developments, etc. The maximum exposure to a customer should be bank-wide and include all exposures assumed by the Credit and Treasury Departments. The coupon on non-sovereign papers should be commensurate with their risk profile. The banks should exercise due caution, particularly in investment proposals, which are not rated and should ensure comprehensive risk evaluation. There should be greater interaction between Credit and Treasury Departments and the portfolio analysis should also cover the total exposures, including investments. The rating migration of the issuers and the consequent diminution in the portfolio quality should also be tracked at periodic intervals.

Chapter 3 - Credit Risk Models

3.1 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.

3.1.1 The increasing importance of credit risk modelling 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 securitisation/ loan sales market.

·           Regulators are concerned to improve the current system of bank capital requirements especially as it relates to credit risk.

3.1.2 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 marshalled at prohibitive cost. In a marketplace where 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 organisations.

3.2 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.

3.2.1 Techniques: The following are the more commonly used techniques:

(a)      Econometric Techniques such as linear and multiple discriminant analysis, 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)      Optimisation 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.

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

(a)  Credit approval: Models are used on a stand alone basis or in conjunction with a judgemental 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 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 other 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 premia 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.

3.3 Credit Risk Models: Approaches

3.3.1  The  literature  on  quantitative  risk  modelling  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

modelling approach tries to capture distribution of the firm's asset-value

over a period of time.

3.3.2 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.

3.3.3  The second type of modelling 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.

3.3.4  Closely related to credit risk models are portfolio risk models.  In

the last three years, important advances have been made in modelling

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.

3.4  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:

v  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

v  Identify concentration in the portfolios

v  Identify problem credits before they become NPAs

v  Identify adequacy/ inadequacy of loan provisions

v  Help in pricing of credit

v  Recognise variations in macro-economic factors and a possible impact under alternative scenarios

v  Determine the impact on profitability of transactions and relationship.

Chapter 4 - Portfolio Management and Risk Limits

4.1. The need for credit portfolio management emanates from the necessity to optimize the benefits associated with diversification and reduce the potential adverse impact of concentration of exposures to a particular borrower, sector or industry. The conventional approach to credit portfolio management has been largely based on the counter party exposure limits, which largely provides the guideline for incremental asset/ exposure build-up. This “forward” or incremental approach to credit portfolio management is, to an extent, a reactive strategy and though it does guide the decision-making process, it has limited contribution for managing the existing credit portfolio of the bank.

4.2 The recent developments in the measurement and management of portfolio credit risk have been based on two key attributes: correlation and volatility. Consider two companies, one operates large capacities in the steel sector and the other a large player in the cement sector, promoted by two entirely unrelated promoters. Though these would classify as two separate counter parties, both of them may be highly sensitive to the Government’s expenditure in new projects/ investments. Thus, reduction in Government investments could impact these two companies simultaneously (correlation), impacting the credit-quality of such a portfolio (volatility), even though from a regulatory or conventional perspective, the risk had been diversified (2 separate promoters, 2 separate industries). Thus, though the credit portfolio may be well diversified and fulfils the prescribed criteria for counter party exposure limits, the high correlation in potential performance between two counter parties may impact the portfolio quality (default levels) under stress conditions.

4.3 In addition to the widespread instances of high correlation and resultant volatility, the emergence of new techniques for managing a bank’s credit portfolio have actively contributed to the development and adoption of broader credit risk management practices. Specifically, the

adoption and wider acceptance of securitisation of loan assets in the developed markets has permitted banks to pursue credit portfolio management on a proactive manner. These have usually been in the nature of collateralised loan obligations. Though securitisation of loan receivables, mainly consumer and auto loans, has been prevalent in India, it has usually been deployed as an asset acquisition or a hive-off approach rather than active credit portfolio management. The steps taken to enhance the liquidity and depth of debt markets in India and simplify the process of securitisation are expected to improve the prospects of credit portfolio management in the near future.

4.4 The measurement of credit-portfolio concentration has been elaborated in detail in the regulatory prescriptions for counter-party exposures in India. The issue of credit portfolio correlation is discussed here in some detail. In statistical terms, credit portfolio correlation would mean the number of times companies/ counter-parties in a portfolio defaulted simultaneously. As evident, this analysis is impossible in practice and the number of such instances for developing a reasonable generalisation would be too few. Some credit portfolio management techniques developed overseas estimate the correlation between defaults and bond-market spreads and generalise this for assessing the correlation in a given portfolio. Given the limited data on corporate bond market spreads and their statistical linkages with ratings in India, this approach may not be appropriate for Indian banks at this stage. Banks should, however, direct their data management efforts in this direction so that a beginning in active portfolio management can be made.

4.5 One possible technique for analysing credit-portfolio correlation is based on a macro-economic factor model. This approach involves projecting the performance (volatility) of a credit portfolio under altering macro-economic environments. In specific terms, this would involve a stress-test on the debt-servicing ability of a portfolio of borrowers under alternative scenarios. The input data would consist of the projected financial performance (income statement and balance sheet details) of

each of these portfolio constituents. In the appraisal system adopted by Indian banks in general, these are normally developed for individual borrowers for seeking credit approvals from the specific internal authorities. Such portfolio constituents could be relatively independent counterparties, spanning a relatively wide spectrum of region, industry, size of operation, adoption of technology and promoters. The key financial parameters of these counterparties (growth, profitability, access to funds, etc.) should be linked to the macro-economic parameters under consideration. Some of the relevant macro-economic parameters could include overall growth rates, growth in exports/ industrial/ agricultural sectors, interest rates, exchange rates, import duties, equity market and liquidity conditions. By developing alternative scenarios for these parameters, the credit-portfolio’s aggregate performance (default rates and levels) can be assessed and possible correlation between a set of obligors (even though they constitute entirely separate counterparties) may be established. For instance, under the assumptions of low overall economic growth, poor growth in agriculture sector and reduction in import duties, the assessment may give some correlation between the borrowers in the petrochemicals industry and the consumer-electronics industry. Though there may not be any “counter party” relationship in this set of borrowers, both of them are possibly susceptible to reduced import duties and low economic growth. These illustrations are relatively simplistic and the detailed analysis, as discussed above, may give critical inputs for minimising the credit risk of the given portfolio. A possible advantage of starting with the macro-economic factor model is that it is amenable to the current levels of credit risk assessment practices in Indian banks and can be correspondingly adopted with relative ease. Though superior and more sophisticated tools have been developed, their findings may be limited due to the lack of representative data. Such options can be considered as Indian banks further enhance their internal systems and processes in credit risk management.

Chapter 5 – Managing Credit Risk in Inter-bank Exposure

5.1 During the course of its business, a bank may assume exposures on other banks, arising from trade transactions, money placements for liquidity management purposes, hedging, trading and transactional banking services such as clearing and custody, etc. Such transactions entail a credit risk, as defined, and therefore, it is important that a proper credit evaluation of the banks is undertaken. It must cover both the interpretation of the bank's financial statements as well as forming a judgement on non-financial areas such as management, ownership, peer/ market perception and country factors.

5.2 The key financial parameters to be evaluated for any bank are:

a)    Capital Adequacy

b)   Asset Quality

c)    Liquidity

d)   Profitability

Banks will normally have access to information available publicly to assess the credit risk posed by the counter party bank.

