CREDIT RISK A GRAND PROJECT REPORT ON CREDIT RISK With reference to PUBLIC AND PRIVATE BANKS PREPARED BY ALPESH

JETHAVA ROLL NO. 24 MBA Sem. IV (2008-10) SEAT NO: 40694 GUIDED BY MR. NISHANT VACHHANI ATMIYA INSTITUTE OF TECHNOLOGY & SCIENCE SUBMITTED TO SAURASHTRA UNIVERSITY DEPARTMENT OF BUSINESS MANAGEMENT RAJKOT ATMIYA INSTITUTE OF TECHNOLOGY & SCIENCE ( MBA DEPARTMENT ) Page 1

CREDIT RISK PREFACE In today s era of cut-throat competition, Masters of Business Administrations (MBA ) are sure to have edge over their counterparts. MBA education brings its students in direct contact with the real corporate worl d through Grand Project. The MBA program provides its students with an in-depth st udy of various managerial activities that are performed in an organization. A detailed analysis of managerial activities conducted in various departments li ke, marketing, finance, human resources, exports-imports, credit dept., research and development, etc., gives the student a conceptual idea of what they are expected to manage, h ow to manage, how to obtain the maximum inputs and how to minimize the wastage of resources. to enrich my knowledge about the Particular aspects of Various Banking Industrie s with the Field of the How s the works of Trade Finance Activity in Banks. ATMIYA INSTITUTE OF TECHNOLOGY & SCIENCE ( MBA DEPARTMENT ) Page 2

CREDIT RISK ACKNOWLEDEMENT I, the students of ATMIYA INSTITUTE OF TECHNOLOGY & SCIENCE is extremely thankful to our institute for giving us an opportunity to undertake this Grand P roject. I am very much thankful to SBI, DENA BANK & BANK OF BARODA (Branch Manager) providing me the permission to give all type of information & guidance which is necessary for this study I am also thankful to DIRECTOR DR. J .P.SHARMA & MR. NISHANT VACHHANI (project guide) for providing us the helpful support for completing the report i n a for given schedule. Thanks for their benevolent support and kind attention. Their valuable guidance at each and every stage of the project always gave a Phillip to our enthusiasm. Last but not the least we express our gratitude to all people who are directly o r indirectly involved in the preparation of this report. ALPESH JETHAVA ATMIYA INSTITUTE OF TECHNOLOGY & SCIENCE ( MBA DEPARTMENT ) Page 3

CREDIT RISK DECLERATION I undersigned, ALPESH JETHAVA, the student of ATMIYA INSTITUTE OF TECHNOLOGY AND SCIENCE (Department of Management) hereby declare that STUDY CREDIT RISK report is my own work. Report has not been published anywhere. This has been und ertaken for the purpose of partial fulfilment of Saurashtra University requirement for the a ward of the Degree of Master of Business Administration. DATE: __________________ PLACE: _________________ SIGN OF STUDENT, (ALPESH JETHAVA) ATMIYA INSTITUTE OF TECHNOLOGY & SCIENCE ( MBA DEPARTMENT ) Page 4

CREDIT RISK EXECUTIVE SUMMARY The grand project training of my MBA Programmed was conducted at I have chosen t his project with the reason that i want to expand our knowledge about banking indust ry. By doing project on credit risk I learnt so many lessons. What is the important of it s in our country s economy. In today business world, this aspect need very much important t o understand. During the Training period I have been aware about the concept of credit risk an d its important and its effect on the banks. From the various types of risks, I have chosen credit risk for the project purpose; I took six banks, three from public sector namely. 1. State bank of India 2. Bank of Baroda 3. Union bank of India And three from private sector namely, 1. ICICI bank 2. HDFC bank 3. Axis bank ATMIYA INSTITUTE OF TECHNOLOGY & SCIENCE ( MBA DEPARTMENT ) Page 5

CREDIT RISK TABLE OF CONTENT CH.NO PARTICULARS PAGE NO. 1 Introduction 8 Origin of the word bank 8 History of banking in India 9 2 Nationalised banks 13 State bank of india 17 Bank of baroda 20 Union bank of india 22 Icici bank 24 Axis bank 27 Hdfc bank 30 3 Types of loan 33 1 personal loan 33 2 vehical loan 36 3 home loan 37 4 business loan 40 5 education loan 42 4 Background of the risk 44 5 Introduction risk and risk management 46 6 Credit risk 52 Importance of credit risk management 54 Managing credit risk 58 Securities of credit exposures 59 System and procedures 65 Credit derivatives 74 ATMIYA INSTITUTE OF TECHNOLOGY & SCIENCE ( MBA DEPARTMENT ) Page 6

CREDIT RISK Credit risk monitoring and control 80 Risk review 83 7 NPA 84 8 Research methodology 88 Primary objectives 88 Types of research 88 Source of data 89 Data collection 89 Analysis 90 Findings 102 Suggestion 103 Limitation 104 9 Conclusion 105 10 Bibliography 106 11 Annexture 107 ATMIYA INSTITUTE OF TECHNOLOGY & SCIENCE ( MBA DEPARTMENT ) Page 7

CREDIT RISK INTRODUCTION ORIGIN OF THE WORD "BANK" After commerce and the arts had revived in Italy, the business of banking was re sumed. The word "bank" is commonly regarded as derived from the Italian word banco, a bench -the Jews in Lombardy having benches in the market-place for the exchange of money and bills. When a banker failed, his bench was broken by the populace; and from this circum stance we have our word bankrupt. But while this is the derivation generally accepted, som e writers have asserted that a more accurate explanation of the use of the word "bank" is that which makes it synonymous with the Italian Monte (Latin Mons, Metritis), a mound, heap, or bank . Thus the Italian Monte di Pieta and the French Mont de Piete signify "a Charity Bank." Ba con and Evelyn use the word in the same sense. Bacon says: "Let it be no bank or common stock, but every man is master of his own money." Evelyn, referring to the Monte di Pieta at Padua, w rites: "There is a continual bank of money to assist the poor." Black-stone also says: "At Florence , in 1344, government owed 60,000, and being unable to pay it, formed the principal into an aggregate sum called, metaphorically a Mount or Bank. ATMIYA INSTITUTE OF TECHNOLOGY & SCIENCE ( MBA DEPARTMENT ) Page 8

CREDIT RISK HISTORY OF BANKING IN INDIA Without a sound and effective banking system in India it cannot have a healthy e conomy. The banking system of India should not only be hassle free but it should be able to meet new challenges posed by the technology and any other external and internal factors. For the past three decades India's banking system has several outstanding achiev ements to its credit. The most striking is its extensive reach. It is no longer confined to on ly metropolitans or cosmopolitans in India. In fact, Indian banking system has reached even to the r emote corners of the country. This is one of the main reasons of India's growth process. The government's regular policy for Indian banks since 1969 has paid rich divide nds with the nationalisation of 14 major private banks of India. Not long ago, an account holder had to wait for hours at the bank counters for g etting a draft or for withdrawing his own money. Today, he has a choice. Gone are days when the mo st efficient bank transferred money from one branch to other in two days. Now it is simple as instant messaging or dials a pizza. Money has become the order of the day. The first bank in India, though conservative, was established in 1786. From 1786 till today, the journey of Indian Banking System can be segregated into three distinct phases. T hey are as mentioned below: Early phase from 1786 to 1969 of Indian Banks Nationalisation of Indian Banks and up to 1991 prior to Indian banking sector Re forms. New phase of Indian Banking System with the advent of Indian financial & Banking Sector Reforms after 1991. To make this write-up more explanatory, I prefix the scenario as Phase I, Phase II and Phase III. ATMIYA INSTITUTE OF TECHNOLOGY & SCIENCE ( MBA DEPARTMENT ) Page 9

