4.credit Risk Management

Credit Risk Management- Brief
on Standardized & IRB

Approaches with Capital
Calculation Exercises
A Presentation By
A K Mishra, Ex GM(CBI)
Now Faculty IIBF Mumbai
Mob- 7428045854 Dt 14th Dec 23
Mail ID- fm.trg2@iibf.org.in
INDIAN INSTITUTE OF BANKING & FINANCE

The Session Covers
1. Why Banks need Capital ?

2. Capital and Credit risk
3. Risk Weighted Assets & RBI Guidelines
4. Capital Requirements for Credit Risk under
Standardized and IRB approaches

Banking Business and Risks
Liabilities Assets
Equity (Networth) 5% Cash and Balances 6%

with Banks
Borrowings (Long Term, 3% Investments 26%

Unsecured)
Borrowings (Short term) 2% Loans and 64%

Risks in
Advances Banking
Business
Deposits 87% Fixed + Other 4%
Assets
Provisions 3% Off B/S (as % of On 22%

B/S Assets)

Introduction
 Banks are Financial Intermediaries
 Banks Confront with Financial and Non-Financial Risk
 Credit Risk, Market Risk, Operational Risk, Commodity

Price Risk, Legal, Regulatory & Reputational Risk etc.
 Credit is the largest Portfolio and as such Credit Risk is

the oldest Risk of all

What is
Credit
Risk?

What is Credit Risk ?
 Credit
Risk refers to the probability of the
Loss emanating from the Default in
Repayment of Credit facilities extended,
as a result of the Non-fulfilment of
contractual obligations arising from
Unwillingness or
Inability of the counterparty
Or for any other reasons
What is Credit Risk?
 Default by a Counterparty on a
Contractual obligation leading to a
Loss to the bank
 Borrower Default on Principal and
Interest on loans
 Counterparty Default- On Investment in
Bonds, Debentures, Commercial Paper
etc
Credit Risk
Credit Risk is the possibility of

Losses associated with
Diminution in the Credit quality
of Borrowers or Counterparties.

Various
Forms of
Credit Risk

Non-payment
of interest or
principal or
both
Default from
Inability to
the flow of
arrange fund
forex in terms
for devolved
of cross-border Forms of LC/LG
obligations Credit Risk
Default by
Not meeting counterparties
settlement dues in meeting
from security obligations from
trading treasury
operations

Credit Risk originates from
1 2
Default due to Loss from

inability or Reduction
Unwillingness in Portfolio
of a Borrower value
to meet
Repayment
commitments

Concept of Credit Risk
 Credit Risk refers to the Probability of the loss (due to the Non-
Recovery of Principal and/or Interest) emanating from the Credit
extended as a result of the Non-fulfilment of Contractual obligation
arising from unwillingness or inability of the counterparty or any of the
other reasons.
 A single borrower/obligor exposure is generally known as Firm Credit

Risk or Obligor Credit Risk while the Credit exposure to a group of
Borrowers is called Portfolio Credit Risk.
Causes of
Credit Risk?

Causes of Credit Risk
Systemic Un-Systemic
Systemic Risk :-External factors that affect all business and households in the country
or economic system are called systemic risks and are considered as uncontrollable
risks . For instance, if the economy is witnessing a sharp economic crisis/recessions,
bankruptcies will increase, triggering credit losses, while stock market will decline
due to lower corporate profits, while unemployment rises, amongst other effects.
Political uncertainties in any economy can also impact the quality of credit asset and
may lead to losses
Causes of Credit Risk
Unsystemic Risk :- These risks do not affect the entire economy
or all business enterprises / households. These risks are mainly
industry specific and/or firm specific.
Credit risk are triggered by both systemic and un-systemic

factors and are required to be carefully handled.
Interest rate changes, inflation, recessions and wars all

represent sources of Systemic Risk
Un-Systemic Risk is a Risk unique to the operation of an

individual firm. Examples of this can include management risks,
location risks and succession risks.

Impact of Credit
Risk?

Impact of unchecked Credit risk
Unrelenting pressure on Earnings & Profitability
Erosion of Capital
Blocks Recycling of Funds causing illiquidity
Bank’s Insolvency

Why Banks need Capital ?

Why Banks need Capital ?
01 02 03 04
Protects Provides fund Improves risk Conforms to

Banks against for absorption regulatory
Unexpected developing capability requirement
unanticipated logistics
loss

Capital adequacy captured centre stage in the business plan of a Banker
Basel III Accord 2010

Basel II Accord 2004
The quality and level
More comprehensive of capital was raised to
Basel I Accord approach make Banking system
1988 Minimum Capital more resilient
Risk based capital Requirement linked to
Added buffers to
adequacy standard Credit, Market,
Operational risk address systemic issues
Only Credit Risk
Multiple levels of risk
Market risk added measurement with
1996 increased sophistication

Question - 1
1
1. Bank’s capital is meant to cover
A.Volatility in the market
B.Interest and non interest

expenses
C.Expected Loss
D.Unexpected Loss

1. Bank’s capital is meant to cover
A.Volatility in the market

B.Interest and non interest
expenses
C.Expected Loss
D.Unexpected Loss

Question - 2
2
2. Under Basel III accord, greater focus was
given on :
A.Enough capital to cover credit, market and

operational risk
B.Enough capital to cover all the risks as per its

risk profile
C.Improving both the quality and quantity of capital
D. Ensuring a stable financial system

2.Under Basel III accord, the focus was
given on :
A.Enough capital to cover credit,
market and operational risk
B.Enough capital to cover all the risks
as per its risk profile
C.Improving both the quality and
quantity of capital
D. Ensuring a stable financial system

Question - 3
3
3.Your Bank A had invested in a bond. The bond
matured on the due date . But on presentation, the
issuer of the Bond could not make payment. As
Risk Manager how will you categorize the risk arising in
the investment portfolio
A.Credit Risk
B.Operational Risk
C.Market Risk
D.Business Risk
3.Your Bank A had invested in a
bond. The bond matured on the due
date . But on presentation, the issuer
of the Bond could not make
payment. As Risk Manager how will
you categorize the risk arising in the
investment portfolio
A.Credit Risk
B.Operational Risk
C.Market Risk
D.Business Risk

Approaches for calculation of
Capital requirement on Credit
Exposure?

Capital Calculation for Credit Risk
HOW TO ARRIVE AT CAPITAL

REQUIREMENT ?

Capital Calculation for Credit Risk
Basel III prescribes three options for computing Capital
on account of Credit risk
Banks have been

allowed to adopt an
approach depending
on their level of Advanced Internal
Foundation Rating Based
preparedness Internal Approach(AIRB)
Rating Based
Approach
Standardized (FIRB)
Approach

Capital calculation under Standardized Approach :
-Process Flow Chart

Capital calculation under Standardized Approach : Process flow chart
Aggregate
Undraw the RWAs
n of individu
Fund- Commit al exposur
Adjustme es
Based ments & Calculate
Exposure Non- nt made
for Risk Capital
Including Fund Calculate Require
NPA Based Mitigation ment for
RWA of
Exposure Collateral Credit Risk
RWA individual
s Eligible @ 11.5%
=Appr RW RWA=Ap exposure
collateral s
x pr RW x x Appro.
Outstandi Credit Haircut
ng equivale
nt