5.2.1 Capital Adequacy

5.2.1.1 Banks with high capital ratios above the regulatory minimum levels, particularly Tier I, will be assigned a high rating whereas the banks with low ratios well below the standards and with low ability to access capital will be at the other end of the spectrum.

5.2.1.2 Capital adequacy needs to be appropriate to the size and structure of the balance sheet as it represents the buffer to absorb losses during difficult times. Over capitalization can impact overall profitability. Related to the issue of capitalization, is also the ability to raise fresh capital as and when required. Publicly listed banks and state owned banks may be best positioned to raise capital whilst the unlisted private banks or regional banks are dependant entirely on the wealth and/ or credibility of their owners.

5.2.1.3 The capital adequacy ratio is normally indicated in the published audited accounts. In addition, it will be useful to calculate the Capital to Total Assets ratio which indicates the owners' share in the assets of the business. The ratio of Tier I capital to Total Assets represents the extent to which the bank can absorb a counterparty collapse. Tier I capital is not owed to anyone and is available to cover possible losses. It has no maturity or repayment requirement, and is expected to remain a permanent component of the counter party's capital.

5.2.1.4 The Basel standards currently require banks to have a capital adequacy ratio of 8% with Tier I ratio not less than 4%. The Reserve Bank of India requirement is 9%. The Basel Committee is planning to introduce the New Capital Accord and these requirements could change the dimension of the capital of banks.

5.2.2 Asset Quality

5.2.2.1 The asset portfolio in its entirety should be evaluated and should include an assessment of both funded items and off-balance sheet items. Whilst non performing assets and provisioning ratios will reflect the quality of the loan book, high volatility of valuations and earnings will reflect exposure to the capital market and sensitive sectors.

The key ratios to be analysed are

·           Gross NPAs to Gross Advances ratio,

·           Net NPAs to Net Advances ratio

·           Provisions Held to Gross Advances ratio and

·           Provisions Held to Gross NPAs ratio.

5.2.2.3 Some issues which should be taken cognisance of, and which require further critical examination are:

-      where exposure to a particular sector is above a certain level, say, 10% of total assets

-      where a significant part of the portfolio is to counter parties based in countries which are considered to be very risky

-          where Net NPAs are above a certain level, say, 5% of the loan assets.

-          where loan loss provision is less than a certain level, say, 50% of the Gross NPA.

-      where high risk/ return lending accounts for the majority of the assets.

-      where there are rapid rates of loan growth. (These can be a precursor to reducing asset quality as periods of rapid expansion are often followed by slow downs which make the bank vulnerable.)

-      net impact of mark-to-market values of treasury transactions.

5.2.2.4 Commercial banks are increasingly venturing into investment banking activities where asset considerations additionally focus on the marketability of the assets, as well as the quality of the instruments. Preferably banks should mark-to-market their entire investment portfolio and treat sticky investments as "non-performing", which should also be adequately provided for.

5.2.3 Liquidity

5.2.3.1 Commercial bank deposits generally have a much shorter contractual maturity than loans, and liquidity management needs to provide a cushion to cover anticipated deposit withdrawals. The key ratios to be analysed are

·           Total Liquid Assets to Total Assets ratio (the higher the ratio the more liquid the bank is),

·           Total Liquid Assets to Total Deposits ratio (this measures the bank's ability to meet withdrawals),

·           Loans to Deposits ratio and

·           Inter-bank deposits to total deposits ratio.

5.2.3.2 It is necessary to develop an appropriate level of correlation between assets and liabilities. Account should be taken of the extent to which borrowed funds are required to bolster capital and the respective redemption profiles.

5.2.4 Profitability

5.2.4.1   A consistent year on year growth in profitability is required to

provide an acceptable return to shareholders and retain resources to fund

future growth. The key ratios to be analysed are:

·           Return on Average Assets (measures a bank's growth/ decline in profits in comparison with its balance sheet expansion/ contraction),

·           Return on Equity (provides an indication of how well the bank is performing for its owners),

·           Net Interest Margin (measures the difference between interest paid and interest earned, and therefore a bank's ability to earn interest income) and

·           Operating Expenses to Net Revenue ratio (the cost/income ratio of the bank).

5.2.4.2   The degree of reliance upon interest income compared with fees

earned, heavy dependency on certain sectors, and the sustainability of

income streams are relevant factors to be borne in mind.

5.2.4.3 The ability of a bank to analyse another bank on the above lines will

depend upon the information available publicly and also the strength of

disclosures in the financial statements.

5.3 In addition to the quantitative indices, other key parameters to be assessed are:

·           Ownership

·           Management ability

·           Peer comparison/ Market perception

·           Country of incorporation/ Regulatory environment

Ownership

5.3.1  The spread and nature of the ownership structure is important, as

it impinges on the propensity to induct additional capital. Support from a

large body of shareholders is difficult to obtain if the bank's performance

is adverse, whilst a smaller shareholder base constrains the ability to

garner funds.

Management Ability

5.3.2 Frequent changes in senior management, change in a key figure, and the lack of succession planning need to be viewed with suspicion. Risk management is a key indicator of the management's ability as it is integral to the health of any institution. Risk management should be deeply embedded and respected in the culture of the financial institution.

Peer Comparison/ Market Perception

5.3.3 It is recognized that balance sheets tend to show different structures from one country to another, and from one type of bank to another. Accordingly, it is appropriate to assess a bank's financial statements against those of its comparable peers. Similarly market sentiment is highly important to a bank's ability to maintain an adequate funding base, but is not necessarily reflective of published information. Special notice should be taken where the overall performance of the peer sector, in general, falls below international standards.

Country of Incorporation/ Regulatory Environment

5.3.4 Country risk needs to be evaluated since a bank which is financially strong may not be permitted to meet its commitments in view of the regulatory environment or the financial state of the country in which it is operating in.

5.4 Banks should be rated (called Bank Tierings) on the basis of the above factors. An indicative tiering scale is:¹

Bank Tier			Description
1			Low risk
2			Modest risk
3			Satisfactory risk
4			Fair Risk
5			Acceptable Risk
6			Watch List
7		Substandard
8			Doubtful
9			Loss

5.5 Facilities

Facilities to banks can be classified into three categories:

a)            On balance sheet items such as cash advances, bond holdings and investments, and off-balance sheet items which are not subject to market fluctuation risk such as guarantees, acceptances and letters of credit.

b)           Facilities which are off-balance sheet and subject to market fluctuation risk such as foreign exchange and derivative products.

c)            Settlement facilities: These cover risks arising through payment systems or through settlement of treasury and securities transactions.

The tiering system enables a bank to establish internal parameters to help

determine acceptable limits of exposure to a particular bank/ banking

group. These parameters should be used to determine the maximum level of

(a)    and (b) above, maximum tenors for term products which may be considered prudent for a bank and settlement limits. Medium term loan facilities and standby facilities should be sanctioned very exceptionally. Standby lines, by their very nature, are likely to be drawn only at a time when the risk in making funds available is generally perceived to be unattractive.

Bank-wise exposure limits should be set taking into account the counter

party and country risks. The credit risk management of exposure to banks

should be centralised on a bank-wide basis.

¹ The rating scale for bank rating should be in tandem with CRF to synthesize credit risk on account of all activities for the bank as a whole.