CREDIT RISK Phase I The General Bank of India was set up in the year 1786. Next came Bank of Hindust an and Bengal Bank. The East India Company established Bank of Bengal (1809), Bank of B ombay (1840) and Bank of Madras (1843) as independent units and called it Presidency B anks. These three banks were amalgamated in 1920 and Imperial Bank of India was established which started as private shareholders banks, mostly Europeans shareholders. In 1865 Allahabad Bank was established and first time exclusively by Indians, Pu njab National Bank Ltd. was set up in 1894 with headquarters at Lahore. Between 1906 and 1913, Bank of India, Central Bank of India, Bank of Baroda, Canara Bank, Indian Bank, and Bank of Mysore were set up. Reserve Bank of India came in 1935. During the first phase the growth was very slow and banks also experienced perio dic failures between 1913 and 1948. There were approximately 1100 banks, mostly small. To str eamline the functioning and activities of commercial banks, the Government of India came up with The Banking Companies Act, 1949 which was later changed to Banking Regulation Act 19 49 as per amending Act of 1965 (Act No. 23 of 1965). Reserve Bank of India was vested with extensive powers for the supervision of banking in India as the Central Banking Authority. During those day s public has lesser confidence in the banks. As an aftermath depo sit mobilization was slow. Abreast of it the savings bank facility provided by the P ostal department was comparatively safer. Moreover, funds were largely given to traders. ATMIYA INSTITUTE OF TECHNOLOGY & SCIENCE ( MBA DEPARTMENT ) Page 10

CREDIT RISK Phase II Government took major steps in this Indian Banking Sector Reform after independe nce. In 1955, it nationalised Imperial Bank of India with extensive banking facilities on a la rge scale especially in rural and semi-urban areas. It formed State Bank of India to act as the princ ipal agent of RBI and to handle banking transactions of the Union and State Governments all over t he country. Seven banks forming subsidiary of State Bank of India was nationalised in 1960 o n 19th July, 1969, major process of nationalisation was carried out. It was the effort of the then Prime Minister of India, Mrs. Indira Gandhi. 14 major commercial banks in the country were nationalised. Second phase of nationalisation Indian Banking Sector Reform was carried out in 1980 with seven more banks. This step brought 80% of the banking segment in India under Go vernment ownership. The following are the steps taken by the Government of India to Regulate Banking Institutions in the Country: 1949: Enactment of Banking Regulation Act. 1955: Nationalisation of State Bank of India. 1959: Nationalisation of SBI subsidiaries. 1961: insurance cover extended to deposits. 1969: Nationalisation of 14 major banks. 1971: Creation of credit guarantee corporation. 1975: Creation of regional rural banks. 1980: Nationalisation of seven banks with deposits over 200 crore. After the nationalisation of banks, the branches of the public sector bank India rose to approximately 800% in deposits and advances took a huge jump by 11,000%. Banking in the sunshine of Government ownership gave the public implicit faith a nd immense confidence about the sustainability of these institutions. ATMIYA INSTITUTE OF TECHNOLOGY & SCIENCE ( MBA DEPARTMENT ) Page 11

CREDIT RISK Phase III This phase has introduced many more products and facilities in the banking secto r in its reforms measure. In 1991, under the chairmanship of M Narasimham, a committee was set up by his name which worked for the liberalisation of banking practices. The country is flooded with foreign banks and their ATM stations. Efforts are be ing put to give a satisfactory service to customers. Phone banking and net banking is introduced. The entire system became more convenient and swift. Time is given more importance than mone y. The financial system of India has shown a great deal of resilience. It is shelte red from any crisis triggered by any external macroeconomics shock as other East Asian Countries suf fered. This is all due to a flexible exchange rate regime, the foreign reserves are high, the c apital account is not yet fully convertible, and banks and their customers have limited foreign exchan ge exposure. ATMIYA INSTITUTE OF TECHNOLOGY & SCIENCE ( MBA DEPARTMENT ) Page 12

CREDIT RISK Nationalisation The nationalisation of banks in India took place in 1969 by Mrs. Indira Gandhi t he then prime minister. It nationalised 14 banks then. These banks were mostly owned by busine ssmen and even managed by them. Central Bank of India Bank of Maharashtra Dena Bank Punjab National Bank Syndicate Bank Canara Bank Indian Bank Indian Overseas Bank Bank of Baroda Union Bank Allahabad Bank United Bank of India UCO Bank Bank of India Before the steps of nationalisation of Indian banks, only State Bank of India (S BI) was nationalised. It took place in July 1955 under the SBI Act of 1955. Nationalisat ion of Seven State Banks of India (formed subsidiary) took place on 19th July, 1960. The State Bank of India is India's largest commercial bank and is ranked one of the top five banks worldwide. It serves 90 million customers through a network of 9,000 branc hes and it offers --either directly or through subsidiaries --a wide range of banking servi ces. ATMIYA INSTITUTE OF TECHNOLOGY & SCIENCE ( MBA DEPARTMENT ) Page 13

CREDIT RISK The second phase of nationalisation of Indian banks took place in the year 1980. Seven more banks were nationalised with deposits over 200crores. Till this year, approximat ely 80% of the banking segment in India was under Government ownership. After the nationalisation of banks in India, the branches of the public sector b anks rose to approximately 800% in deposits and advances took a huge jump by 11,000%. 1955: Nationalisation of State Bank of India. 1959: Nationalisation of SBI subsidiaries. 1969: Nationalisation of 14 major banks. 1980: Nationalisation of seven banks with deposits over 200crores. The commercial banking structure in India consists of: Scheduled Commercial Banks in India Unscheduled Banks in India Scheduled Banks in India constitute those banks which have been included in the Second Schedule of Reserve bank of India (RBI) Act, 1934. RBI in turn includes only tho se banks in this schedule which satisfy the criteria laid down vide section 42 (6) (a) of the Act . As on 30th June, 1999, there were 300 scheduled banks in India having a total ne twork of 64,918 branches. The scheduled commercial banks in India comprise of State bank of Indi a and its associates (8), nationalized banks (19), foreign banks (45), private sector bank s (32), cooperative banks and regional rural banks. "Scheduled banks in India" means the State Bank of India constituted under the S tate Bank of India Act, 1955 (23 of 1955), a subsidiary bank as defined in the State Bank of India (Subsidiary Banks) Act, 1959 (38 of 1959), a corresponding new bank constituted under sectio n 3 of the Banking Companies (acquisition and Transfer of Undertakings) Act, 1970 (5 of 197 0), or under ATMIYA INSTITUTE OF TECHNOLOGY & SCIENCE ( MBA DEPARTMENT ) Page 14

CREDIT RISK section 3 of the Banking Companies (Acquisition and Transfer of Undertakings) Ac t, 1980 (40 of 1980), or any other bank being a bank included in the Second Schedule to the Reserve Bank of India Act, 1934 (2 of 1934), but does not include a co-operative bank". "Non-scheduled bank in India" means a banking company as defined in clause (c) o f section 5 of the Banking Regulation Act, 1949 (10 of 1949), which is not a scheduled bank". The following are the Scheduled Banks in India (Public Sector): State Bank of India State Bank of Bikaner and Jaipur State Bank of Hyderabad State Bank of Indore State Bank of Mysore State Bank of Saurashtra State Bank of Travancore Andhra Bank Allahabad Bank Bank of Baroda Bank of India Bank of Maharashtra Canara Bank Central Bank of India Corporation Bank Dena Bank Punjab National Bank Punjab and Sind Bank Syndicate Bank Union Bank of India United Bank of India UCO Bank ATMIYA INSTITUTE OF TECHNOLOGY & SCIENCE ( MBA DEPARTMENT ) Page 15