Choosing appropriate Risk weight
1. An individual person/persons
2. A small business with
average annual turnover (for
3 years) less than Rs 50 Cr Regulatory
3. Covers fund based and non Retail
fund based facilities
4. Aggregate exposure to single Exposure :
party not to exceed 0.2% of Risk weight
overall Retail portfolio 75%
5. Max aggregated exposure to
one party Rs7.50 Cr.
Claims secured by residential property
1. Risk weight for individual
housing loan vary depending For Loans sanctioned on or after
7/6/2017
on the value of LTV ratio
which is calculated as Loan Risk
LTV
𝐿𝑜𝑎𝑛 O𝑠𝑡𝑔+𝐴𝑐𝑐𝑟 𝐼𝑛𝑡+𝑂𝑡ℎ𝑒𝑟 𝐸𝑥𝑝/
Value Weight
𝑅𝑒𝑎𝑙𝑖𝑧𝑎𝑏𝑙𝑒 𝑣𝑎𝑙𝑢𝑒 𝑜𝑓 𝑀𝑜𝑟𝑡𝑔𝑎𝑔𝑒𝑑 𝑝𝑟𝑜𝑝𝑒𝑟𝑡𝑦
≤ 80% 35%
Up to 30
2. Loans for Commercial Real lakh >80 &
Estate (for Retail Housing) is 50%
≤90%
75% > 30 &
3. Restructured housing loan is upto 75 ≤ 80 35%
risk weighted with additional lakh
risk weight of 25% to the Above 75
≤ 75 % 50%
prescribed risk weight lakh

Claims secured by residential property
Amendments- on 16th October 2020
For Loans sanctioned on or after
As a countercyclical 16/10/2020 till 31st Mar 2023
measure, RBI has Risk
Loan Value LTV
rationalized the risk weights Weight
on individual housing loans, ≤ 80% 35%
Irrespective
irrespective of the amount. >80 &
of amount 50%
The risk weights for all new ≤90%
housing loans to be
sanctioned on or after 16th
October 2020 and upto
March 31, 2023 shall be--
Other categories
1. Exposure ( FB+NFB) on Central
Govt & Central Govt guaranteed
a/cs- RW ZERO 1. Consumer credit including personal
2. Direct Loan /credit/ overdraft loan but excluding credit card
facilities to State Govts- RW receivables will attract RW 100%
ZERO. But State Govt guaranteed (RBI Cir 12 Sep 2019)-125% Wef
a/c RW- 20% 16th Nov 23
3. Claims on RBI, DICGC, CGTMSE, 2. Advance classified as capital mkt
CRGFTLIH – RW ZERO . Claims on exposure will attract RW of 125%
ECGC RW- 20% 3. Fund based and non fund based
4. Loans and advances of Banks own exposure on venture capital Fund
staff which are fully covered by are considered high risk and
superannuation benefits and attracts RW of 150%
mortgage of flats/ house RW 20%

Query - 1
1. Dr A has availed a Term Loan to purchase

an X-Ray machine. The present outstanding
in the A/c is Rs 100 lakh. Assess the capital
requirement on account of this exposure
A.7.5 lakh
B.9.0 lakh
C.8.63 lakh
D.8.0 lakh

1.Dr A has availed a Term Loan to
purchase an X-Ray machine. The
present outstanding in the A/c is
Rs 100 lakh. Assess the capital
requirement on account of this
exposure
A.7.5 lakh
B.9.0 lakh
C.8.63 lakh(75%x11.5% RWA)
D.8.0 lakh

Query - 2
2
2. An SME unit is enjoying the following
Facilities.
Fund Bases Limit Rs 400 lakh Ostg Rs 350
lakh Non-Fund Based Limit Rs 200 Ostg Rs
150 lakh RWA will be decided as per
A.RW applicable as per internal rating
B.RW applicable to Regulatory Retail
Credit
C.RW applicable to the rating given by
CRA
D.RW applicable to SSI unit

2. An SME unit is enjoying the
following Facilities.
Fund Bases Limit Rs 400 lakh Otg Rs 350
lakh. Non Fund Based Limit Rs 200 Otg Rs
150 lakh
RWA will be decided as per

A.RW applicable as per internal
rating
B.RW applicable to Regulatory
Retail Credit
C.RW applicable to the rating
given by CRA
D.RW applicable to SSI unit

Query - 3
3
3.Bank A subscribed to a Development Bond
Issued By State Govt to the extent of Rs 50 cr.
What will be the risk weighted asset of this
exposure amount to
A. Rs 20 cr
B. Rs 10 cr
C.Rs 9 cr
D.NIL

3.Bank A subscribed to a
Development Bond Issued By State
Govt to the extent of Rs 50 cr. What
will be the risk weighted asset of
this exposure
A. Rs 20 cr
B. Rs 10 cr
C. Rs 9 cr
D. NIL

Query - 4
3
4. Which of the following sectors will be your
preferred sector as a risk manager and why
A. Housing sector
B. Auto Loan
C.Personal Loan
D.Corporate Loan BBB rating

4 Which of the following sectors will be
your preferred sector as a risk manager
and why
A. Housing sector
B. Auto Loan
C. Personal Loan
D. Corporate Loan BBB rating

RWA for Credit Risk - Approaches
PILLAR 1 FOR CREDIT RISK Banks use internal
estimations of PD,
Loss Given Default
(LGD) and
Advanced Internal Exposure at Default
Ratings Based
(EAD) to calculate
INCREASED SOPHISTICATION
Approach
Risk Weights for
Exposure classes
Foundation Internal Banks use internal

Ratings estimations of probability
Based Approach of Default (PD) to
calculate Risk weights for
exposure classes. Other
Risk components are
Standardized Risk weights are standardized.
Approach based on
assessment by
external credit
assessment
institutions

RBI circular on Basel III(12/05/23)
 Under Pillar 1, the Basel III Framework will continue to offer the
3(three distinct) options for computing Capital requirement for
Credit Risk and three(3) other options for computing Capital
requirement for Operational Risk, albeit with certain modifications
/ Enhancements. These options for Credit and Operational Risks are
based on increasing Risk Sensitivity and allow Banks to select an
approach that is most appropriate to the stage of development of
Bank’s Operations.
 The options available for computing Capital for Credit Risk are
Standardized Approach, Foundation Internal Rating Based
Approach(FIRB) and Advanced Internal Rating Based
Approach(AIRB).

RBI guidelines as per Basel III
 Keeping in view the Reserve Bank’s goal to have
consistency and harmony with International Standards,
it was decided in 2007 that all Commercial Banks in
India (excluding Local Area Banks and Regional Rural
Banks) should adopt Standardised Approach for Credit
Risk, Basic Indicator Approach for Operational Risk by
March 2009 and banks should continue to apply the
Standardized Duration Approach (SDA) for computing
Capital requirement for Market Risks.

RBI guidelines –Basel III
 Banks were advised to undertake an Internal assessment of their
preparedness for migration to Advanced approaches and take a
decision with the approval of their Boards, whether they would
like to migrate to any of the Advanced approaches.
 Based on Bank’s Internal assessment and its preparation, a Bank
may choose a suitable Date to apply for implementation of
Advanced Approach. Besides, Banks, at their discretion, would
have the option of adopting the Advanced Approaches for one or
more of the Risk Categories, as per their preparedness, while
continuing with the simpler approaches for other Risk categories,
and it would not be necessary to adopt the Advanced approaches
for all the Risk categories simultaneously. However, Banks should
invariably obtain prior approval of the RBI for adopting any of the
Advanced Approaches.