Chapter 6 – Credit Risk in Off-balance sheet Exposures

Risk Identification and Assessment of Limits

6.1. Credit Risk in non-fund based business of banks need to be assessed

in a manner similar to the assessment of fund based business since it has

the potential to become a funded liability in case the customer is not able

to meet his commitments. Financial guarantees are generally long term in

nature, and assessment of these requirements should be similar to the

evaluation of requests for term loans. As contracts are generally for a term

of 2-3 years, banks must obtain cash flows over this time horizon, arising

from  the  specific  contract  they  intend  to  support,  and  determine  the

viability of financing the contract.

Risk Monitoring and Control

6.2  For  reducing  credit   risk  on  account   of  such   off  balance    sheet

exposures, banks may adopt a variety of measures some of which are

indicated below:

i)             Banks must ensure that the security, which is available to the funded lines, also covers the LC lines and the guarantee facilities. On some occasions, it will be appropriate to take a charge over the fixed assets as well, especially in the case of long-term guarantees.

ii)           In the case of guarantees covering contracts, banks must ensure that the clients have the requisite technical skills and experience to execute the contracts. The value of the contracts must be determined on a case-by-case basis, and separate limits should be set up for each contract. The progress vis-à-vis physical and financial indicators should be monitored regularly, and any slippages should be highlighted in the credit review.

iii)          The strategy to sanction non-fund facilities with a view to increase earnings should be properly balanced vis-à-vis the risk involved and extended only after a thorough assessment of credit risk is undertaken.

Chapter 7 – Country Risk

7.1 Country risk is the possibility that a country will be unable to service

or repay its debts to foreign lenders in a timely manner. In banking, this

risk arises on account of cross border lending and investment.      The risk

manifests itself either in the inability or the unwillingness of the obligor

to meet its liability.

Country risk comprises of the following risks:

·         Transfer risk which is the core risk under country risk, arises on account of the possibility of losses due to restrictions on external remittances. Consequently, an obligor may be able to pay in local currency, but may not be able to pay in foreign currency. This type of risk may occur when foreign exchange shortages either close or restrict a country’s cross border foreign exchange market.

·         Sovereign risk is associated with lending to government of a sovereign nation or to taking government guarantees. The risk lies in the fact that sovereign entities may claim immunity from legal process or might not abide by a judgement, and it might prove impossible to secure redress through legal action. Ordinarily, it is assumed that there will be no default by a sovereign. This, however, does not mean that there is no risk involved in sovereign lending, for the risk may manifest itself in terms of rehabilitation of an indebted country in terms of financial solvency and liquidity for which there may be rescheduling of country debt or external debt.

·         Non-sovereign or political risk arises when political environment or legislative process of a country leads to Government taking over the assets of the financial entity (e.g. nationalisation) and preventing discharge of its liabilities in a manner that had been agreed to. It is also referred to as risk of appropriation and expropriation. Non-sovereign risk includes, in addition to sovereign risk, private claims and direct investments like lending to corporates and project finance lending and includes risks associated with legal frameworks and economic environment.

·         Cross border risk arises on account of the borrower being a resident of a country other than the country where the cross border asset is booked, and includes exposures to local residents denominated in currencies other than the local currency.

·         Currency risk is the possibility that exchange rate changes will alter the expected amount of principal and return of the lending or investment. At times, banks may try to cope with this specific risk on the lending side by shifting the risk associated with exchange rate fluctuations to the borrowers. The risk however does not get extinguished, but gets converted to credit risk.

·         Macroeconomic and Structural Fragility Risk has come into prominence after the East Asian crises of 1990s. In these crises firms could purchase foreign exchange to service foreign debt but collapse of exchange rates and surge in interest rates due to severe government restrictions on firms owning external debt resulted in highly unfavourable exchange rates and very high interest costs on domestic borrowings for these firms. This severely impaired these firms’ ability to service foreign debt. The structural fragility risk can also include that associated with poor development of domestic bankruptcy laws and weak courts for their enforcement.

7.2  Broad Contours of Country Risk Management (CRM)

The broad contours of CRM are:

·           Risk Categories

·           Country Risk Assessments

·           Fixing of country limits

·           Monitoring of country exposures

7.2.1 Risk Categories

Countries can be broadly classified into six risk categories – insignificant, low, moderate, high, very high and off-credit. IBA would be assigned the responsibility of developing a mechanism for assigning countries to the six risk categories specified above. Banks may be allowed to adopt a more conservative categorisation of the countries.

7.2.2 Country Risk (CR) Assessment

To begin with, banks may adopt the sovereign ratings of international credit rating agencies. However, banks should eventually put in place appropriate systems to move over to internal assessment of country risk within a prescribed period, say by 31 March 2005. Banks may adopt the ratings of any of the international credit rating agencies during the transition period. In case there is divergence in the ratings accorded to any country by the international credit rating agencies, banks may adopt the lower/ lowest of the ratings.

Banks should also evolve sound systems for measuring and monitoring country risk. The system should be able to identify the full dimensions of country risk as well as incorporating features that acknowledge the links between credit and market risk. Banks should use a variety of internal and external sources as a means to measure country risk. Banks should not rely solely on rating agencies or other external sources as their only country risk-monitoring tool. Banks should also incorporate information from the relevant country managers of their foreign branches into their country risk assessments. However, the rating accorded by a bank to any country should not be better than the rating of that country by the international rating agency.

The frequency of periodic reviews of country risk ratings should be at least once a year with a provision to review the rating of specific country, based on any major events in that country, where bank exposure is high, even before the next periodical review of the ratings is due.

7.2.4 Fixing of country limits

Bank Boards may set country exposure limits in relation to the bank’s regulatory capital (Tier I + Tier II) with sub-limits, if considered necessary for products, branches, maturity etc. The basis for setting the limits for the country/ category shall be left to the discretion of the banks’ Boards. The country exposure limits set by the Board should be reviewed periodically.

Exposure limit for any country should not exceed its regulatory capital, except in the case of insignificant risk category. In respect of foreign banks, the regulatory capital would be the capital held in their Indian books.

Banks may also set up regional exposure limits for country groups, at the discretion of their Boards. The Board may decide on the basis for grouping of countries and also lay down the guidelines regarding all aspects of such regional exposure limits.

7.3.5 Monitoring of country exposures

Banks should monitor their country exposures on a weekly basis before switching over to real-time monitoring. However, exposures to high-risk (and above) categories should be monitored on a real-time basis. Banks should switchover to real-time monitoring of country exposures (all categories) by 31st March 2004.

Boards should review the country risk exposures at every meeting. The review should include progress in establishing internal country rating systems, compliance with the regulatory and the internal limits, results

of stress tests and the exit options available to the banks in respect of countries belonging to ‘high risk & above’ categories.

Management of country risk should incorporate stress testing as one method to monitor actual and potential risks. Stress testing should include an assessment of the impact of alternative outcomes to important underlying assumptions.

Country risk management processes employed by banks would require adequate internal controls that include audits or other appropriate oversight mechanisms to ensure the integrity of the information used by senior officials in overseeing compliance with policies and limits.

Chapter 8 – Loan Review Mechanism/ Credit Audit

Credit Audit examines compliance with extant sanction and post-sanction processes/ procedures laid down by the bank from time to time.

8.1 Objectives of Credit Audit

Ø  Improvement in the quality of credit portfolio

Ø  Review sanction process and compliance status of large loans

Ø  Feedback on regulatory compliance

Ø  Independent review of Credit Risk Assessment

Ø  Pick-up early warning signals and suggest remedial measures

Ø  Recommend corrective action to improve credit quality, credit administration and credit skills of staff, etc.

