Credit Management

An Overview

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 Credit Life Cycle Theory

Credit Opportunity Credit Creation

Credit Completion

Credit Management

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 Agenda
Basics of credit management
Introduction of credit risk management
Other issues

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 Introduction
Credit refers to
Short Term Loans & Advances
Medium / Long Term Loans
Off-Balance Sheet Transactions
Management refers to
Pre-sanction appraisal
Documentation
Disbursement and Disbursal
Post-lending supervision and control

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 Credit Management
Credit Management now includes
Capital adequacy norms
Risk Management including ALM
Exposure Norms
Pricing policy and credit risk rating
IRAC norms
Appraisal, credit-decision making and loan
review mechanism

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 Approach for safety of loans
Safety of loans is directly related
to the basis on which decision to lend is
taken
Type and quantum of credit to be provided
Terms and conditions of the loan

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 Approach for safety of loans
(Contd.)

Two-pronged approach
Pre-Sanction appraisal
To determine the bankability of each loan proposal

Post-Sanction control
To ensure proper documentation, follow-up and
supervision

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 Pre-Sanction appraisal
Concerned with measurement of risk(iness) of
a loan proposal
Requirements are:
Financial data of past and projected working results
Detailed credit report is compiled on the borrower / surety
Market reports
Final / audited accounts
Income tax and other tax returns / assessments
Confidential reports from other banks and financial institutions

Credit Report (CR) needs to be regularly updated

Appraisal should reveal whether a loan
proposal is a fair banking risk

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 Post-Sanction appraisal
Depends to large extent upon findings of
pre-sanction appraisal
Requirements are:
Documentation of the facility and after care follow- up
Supervision through monitoring of transactions in loan
amount
Scrutiny of periodical statements submitted by the
borrower
Physical inspection of securities and books of accounts of
the borrower
Periodical reviews etc.

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 Bankers Credit Report
Includes seeking information including
other banks (writing or over telephone
etc.)
Sharing of information could be a sensitive
issue
Advisable to take an undertaking from
customers
Make the condition as part of account
opening form or loan application

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 Types of loans and advances
Working Capital Finance
Extended to meet day-to-day short term
operational requirements (sales & purchase
of commodities, purchase of raw materials
etc.)
Loan for setting up new project, expansion
and diversification of existing project etc.
Short term or medium term

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 Loans and Advances (Contd.)

Difference between Loans and Advances

Loans are extended in accounts in which no
drawings are permitted to the borrowers
Generally there is one debit to principal amount to
loan account though disbursal in stages is
possible depending on the need of the borrower
For operational purposes loan can be credited to a
special account where withdrawal from time to
time can be done by the party depending upon his
requirements
In case of advances, the sanctioned limit is placed
at the disposal of the borrower, subject to terms of
sanction, in running accounts which can be drawn
upon by cheques by the borrower

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 Loans and Advances (Contd.)

Working capital finance in form of loan is

also known as demand loan
As an advance it is commonly known as
cash credit facility
Banks apart from working capital and
medium term and long term finance may
also extend casual overdrafts to approved
customers
In current accounts
Loans against security of shares, FDs, housing
loans etc.

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 Securities for lending
Section 5 of B. R. Act defines secured and
unsecured loans
Secured Loans and advances made on
security of assets the market value of which
is not at any time less than the amount of the
loan or advances
Unsecured Means a loans or advance not so
secured
Security taken as an insurance against
unwarranted situations

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 Securities for lending
Two types: Primary and Collateral
Primary Security Generally from a viable
and professionally managed enterprise
Personal
Created by a duly executed promissory note,
acceptance or endorsement of bill of exchange
etc.
Gives bank the right of action to proceed against
the borrower personally in the event of default
Impersonal
Createdby way of a charge (pledge,
hypothecation, mortgage, assignment etc.)