Basel III Treatment of Credit Risk
• Assigns Different Risk Weights to individual Credit Exposures
(Fund based and Non-Fund based) to calculate the Credit Risk
Weighted Assets
• Recognizes the effects of Risk Mitigants like Eligible financial
Collateral and Guarantees
• RWA = Risk Weight * Adjusted Exposure
• Adjusted Exposure:
– Non-Fund Based limits converted to Fund based Exposure(CEA/CCF)
– All exposures with eligible Risk Mitigants adjusted to reflect the Risk
Reduction
• The total Credit RWA = ∑ RWAi
• Credit Risk Capital = RWA *Min CAR% (11.5%)

Capital calculation under Standardized Approach: Process flow chart
Determining Adjusted Exposure 1.Outstanding balances in fund based

facilities,
2. Undrawn/Unavailed portion of the
sanctioned Fund-Based Facilities and
3.Outstanding Non-Fund Based Facilities
Determining Allowable reduction 1.Deposits under lien
2.Approved Financial collaterals

Determining Applicable Risk Weight
Determining RWA for the exposure

Consolidation of RWA of all Exposures

Adjusted Exposure for undrawn portion of Fund based
sanctioned limits
 Exposure on account of undrawn portion of sanctioned limit would be NIL if
commitments are cancellable at any time without giving any prior notice or
upon deterioration of borrowers credit worthiness
 In other cases, exposure on account of un-availed portion of sanctioned limit
would be
(i) 20% of undrawn portion under all fund based Cash Credit/Overdraft
facilities with maturity inclusive and up to one year
(ii) 20% of undrawn portion of Term Loan which is to be drawn within 1 Year
(iii) 50% of undrawn portion of Term Loan which is to be drawn after 1 year
 Note: In respect of borrowers having aggregate fund based Working Capital
limit of Rs150 crores and above from the banking system, the undrawn
portion of cash credit/ overdraft limits sanctioned, irrespective of whether
unconditionally cancellable or not, shall attract a credit conversion factor of
20%

RW for Off Balance Sheet items
 The notional amount of the transaction is converted into a Credit
Equivalent Amount by multiplying by the specified Credit Conversion
Factor(CCF) and the Equivalent Amount is then multiplied by RW
applicable to the Counterparty based on the Rating or otherwise
 The credit conversion factors for Non-Market related Off-
Balance Sheet items
Sr Instruments CCF
No (%)
1. Financial Guarantees and its equivalent of similar nature 100
2. Performance Guarantees or of similar nature 50
3. Documentary Credits collateralised by the underlying shipment 20

Credit Risk Mitigation
 Meeting the requirement of legal certainty i.e.
enforceability
 These techniques should not increase other risks like
concentration, liquidity & market risk
 CRM Techniques-Collateralised Transactions
 (i) Credit exposure is hedged in whole or part by collateral
posted by a counterparty or by a third party on behalf of
the counterparty
 (ii) Specific lien and legal certainty requirements are met

 Overall framework and minimum conditions

 Simple approach:- substitutes the risk weighting
of the collateral for the risk weighting of the
counterparty for collateralised portion of the
exposure(20% floor)
 Comprehensive approach:- Banks in India shall
adopt the Comprehensive approach, which allows
fuller offset of collateral against exposure and is
allowed on an account-by-account basis.

Credit Risk
Mitigation
 Comprehensive approach:-
 Value of any collateral

received, should take
account of possible future
fluctuation in the value,
occasioned by market
movements. These
adjustments are referred
to as “Haircuts”

 Haircuts:-
 (i)Standard supervisory haircuts, using
parameters set by the Basel committee
 (ii)Own estimate haircuts, using banks’
own internal estimates of market price
volatility
 Banks in India shall use only the
standard supervisory haircuts for both
the exposure as well as the collateral
 CRM techniques-Guarantees:-
 Guarantees are direct, explicit, irrevocable and
unconditional
 Guaranteed exposure is classified as NPA, then Credit Risk
mitigation in the form of Guarantees will not be allowed
 Banks must have the right to receive any such payments
from the Guarantor without first having to take legal
actions against the Counterparty
 Where a Guarantee covers payment of principal only,
interests and other uncovered amount should be treated
as unsecured

Risk Weights:-
Protected portion is assigned the risk weight of the

protection provider e.g. Exposures covered by the
State Govt. guarantees will attract a Risk Weight of
20%
Uncovered portion will be assigned Risk Weight of the
underlying counterparty

Eligible Financial Collateral
 Eligible Financial Collateral (subject to haircut)
 Cash & FDR of the Bank, Securities issued by Central/State
Govt.
 Gold- 99.99 purity and will include both bullion and jewelry
 KVP, NSC , (provided no lock-in period is operational) Life
insurance policy with a declared surrender value
 Rated debt securities which would attract a Risk weight of
almost 100% and Bank is confident of market liquidity. In case
of Debenture, it should be traded at least 90% of the trading
days during the preceding 365 days or traded minimum 25
trades in the previous one month
 Unrated Debt Securities issued by a bank, listed on a
recognized Stock Exchange, classified as a senior debt
 Units of Debt Mutual Funds, daily NAV is available in public
domain
Eligible Financial Collateral-Range of
Guarantees – issued by
 Sovereign, Sovereign entities (including BIS, IMF,
European Central Bank and European community), ECGC
and CGTMSE, Banks and Primary Dealers with a lower
Risk Weight than the Counterparty
 Other Entities having externally rated and this includes
Guarantee cover provided by the Parent, Subsidiary and
affiliate companies when they have a lower Risk Weight
than the obligor. The rating of the guarantor should be
an Entity rating.

Eligible Financial Collateral
 Sovereign Guarantees and Counter-Guarantees
 A claim may be covered by a guarantee that is indirectly counter-
guaranteed by a Sovereign. Such a claim may be treated as covered by
a Sovereign Guarantee provided that:
 (i) the Sovereign Counter-Guarantee covers all Credit Risk elements of
the claim;
 (ii) both the Original Guarantee and the Counter-Guarantee meet all
operational requirements for Guarantees and
 (iii) the Cover should be Robust and no historical evidence suggests
that the coverage of the counter-guarantee is less than effectively
equivalent to that of a direct Sovereign Guarantee.

Eligible guarantee provider
Sovereigns, sovereign entities

(including BIS, IMF, European
Central Bank and European
Community, ECGC, CGTMSE (The
Credit Guarantee Fund Trust for Micro
and Small Enterprises), CRGFTLIH
(Credit Risk Guarantee Fund Trust for
Low Income Housing), banks and
primary dealers with a lower
risk weight than the
counterparty.