8.2 Structure of Credit Audit Department

The credit audit / loan review mechanism may be assigned to a specific Department or the Inspection and Audit Department.

8.3 Functions of Credit Audit Department

Ø  To process Credit Audit Reports

Ø  To analyse Credit Audit findings and advise the departments/ functionaries concerned

Ø  To follow up with controlling authorities

Ø  To apprise the Top Management

Ø  To process the responses received and arrange for closure of the relative Credit Audit Reports

Ø  To maintain database of advances subjected to Credit Audit

8.4 Scope and Coverage

The focus of credit audit needs to be broadened from the account level to look at the overall portfolio and the credit process being followed. The important areas are:

8.4.1 Portfolio Review : Examine the quality of Credit & Investment (Quasi Credit) Portfolio and suggest measures for improvement, including

reduction of concentrations in certain sectors to levels indicated in the Loan Policy and Prudential Limits suggested by RBI.

8.4.2 Loan Review : Review of the sanction process and status of post sanction processes/ procedures (not just restricted to large accounts)

·         all fresh proposals and proposals for renewal of limits (within 3 - 6 months from date of sanction)

·         all existing accounts with sanction limits equal to or above a cut off depending upon the size of activity

·         randomly selected ( say 5-10%) proposals from the rest of the portfolio

·         accounts of sister concerns/group/associate concerns of above accounts, even if limit is less than the cut off

8.4.3 Action Points for Review

o    Verify compliance of bank's laid down policies and regulatory compliance with regard to sanction

o   Examine adequacy of documentation

o   Conduct the credit risk assessment

o   Examine the conduct of account and follow up looked at by line functionaries

o   Oversee action taken by line functionaries in respect of serious irregularities

o   Detect early warning signals and suggest remedial measures thereof

8.4.4 Frequency of Review

The frequency of review should vary depending on the magnitude of risk (say, for the high risk accounts - 3 months, for the average risk accounts- 6 months , for the low risk accounts- 1 year).

·           Feedback on general regulatory compliance.

·           Examine adequacy of policies, procedures and practices.

·           Review the Credit Risk Assessment methodology.

·           Examine reporting system and exceptions thereof.

·           Recommend corrective action for credit administration and credit skills of staff.

·           Forecast likely happenings in the near future.

8.5 Procedure to be followed for Credit Audit

Ø  Credit Audit is conducted on site, i.e. at the branch which has appraised the advance and where the main operative credit limits are made available.

Ø  Report on conduct of accounts of allocated limits are to be called from the corresponding branches.

Ø  Credit auditors are not required to visit borrowers’ factory/ office premises.

Chapter 9 – RAROC Pricing/ Economic Profit

9.1 In acquiring assets, banks should use the pricing mechanism in conjunction with product/ geography/ industry/ tenor limits. For example, if a bank believes that construction loans for commercial complexes are unattractive from a portfolio perspective, it can raise the price of these loans to a level that will act as a disincentive to borrowers. This is an instance of marginal cost pricing - the notion that the price of an asset should compensate the institution for its marginal cost as measured on a risk-adjusted basis. Marginal cost pricing may not always work. A bank may have idle capacity and capital that has not been deployed. While such an institution clearly would not want to make a loan at a negative spread, it would probably view even a small positive spread as worthwhile as long as the added risk was acceptable.

9.2 Institutions tend to book unattractively priced loans when they are unable to allocate their cost base with clarity or to make fine differentiations of their risks. If a bank cannot allocate its costs, then it will make no distinction between the cost of lending to borrowers that require little analysis and the cost of lending to borrowers that require a considerable amount of review and follow up. Similarly, if the spread is tied to a too coarsely graded risk rating system (one, for example, with just four grades) then it is more difficult to differentiate among risks when pricing than if the risk rating is graduated over a larger scale with, say, 15 grades.

9.3 A cost-plus-profit pricing strategy will work in the short run, but in the long run borrowers will balk and start looking for alternatives. Cost-plus-profit pricing will also work when a bank has some flexibility to compete on an array of services rather than exclusively on price. The difficulties with pricing are greater in markets where the lender is a price taker rather than a price leader.

9.4 The pricing is based on the borrower's risk rating, tenor, collateral,

guarantees, historic loan loss rates, and covenants. A capital charge is

applied  based   on  a   hurdle  rate   and  a   capital   ratio^ª .  Using    these

assumptions, the rate to be charged for a loan to a customer with a given rating could be calculated.

9.5 This relatively simple approach to credit pricing works well as long as

the assumptions are correct - especially those about the borrower’s credit

quality. This method is used in many banks today. The main drawbacks

of this method are:

·           Only ‘expected losses’ are linked to the borrower’s credit quality. The capital charge based on the volatility of losses in the credit risk category may also be too small. If the loan were to default, the loss would have to be made up from income from non-defaulting loans.

·           It implicitly assumes only two possible states for a loan: default or no default. It does not model the credit risk premium or discount resulting from improvement or decline in the borrower's financial condition, which is meaningful only if the asset may be repriced or sold at par.

9.6 Banks have long struggled to find the best ways of allocating capital

in a manner consistent with the risks taken. They have found it difficult

to come up with a consistent and credible way of allocating capital for

such varying sources of revenue as loan commitments, revolving lines of

credit (which have no maturity), and secured versus unsecured lending.

The different approaches for allocating capital are as under:

·           One approach is to allocate capital to business units based on their asset size. Although it is true that a larger portfolio will have larger losses, this approach also means that the business unit is forced to employ all the capital allocated to it. Moreover, this method treats all risks alike.

·           Another approach is to use the regulatory (risk-adjusted) capital as the allocated capital. The problem with this approach is that

regulatory capital may or may not reflect the true risk of a

^ª   The hurdle rate is defined as the minimum acceptable return on a business activity.

business. For example, for regulatory purposes, a loan to a AAA rated customer requires the same amount of capital per Rupees lent as one to a small business.

·           Yet another approach is to use unexpected losses in a sub-portfolio (standard deviation of the annual losses taken over time) as a proxy for capital to be allocated. The problem with this approach is that it ignores default correlations across sub-portfolios. The volatility of a sub-portfolio may in fact dampen the volatility of the institution's portfolio, so pricing decisions based on the volatility of the sub-portfolio may not be optimal. In practical terms, this means that one line of business within a lending institution may sometimes subsidize another.

Risk Adjusted Return on Capital (RAROC)

9.7 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 the capital arose. The value-producing capacity of an asset

(or a business) is expressed as a ratio that allows comparisons to be made

between assets (or businesses) of varying sizes and risk characteristics.

The ratio is based either on the size of the asset or the size of the capital

allocated to it. When an institution can observe asset prices directly (and/

or infer risk from observable asset prices) then it can determine how

much capital to hold based on the volatility of the asset. This is the

essence  of  the  mark-to-market  concept.  If  the  capital  to  be  held  is

excessive relative to the total return that would be earned from the asset,

then the bank will not acquire it. If the asset is already in the bank's

portfolio, it will be sold. The availability of a liquid market to buy and sell

these assets is a precondition for this approach. When banks talk about

asset concentration and correlation, the question of capital allocation is

always in the background because it is allocated capital that absorbs the

potential   consequences    (unexpected    losses)    resulting    from    such

concentration and correlation causes.