CREDIT RISK Indian Overseas Bank Indian Bank Oriental Bank of Commerce Vijaya Bank The following are the Scheduled Banks in India (Private Sector): ING Vysya Bank Ltd Axis Bank Ltd Indusind Bank Ltd ICICI Bank Ltd South Indian Bank HDFC Bank Ltd Centurion Bank Ltd Bank of Punjab Ltd IDBI Bank Ltd The following are the Scheduled Foreign Banks in India: American Express Bank Ltd. ANZ Gridlays Bank Plc. Bank of America NT & SA Bank of Tokyo Ltd. Banquc Nationale de Paris Barclays Bank Plc Citi Bank N.C. Deutsche Bank A.G. Hongkong and Shanghai Banking Corporation Standard Chartered Bank. The Chase Manhattan Bank Ltd. Dresdner Bank AG. ATMIYA INSTITUTE OF TECHNOLOGY & SCIENCE ( MBA DEPARTMENT ) Page 16

CREDIT RISK

STATE BANK OF INDIA The evolution of State Bank of India can be traced back to the first decade of t he 19th century. It began with the establishment of the Bank of Calcutta in Calcutta, on 2 June 1806 . The bank was redesigned as the Bank of Bengal, three years later, on 2 January 1809. It was t he first ever jointstock bank of the British India, established under the sponsorship of the Govern ment of Bengal. Subsequently, the Bank of Bombay (established on 15 April 1840) and the Bank of Madras (established on 1 July 1843) followed the Bank of Bengal. These three banks domi nated the modern banking scenario in India, until when they were amalgamated to form the I mperial Bank of India, on 27 January 1921. An important turning point in the history of State Bank of India is the launch o f the first Five Year Plan of independent India, in 1951. The Plan aimed at serving the Indian ec onomy in general and the rural sector of the country, in particular. Until the Plan, the commercial banks of the country, including the Imperial Bank of India, confined their services to th e urban sector. Moreover, they were not equipped to respond to the growing needs of the economic revival taking shape in the rural areas of the country. Therefore, in order to serve the economy as a whole and rural sector in particular, the All India Rural Credit Survey Committe e recommended the formation of a state-partnered and state-sponsored bank. The State Bank of India emerged as a pacesetter, with its operations carried out by the 480 offices comprising branches, sub offices and three Local Head Offices, inherited from the Imperial Bank. Instead of serving as mere repositories of the community's saving s and lending to creditworthy parties, the State Bank of India catered to the needs of the custom ers, by banking purposefully. The bank served the heterogeneous financial needs of the planned e conomic development. ATMIYA INSTITUTE OF TECHNOLOGY & SCIENCE ( MBA DEPARTMENT ) Page 17

CREDIT RISK Branches The corporate center of SBI is located in Mumbai. In order to cater to different functions, there are several other establishments in and outside Mumbai, apart from the corporate center. The bank boasts of having as many as 14 local head offices and 57 Zonal Offices, loc ated at major cities throughout India. It is recorded that SBI has about 10000 branches, well networked to cater to its customers throughout India. ATM Services SBI provides easy access to money to its customers through more than 8500 ATMs i n India. The Bank also facilitates the free transaction of money at the ATMs of State Bank Gr oup, which includes the ATMs of State Bank of India as well as the Associate Banks State Ba nk of Bikaner & Jaipur, State Bank of Hyderabad, State Bank of Indore, etc. You may al so transact money through SBI Commercial and International Bank Ltd by using the State Bank ATM-cumDebit (Cash Plus) card. Subsidiaries The State Bank Group includes a network of eight banking subsidiaries and severa l non-banking subsidiaries. Through the establishments, it offers various services including m erchant banking services, fund management, factoring services, primary dealership in government securities, credit cards and insurance. The eight banking subsidiaries are: State Bank of Bikaner and Jaipur (SBBJ) State Bank of Hyderabad (SBH) State Bank of India (SBI) State Bank of Indore (SBIR) State Bank of Mysore (SBM) ATMIYA INSTITUTE OF TECHNOLOGY & SCIENCE ( MBA DEPARTMENT ) Page 18

CREDIT RISK State Bank of Patiala (SBP) State Bank of Saurashtra (SBS) State Bank of Travancore (SBT) Products And Services Personal Banking SBI SBI SBI SBI SBI Term Deposits SBI Loan for Pensioners Recurring Deposits Loan against Mortgage of Property Housing Loan against Shares & Debentures Car Loan Rent plus Scheme Educational Loan Medi-Plus Scheme

Other Services Agriculture/Rural Banking NRI Services ATM Services Demat Services Corporate Banking Internet Banking Mobile Banking International Banking Safe Deposit Locker SBI Vishwa Yatra Foreign Travel Card Broking Services ATMIYA INSTITUTE OF TECHNOLOGY & SCIENCE ( MBA DEPARTMENT ) Page 19

CREDIT RISK

BANK OF BARODA Type Public BSE & NSE:BOB} Founded 1908 Headquarters Bank of Baroda, Baroda Corporate Centre, Plot No -C-26, G -Block, Bandra Kurla Complex, Mumbai India Key people M D Mallya, Chairman & Managing Director Industry Banking Capital Markets and allied industries Products Loans, Credit Cards, Savings, Investment vehicles etc. Revenue Rs. 17754 crores (US$ 3.9 billion) Total assets Rs. 2,274 bn (US$ 50 billion) Website www.bankofbaroda.com Bank of Baroda is one of the most prominent banks in India, having its total ass ets as Rs. 1, 43,146 Crores as on 31st of March 2007. The bank was founded by Maharaja Sayajir ao Gaekwad III (also known as Shrimant Gopalrao Gaekwad), the then Maharaja of Baro da on 20th of July 1908 with a paid capital of Rs. 10 Lacs. From its introduction in a smal l building of Baroda, the bank has come a long way to achieve its current position as one of t he most important banks in India. On 19th of July 1969, Bank of Baroda was nationalized by the Government of India along with 13 other commercial banks. ATMIYA INSTITUTE OF TECHNOLOGY & SCIENCE ( MBA DEPARTMENT ) Page 20

CREDIT RISK Financial Details As of March 2007, the bank had total deposits worth Rs. 1,24,915 Crores while it had a total number of 2956 branches located worldwide as on April 2009, out of which 626 wer e located in Metro cities, 524 in Urban areas, 642 in Semi-Urban locations, 1092 in Rural are as and 72 were located outside India. The bank has 10 Zonal Offices and 43 Regional Offices whi ch help it control its operations nationally. International Presence Along with a huge network of its branches spread across India, Bank of Baroda ha s its overseas branches located in 14 other countries, which include Bahamas, Bahrain, Belgium, China, Fiji Islands, Hong Kong, Mauritius, Republic of South Africa, Seychelles, Singapore, Sultanate of Oman, United Arab Emirates, United Kingdom and United States of America. Apart f rom it, the bank has established its subsidiaries in 7 countries viz. Botswana, Ghana, Guyan a, Kenya, Tanzania, Trinidad & Tobago and Uganda, and its representative offices in 3 coun tries which are Australia, Malaysia and Thailand. Other Details Bank of Baroda had a total workforce of 38063 employees offering their services to the institution as of September 2006. Out of these, 13525 were Officers, 16497 were Clerks while 8041 were Sub-Staff members. The bank offers a wide array of customized and specialized services to meet the diverse needs of its customers, and these services have been categorized into Personal Banking, B usiness Banking, Corporate Banking, International Banking, Treasury Banking and Rural Ba nking services. ATMIYA INSTITUTE OF TECHNOLOGY & SCIENCE ( MBA DEPARTMENT ) Page 21