ECGC Guaranteed Exposures:
 Under the Export Credit insurance for Banks on Whole Turnover Basis,
the guarantee/insurance cover given by ECGC for Export Credit exposures
of the Banks ranges between 50% and 75% for Pre-Shipment Credit and
50% to 85% in case of Post-Shipment Credit. However, the ECGC’s
total liability on account of default by the exporters is
capped by an amount specified as Maximum Liability (ML). In
this context, it is clarified that Risk Weight applicable to the claims on
ECGC should be capped to the ML amount specified in the whole turnover
Policy of the ECGC. The Banks are required to proportionately distribute
the ECGC maximum liability amount to all individual Export Credits that
are covered by the ECGC Policy. For the covered portion of individual
Export Credits, the Banks may apply the Risk Weight applicable to claims
on ECGC. For the remaining portion of individual Export Credit, the Banks
may apply the Risk Weight as per the Rating of the Counter-Party.
Example of ECGC coverage
Accou Limits Coverage Coverage to be taken for calculation of RWA
nt sr (Rs in as per
no cr) ECGC(75%)
B x A…./213.75(C)=
(A)
1 100 75.00 26.32 So exposure of Rs26.32 cr will attract RW of 20%
and remaining amount of Rs73.68 crores will attract risk
weight of as per the external rating of exposure
2 25 18.75 6.58
3 20 15.00 5.26
4 50 37.50 13.16
5 90 67.50 23.68
Total 285
213.75(C) 75.00(B)
It is presumed that total coverage under whole turnover
packing credit is restricted to Rs75 crores to the
institution for a year (75X75/213.75= 26.3175)

Hair cut
Issue Rating Residual Maturity Haircut %
Type. A Securities issued/guaranteed by GOI & issued by State Govt

Rating not applicable ≤1Yr 0.05
>1 yr but ≤ 5 yrs 2.0
>5 yrs 4.0

Type B Domestic debt securities other than indicated above including securities
guaranteed by State Govt
AAA to AA, A1 ≤1 yr 1
> 1 yr but ≤ 5 yr 4
> 5 yrs 8
A to BBB, A2, A3, unrated ≤1 Yr 2
Bank securities
>1 yr but ≤ 5 yrs 6
>5yrs 12
Maturity Mismatch of Financial Collaterals
 For the purpose of calculating risk-weighted assets, a maturity mismatch
occurs when the residual maturity of collateral is less than that of the
underlying exposure. Where there is a maturity mismatch and the CRM
has an original maturity of less than a year, the CRM is not recognised for
capital purposes.
 Loans collateralized by own deposits, and even if the tenor of such
deposits is less or deposits have maturity mismatch, The above condition
would not be applicable provided lien does provide for automatic
renewal/ adjustment till the full repayment of the underlying loan
 Pa=P×(t-0.25)÷(T-0.25)
 Pa=Value of the Credit protection adjusted for maturity mismatch
 P=Credit protection (e.g. collateral amount, guaranteed amount) adjusted
for any hair cuts
 t=min(t, residual maturity of the credit protection arrangement)
expressed in years
 T=(T, Residual maturity of the Exposure) expressed in years

Credit Risk:Standardized Approach
 Exposure is divided into Corporate Exposure and Retail/Small
Business Exposure
 Any individual person/persons or Small Business :-Total average
annual turnover for the last 3 years (in case of existing units)is
less than Rs.50 crores, also projected turnover in case of new
entities and both actual and projected turnover for entities which
are yet to complete three(3) years
 Exposure ceiling not to exceed Rs7.5 Crores to one party
 Aggregate Exposure (Gross Amount) to one counterparty should
not exceed 0.2% of the overall Regulatory Retail Portfolio(RRP)
 W. E. F.12.10.20, the ceiling of Rs5.00 cr has been increased to Rs7.50 cr.
The Risk Weight of 75% will apply to all Fresh Exposures and also to existing
exposures where incremental Exposure may be taken by the banks up-to the
revised limit of Rs7.5 Crores. The other exposures shall continue to attract
the normal Risk Weights as per the extant guidelines

Exclusion of exposure(FB+NFB) from RRP
 1. Investment in Securities (such as Bonds & Equities) whether
listed or not
 2. Mortgage Loans to the extent that they qualify for treatment
as claims secured by residential property or claims secured by
commercial Real Estate
 3. Loans & Advances to bank’s own staff which are fully
covered by superannuation benefits and /or mortgage of
flat/house
 4. Consumer credit including personal loans and credit card
receivables
 5. Capital Market exposures
 6. Venture Capital funds

Risk Weight under Standardized Approach
Particulars Risk weight
Claims on Domestic Sovereigns –FB+NFB exposure on central Govt 0%
Central Govt. guaranteed claims will also attract 0%
Direct exposure to State Govt. & investment in State Govt. 0%
securities
State Govt. guaranteed claims will attract 20%
Exposure on RBI,CGTMSE,DICGC & CRGFTLIH-Credit Risk 0%
Guarantee Fund Trust for Low Income Housing
Claims on Foreign Sovereigns & Foreign PSE As per the
International
Rating
ECGC 20%
Claims on Public sector Entities(PSEs)

INDIAN INSTITUTE OF BANKING &AsFINANCE
applicable to
Corporates
Particulars Risk weight
Claims on MDBs, BIS and IMF 20% subject to meeting min. CAR
Claims on Banks As per CRAR of the Bank
Claims on Primary Dealers Similar to Corporates
Claims on Corporate As per External Rating
Exposures to all NBFCs, excluding Core Investment As per External Rating

Companies (CICs)
Exposures to CICs, rated as well as unrated 100%
Claims included in the Regulatory Retail Portfolio 75%

Risk Weight under standardized Approach
Particulars Risk weight applicable
Claims secured by Commercial Real Estate— 100%

CRE-RH-- 75%
Restructuring exposure 125% RW till satisfactory period of

repayment is over and after that as per
rating
Credit Card O/s 125% (150% w.ef 16th Nov 2023)
Personal Loans 100% (125% wef 16th Nov 2023)

Venture Capital Funds 150%
Capital Market Exposure 125% or External Rating of the
Counterparty, Whichever is Higher

RW under Standardised Approach
RW on Residential Property:-
Category of loan LTV ratio% Risk weight%
Individual Housing Loans
(i) Up to Rs30 lakh Less than or 35
equal to 80%
More than 80 50
but less than or
equal to 90
(ii)>30 & up to 75 lakhs Less than or 35

equal to 80%
(iii) Above 75 lakhs Less than or 50

equal to 75%

RW under Standardised Approach
RW on Residential Property wef 16.10.20 to
31.03.2023:-
Category of loan LTV Ratio% Risk Weight%
Individual Housing Loans (Irrespective of the amount)
Less than or equal to 80% 35
>80% and Less than or 50

equal to 90%
Loans sanctioned prior to 16.10.20 shall continue to
be as per previous slide

ABC Bank has the following Exposures in its B/S as on 31st Mar 23-
Compute RWAs for Capital Requirements
Sl Type of Exposure Amount
no in Crs
1 Central Govt Guaranteed A/c 2000
2 State Govt Guaranteed A/c 1000
3 FBWCL Exposure to AA Rated Company ECGC Guaranteed- 66.66% 300
4 FB Exposure(WCTL) for ECLGS 100% Guaranteed by NCGTC 200
Total Exposure 3500
1 CG Guaranteed- 2000 @ 0% RWA- NiL NiL
2 State Govt Guaranteed A/c- 1000 @20% RWA- 200 200
3 FBWCL-300Crs (a) Uncovered Portion-33.33% of300 RWA@30%-100 30
(b) ECGC Covered Portion of FBWCL Rs200 Cr RWA @20%=Rs40 Crs 40
4 FBWCTL Exposure of Rs200Crs- RWA@0%= Nil NIL
Total RWAs of all Exposures= 200+30+40 270 Crs

ABC Bank has extended FBWCL Facility of Rs7 Crs with an O/s Bal of Rs6.50 Crs to a
Plastic Container Mfg MSME Unit with Annual Sales Turnover of Rs20 Crs, Rs35 Crs &
Rs60 Crs for FY 2020-21,21-22 & 22-23 respectively. ABC Bank has got Regulatory Retail
Portfolio of Rs5000 Crs. Compute RWA of this Exposure
 Exposure belongs to Regulatory Retail Exposure because