9.8  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%

confidence level) over one year on an after-tax basis. As may be expected,

the higher the volatility of the returns, the more capital is allocated. The higher capital allocation means that the transaction has to generate cash flows large enough to offset the volatility of returns, which results from the credit risk, market risk, and other 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.

9.9 RAROC is an improvement over the traditional approach in that it allows one to compare two businesses with different risk (volatility of returns) profiles. A transaction may give a higher return but at a higher risk. Using a hurdle rate (expected rate of return), 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 toward examining an institution’s entire balance sheet on a mark-to-market basis - if only to understand the risk-return trade-offs that have been made.

Chapter 10 – New Capital Accord: Implications for Credit Risk Management

10.1 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.

10.2 The Committee proposes two approaches, viz., Standardised and Internal Rating Based (IRB) for estimating regulatory capital. Under the standardised approach, the Committee desires neither to produce 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 Committee’s 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.

10.3 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.

10.4.1 Standardised Approach

Under the standardised 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.

10.4.2 IRB Approach

The Committee proposes two approaches – foundation and advanced - as

an alternative to standardised 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:

Ø  Each borrower within a portfolio must be assigned the rating before a loan is originated.

Ø  Minimum of 6 to 9 borrower grades for performing loans and a minimum of 2 grades for non-performing loans.

Ø  Meaningful distribution of exposure across grades and not more than 30% of the gross exposures in any one borrower grade.

Ø  Each individual rating assignment must be subject to an independent review or approval by the Loan Review Department.

Ø  Rating must be updated at least on annual basis.

Ø  The Board of Directors must approve all material aspects of the rating and PD estimation.

Ø  Internal and External audit must review annually, the banks’ rating system including the quantification of internal ratings.

Ø  Banks should have individual credit risk control units that are responsible for the design, implementation and performance of internal rating systems. These units should be functionally independent.

Ø  Members of staff responsible for rating process should be adequately qualified and trained.

Ø  Internal rating must be explicitly linked with the banks’ internal assessment of capital adequacy in line with requirements of Pillar 2.

Ø  Banks must have in place sound stress testing process for the assessment of capital adequacy.

Ø  Banks must have a credible track record in the use of internal ratings at least for the last 3 years.

Ø  Banks must have robust systems in place to evaluate the accuracy and consistency with regard to the system, processing and the estimation of PDs.

Ø  Banks must disclose in greater detail the rating process, risk factors, 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 standardised 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.

10.5 The adoption of the New Accord, in the proposed format, requires substantial upgradation 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.

-------------------------------------------------------------------------------------------

Current Affairs on August 21st 2018

Today's Headlines from www:

*Economic Times*

📝 EPFO payroll data: 47 lakh jobs created in 10 months till June

📝 Share of imported non-coking coal consumption to fall to 13.4% in FY23: Crisil

📝 RBI staff to go on mass leave on Sept 4, 5 over pension issues

📝 Route Mobile gets Sebi nod for Rs 600 crore IPO

📝 Government eyes Rs 12,000 crore via share buyback in 6-8 PSUs

📝 Auto component exports grow 24-53% in Q1: EEPC India

📝 ChrysCapital in advanced talks to buy stake in Dr Agarwal's Health Care

📝 Leasing activity up 45% across metros in Jan-June 2018: Report

📝 Sembcorp Energy India bags 250mw Bangladesh contract

*Business Standard*

📝 Global e-commerce firms look to buy domestic retailers to up India game

📝 RBI Deputy Governor bats for umbrella law for public credit registry

📝 Indices climb to fresh highs: Sensex soars 330 points to close at 38,278

📝 Copper climbs above $6,000 on easing trade tensions between US, China

📝 SIPs' contribution to mutual funds up 53% in July at Rs 75.54 billion

📝 DoT pushes for upgrade to block internet services to maintain law and order

📝 Lending to MSMEs can become Rs 15-trn business in next 5 years: Study

📝 MCA probes Jet Airways on suspicion of siphoning funds: Sources


*Financial Express*

📝 DGCA data: Domestic air passenger traffic rises 21 percent in July

📝 Tanla Solutions acquires Karix Mobile for Rs 340 crore

📝 Hyundai Motor picks up stake in car-sharing company Revv

📝 Snapdeal increases authorised capital to Rs 15 crore

📝 1.55 crore wireless telecom subscribers added in June: TRAI

📝 Puravankara, Google tie up for smart homes

📝 RJio, Airtel account for two-thirds of subscriber additions in H1 CY2018

*Mint*

📝 Alibaba in talks with Reliance Retail for joint venture

📝 Firm sues TCS for IP infringement in US

📝 Crystal Crop acquires 4 brands from FMC, to widen portfolio

📝 PepsiCo to buy Israel’s SodaStream for $3.2 billion

📝 Fotowatio Renewable Ventures looks to exit solar project in India

📝 CSIR lab develops potential clot buster drug for stroke, licences it for clinical trials

📝 Bajaj Group plans ₹3,000 crore IPO of power generation business.

Cyber fraud management exam recollected 18-Aug-2018

1. 2Q on Detection control & 1Q on prevention control- select which is detection control of these.
2. E governance- Many questions
3. Netra related to which org.
4. Case based questions of 2Mks
5. Cyber Crime Triangle
6. Given a statement- In which act it is included.
7. 1Q on a case related to cyber crime. For what the case is for.

Information Silo
DGCA
C-DAC
Satyam & Sify
PCIDSS
Lebanese Loop
Man in the Middle Attack
Sinkholding
UCP600 -July2007
SCADA
Cyber Stalking
TLD ( dot in )
mens rea
Dumpster Diving
BYOD (Bring your Own Device)
Installing CCTV & Fire Alaram is which type control
Tailgating
OLA is not a popular app store
multylayered security
what is data
prepaidcard
micro ATM
cross site Scripting.
hectivist.
Trojan hourse
Cyber Smearing
data backup is an example of which type of control
INFO stealer
CAPTCHA
definition of Control
why digital wallet being promoted by bank
Staganography
Blue hat hacker
CBI
packet filter firewall

Current Affairs on August 20th 2018

Today's Headlines from www:

*Economic Times*

📝 Intel India trains 99,000 people in artificial intelligence

📝 Sebi to expand scope of cybersecurity initiatives for MIIs

📝 FPIs' bullish stance continues; inflow at Rs 7,577 crore in August so far

📝 Peak power deficit in April-July at 0.9 per cent: CEA

📝 ONGC repays a third of loan taken to buy HPCL

📝 Serum Institute to launch dengue vaccine in South America next year

📝 AAI prepares specifications for remote air traffic control towers; to invite bids shortly

📝 Jubilant Life Sciences plans Rs 550-cr capex in FY19

*Business Standard*

📝 Bank of India puts on sale 50 corporate NPAs with Rs 55.57 bn outstanding

📝 TaxiForSure founder bets big on content platform in regional languages

📝 Pratt and Whitney engine issues ground new IndiGo Airbus A320 neo aircraft

📝 For every Rs 100 earned, Indian Railways spent Rs 111 in April-July 2018

📝 From next year, no ATM refilling post 9 pm in cities, 6 pm in rural areas

📝 Airtel, Zee Entertainment join hands to drive growth of digital content

📝 Indian equity market best performer among emerging economies this year

*Financial Express*

📝 Airfares don’t rise despite passenger traffic increase of 17% in the last year

📝 Amway plans to invest Rs 1,000 cr in India over a period of 2-3 years

📝 Big Bazaar goes digital for sale days; plans online retail only during seasonal, festive, special days

📝 Tepid response likely for spectrum auction, even Reliance Jio not in a hurry to acquire more frequencies

📝 Merchandise exports from job-intensive sectors contract in Q1

📝 With deposit rates broadly stable, further rise in MCLR at a swift pace is less likely

*Mint*

📝 Trai consultation soon on traffic rules for net neutrality

📝 BSE, NSE to suspend trading in Gitanjali Gems, Amtek Auto

📝 Coal India expects 367 mt output from 115 projects in 2018-19

📝 India’s current account deficit may widen to 2.8%: Nomura

📝 Vedanta to invest $2.3 billion in oil and gas in near term

📝 Legal costs of firms rose 56.73% in last five years

📝 HPCL arm Prize Petroleum takes a ₹ 24.41 crore hit

📝 Lifestyle to invest up to ₹ 200 crore to open 20 stores.