CREDIT RISK

UNION BANK OF INDIA Type Public Headquarters Mumbai, India Key people Mavila Vishwanathan Nair (Chair) Industry Financial Commercial banks Revenue USD 1.23 billion Net income USD 0.16 billion Employees 25,630 Website www.unionbankofindia.co.in Union Bank of India (UBI) is one of India's largest state-owned banks (the gover nment owns 55.43% of its share capital), is listed on the Forbes 2000. It has assets of USD 13.45 billion and all the bank's branches have been networked with its 1135 ATMs. Its online Teleb anking facility is available to all its Core Banking Customers -individual as well as corporate. It has representative offices in Abu Dhabi, United Arab Emirates, and Shanghai, Peoples Republic of China, and a branch in Hong Kong. Because of its acronym UBI, the public sometim es confuses it with United Bank of India ATMIYA INSTITUTE OF TECHNOLOGY & SCIENCE ( MBA DEPARTMENT ) Page 22

CREDIT RISK History 1919 UBI was registered on November 11, 1919 as a limited company in Mumbai. It was inaugurated by Mahatma Gandhi. 1947 UBI had only 4 branches -3 in Mumbai and 1 in Saurashtra, all concentrated in key trade centres. 1975 The Government nationalized UBI. At the time of its nationalization, UBI ha d 240 branches in 28 states. After nationalization, UBI merged in Belgaum Bank, a private sector bank establi shed in 1930. 1985 UBI merged in Miraj State Bank, established in 1929. 1999 UBI acquired Sikkim Bank in a rescue at the request of the Reserve Bank of India after the discovery of extensive irregularities at the non-scheduled bank. Sikki m Bank had eight branches located in the North-east, which was attractive to UBI. 2007 UBI opened representative offices in Abu Dhabi, United Arab Emirates, and Shanghai, Peoples Republic of China. 2008 UBI opened a branch in Hong Kong, its first branch outside India. Dec 2009 UBI opened a representative office in Sydney ATMIYA INSTITUTE OF TECHNOLOGY & SCIENCE ( MBA DEPARTMENT ) Page 23

CREDIT RISK

ICICI BANK Type Private BSE & NSE:ICICI, NYSE: IBN Key people K.V.Kamath,Chairman Chanda Kochhar, Managing Director & CEO Sandeep Bakhshi, Deputy Managing Director N.S. Kannan, Executive Director & CFO K. Ramkumar, Executive Director Industry Banking Insurance Capital Markets and allied industries Products Loans, Credit Cards, Savings, Investment vehicles, Insurance etc. Revenue . USD 15.06 billion Total assets . USD 120.61 billion (at March 31, 2009.) Website www.icicibank.com ICICI Bank started as a wholly owned subsidiary of ICICI Limited, an Indian fina ncial institution, in 1994. Four years later, when the company offered ICICI Bank's sh ares to the public, ICICI's shareholding was reduced to 46%. In the year 2000, ICICI Bank of fered made an equity offering in the form of ADRs on the New York Stock Exchange (NYSE), there by becoming the first Indian company and the first bank or financial institution fr om non-Japan Asia to be listed on the NYSE. In the next year, it acquired the Bank of Madura Limit ed in an allstock amalgamation. Later in the year and the next fiscal year, the bank made se condary market sales to institutional investors. With a change in the corporate structure and the budding competition in the Indi an Banking industry, the management of both ICICI and ICICI Bank were of the opinion that a merger ATMIYA INSTITUTE OF TECHNOLOGY & SCIENCE ( MBA DEPARTMENT ) Page 24

CREDIT RISK between the two entities would prove to be an essential step. It was in 2001 tha t the Boards of Directors of ICICI and ICICI Bank sanctioned the amalgamation of ICICI and two o f its whollyowned retail finance subsidiaries, ICICI Personal Financial Services Limited and ICICI Capital Services Limited, with ICICI Bank. In the following year, the merger was approve d by its shareholders, the High Court of Gujarat at Ahmedabad as well as the High Court o f Judicature at Mumbai and the Reserve Bank of India. Present Scenario ICICI Bank has its equity shares listed in India on Bombay Stock Exchange and th e National Stock Exchange of India Limited. Overseas, its American Depositary Receipts (ADR s) are listed on the New York Stock Exchange (NYSE). As of December 31, 2008, ICICI is India's secondlargest bank, boasting an asset value of Rs. 3,744.10 billion and profit after t ax Rs. 30.14 billion, for the nine months, that ended on December 31, 2008. Branches & ATMs ICICI Bank has a wide network both in Indian and abroad. In India alone, the ban k has 1,420 branches and about 4,644 ATMs. Talking about foreign countries, ICICI Bank has m ade its presence felt in 18 countries -United States, Singapore, Bahrain, Hong Kong, Sri Lanka, Qatar and Dubai International Finance Centre and representative offices in United Arab Emirates, China, South Africa, Bangladesh, Thailand, Malaysia and Indonesia. The Bank prou dly holds its subsidiaries in the United Kingdom, Russia and Canada out of which, the UK subsi diary has established branches in Belgium and Germany. Products & Services Personal Banking Deposits Loans Cards ATMIYA INSTITUTE OF TECHNOLOGY & SCIENCE ( MBA DEPARTMENT ) Page 25

CREDIT RISK Investments Insurance Demat Services Wealth Management NRI Banking Money Transfer Bank Accounts Investments Property Solutions Insurance Loans Business Banking Corporate Net Banking Cash Management Trade Services FXOnline SME Services ATMIYA INSTITUTE OF TECHNOLOGY & SCIENCE ( MBA DEPARTMENT ) Page 26

CREDIT RISK

Type Public BSE: 532215 Founded Ahmedabad, 1994. Headquarters Mumbai, India Key people Shikha Sharma, MD & CEO Industry Financial Commercial banks Employees 13,389 (2007) Website www.axisbank.com Axis Bank was formed as UTI when it was incorporated in 1994 when Government of India allowed private players in the banking sector. The bank was sponsored together b y the administrator of the specified undertaking of the Unit Trust of India, Life Insu rance Corporation of India (LIC) and General Insurance Corporation ltd. and its subsidiaries namel y National insurance company ltd., the New India Assurance Company, the Oriental Insurance Corporation and United Insurance Company Ltd. However, the name of UTI was changed because o f the disagreement on terms and conditions of the bank authority over certain stipulat ions including royalty charged over the name from UTI AMC. The bank also wanted to have a new n ame from its pan-Indian as well as international business perspective. So from July 30, 2 007 onwards the UTI bank was named as Axis Bank. Axis Bank: Branches and Business Set up with a capital of Rs. 115 crore-with UTI contributing Rs. 100 crore, LIC contributing Rs. 7.5 crore and GIC and its four subsidiaries contributing Rs. 1.5 crores, the ban k came in operation with its first registered office at Ahmedabad . Today, Axis Bank has m ore than 726 ATMIYA INSTITUTE OF TECHNOLOGY & SCIENCE ( MBA DEPARTMENT ) Page 27