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 Securities for lending
Collateral Security Meaning running
parallel or together
Taken as additional and separate security
Could be secured / unsecured guarantees, pledge of
shares and other securities, deposits of title deeds etc.
Used to reinforce the primary security (for e.g. plantation
advances are not considered fully secured until crop is
harvested)

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 Preconditions of loans
Willingness or intention to repay as per
agreement
Relatively easier to assess
Determined by good track record of payments
and debt servicing
Uncertain / uncontrollable events could affect
the judgment
Purpose for which loan is sought
Should be documented carefully
Type of loan applied for - Working capital loan, term loan,
personal loan etc.
Conditions which can set the trend of future

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 Conditions determining future
trends
Three factors which can undergo changes:
Prospects
Future risk profile
Repayment capacity

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 Tools for determining future
trends
Financial Analysis past and projected
Credit rating
Assessment of credit needs
Terms of sanction
Documentation and creation of security
interest
Post-lending supervision 3 stages
Regular surprise verification of security
Stock audit
Obtaining and scrutiny of control statement
(stock statements, financial statements)
Repayment and / or rollover

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 Risks in Bank Lending
Credit Risk
Market Risk
Operational Risk

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 Credit Risk
RBI defines credit risk as:
the possibility of losses associated with
diminution in the credit quality of borrowers
or counterparties. In a banks 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.

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 Credit Risk Management
Credit risk is defined, as the potential that
a borrower or counter-party will fail to meet
its obligations in accordance with agreed
terms
It is the probability of loss from a credit
transaction

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 Credit Risk Management
According to Reserve Bank of India, the following
are the forms of credit risk:
Non-repayment of the principal of the loan and/or the
interest on it
Contingent liabilities like letters of credit/guarantees
issued by the bank on behalf of the client and upon
crystallization amount not deposited by the customer
In the case of treasury operations, default by the
counter-parties in meeting the obligations
In the case of securities trading, settlement not taking
place when it is due
In the case of cross-border obligations, any default
arising from the flow of foreign exchange and/or due
to restrictions imposed on remittances out of the
country

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 Principles of sound credit risk
management
BOD should have responsibility for
approving and periodically reviewing credit
risk strategy
Senior management should have the
responsibility to implement the credit risk
strategy
Bank should identify and manage credit
risk inherent in all product and activities

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 Prudential Norms for appropriate
Credit Risk environment
Norms for Capital Adequacy
Exposure Norms
Credit Exposure and Investment Exposure
Norms to individual and group borrowers
Capital Market Exposures
Banks-specific internal exposure limits
IRAC norms
Credit rating system and risk pricing policy
ALM
Norms for setting up loan policy

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 Framework for Credit Risk
Management
CRM framework includes:
Policy framework: requires the following
distinct building blocks: (1) Strategy and
policy, (2) organization, and (3)
operations/systems
Credit risk rating framework
Credit risk limits
Credit risk modeling
RAROC pricing
Risk mitigants
Loan review mechanism/credit audit

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 Policy Framework
Strategy and Policy:
Credit policies and procedures of banks
should necessarily have the following
elements:
Written policies defining target markets, risk acceptance
criteria, credit approval authority, credit origination and
maintenance procedures and guidelines for portfolio
management and remedial management
Systems to manage problem loans to ensure appropriate
restructuring schemes
A conservative policy for the provisioning of non-
performing advances should be followed

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 Policy Framework (Contd.)

Strategy and Policy:

Credit policies and procedures of banks
should necessarily have the following
elements:
Consistent approach towards early problem recognition,
classification of problem exposures, and remedial action
Maintain a diversified portfolio of risk assets in line with
the capital desired to support such a portfolio
Procedures and systems, which allow for monitoring
financial performance of customers and for controlling
outstanding within limits

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 Policy Framework (Contd.)

Organizational Structure
Banks should have an independent group
responsible for the CRM
Responsibilities to include formulation of
credit policies, procedures and controls
extending to all of its credit risk arising from
corporate banking, treasury, credit cards,
personal banking, trade finance, securities
processing, payments and settlement systems
Board of Directors should have the overall
responsibility for management of risks

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 Policy Framework (Contd.)

Organizational Structure
The Board should decide the risk management
policy of the bank and set limits for liquidity, interest
rate, foreign exchange and equity price risks
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
RMC should effectively coordinate between the
Credit Risk Management Committee (CRMC), the
Asset Liability Management Committee and other
risk committees of the bank, if any

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 Policy Framework (Contd.)

Operations / Systems
Credit process typically involves the following
phases:
Relationship management phase, that is, business
development
Transaction management phase to cover risk assessment,
pricing, structuring of the facilities, obtaining internal
approvals, documentation, loan administration and routine
monitoring and measurement, and
Portfolio management phase to entail the monitoring of
portfolio at a macro level and the management of problem
loans.