 Last 3 Years Average Sales Turn Over is= 20+35+60 =115/3= 38.33 Crs <
Rs50 Crs
 Current FBWCL Exposure is Rs7.00 Crs which is less than Rs7.50 Crs(RRP)
 Bank Total RRP being Rs5000 Crs,Current FBWCL Exposure is
(7/5000)x100=0.14% of RRP ie Less than 0.20 % of Bank’s RRP
 As such qualifying for RRP, Will have applicable RWA @75% only
 Now Fund Based Exposure is Rs6.50 Crs
 Undrawn Portion of FBWCL of Rs0.50 Crs-Credit Equivalent Amount 20% of
0.50=0.10 Cr
 Total Fund Based Exposure comes to Rs6.60 Crs
 Hence applicable RWA @75% of Rs6.60 Crs comes to Rs4.95 Crs

Other guidelines regarding RW on claims secured by Residential
Property
 All other claims secured by residential property would attract the higher of
the risk weight applicable to the counter party or to the purpose for which
the bank has extended finance
 Restructured housing loans-additional RW of 25%
 Loan/exposures to intermediaries for on-lending will not be eligible for
inclusion under claims secured by residential property but will be treated
as claims on corporates or claims included in RRP as the case may be
 Investment in mortgage-backed securities (MBS) backed by exposures on
residential property(Housing Loans) will be governed by the guidelines
pertaining to securitisation exposure

NPAs-Regulatory Prescription of RW
Nature of Security Extent of specific provision Risk weight
of NPA (%)
Unsecured portion Specific provisions are less than 20% of 150

of NPA(other than a the outstanding amount of the NPA
qualifying
Residential
Mortgage loan) net Specific provisions are at least 20% of 100
of specific the outstanding amount of the NPA
provision(including
partial Write-offs)
Specific provisions are at least 50% of 50
the outstanding amount of the NPA

NPAs-Regulatory prescription of RW
Nature of Extent of specific provision Risk weight
Security of (%)
NPA
Claims Specific provisions are less than 20% of the 100

secured by outstanding amount of the NPA
Residential
Properties
which are Specific provisions are at least 20% but less than 75
NPA 50% of the outstanding amount of the NPA
Specific provisions are 50% or more of the 50

outstanding amount of the NPA

Other guidelines regarding RW on NPA
 For the Purpose of computing the level of specific

provisions in NPAs for deciding the Risk Weighting, all
Funded NPA exposure of a single counterparty (without
Netting the value of the eligible Collateral) should be
reckoned in the denominator
 For the purpose of deciding the Secured portion of the NPA,
eligible collateral will be the same as recognised for Credit
Risk Mitigation purposes. Hence other form of collateral like
land, buildings, plant Machinery, Current Assets etc will not
be reckoned while computing the Secured portion of NPAs
for Capital Adequacy purposes

Other guidelines regarding RW on NPA
 In addition to the above, where NPA is fully secured by the following forms of
collateral that are not recognised for Credit Risk Mitigation purpose, either
independently or along with other eligible collateral a 100% Risk Weight may
apply, net of specific provision, when provision reach 15% of the outstanding
amount
 (i) Land & Building which are valued by an expert valuer and where the
valuation is not more than 3 years old
 (ii) Plant & Machinery in good working condition at a value not higher than the
Depreciated value as reflected in the audited B/S of the borrower, which is not
older than 18 months
 The above collaterals will be recognized only where the bank is having clear
title to realize the sale proceeds thereof and can appropriate the same towards
the amounts due to the bank. The bank’s title to the collateral should be well
documented. These forms of Collateral are not recognized anymore else under
the Standardized Approach

XYZ Bank has extended Housing Loan of Rs2.00
Crs for Purchase of a Residential property costing
Rs2.50 Crs secured by EM on RP. O/s Bal in the
Housing Loan a/c is Rs1.60 Crs as of 31st Mar 23
after full disbursement. Market Value of RP is
Rs3.00 Crs while its RVS is Rs2.25 Crs. Calculate
RWA for this Exposure??
 Exposure belongs to Exposure Under Claims Secured by Residential
Property
 LTV Ratio in this Exposure is = O/s Bal/RVS=1.60/2.25=71.11% ie<75%
 Hence Applicable RWA on this Housing Loan is @50% only
 Applicable RWA on this Exposure of Rs1.60 Crs =1.60 Crx50% =0.80 Crs

XYZ Bank has extended Credit Facilities to a Company with O/s
Bal of Rs10.00 Crs & is NPA with specific provision of Rs2.00 Crs
against NPA. Securities available is(a) Hypo of Stocks worth
Rs8.00 Crs(b) Hypo of Book Debts & Moveable Assets worth
Rs2.00 Crs (c) Lien of Bank’s TD of Rs0.50 Crs in the name of
the Company adjustable to Loan A/c (d) Personal Guarantee of
Promoter Directors with Combined NW of Rs8.00 Crs. Compute
RWA of this Exposure!
 Exposure: Claims which have become NPA
 Unsecured Portion of Exposure Net of Specific
Provision:Rs10-2Crs- 0.50 Crs=Rs7.50 Crs
 Level of Specific provision Made in NPA = Rs2.00 Crs/Rs10
Crs =@20%
 Applicable RWA on this type of Exposure would be @ 100%
 Hence RWA on this Exposure =Rs7.50 Crsx100% =Rs7.50 Crs

PQR Bank has extended Credit facility to an Individual for
acquiring a Residential Property valued Rs2.50 Crs with
Present O/s Bal Rs2.00 Crs secured by EM on this Property
but now NPA. Bank has made a Specific Provision of
Rs0.50 Crs against this NPA A/c. Compute RWA of this
Exposure?
 Exposure Type: NPA A/c Secured by Mortgage on Residential
Property
 O/s Exposure considered as Net of provisions =Rs2.00 Crs- 0.50
crs=Rs1.50 Crs
 Specific Provision on NPA made as % of O/s Amount =
(0.50/2.00)x100=25%
 Hence Applicable RWA on this Exposure would be @75%
 Hence RWA amount on this Exposure Would be= 75% of Rs1.50
Crs=Rs1.125Crs

XYZ Bank has extended an Irrevocable LC for
Rs8.00 Crs fvg a Mfg Company on behalf of its
applicant Borrower Company with “AA” Credit
Rating. O/s Bal in LC Facility is Rs 8.00 Crs as on
31st March 23. Compute RFA of this Exposure??
 Exposure Type- AA Rated Corporate Company
 O/s NFB Exposure – Rs8.00 Crs
 CEA of NFB Exposure of Rs8.00 Crs with a CCF@20%=20% of
Rs8.00 Crs=Rs1.60 Crs
 Hence Equivalent Funded Exposure is Rs1.60 Crs
 Applicable RWA for a “AA” Rated Company would be @30%
 RWA on Rs1.60 Crs @ 30% would be 30% of Rs1.60 Crs =
Rs0.48 Crs