CREDIT RISK branch offices and Extension Counters spread over 341 cities, towns and villages of the country. Presently, the authorized share capital of Axis Bank is Rs. 300 Crores and the p aid up share capital is Rs. 232.86 Crores. The Axis bank is currently capitalized with Rs. 28 2.65 Crores with a public holding of 57.05% apart from the promoters. The FY2009 shows a net prof it of Rs. 500.86 crore up by 63.24% yoy over the Net Profit of Rs. 306.83 crores for the t hird quarter of last year. Axis Bank: Facilities and Services Axis Bank its customers with all kinds of facilities that should be provided by a modern Bank. It deals with personalized as well as commercial banking. It has one of the largest spread ATM network in the country. Corporate Facilities Cash Credit Working Capital Demand Loan Export Finance Short Term Loan Term Loan Clean Bill Discounting Co-Acceptance of Bills Credit Facilities against Guarantee or Stand By Letter of Credit issued by Forei gn Banks Letter of Credit Bank Guarantee Solvency Certificates Personal Facilities Home Loans Personal Loans ATMIYA INSTITUTE OF TECHNOLOGY & SCIENCE ( MBA DEPARTMENT ) Page 28

CREDIT RISK Car Loan Zero Balance Savings Account VBV -Online purchases using Credit Card VBV / MSC -Online purchases using Debit Card Mobile Banking NRI Account Study Loans Mohur Gold Easy Savings Account ATMIYA INSTITUTE OF TECHNOLOGY & SCIENCE ( MBA DEPARTMENT ) Page 29

CREDIT RISK

HDFC BANK Founded 1994 Founder(s) Mr Deepak Parekh of HDFC Headquarters Mumbai, India Key people Mr. Aditya Puri, Managing Director Mr. Harish Engineer, Executive Director Industry Banking Insurance Capital Markets and allied industries Products Financial services Revenue . Rs. 197.5 billion (2009) Net income . Rs. 2.24 billion (2009) Total assets . Rs. 1.8 trillion (2009) Employees 52,687 (2009) Website www.hdfcbank.com HDFC Bank was incorporated in the year of 1994 by Housing Development Finance Co rporation Limited (HDFC), India's premier housing finance company. It was among the first companies to receive an 'in principle' approval from the Reserve Bank of India (RBI) to set u p a bank in the private sector. The Bank commenced its operations as a Scheduled Commercial Bank in January 1995 with the help of RBI's liberalization policies. In a milestone transaction in the Indian banking industry, Times Bank Limited (p romoted by Bennett, Coleman & Co. / Times Group) was merged with HDFC Bank Ltd., in 2000. T his was the first merger of two private banks in India. As per the scheme of amalgamatio n approved by the shareholders of both banks and the Reserve Bank of India, shareholders of Ti mes Bank received 1 share of HDFC Bank for every 5.75 shares of Times Bank. In 2008 HDFC Bank acquired Centurion Bank of Punjab taking its total branches to more than 1,000. The amalgamated bank emerged with a strong deposit base of around Rs. 1,2 2,000 crore and net advances of around Rs. 89,000 crore. The balance sheet size of the combi ned entity is ATMIYA INSTITUTE OF TECHNOLOGY & SCIENCE ( MBA DEPARTMENT ) Page 30

CREDIT RISK over Rs. 1,63,000 crore. The amalgamation added significant value to HDFC Bank i n terms of increased branch network, geographic reach, and customer base, and a bigger pool of skilled manpower. Business Focus HDFC Bank deals with three key business segments -Wholesale Banking Services, Re tail Banking Services, Treasury. It has entered the banking consortia of over 50 corp orates for providing working capital finance, trade services, corporate finance and merchan t banking. It is also providing sophisticated product structures in areas of foreign exchange and derivatives, money markets and debt trading and equity research. Wholesale Banking Services The Bank's target market ranges from large, blue-chip manufacturing companies in the Indian corporate to small & mid-sized corporates and agri-based businesses. For these c ustomers, the Bank provides a wide range of commercial and transactional banking services, inc luding working capital finance, trade services, transactional services, cash management , etc. The bank is also a leading provider of structured solutions, which combine cash management s ervices with vendor and distributor finance for facilitating superior supply chain management for its corporate customers. HDFC Bank has made significant inroads into the banking consortia of a number of leading Indian corporates including multinationals, companies from the domestic business houses and prime public sector companies. It is recognized as a leading provider of cash management and transactional banking solutions to corporate customers, mutual fu nds, stock exchange members and banks. Retail Banking Services The objective of the Retail Bank is to provide its target market customers a ful l range of financial products and banking services, giving the customer a one-stop window for all his /her banking requirements. The products are backed by world-class service and delivered to cu stomers ATMIYA INSTITUTE OF TECHNOLOGY & SCIENCE ( MBA DEPARTMENT ) Page 31

CREDIT RISK through the growing branch network, as well as through alternative delivery chan nels like ATMs, Phone Banking, Net Banking and Mobile Banking. HDFC Bank was the first bank in India to launch an International Debit Card in a ssociation with VISA (VISA Electron) and issues the MasterCard Maestro debit card as well. The B ank launched its credit card business in late 2001. By March 2009, the bank had a to tal card base (debit and credit cards) of over 13 million. The Bank is also one of the leading players in the merchant acquiring business with over 70,000 Point-of-sale (POS) terminals for deb it / credit cards acceptance at merchant establishments. The Bank is well positioned as a le ader in various net based B2C opportunities including a wide range of internet banking services for Fixed Deposits, Loans, Bill Payments, etc. ATMIYA INSTITUTE OF TECHNOLOGY & SCIENCE ( MBA DEPARTMENT ) Page 32

CREDIT RISK TYPES OF LOAN PERSONAL LOANS In today s world, no matter how much you earn, you may find that it is not enough to meet your needs. Yesterday s luxuries have become today s necessities. Owning a good car, havi ng your own house or traveling the world are decisions which are made without much think ing? Simply because these are a few material comforts that are a must for any family. In ord er to meet these needs, even the woman of the house works. It is not uncommon to find both parent s working at jobs which demand a lot of time, but which also bring in a steady income. Howeve r, you may still find that even with the steady money coming in, there are expenses of a sl ightly bigger proportion such as a wedding, or annual families get together which cannot be fi nanced with what is at hand. What can a person do in such a circumstance? Read below about p ersonal loans which panacea for all these troubles. In such a situation where getting a huge amount of money is a must, one can appl y for a personal loan. A personal loan is a loan taken from a credible authority, such as a bank or a moneylender, and which is repaid back over a fixed period of time, and with interest. The rea sons for taking a personal loan could be buying household items spending on wedding financing a holiday buying a new car etc. The concept of a loan itself has been around for centuries. If we look at histor y, one can find that the lending authorities in earlier times used to be the religious temples and fe w money lenders who used to charge high rate of interests and the borrower was always under pres sure of how repay the debt. Even back then, there were records of loans being paid back with rich harvests and interest rates being charged. The terms and conditions of each loan and the method of repayment varied from person to person. ATMIYA INSTITUTE OF TECHNOLOGY & SCIENCE ( MBA DEPARTMENT ) Page 33