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 Credit Risk Rating Framework
Use of credit rating models and credit
rating analysts
Loans to individuals or small businesses,
credit quality is assessed through credit
scoring which is based on a standard
formulae which incorporates partys
information viz. annual income, existing
debts, other details such as homes (rented
or owned) etc.

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 Credit Risk Limits
Bank generally sets an exposure credit limit
for each counterparty to which it has credit
exposure
Depending on the assessment of the
borrower (commercial as well as retail) a
credit exposure limit is decided for the
customer, however, within the framework
of a total credit limit for the individual
divisions and for the company as a whole

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 Credit Risk Limits
Also within the limit as per RBI, i.e. not
more than 15% of capital to individual
borrower and not more than 40% of capital
to a group borrower
Threshold limits are set which are
dependent upon
Credit rating of the borrower
Past financial records
Willingness and ability to repay
Borrowers future cash flow projections

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 Risk Mitigants
Credit risk mitigation means reduction of
credit risk in an exposure by a safety net of
tangible and realizable securities including
third-party approved guarantees/insurance
Various risk mitigants are:
Collateral (tangible, marketable) securities
Guarantees
Credit derivatives
On-balance-sheet netting

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 Risk Mitigants (Contd.)

Conditions for use of credit risk mitigants

All documentation used in collateralized
transactions must be binding on all parties
and must be legally enforceable in all
relevant jurisdictions
Banks must have properly reviewed all the
documents and should have appropriate legal
opinions to verify such, and ensure its
enforceability

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 Loan Review Mechanism / Credit
Audit
Credit audit examines the compliance with extant
sanction and post-sanction processes and procedures
laid down by the bank from time to time
The objectives of credit audit are:
Improvement in the quality of credit portfolio
Review of sanction process and compliance status of
large loans
Feedback on regulatory compliance
Independent review of credit risk assessment
Pick-up of early warning signals and suggest remedial
measures, and
Recommend corrective actions to improve credit quality,
credit administration, and credit skills of staff

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 RBI Guidelines on Credit
Exposure and Management
Credit exposure to an individual borrowers
not to exceed 15% of capital funds
Group borrowers exposure not to exceed
40% of capital funds
Aggregate ceiling in unsecured advances
should not exceed 15 % of total DTL of the
bank from earlier 33.33%

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 RBI Guidelines on Credit
Exposure and Management (Contd.)

Bank cannot grant loans against security of

its own shares
Prohibition on remission of debts for UCBs
without prior approval of RBI
Restrictions on loans and advances to
Directors and their relatives
Ceiling on advances to Nominal Members
With deposits up to Rs. 50 crore (Rs.
50,000/- per borrower) and RS. 1,00,000/-
for above Rs. 50 crore

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 RBI Guidelines on Credit
Exposure and Management
Prohibition on UCBs for bridge loans
including that against capital / debentures
issues
Loan and advances against shares,
debentures
UCBs are prohibited from permitted to extend
any facilities to stock brokers
Margin of 40 per cent to be maintained on all
such advances
Restriction on advances to real estate
sector only for genuine constriction and
not for speculative purposes
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 Components of Credit Risk
Default Risk Risk that a borrower or
counterparty is unable to meet its
commitment
Portfolio Risk Risk which arises from the
composition / concentration of banks
exposure to various sectors
Two factors affect credit risk
Internal Factors Bank specific
External factors State of economy, size of
fiscal deficit etc.

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 Managing Internal Factors
Adopting proactive loan policy
Good quality credit analysis
Loan monitoring
Sound credit culture

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 Managing External Factors
Well diversified loan portfolio
Scientific credit appraisal for assessing
financial and commercial viability of loan
proposal
Norms for single and group borrowers
Norms for sectoral deployment of funds
Strong monitoring and internal control
systems
Delegation and accountability

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 Credit Risk Management as per
RBI
Measurement of risk through credit scoring
Quantifying risk through estimating loan
losses
Risk pricing Prime lending rate which also
accounts for risk
Risk control through effective Loan Review
Mechanism and Portfolio Management

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 Thank You

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