ABC Bank has extended a Term Loan of Rs5.00 Crs to a Mfg
Company with “AA” Credit Rating. Disbursement made so far is
Rs2.00 Crs only it is still under process with another Rs2.00 Crs
to be disbursed within next 1 Year & balance Rs1.00 Crs to be
disbursed in next 2nd Year. Present O/s Bal is Rs2.00 Crs as on
Mar 23 with all interest charged as serviced in time. Compute
RWA of this Exposure??
 Exposure Type: Term Loan to a AA Rated Company
 FB Exposure of TL as of Mar 23 =Rs2.00 Crs
 CEA of Undrawn Portion of Rs2.00 Crs within next 1 Year with CCF @20% &
CEA of Rs1.00 Crs undrawn TL to be disbursed after 1 Year with a CCF
@50% would be =Rs2.00 Crs x 20% + Rs1.00 Crs x 50% =0.40 +Rs0.50
=Rs0.90 Crs
 Total FB Exposure of entire TL of Rs5 Crs is Rs2.00 Crs +0.90 Crs= Rs2.90
Crs
 Applicable RWA on a AA Rated Company is @30%
 RWA of this Exposure would be 30% of Rs2.90 Crs =0.87 Crs
XYZ Bank has extended Credit Facilities to an “A” Rated Corporate with Following Facilities for a
Maturity period of 3 Years: CC- Limit Rs6.00 Crs O/s Bal Rs4.00 Crs, Fully disbursed Term Loan-
Rs5.00 Crs, O/s Bal Rs3.00 Crs, Inland LC Limit Rs2.00 Crs- O/s Bal- Rs2.00 Crs, Performance
Guarantee- Limit Rs1.00 Crs- O/s Rs1.00 Crs, Total Limits Rs14.00 Crs- O/s Bal Rs9.00 Crs. Facility
Secured by(a) Hypo of Goods & Stock- Rs7.00 Crs(b) Personal Guarantee of Promoter/Director with
NW of Rs10 Crs (c) Pledge of AA Rated Bond valued Rs2.00 Crs with Residual Maturity of 2 Years.
Compute RWA
 1) Exposure Type- FB+NFB to A rated Corporate
 2) Exposure Maturity- 3 Years
 3)Total FB Exposure = CC- 4.00+ TL-3.00= Rs7 Crs
 4) Credit equivalent of Undrawn Portion of CC of Rs2.00 Crs@20% CCF=0.40 Crs
 5) Credit Equivalent of Inland LC of Rs 2 Crs@20% CCF =0.40 Crs
 6) Credit Equivalent of PBG of Rs1 Crs @ 50% of CCF= Rs0.50 Crs
 7) Total funded Exposure= Rs8.30 Crs
 8) Value of Collateral =Rs2.00 Crs with Residual Maturity of 2 Years
 9) Mismatch Haircut: T- Min(5, Residual Period of Exposure-3 Years), t- Min(Residual Period of Collateral-
2Years, Pa=Px (t-0.25)/(T-0.25) =2.00x(2-0.25)/(3-0.25)= 2.00x1.75/2.75 =1,27,27,272
 10) Collateral Haircut 2.00Crx4%(for Dated Securities RM 2 Yrs) =8,00,000
 11) Total Haircut =12727272+800000=13527272 (12) Adjusted Exposure= 8.30 Crs-13527272=69472728
 12) RWA =Adjusted Exposurex 50% RWA for “A” Rated Corporate =6,94,72, 728/2=3,47,36,364
RW under standardized approach
 Unhedged Foreign Currency Exposure:-
Likely Loss/EBID (%) Incremental capital requirement
Up to 75% 0
More than 75% 25% increase in the RW
 Other Assets:-
 Loans and advances to bank’s own staff which are fully covered by
superannuation benefits and /or Mortgage of Flat/house will attract a
20% RW
 Other Loans and advances to staff:- will be classified under
Regulatory Retail Portfolio(RRP) and will attract- 75% RW

What is Credit Rating and related guidelines
 Credit ratings are forward looking opinion expressed by a Credit
Rating agency on the ability and willingness of a Borrower to pay
his dues in full and on time
 Choice of Rating agency to remain consistent with No cherry
picking
 Bank to disclose the name of Credit Rating Agency they use for
Risk Weighting their account
 The rating agency must take into account entire Credit Exposure
 To be eligible Rating should be in force
 Rating accorded only when solicited by Bank/company
 For exposure less than and equal to one year –short term rating
may be applicable
 Cash Credit account should be treated as Long Term Exposure

Credit rating agencies approved by RBI
International Rating agencies Domestic rating agencies
a) CARE (Credit Analysis & Research Ltd)

Fitch b) CRISIL Ratings Ltd
Standard & Poor’s c) India Ratings (India Rating & Research
Moody’s Pvt Ltd)
d) ICRA Ltd
e) Acuite (Acuite Ratings & Research
Ltd)
f) INFOMERICS (Informerics Valuation &
Rating Pvt Ltd)

Long Term Ratings
CARE CRISIL India ICRA Acuite Infomerics RW %(std
Ratings (IVR) Approach)
(IND)
AAA AAA AAA AAA AAA AAA 20
AA AA AA AA AA AA 30
A A A A A A 50
BBB BBB BBB BBB BBB BBB 100
BB, B ,C & BB & Below BB & Below BB & Below BB & Below BB & Below 150
D
Unrated Unrated Unrated Unrated Unrated Unrated 100

External Credit Ratings
 SMERA ratings is now called Acuite - Now it is a full

fledged Rating agency
 Infomerics- Integrated Financial Omnibus Metrics
Research of International Corporate systems- New rating
agency

Short Term Ratings of the Domestic Rating Agencies
CARE CRISIL INDIA ICRA Infomeric Acuite RW% (std
RATINGS s approach)
Care A1+ A1+ A1+ A1+ A1+ A1+ 20
Care A1 A1 A1 A1 A1 A1 30
Care A2 A2 A2 A2 A2 A2 50
Care A3 A3 A3 A3 A3 A3 100
Care A4 A4 A4 A4 A4 A4 150
&D &D &D &D &D &D
unrated unrated unrated unrated unrated unrated 100

ABC Bank has extended a CC Facility of Rs5.00 Crs
to a Mfg Company with a Credit rating of ”A”.
Present O/s Balance as of 31st Mar23 is Rs3.50 Crs.
Compute RWA for this Exposure??
 Exposure Type: Corporate-A Rated Company
 Fund Based O/s Exposure in the Account is Rs3.50 Crs
 Un-drawan Portion of this exposure=Rs5.00-3.50=Rs1.50 Crs
 Credit Equivalent Amount of this Undrawn Portion with CCF@20% is
20% of Rs1.50 Crs =Rs 0.30 Crs
 Hence Total Notional FB Exposure comes to Rs3.50 Crs+Rs0.30 Crs=
Rs3.80 Crs
 Applicable RWA on this Type of Exposure for A rated Company is
@50%
 Hence RWA for this exposure to the Bank is 50% of Rs3.80 Crs
=Rs1.90 Crs
RW under Standardized Approach
 W.e.f 30/06/2017, all unrated exposure (claims)
on corporates, AFC’s & NBFC-IFCs, having
aggregate exposure from banking system of more
than Rs200 crores will attract a Risk Weight of
150%
 Claims on Corporates, AFC’s & NBFC-IFCs, having
aggregate exposure from banking system of more
than Rs100 crores which were rated earlier and
subsequently have become unrated will attract a
risk weight of 150%

Problem on CRAR Std approach
A bank has sanctioned the following facility  Step 1-O/s Fund based limits-TL-Rs0.50
to a Company Cr+CC Rs2.50 Cr=Rs3.00Cr
( Average sales turnover last 3 yrs Rs 20 cr)  Step 2-O/s BG Rs 1.00cr, CCF=50%, So
credit equivalent amount Rs0.50cr
Overall limit : Rs 5.00 cr
Sub limit :Term Loan Rs 1.00 cr  Step 3-Unavailed TL-Rs0.50Cr and un-
Cash Credit Rs 3.00 cr availed CC-0.50 Crs=1.00 Cr@ CCF20%
BG Rs 1.00 cr So Credit Equivalent is Rs0.20 Cr
O/S Position as on 31st March
Term Loan Rs 0.50 cr  Step 4-Adjusted aggregate exposure
Cash Credit Rs2.50 cr =Rs3.00+Rs0.50+Rs0.20=Rs3.70 Cr
Bid Bond BG Rs1.00 cr  Step 5-Risk Weight-75%
 Step 6-RWA=3.70×75%=Rs2.775cr
Calculate the RWA for the above a/c under
Standardized Approach and min capital  Step 7-Min Capital required inclusive of
required including CCB, assuming BG is CCB i.e @11.50% of Rs2.78 Cr=0.32 Cr
performance and unavailed limits are to
be availed withing one year