CREDIT RISK Current scenario: Today, when a person wants a loan, he goes to a bank with which s/he has a perso nal account or to a credible money lender. Although there are any high profile lenders in the m arket, it may be difficult to get a loan from them as they often have very stringent parameters t hat need to be met. It however, is much easier to get a loan from an online moneylender or any other such authority. Loans are also given to people who have a bad credit score, or who have a bankru ptcy status. It is important to know the profile of the creditor properly, as there are a lot of fraudsters in the market. Types of Personal loans: -There are two kinds of personal loans that one can ava il of in the market. Different terminology is used for different types of personal loans howe ver broadly there are only two categories i.e. unsecured loans and secured loans. The first is called an Unsecured Loan. As the name suggests, an unsecured loan i s a loan, which is given without any collateral as a security for example a house, or any other asset. This works well for people who wish to take a loan but who do not have the required a ssets to fall back on. As there is no collateral which is offered here, generally the money on e can apply for in the loan is also of a lower amount, while the Annual Percentage Rate may be quit e high. People who have a bad credit score and also who have a mortgage to pay or who have appl ied for many loans can avail of this type of loan. However there are a few conditions which n eed to be fulfilled. A regular source of income needs to be shown, as a background check w ould be carried out by the lender. Also, proof that an applicant has stayed at the same place of residence for atleast three years is also a must. It is found that married people who have a s teady source of income are generally the people who are most preferred by lenders as they are mo re credible in nature. Generally, newly wed couples and students favour this kind of loan. The second type of loan is called a Secured Loan. Here, the money lent is secure d against some kind of collateral, which in most cases is the house that the applicant lives in. These kinds of loans are believed to be more risk free, and also with the popularity of the Internet.. ATMIYA INSTITUTE OF TECHNOLOGY & SCIENCE ( MBA DEPARTMENT ) Page 34

CREDIT RISK Points to keep in mind: No matter what kind of loan you decide to go for, it is still borrowed money being lent out with its own terms and conditions. 1. Understand what exactly your need for a loan is. 2. How much you want to borrow. 3. Remember that whatever you borrow needs to be paid back with interest in time . So do not take a huge amount if you feel you may not be able to repay it within the specif ied timeframe. 4. Take a look at your finances and note down your monthly expenses. Being in co ntrol of your expenses helps you plan ahead better. 5. It is important to search the market properly for a reputed and credible mone ylender. Go in for a moneylender who makes you comfortable and who willingly answers any questions you might have. 6. Read the documents carefully before signing anything, and make sure you ask t he relevant questions to clear any doubts you may have. 7. Analyzing the market and various options would help you understand the rates that are there in the market, the time frame in which you can apply for the amount, and also the m aximum amount you can apply for. 8. Do not hesitate to meet up with as many moneylenders as possible, as talking with them would help you understand if you should take a loan from them or not. 9. Lastly, make use of the Internet to get whatever information you require and to hunt around for good deals. ATMIYA INSTITUTE OF TECHNOLOGY & SCIENCE ( MBA DEPARTMENT ) Page 35

CREDIT RISK VEHICLE LOAN A loan is a type of debt. Like all debt instruments, a loan entails the redistri bution of financial assets over time, between the and the . The borrower initially receives an amount of money from the lender, which they pay back, usually but not always in regular installm ents, to the lender. This service is generally provided at a cost, referred to as interest on the debt. Thus, an AUTO LOAN is a kind of personal loan that is used to purchase an automobile. Need & Requirement of Auto Loans? Buying a new vehicle is one of the single biggest purchases, a person is likely to make in is life. This expenditure may be only comparable to his other personal expenditures like purchase of a house or may be the expense over his own education. Hence, it comes with no big surprise that most people can t afford to pay for their new vehicle. The concept of fast loans was especially designed for the fast approval of the r equired funds for the borrowers. The loan seeker can avail the following advantages while consider ing the option of fast loans: The loan seeker can apply online for the loan. The loan lender re ceives your request application for the grant of loan in just no time, i.e. with a single click of t he mouse. Hence, the processing time for the application reduces manifold, provided the de tails given by the applicant are authentic. So, the borrower must look out for providing his de tails correctly by filling the form online, in full conscious. Fast loans save the time wasted othe rwise for the valuation of the collateral. This is because, the lender already knows the care model and its make (as mentioned by the applicant in the loan form), he can quickly decide over the loan amount to be offered. Grabbing a great Auto Loan Deal can be done in simple 4 steps: Studying the financial companies providing loans Negotiating your terms Increasing your down payment Demanding a better deal with the company of your choice ATMIYA INSTITUTE OF TECHNOLOGY & SCIENCE ( MBA DEPARTMENT ) Page 36

CREDIT RISK HOME LOAN One such loan which is very common now days is the home loan which is usually ta ken by the borrowers on behalf of their salaries. Since construction of home requires heavy volume of cash, such loans help the constructor of the home not to spend this huge amount at onc e rather he has to spend no amount but borrow the required amount which can be repaid in easy in stallments whenever he has a funds. This is according to the mutual agreement between the t wo. Everyone is keen to procure a good accommodation i.e. flat, a banglaw for them. A regular source of incomes as a proof has to be shown to get such loans. A second type of loan is H ome owners loan in which one can avail loan by mortgaging his current accommodation. Someti mes a loan is provided to repay a previous loan which was taken during the construction of the house. But the under the situation, the amount of loan can be availed only till the ext ent it covers the value of the home equity. Home owner loan is also known as mortgage loan. Need for home loan The requirement of home loan arises due to shortage of funds available with an i ndividual for buying a property as this process involves huge funds. One is able to finance th e expenditure through these loans rather than withdrawing a large amount from the bank at once . The major advantage of taking such loan is that these kinds of loans usually carry low rat es of interests as they are secured loans. They usually have liberal terms and conditions of repaym ent. Unlike unsecured loans a large amount can be borrowed in forms of such loans and repaym ent for these can be done through easy installments. One needs to have a good credit history a nd minimum borrowing in the past to secure such loans. In this case one should go in for ho me owner loans as these loan are even given to people who have had bad credit history because of t he fact that these unsecured credit loans which reduces the risk of the lenders to a great extent. Once you avail such loan you can use in the way you want to which means that suc h loans have flexible approach. It can be used for number of purposes like purchase of a car, for financing a trip, financing the education expenses of the children, renovation or improvemen t of their house. One can look for lenders easily as lending is being done online too and comparis on should be made between different home loans available and the best option should be taken

up. ATMIYA INSTITUTE OF TECHNOLOGY & SCIENCE ( MBA DEPARTMENT ) Page 37

CREDIT RISK Types of Home Loans One can make additions to the original home for increasing the value of the prop erty by improving the home and these loans prove to be a boom in this case too because o f their tax deductible feature. Improvements in the house may be in the form of refurnishing , redesigning, air conditioning and by adding more acceries to the home. Collateral security is required to get home improvement loans. Since it makes a less risky task for the companies as it involves lower rate of interest. The basic condition to acquire such loan is that one must own a home and must hold a good mortgage structure of payment in the past. There are two firms of home loans available to an individual. These loans are : Home improvement loans of FHA title Home improvement loan of traditional type Any of these could be used for any fresh constructions, renovations, refurnishin g your bedroom, kitchen, garage, bathroom, swimming pool etc. One needs to have an equity in the house if one wishes to renovate, in case a traditional home improvement loan is being conside red consisting of one fifth of the cost of the house. The already constructed equity and those acquired by the changes in the home are to be taken as security for the repayment of loan. Lende r is the firm providing the loan. In an home improvement loan, the firm will issue first or se cond lieu which empowers its right over property till the debt is repaid. Generally home improvement loan is for a period of ten years or less but could b e extended to fifteen years depending on the programme and lender at once disposal. FHA title 1 Home improvement loan can be distinguished from traditional Home improvement loan as the former is a government plan. Although FHA loan does not allow luxury remodeling but can be used for inevitabl e repairs and restoring good conditions. This is the general method followed as equity in the home is wished for this type of the loan and traded outcomes of the past is generally not an is sue. FHA title loan can be repaid for the period as long as 2020 years, if the owner has kept his cr edit in adequate standing, that happens lately. In case decision to buy a first home is made or s till in investigating ATMIYA INSTITUTE OF TECHNOLOGY & SCIENCE ( MBA DEPARTMENT ) Page 38