Credit Thrust

Credit Thrust: It means the main focus area for a bank or a specific branch should
give. If a branch is in rural, thrust should be on agri sector loans, and so on. This gives
an opportunity for a bank/branch to gather maximum profit with minimum staff, as the
customer is ready. Precaution: While disbursement, the financials and history to be
checked to prevent NPA in future.
Credit Priorities are Same  as Credit thrust.
Credit Acquisitions: It means sanctioning the loans to customers by closing their
loans with other banks. In short, acquiring other bank‘s customers for business growth.
Points to remember:
1 Whether the loan in other bank is in standard condition
2 Why is the other bank ready to let go the loan
3 Credit history of the borrower
4 Adequate collateral
Statutory & Regulatory restrictions on Advances :
No banking company shall-
(a) grant any loans or advances on the security of its own shares, or
(b) enter into any commitment for granting any loan or advance to or on behalf
of-
(i) any of its Directors,
(ii) any firm in which any of its Directors is interested as Partner, Manager,
Employee or Guarantor, or
(iii) any company(proprietor/partner/pvt ltd/public) in which any of the
Directors of the banking company is a Director, Managing Agent,
Manager, Employee or Guarantor or in which he holds substantial
interest, or
(iv) any individual in respect of whom any of its Directors is a partner or
guarantor.
Restrictions on Grant of Loans & Advances to Officers and Relatives of Senior
Officers of Banks
The following guidelines should be followed by all the banks with reference to the
extension of credit facilities to officers and the relatives of senior officers:
(i) Loans & advances to officers of the bank
No officer or any Committee comprising, inter alia, an officer as member, shall, while
exercising powers of sanction of any credit facility, sanction any credit facility to his/her
relative. Such a facility shall ordinarily be sanctioned only by the next higher sanctioning
authority. Credit facilities sanctioned to senior officers of the financing bank should be
reported to the Board.
(ii) Loans and advances and award of contracts to relatives of senior officers of the bank
Proposals for credit facilities to the relatives of senior officers of the bank sanctioned by
the appropriate authority should be reported to the Board.
Credit Appraisal :

CREDIT RISK ASSESSMENT (CRA)
The CRA models adopted by the Bank take into account all possible factors into
appraising the risks, associated with a loan.
These have been categorized broadly into financial, business, industrial & management
risks are rated separately.


These factors duly weighted are aggregated to arrive at a credit decision whether loan
should be given or not
Validation of proposal:
It is done considering 5 key factors below:
1. CIBIL Score and Report: It is one of the most important factor that affects your
loan approval. A good credit score and report is a positive indicator of your credit
health.
2. Employment Status: Apart from a good credit history, banks also check for
your steady income and employment status.
3. Account Details: Suit filed or written off cases are carefully examined by banks.
4. Payment History: Banks check for any default on payments or amount overdue
cases, which might project a negative overview of your overall report.
5. EMI to Income Ratio: Banks also consider the proportion of your existing loans
when compared to your salary at the time of loan application. Your chances of loan
approval gets reduced if your total EMI‘s exceed your monthly salary by 50%.
Apart from your CIBIL Score, loan eligibility criteria differs from bank to bank and across
loan types. However, some of the basic requirements in terms of documentation are:
 Identity Proof: Aadhar Card, Valid Passport, Driving License, Voters ID or PAN
Card
 Address Proof: Aadhar Card, Valid Passport, Driving License, Voters ID or Utility
Bills
 Proof of Employment: Salary slip, Official ID card or letter from company
 Income Proof: Latest 3 months Bank Statement, salary slip for last 3 months
 3 Passport size photographs


Dimensions of Credit Appraisals
Six ―C‖ s
1. Character

You are considered to have good credit character when you live up to your
financial and credit agreements. Paying bills on time and meeting financial
obligations are signs of good character.
Your credit score and your credit history are good ways for a bank to learn about
your character or credit reputation and how well you pay your credit obligations.
2. Capacity
Capacity reflects your ability to repay a loan or other financial agreement.
Potential creditors want to see that you‘ll have enough cash left over after paying
your fixed monthly expenses to repay a new credit or loan account.
3. Capital
A potential bank also will assess your capital. Wondering if you have any?
Subtract all your debts from your assets, including any property that you may own,
and this is your capital. Banks and creditors like to see that you have enough
capital to handle another loan or credit account before approving you for new
credit.
4. Conditions
Banks look at conditions such as the stability of your employment, your other
debts and financial obligations, and how often you‘ve moved in the past year when
considering whether to approve you for a loan. The longer you‘ve been in a job
and the less frequently you‘ve moved the more stable your life conditions appear
to potential creditors and banks.
5. Collateral
Collateral is any property or possession that can be used as security for a
payment of a debt. For example, a home or automobile serve as collateral against
the loans you might take out to purchase them. Banks like collateral because it
guarantees them against a total loss if you fail to repay your loan. If that happens,
your collateral may be sold or repossessed to repay your financial obligation.
6. Cash Flow
adequate cash flow to repay a new loan.
Income in each month
Are you paid regularly, or does your income fluctuate based on seasonality or
other factors?
A Bank wants to make sure you have enough cash flowing your way on a regular
basis so that you can pay for a new credit obligation.

Mintzberg Model: 10 Different Roles of a Successful Manager

Mintzberg Model: 10 Different Roles of a Successful Manager

Managers wear a lot of hats. Understanding these “hats,” and reflecting on how you’re wearing them, is the best way to grow as a team leader.
Henry Mintzberg, understood this and organized the roles of management systematically in his 1990 book Mintzberg on Management: Inside our Strange World of Organizations. Since then, the PhD from MIT and internationally renowned academic and author on business and management has gone on to stress the importance of practical application of business theory. Mintzberg maintains that management is often more art than science, evident in his very practical and applicable model outlining 10 Management Roles:

In his book, Mintzberg divides managerial work into three categories: interpersonal roles, informational roles and decisional roles. These roles require developing peer relationships, carrying out negotiations, motivating subordinates, resolving conflicts, establishing information networks, making decisions with little or ambiguous information and allocating resources. In this process, at different times, managers “wear ten hats” divided into the three categories:

Interpersonal Roles
The Figurehead: performs ceremonial duties. Examples: greeting visiting dignitaries, attending an employee’s wedding, taking an important customer to lunch.
The Leader: responsibility for the work of subordinates, motivating and encouraging employees, exercising their formal authority.
The Liaison: making contacts outside the vertical chain of command including peers in other companies or departments, and government and trade organization representatives.
Informational Roles
4. The Monitor: scans the environment for new information to collect.