Exercise : Calculation of RWA under Standardised Method
A bank has sanctioned the following facility to a Company
( Average sales turnover last 3 yrs Rs 20 cr)

Sub limit : Term Loan Rs 1.00 cr
Cash Credit Rs 3.00 cr
BG Rs 1.00 cr
Outg Position as on 31st March

Term Loan Rs 0.50 cr
Cash Credit Rs2.50 cr
Bid Bond BG Rs1.00 cr
Calculate the RWA for the above a/c under Standardized

Approach.
Exercise : Calculation of RWA under Stadardised Method
A bank has sanctioned the following facility to a

Company Step 1
( Average sales turnover last 3 yrs Rs 20 cr) Applicable Risk Weight- 75%
Step 2
Outg Fund based limit
Sub limit : Term Loan Rs 1.00 cr
T/L Rs 0.50 cr +
Cash Credit Rs 3.00 cr
CC Rs2.50 cr =Rs 3.00 cr
BG Rs 1.00 cr
Outg Position as on 31st March Step 3
Term Loan Rs 0.50 cr 1.Outg BG Rs 1.00 cr
Cash Credit Rs2.50 cr CCF =50%
Bid Bond BG Rs1.00 cr Credit equiv Amt -Rs 0.50 cr
2. Unavailed TL – Rs 0.50* cr
Calculate the RWA for the above a/c under Unavailed CC- Rs 0.50 cr
Standardized Approach. CCF 20%
Credit eqiv Amt - Rs 0.20 cr
* Assuming undrawn commitment upto 1 year

Step 4. Adjusted Aggregate Credit exposure = Rs3.00 +Rs 0.50+Rs0.20= Rs3.70 cr
RWA= 75% of Rs 3.70 cr= Rs 2.775 cr
Advanced Approaches-INTERNAL
RATING BASED APPROACH (IRB)
 Advanced methods are classified:

 1. Foundation IRB Approach (FIRB)
 2. Advanced IRB Approach (AIRB)

Key Risk Parameters of IRB approach
 Exposure at Default (EAD): In the event of default, how large will be the
outstanding obligations. EAD gives an estimate of the amount
outstanding (drawn amount plus likely future drawdowns of yet undrawn
lines) in case the borrower defaults.
 Probability of Default (PD): The probability that the obligor or counterparty
will default on its contractual obligations to repay its debt. PD per rating
grade is the average percentage of obligors that default in this rating
grade in the course of one year.
 Loss Given Default (LGD): The percentage of exposure the bank might
lose in case the borrower defaults. LGD=( 1- recovery rate)
 Effective Maturity(M);- Effective maturity of the underlying should be
gauged at the longest possible remaining time before the borrower is
scheduled to fufill its obligations
INDIAN INSTITUTE OF BANKING & FINANCE 98

IRB Approach for Credit Risk
Categorisation of Exposures
 Classes of Assets
 Corporate
 Sovereign
 Bank
 Retail
 Equity
 Others

FIRB & AIRB
Parameter Foundation IRB Advanced IRB
PD Bank Bank
LGD Supervisor Bank
EAD Supervisor Bank
M(Maturity) Supervisor Bank
Risk Weight Function provided by a Function provided by a

committee consisting Committee consisting
of Banks, Risk Experts of Banks, Risk Experts
and Supervisor and Supervisor
Data Requirement Historical data of 5 Historical data of 7
years to estimate PD years to estimate PD,
for 5 Years LGD and EAD

Advanced Approaches to Capital calculation
Internal Rating Based Approach(IRB)
 Credit losses vary from year to year depending on the number
and severity of default event
 The average level of losses a bank can reasonably expect to
experience is referred to as Expected Loss (EL) and is
considered a part cost of doing business-covered by
provisioning and pricing policies. The pricing aspect of the EL
is termed Risk Premium
 UL-Unexpected Loss. It is that part of Credit loss that cannot
be estimated or priced into the product and hence Banks have
to provide capital for it by Risk weighting their assets-this
reduces the probability of insolvency.
 If (UL) is a function of PD,LG,EAD and M
 Capital(UL)=fn(PD,LGD,EAD,M)

Rating Migration Analysis: A tool to compute PD
1. A tool to provide dynamic information on credit

quality
2. Rating migration shows the probability that a
credit moves from one credit level/rating to
another due to the fact that credit quality
improves/deteriorates
3. Rating migration Matrix contains transition
probability
INDIAN INSTITUTE OF BANKING & 19.04.2021

FINANCE 102
Credit Rating Migration Tool to arrive at PD
1. Most probable position – Credit quality will remain
the same over a period of one year
2. Higher default risk & higher migration volatility for
lower quality grades
3. Probability of downgrade/upgrade is significantly
higher if the rating was downgraded/upgraded earlier
4. Regarding influence of business cycle on rating
migration, the probability of a downgrade or a default
is higher in recession than in boom period

FINANCE 103
Loss Given Default
Loss given default(LGD)- Percentage of exposure the
bank might lose (economic loss) in case borrower
defaults (in %)
LGD = (1– r) Where r is Recovery Rate

FINANCE 104
Exposure at Default (EAD)
Exposure at default(EAD)- Estimate of the

amount outstanding in case of borrower defaults
(in Rs.)
Sanctioned Limit ( Cash Credit) : Rs 200 K
Outstanding Balance : Rs 150 K
Undrawn Balance : Rs 50 K
Credit Conversion Factor for Undrawn
Balance In Cash Credit A/c : 20%
Notional Credit Equivalent Undrawn CC Bal 50 x 0.20 = 10 K
EAD of the A/c 150 K + 10 K = 160 K
FINANCE 105
Expected loss (EL) Vs Unexpected loss(UL)
1. While it is never possible to know in advance the losses a
bank will suffer in a particular year, a bank can forecast the
average level of credit losses (EL) it can reasonably expect to
experience.
2. Losses above the expected levels are usually referred to as
unexpected losses. Institutions know that these losses will
occur now and then, but they cannot know in advance the
time of their arrival and their severity.
3. Banks are in general expected to cover their EL on an
ongoing basis ,e.g. by pricing, provisions and write-offs,
because it represents just another cost component of the
lending business.
4. According to this concept, capital is only needed for covering
unexpected losses.
FINANCE 106
Expected Loss Formula
 Expected Loss = PDxLGDxEAD

 For Example if an exposure has the following
characteristics:
 PD=10%, LGD=30%, EAD=Rs 1 Cr
 Then expected loss on account of this Exposure
is
 0.1*0.30*1Cr=Rs3,00,000
 Expected Loss is expected to be covered by
 1. Pricing (By way of Risk Premium)
 2. Provisioning like Standard Asset provisioning
Expected Loss Based Provisioning
 The IRB Capital requirement for Credit Risk covers only