CREDIT RISK phase, local or state community should be checked for programmes available for t he first time buyers of home. Factors affecting borrowing of Home Loans 1. The principle amount in a loan is the first factor to be kept in mind while b orrowing the loan. In case due to negligence on avoid this factor he/she may become liable to pay higher interest because of high principal amount he had borrowed. 2. Secondly interest factor. Higher interest loans should be avoided. Hence care ful selection should be done. 3. Thirdly, according to ones comfort and source of payment, one should select t he loan with low amount of down payments. 4. The lender should be a reputed and faithful one before mortgaging any securit y with the lender one should confirm their reliability. 5. The amount of loan to be taken should be assessed and accordingly one should select a lender who provides the cheapest interest loan. 6. The instruction and terms of the loan should be read with extra attention so as to minimise the risk of paying hidden charges which may not be highlighted. 7. Lastly on should try to borrow loans of short duration as repayments of such loans do not cost high interest rates. Hence, cess interest to pay. Hence we conclude that a thorough market research has to be done to select the l oan to be borrowed. The utmost important factor to be kept in mind is the rate of interest . The other factor like terms and conditions of the loan and the duration of repayment should also be taken care of. The collateral security to be mortgaged is another feature of secured loans to b e thought of . Hence a careful study has to made regarding amount required, repayment ability o f the customer and security available to borrow a loan. ATMIYA INSTITUTE OF TECHNOLOGY & SCIENCE ( MBA DEPARTMENT ) Page 39

CREDIT RISK BUSINESS LOAN With lesser and lesser jobs available, people are trying to start their own busi ness to earn a living. Running your own business has its own ups and downs. In business profess ion an individual being the sole owner of the business has to control it himself and ta ke all decisions independently unlike any job where work is performed as per the guidelines given as per the authority. But starting of a business and running it successfully involves many complicated procedures. In fact it is a risk taking venture. Even the smallest of a wrong de cision taken ,may lead to heavy losses and for this purpose small business loans have been introdu ced to enable the owner of business to obtain the required funds whenever they are in need of mone y which proves to be a valuable source. To start a business a person requires huge funds which may be obtained through v arious sources. Running of a business smoothly requires huge percentage of liquidity. Types of Business Loans Various types of business loans are provided these days by the lending instituti ons which may be in the form of secured business loans which requires something as collateral sec urity or it may be in the form of unsecured business loan which is required for the purpose of carr ying out a petite business task and such loan depends on the financial status of the borrower, apa rt from the unsecured business loans government is also providing financial assistance for c arrying out minute business tasks. Such government loans are provided for the prosperous fut ure of the society. In majority cases such loans provided depends on the financial status o f the individual. The basis for which a business may require a loan may vary. Some of the most com mon business loans available to business owners are: Acquirement ATMIYA INSTITUTE OF TECHNOLOGY & SCIENCE ( MBA DEPARTMENT ) Page 40

CREDIT RISK Financial credit receivable loans Commercial asset loans Tools hire Authorization loans Stock loans Worldwide business loans Operational wealth loans which the companies property into working capital Storehouse financing ATMIYA INSTITUTE OF TECHNOLOGY & SCIENCE ( MBA DEPARTMENT ) Page 41

CREDIT RISK EDUCATION LOAN EVER increasing demand for education loan can be analyzed from the fact that the expenses of Higher education have become unbearable and which has now become a necessity. Du e to this many institutions have come forward with a view to provide financial help to stu dents .These institutions provide better opportunities to students to avail the required fina nces .These finances enable the students to compete their education without any hindrance. Students e ven ensure a lucrative future for themselves as many companies are coming up these days which demand qualified students and offer them high positions and handsome salaries and other benefits. Education loans cover a wide variety of expenses. It not only helps in meeting t he tuition fees but also the others benefits like hostel fee, expenses of books and all other expens es related to education. Education Loans Enquiry Form Education loans can be classified into two types known as scheduled loans and un scheduled loans. Education loans imposes no mental stress on borrower, as the borrower can repay it whenever he becomes self reliant to pay back the amount. The student can repay t he loan after getting a fixed source of employment. The only disadvantage is that the rate of interest is much higher as compared to others but it has many advantages like the loan can be obtained easily as it involves no security and more over it can be obtained in minimum time period. Education loans fulfill the requirements of an individual whenever required. Student takes up the responsibility of repaying th e loan which also reduces the financial stress of the parents. The other source of finances can be borrowing the required funds from the borrow er. However if the borrower prefers borrowing from the borrower instead of education loans then he can be duped by the borrower. Borrower might acquire education loans at competitive rat e of interest and at longer and on long credit terms. However if you are a prospective borrowe r, then you can bargain the interest rate in comparison with less educated credit borrower. ATMIYA INSTITUTE OF TECHNOLOGY & SCIENCE ( MBA DEPARTMENT ) Page 42

CREDIT RISK Types of Education Loans: Education loans are classified into two categories: Secured Education Loans Unsecured Education Loans Assets are kept as collateral in secured education loan and the funds are availa ble for long period and more over the rate of interest is lower .The reason behind this advantage is that the lender is free from any kind of risks. Another advantage is that by personal conversation with the buyer s rate of interest can be reduced. However under unsecured loan no asset has to be kept as collateral security. The rate of interest is much higher as compared to secured since no collateral is demanded in this ca se. The rate of interest is not always higher as they can be obtained from lenders in competitiv e market. Education loan is considered must today for a student to complete his higher edu cation. These days there are many sources available for a student to obtain the loan. They hav e much opportunity available to themselves to acquire the loan. To achieve a prospectiv e future there are two main sources from where education loans can be acquired to obtain the financ ial assistance which will enable to furnish a beautiful future for yourself. The two main sources are discussed bellow: Government Lenders Private Lenders Since loans of subsidized nature are provided by the government, so students gen erally prefer to finance from government lenders. Subsidized funds are managed and controlled by the concerned government and the ministry of finance in rest of the countries and th ey are available at cheaper rates. However, private lenders charge rate of interest based on education loans. There is a Federalized program of education prevailing under this which is very useful as it offers rea sonable and flexible opportunities related to educational loans. Students are charged very l ow rate of interest under this program which also offers the opportunity of repaying the amount in t he long run. ATMIYA INSTITUTE OF TECHNOLOGY & SCIENCE ( MBA DEPARTMENT ) Page 43

CREDIT RISK BACKGROUND OF RISK The etymology of the word Risk can betraced to the Latin word Rescum meaning Risk at

Sea or that which cuts. Risk is associated with uncertainty and reflected by way of charge on the fundamental/ basic i.e. in the case of business it is the Capital, which is the cushion that protects the liability holders of an institution. These risks are inter-dependent and eve nts affecting one area of risk can have ramifications and penetrations for a range of other catego ries of risks. Foremost thing is to understand the risks run by the bank and to ensure that the risks are properly confronted effectively controlled and rightly managed. Each transaction that the bank undertakes changes the risk profile of the bank. The extent of calculations that need to be performed to understand the impact of each such risk on the transactions of the bank makes it nearly impossible to con tinuously update the risk calculations. Hence, providing real time risk information is one of the key challenges of risk management exercise. Till recently all the activities of banks were regulat ed and hence operational environment was not conducive risk taking. Better insight, sharp int uition and longer experience were adequate to manage the limited risks. Business is the art of extracting money from other s pocket, sans resorting to violence. But profiting in business without exposing to risk is like trying to l ive without being born. Every one knows that risk taking is failure prone as otherwise it would be treated as sure taking. Hence risk is inherent in any walk of life in general and in financial s ectors in particular. Of late, banks have grown from being a financial intermediary into a risk interm ediary at present. In the process of financial intermediation, the gap of which becomes thinner and thinner, banks are exposed to severe competition and hence are compelled to encounter various t ypes of financial and non-financial risks. Risks and uncertainties form an integral part of banking which by nature entails taking risks. Business grows mainly by taking risk. Greater the risk, higher the profit and hence the business unit must strike a trade off between the two. The essential f unctions of risk management are to identify measure and more importantly monitor the profile of t he bank. While ATMIYA INSTITUTE OF TECHNOLOGY & SCIENCE ( MBA DEPARTMENT ) Page 44