5. The Disseminator: Passing on privileged information directly to subordinates.

6. The Spokesperson: Sharing information with people outside their organization. Examples: a speech to a lobby or suggesting product modifications to suppliers.

Decisional Roles
7. The Entrepreneur: Seeks to improve the unit by initiating projects.

8. The Disturbance Handler: Responds involuntarily to pressures too severe to be ignored. Examples: a looming strike, a major customer gone bankrupt, or a supplier reneging on a contract.

9. The Resource Allocator: Decides who gets what.

10. The Negotiator: Committing organizational resources in “real-time” with the broad information available from their informational roles.

Applying the Model for Improvement
As a manager, you may tend to shy away from some of these roles that you don’t favor i.e. you may tend to avoid monitoring and handling disturbances. Recognizing your strengths and weaknesses according to these ten roles can help you to develop your skills and knowledge and become a more well rounded manager.

ACTIVITY: Think about how much time you spend on each role. Write down the ten roles on a piece of paper and score yourself from 1–5 on each role with 1 being “Very skilled” to 5 being “Not skilled at all.” Consult the list below for improvement tips in the roles where you scored the lowest.

Tips for Improvement
Figurehead: If you struggle wearing this hat, start with cultivating humility and empathy. Focus on using your energy to be a good role model and become more aware of your image and reputation and how you can consistently display model behavior.
Leader: Anyone can be a leader, but not everyone can be an authentic leader who is respected by his or her team. The most important skill here to develop to improve is emotional intelligence.
Liaison: Not everyone is comfortable being a networking ham, but it’s part of the job. You can start by attending small networking events and work your way out.
Monitor: The challenge of this aspect lies in its details. Become a better “skimmer” so you can scan through a lot of information and get to the big picture without experiencing information overload. It’s also important in this area to keep up with industry news.
Disseminator: If you struggle in this area, work on improving your communication skills. Knowing not only what to share, but how and with whom. If you have difficulty expressing things properly, engage a colleague to help in the beginning with proofreading or being a second pair of eyes as you adjust in this role.
Spokesperson: This is an area where a lot of people feel challenged. Read blogs and research how to deliver great presentations and how to deal with the media. Speak with your company leaders to discuss how the company’s brand or image should be represented in the community.
Entrepreneur: Work on problem solving and creativity skills or again, if this is not your strength, employ colleagues who excel here with brainstorming sessions or “crazy ideas” meetings. In addition, change management is a huge necessity in this area.
Disturbance Handler: You can read up on how to handle team conflict to improve your conflict resolution skills, but it may also be helpful to constructively coach team members who have a habit of bringing emotion into the office.
Resource Allocator: To wear this hat, prioritization is key. Take advantage of online tools and systems for this as well as budgeting tips.
Negotiator: Read about Distributive Bargaining or Win-Win Negotiations to beef up your skills. Role playing can also be an important tool here to strengthen your ability to negotiate.
Every manager can use a little help. Visit taskworld.com to learn why managers in over 4000 companies across 80 countries use Taskworld to improve their team’s performance

Customer Rights Policy

Customer Rights Policy
The Customer Rights Policy enshrines basic rights of the customers of the banks regulated by
the Reserve Bank of India. It spells out the rights of the customer and also the responsibilities
of the bank. The Policy applies to all products and services offered by the bank or its agents,
whether provided across the counter, over phone, by post, through interactive electronic
devices, on internet or by any other method.
1. Right to Fair Treatment
Both the customer and the financial services provider have a right to be treated
with courtesy. The customer should not be unfairly discriminated against on
grounds such as gender, age, religion, caste and physical ability when offering
and delivering financial products.
In pursuance of the above Right, bank will –
i) Promote good and fair banking practices by setting minimum standards in all dealings with
the customers;
ii) Promote a fair and equitable relationship between the bank and the customer;
iii) Train bank staff attending to the customers, adequately and appropriately;
iv) Ensure that staff members attend to customers and their business promptly and
courteously;
v) Treat all customers fairly and not discriminate against any customer on grounds such as
gender, age, religion, caste, literacy, economic status physical ability, etc. Bank may,
however, have special schemes or products which are specifically designed for members
of a target market group or may use defensible, commercially acceptable economic
rationale for customer differentiation. Bank may also have schemes or products as part of
an affirmative action such as for women or backward classes. Such schemes / products will
not tantamount to unfair discrimination. The rationale for such special schemes or terms
will be explained by bank wherever required;
vi) Ensure that the above principle is applied while offering all products and services;
vii) Ensure that the products and services offered are in accordance with relevant laws and
regulations;
While it shall be the endeavour of the bank to provide their customers with hassle free and fair
treatment, bank would expect their customers to behave courteously and honestly in their
dealings with the bank.
It shall also be the bank’s endeavour to encourage their customers to approach the bank’s
internal grievance redressal machinery and approach alternate fora after exhausting all their
remedies under bank’s internal grievance mechanism.

2. Right to Transparency, Fair and Honest Dealing
The financial services provider should make every effort to ensure that the
contracts or agreements it frames are transparent, easily understood by and well
communicated to, the common person. The product’s price, the associated risks,
the terms and conditions that govern use over the product’s life cycle and the
responsibilities of the customer and financial service provider, should be clearly
disclosed. The customer should not be subject to unfair business or marketing
practices, coercive contractual terms or misleading representations. Over the
course of their relationship, the financial services provider cannot threaten the
customer with physical harm, exert undue influence, or engage in blatant
harassment.
In pursuance of the above Right, the bank will –
i) Ensure complete transparency so that the customer can have a better understanding of
what he or she can reasonably / fairly expect from the bank;
ii) Ensure that the bank’s dealings with the customer rest on ethical principles of equity,
integrity and transparency;
iii) Provide customers with clear information about its products and services, terms and
conditions, and the interest rates / service charges in simple and easily understandable
language, and with sufficient information so that the customer could be reasonably
expected to make an appropriate and informed choice of product;
iv) Ensure that all terms and conditions are fair and set out the respective rights, liabilities and
obligations clearly and as far as possible in plain and simple language;
v) Make known the key risks associated with the product as well as any features that may
especially disadvantage the customer to him/her. Most Important Terms and Conditions
(MITC) associated with the product or service will be clearly brought to the notice of the
customer while offering the product. In general, it will be ensured that such terms will not
inhibit a customer’s future choice.
vi) Provide information on interest rates, fees and charges either on the Notice Board in the
branches or website or through help-lines or help-desk and where appropriate the customer
will be informed directly;
vii)Display the tariff Schedule on their website and a copy of it will be made available at every
branch for customer’s perusal. Also will display in its branches a notice about the availability
of the Tariff Schedule at the branch;
viii) Give details, in their Tariff Schedule, of all charges, if any, applicable to the products and
services chosen by customer;
ix) Inform the customer of any change in the terms and conditions through a letter or
Statement of Account, SMS, email or display at branch notice board/website at least one
month prior to the revised terms and conditions becoming effective;
x) Ensure that such changes are made only with prospective effect after giving notice of one
month. If the bank has made any change without giving such notice which is favorable to
the customer, it will notify the change within 30 days of such change. If the change is
adverse to the customer, prior notice of minimum 30 days will be provided and the
customer may be provided options, to close the account or switch to any other eligible
account without having to pay the revised charge or interest within 60 days of such notice;
xi) Provide information about the penalties leviable in case of non-observance / breach of any
of the terms and conditions governing the product / services chosen by the customer;