Unexpected Loss.
 The regulatory requirement is that Expected Losses
(average predicted losses) for standard assets are
therefore adequately covered by provisions
 Expected Loss for the Credit Portfolio = ΣPD*LGD*EAD
 Thus, banks adopting the IRB Approach will need to
compare the stock of Standard asset provisions with
Expected Loss
 Any shortfall must be deducted from
Common Equity (under Basel III)
IRB Approach for Credit Risk
 Classify the Credit Exposures into Asset classes
 Obtain internal, bank specific estimates of Credit Risk
factors – factors – PD, LGD, EAD
 Check whether minimum requirements are satisfied - the
minimum standards that must be met in order for a bank to
use the IRB approach for a given asset class.
 Use the Regulatory Risk-Weight functions - the formula by
which Risk components are transformed into Risk-Weights
 The Risk Weighted Asset (RWA) = Risk Weight * EAD
 The Total Credit RWA = ∑ RWAi
 Credit Risk Capital = RWA * Min. Regulatory CAR

Capital Optimization on credit risk
1. Data cleaning and correct classification of

data under credit portfolio
2. Introduction of risk adjusted return on
capital
3. Portfolio balancing to maximise risk adjusted
return
4. Securitization as a tool to free capital and
liquidity
5. Sale of unproductive assets
Credit Risk Management
 Credit Risk Management encompasses
identification, measurement, monitoring and
control of the credit risk exposures.
 Measurement of risk through credit rating/scoring
 Quantification or risk through estimating EL losses
over a chosen time horizon(over5 yrs)
UL losses i.e the amount by which actual losses
exceed the expected loss (through statistical
measurement tools like SD of losses etc)

Advanced Approaches to Capital
Calculation
Internal Rating Based Approach
(Foundation &Advanced)
Journey towards Basel II Advanced Approaches
Foundations of the IRB Risk Weight Formula
▶ Credit losses vary from year to year depending on the number and severity of
default events
▶ The average level of losses a bank can reasonably expect to experience is
referred to as Expected Loss (EL) and is considered a part cost of doing
business- covered by provisioning and pricing policies
▶ Bank hold capital for potential unexpected losses UL- This reduces the
probability of Insolvency down to target level
▶ In the credit loss probability distribution, the tail (if UL exceeds the
economic capital) indicates the potential unexpected loss ( with a miniscule
probability) against which it is judged to be too expensive to hold capital
The Advanced Approach Path
Key Risk Parameters
Probability of default (PD)

Exposures at Default (EAD)
Loss Given Default (LGD)
Effective Maturity (M)
Apply Risk Weight Formula

Given by Basel Committee
To get Risk Weighted Assets &
Regulatory Capital
Key Risk Parameters of IRB Approach

 Probability of Default (PD)- Percentage of borrowers that

default in a Rating Grade in one year (in %)
 Loss Given Default(LGD)- Percentage of exposure the bank

might lose (economic loss) in case borrower defaults (in %)
 Exposure at default(EAD)- Estimate of the amount outstanding

in case of borrower defaults (in Rs.)
 Effective Maturity (M)- Effective maturity of the underlying

should be gauged as the longest possible remaining time
before the borrower is scheduled to fulfill its obligation
FIRB & AIRB Approach
Foundation IRB Advanced IRB
1. PD: provided by Bank 1.PD: estimated by Bank derived from

historical records
2. LGD : Supervisory value set by RBI
2. LGD: Provided by Bank
3. EAD : Supervisory Values set by RBI
3. EAD provided by Bank
4. M : Supervisory value set by RBI
4.M: Provided by Bank based on its
estimate
Expected Loss Formula ??
Expected Loss Formula
Expected Loss = PD x LGD X EAD
For example if an exposure has the following characteristics :
1. PD = 10%
2. LGD=30%
3. EAD= Rs 1 Cr
Then Expected Loss on account of this exposure is
0.1*0.3*1 cr = Rs 3,00,000
Expected Loss is expected to be covered by
1. Pricing (By way of risk premium)
& 2. Provisioning (Already covered to the extent of Rs 40000
being provision for standard asset @0.40%*) (*depending upon
category of loan)
Questions ?
Contact Details : A K Mishra
Mobile No :7428045854
Email Id: fm.trg2@iibf.org.in
Thank You!

4.credit Risk Management

Uploaded by

Document Information

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

4.credit Risk Management

Uploaded by

Copyright:

Available Formats

Credit Risk Management- Brief

on Standardized & IRB

INDIAN INSTITUTE OF BANKING & FINANCE

1. Why Banks need Capital ?

INDIAN INSTITUTE OF BANKING & FINANCE

Equity (Networth) 5% Cash and Balances 6%

Borrowings (Long Term, 3% Investments 26%

Borrowings (Short term) 2% Loans and 64%

Provisions 3% Off B/S (as % of On 22%

INDIAN INSTITUTE OF BANKING & FINANCE

 Banks Confront with Financial and Non-Financial Risk

 Credit Risk, Market Risk, Operational Risk, Commodity

 Credit is the largest Portfolio and as such Credit Risk is

INDIAN INSTITUTE OF BANKING & FINANCE

INDIAN INSTITUTE OF BANKING & FINANCE

Credit Risk is the possibility of

INDIAN INSTITUTE OF BANKING & FINANCE

INDIAN INSTITUTE OF BANKING & FINANCE

INDIAN INSTITUTE OF BANKING & FINANCE

Default due to Loss from

INDIAN INSTITUTE OF BANKING & FINANCE

 A single borrower/obligor exposure is generally known as Firm Credit

INDIAN INSTITUTE OF BANKING & FINANCE

Credit risk are triggered by both systemic and un-systemic

Interest rate changes, inflation, recessions and wars all

Un-Systemic Risk is a Risk unique to the operation of an

INDIAN INSTITUTE OF BANKING & FINANCE

INDIAN INSTITUTE OF BANKING & FINANCE

Blocks Recycling of Funds causing illiquidity

INDIAN INSTITUTE OF BANKING & FINANCE

INDIAN INSTITUTE OF BANKING & FINANCE

Protects Provides fund Improves risk Conforms to

INDIAN INSTITUTE OF BANKING & FINANCE

Basel III Accord 2010

INDIAN INSTITUTE OF BANKING & FINANCE

1. Bank’s capital is meant to cover

A.Volatility in the market

B.Interest and non interest

INDIAN INSTITUTE OF BANKING & FINANCE

A.Volatility in the market

INDIAN INSTITUTE OF BANKING & FINANCE

A.Enough capital to cover credit, market and

B.Enough capital to cover all the risks as per its

C.Improving both the quality and quantity of capital

D. Ensuring a stable financial system

INDIAN INSTITUTE OF BANKING & FINANCE

INDIAN INSTITUTE OF BANKING & FINANCE

INDIAN INSTITUTE OF BANKING & FINANCE

INDIAN INSTITUTE OF BANKING & FINANCE

HOW TO ARRIVE AT CAPITAL

INDIAN INSTITUTE OF BANKING & FINANCE

Banks have been

INDIAN INSTITUTE OF BANKING & FINANCE

INDIAN INSTITUTE OF BANKING & FINANCE

INDIAN INSTITUTE OF BANKING & FINANCE

INDIAN INSTITUTE OF BANKING & FINANCE

INDIAN INSTITUTE OF BANKING & FINANCE

1. Dr A has availed a Term Loan to purchase

INDIAN INSTITUTE OF BANKING & FINANCE

INDIAN INSTITUTE OF BANKING & FINANCE

INDIAN INSTITUTE OF BANKING & FINANCE

RWA will be decided as per

INDIAN INSTITUTE OF BANKING & FINANCE