xii)Display on public domain the Banks’ Policies on Deposits, Cheque Collection, Grievance
Redressal, Compensation and Collection of Dues and Security Repossession;
xiii)Make every effort to ensure that staff dealing in a particular product is properly trained to
provide relevant information to customers fully, correctly and honestly;
xiv)Ensure to communicate to the applicant within a reasonable time period as decided by the
bank about the acceptance / non-acceptance of applications submitted for availing a
product / service and convey in writing the reasons for not accepting / declining the
application. Such period will be notified in the bank’s website and also in the application of
the particular product or service
xv)Communicate unambiguously the information about –
a. discontinuation of particular products,
b. relocation of their offices
c. changes in working hours
d. change in telephone numbers
e. closure of any office or branch
with advance notice of at least 30 days. Also affirms that disclosure of information is an ongoing
process through the life-cycle of the product / relationship and will be diligently
followed by them. Ensure to use all possible channels of communication, including website,
to ensure that information on all changes are made known to the customer upfront;
xvi)Advise the customer at the time of selling the product of the rights and obligations
embedded in law and/or banking regulation including the need to report any critical
incidents that the customer suspect, discover or encounter;
xvii) The bank’s staff members shall, when approached by the customer for availing a product
or service, provide all relevant information related to the product/service and also provide
direction to informational resources on similar products available in the market with a view
to enable the customer to make an informed decision;
xviii)Not terminate a customer relationship without giving reasonable or contractual prior notice
to the customer;
xix) Assist the customer in all available ways for managing his/her account, financial
relationship by providing regular inputs in the bank’s realms such as account
statements/passbooks, alerts, timely information about the product’s performance, term
deposits maturity etc.;
xx) Ensure that all marketing and promotional material is clear and not misleading;
xxi)Not threaten the customer with physical harm, exert influence or engage in behavior that
would reasonably be construed as unwarranted harassment. Ensure adherence only to the
normal appropriate business practices.
xxii)Ensure that the fees and charges on products/services and its structure are not
unreasonable to the customer
3. Right to Suitability
The products offered should be appropriate to the needs of the customer and
based on an assessment of the customer’s financial circumstances and
understanding.
In pursuance of the above Right, the bank will –
i) Ensure that it has a Board approved policy for assessing suitability of products for
customers prior to sale;

ii) Endeavour to make sure that the product or service sold or offered is appropriate to the
customer’s needs and not inappropriate to the customer’s financial standing and
understanding based on the assessment made by it. Such assessment will be appropriately
documented in the it’s records
iii) Sell third party products only if it is authorized to do so, after putting in place a Board
approved policy for marketing and distributing third party financial products;
iv) Not compel a customer to subscribe to any third party products as a quid-pro-quo for any
service availed from the bank;
v) Ensure that the products being sold or service being offered, including third party products,
are in accordance with extant rules and regulations;
vi) Inform the customer about his responsibility to promptly and honestly provide all relevant
and reasonable information that is sought by bank to enable them to determine the
suitability of the product to the customer.
4. Right to Privacy
Customers’ personal information should be kept confidential unless they have
offered specific consent to the financial services provider or such information is
required to be provided under the law or it is provided for a mandated business
purpose (for example, to credit information companies). The customer should be
informed upfront about likely mandated business purposes. Customers have the
right to protection from all kinds of communications, electronic or otherwise,
which infringe upon their privacy.
In pursuance of the above Right, bank will –
i) Treat customer's personal information as private and confidential (even when the customer
is no longer banking with us), and, as a general rule, not disclose such information to any
other individual/institutions including it’s subsidiaries/associates, tie-up institutions etc. for
any purpose unless:
a. The customer has authorized such disclosure explicitly in writing
b. Disclosure is compelled by law/regulation;
c. Bank has a duty to the public to disclose i.e. in public interest
d. Bank has to protect its interests through disclosure
e. It is for a regulatorily mandated business purpose such as disclosure of default to credit
information companies or debt collection agencies
ii) Ensure such likely mandated disclosures be communicated immediately to the customer in
writing
iii) Shall not use or share customer’s personal information for marketing purpose, unless the
customer has specifically authorized it;
iv) Shall adhere to Telecom Commercial Communications Customer Preference Regulations,
2010 (National Customer Preference Registry) issued by Telecom Regulatory Authority of
India, while communicating with customers.
5. Right to Grievance Redress and Compensation
The customer has a right to hold the financial services provider accountable for the
products offered and to have a clear and easy way to have any valid grievances
redressed. The provider should also facilitate redress of grievances stemming from
its sale of third party products. The financial services provider must communicate

its policy for compensating mistakes, lapses in conduct, as well as nonperformance
or delays in performance, whether caused by the provider or
otherwise. The policy must lay out the rights and duties of the customer when
such events occur.
In pursuance of the above Right, bank will –
i) deal sympathetically and expeditiously with all things that go wrong;
ii) correct mistakes promptly;
iii) cancel any charge that has been applied wrongly and by mistake;
iv) compensate the customer for any direct financial loss that might have been incurred by
the customer due to its lapses.
The bank will also –
i) Place in public domain its Customer Grievance Redressal Policy, including the grievance
redressal procedure available for the customer;
ii) Place in public domain the compensation policy for delays / lapses in conducting /
settling customer transactions within the stipulated time and in accordance with the
agreed terms of contract;
iii) Ensure to have a robust and responsive grievance redressal procedure and clearly
indicate the grievance resolution authority who shall be approached by the customer;
iv) Make grievance redressal mechanism easily accessible to customers;
v) Advise the customer about how to make a complaint, to whom such a complaint is to be
made, when to expect a reply and what to do if the customer is not satisfied with the
outcome;
vi) Display name, address and contact details of the Grievance Redressal Authority/Nodal
Officer. The time limit for resolution of complaints will be clearly displayed/accessible at
all service delivery locations;
vii)Inform the complainant of the option to escalate his complaint to the Banking
Ombudsman if the complaint is not redressed within the pre-set time;
viii) Place in public domain information about Banking Ombudsman Scheme;
ix) Display at customer contact points the name and contact details of the Banking
Ombudsman under whose jurisdiction the bank’s branch falls.
Further, the bank will –
i) Acknowledge all formal complaints (including complaints lodged through electronic means)
within three working days and work to resolve it within a reasonable period, not exceeding
30 days (including the time for escalation and examination of the complaint by the highest
ranking internal official responsible for grievance redressal). The 30 day period will be
reckoned after all the necessary information sought from the customer is received;
ii) Provide aggrieved customers with the details of the Banking Ombudsman Scheme for
resolution of a complaint if the customer is not satisfied with the resolution of a dispute, or
with the outcome of a dispute handling process;
In addition, the bank will a) clearly spell out, at the time of establishing a customer
relationship, the liability for losses, as well as the rights and responsibilities of all parties, in
the event of products not performing as per specifications or things going wrong. However,
the bank will not be liable for any losses caused by extraneous circumstances that are

beyond its reasonable control (such as market changes, performance of the product due to
market variables, etc.). b) Ensure the customer is refunded without delay and demur, if it
cannot show beyond reasonable doubt to the customer on any disputed transaction (along
with interest/charges).