CREDIT RISK Non-Performing Assets are the legacy of the past in the present, Risk Management system is the pro-active action in the present for the future. Managing risk is nothing but ma naging the change before the risk manages. While new avenues for the bank has opened up they have brought with them new risks as well, which the banks will have to handle and overcome. ATMIYA INSTITUTE OF TECHNOLOGY & SCIENCE ( MBA DEPARTMENT ) Page 45

CREDIT RISK INTRODUCTION TO RISK AND RISK MANAGEMENT Risk Risks are usually defined by the adverse impact on profitability of several dist inct sources of uncertainty. While the types and degree of risks an organization may be exposed to depend upo n a number of factors such as its size, complexity business activities, volume etc, it is beli eved that generally the banks face Credit, Market, Liquidity, Operational, Compliance / legal / regu latory and reputation risks. Before overarching these risk categories, given below are some basics about risk Management and some guiding principles to manage risks in banking organization. Risk Management Risk Management is a discipline at the core of every financial institution and e ncompasses all the activities that affect its risk profile. It involves identification, measurement , monitoring and controlling risks to ensure that The individuals who take or manage risks clearly understand it. The organization s Risk exposure is within the limits established by Board of Dire ctors. Risk taking Decisions are in line with the business strategy and objectives set by BOD. The expected payoffs compensate for the risks taken Risk taking decisions are explicit and clear. Sufficient capital as a buffer is available to take risk The acceptance and management of financial risk is inherent to the business of banking and banks roles as financial intermediaries. Risk management as commonly perceived does not mean minimizing risk; rather the goal of risk management is to optimize risk-reward trade -off. Notwithstanding the fact that ATMIYA INSTITUTE OF TECHNOLOGY & SCIENCE ( MBA DEPARTMENT ) Page 46

CREDIT RISK banks are in the business of taking risk, it should institution need not engage in business in a manner risk upon it: nor it should absorb risk that can be pants. Rather it should accept those risks that are uniquely part of array of bank s services. be recognized that an that unnecessarily imposes transferred to other partici the

In every financial institution, risk management activities broadly take place si multaneously at following different hierarchy levels. Strategic level: It encompasses risk management functions performed by senior management and BOD. For instance definition of risks, ascertaining institutions risk appetite, formulating strategy and policies for managing risks and establish ade quate systems and controls to ensure that overall risk remain within acceptable level and the reward compensate for the risk taken. Macro Level: It encompasses risk management within a business area or across bus iness lines. Generally the risk management activities performed by middle management o r units devoted to risk reviews fall into this category. Micro Level: It involves On-the-line risk management where risks areactually creat ed. This is the risk management activities performed by individuals who take risk on organization s behalf such as front office and loan origination functions. ATMIYA INSTITUTE OF TECHNOLOGY & SCIENCE ( MBA DEPARTMENT ) Page 47

CREDIT RISK Key Risk Drivers: Credit Credit Risk Includes Concentration Risk Issuer limits Book value vs. market value Rating A/BBB is majority of credit portfolio Little exposure to AA/AAA corporate bonds Some exposure to High Yield Yield / Spread Typically buy and hold investors Trade to manage cash flow, spread and capital gains / losses Lehman Brothers 2005 Survey The results of the survey provided the following observations : Rating (96%), maturity (56%), and asset types (48%) are the factors considered b y most insurers in determining product pricing default charges for bonds Asset type (56%), rating (52%), and subordination (44%) are the factors consider ed by the most insurers in estimating recovery rates for bonds Most companies do not explicitly distinguish privates from publics when assuming default charges 60% of companies do not account for the cost of holding additional capital on downgraded bonds ATMIYA INSTITUTE OF TECHNOLOGY & SCIENCE ( MBA DEPARTMENT ) Page 48

CREDIT RISK For commercial mortgage loan investments, insurers rely on their own experience most when assessing default rates and recovery rates. Risk management framework The risk management framework and sophistication of the process, and internalcon trols, used to manage risks, depends on the nature, size and complexity of institutions activit ies. Nevertheless, there are some basic principles that apply to all financial institutions irrespe ctive of their size and complexity of business and are reflective of the strength of an individual bank' s risk management practices. A risk management framework encompasses the scope of risks to be managed, the process/systems and procedures to manage risk and the roles and responsibilities of individuals involved in risk management. The framework should be comprehensive enough to cap ture all risks a bank is exposed to and have flexibility to accommodate any change in bus iness activities. An effective risk management framework includes: a) Clearly defined risk management policies and procedures covering risk identif ication, acceptance, measurement, monitoring, reporting and control. b) A well constituted organizational structure defining clearly roles and respon sibilities of individuals involved in risk taking as well as managing it. Banks, in addition t o risk management functions for various risk categories may institute a setup that supervises over all risk management at the bank. c) There should be an effective management information system that ensures flow of information from operational level to top management and a system to address any exceptions observed. There should be an explicit procedure regarding measures to be taken to address such deviations. ATMIYA INSTITUTE OF TECHNOLOGY & SCIENCE ( MBA DEPARTMENT ) Page 49

CREDIT RISK d) The framework should have a mechanism to ensure an ongoing review of systems, policies and procedures for risk management and procedure to adopt changes. Risk evaluation/measurement Until and unless risks are not assessed and measured it will not be possible to control risks. Further a true assessment of risk gives management a clear view of institution s s tanding and helps in deciding future action plan. To adequately capture institutions risk ex posure, risk measurement should represent aggregate exposure of institution both risk type an d business line and encompass short run as well as long run impact on institution. To the maximum possible extent institutions should establish systems / models th at quantify their risk profile, however, in some risk categories such as operational risk, quantif ication is quite difficult and complex. Wherever it is not possible to quantify risks, qualitativ e measures should be adopted to capture those risks. Whilst quantitative measurement systems suppo rt effective decision-making, better measurement does not obviate the need for well-informed, qualitative judgment. Consequently the importance of staff having relevant knowledge and exp ertise cannot be undermined. Independent review One of the most important aspects in risk management philosophy is to make sure that those who take or accept risk on behalf of the institution are not the ones who measur e, monitor and evaluate the risks. Again the managerial structure and hierarchy of risk review function may vary across banks depending upon their size and nature of the business, the key is in dependence. To be effective the review functions should have sufficient authority, expertise an d corporate stature so that the identification and reporting of their findings could be accomplished without any hindrance. The findings of their reviews should be reported to business units, S enior Management and, where appropriate, the Board. ATMIYA INSTITUTE OF TECHNOLOGY & SCIENCE ( MBA DEPARTMENT ) Page 50

CREDIT RISK Contingency planning Institutions should have a mechanism to identify stress situations ahead of time and plans to deal with such unusual situations in a timely and effective manner. Stress situations to which this principle applies include all risks of all types. For instance contingency plann ing activities include disaster recovery planning, public relations damage control, litigation strategy, responding to regulatory criticism etc. Contingency plans should be reviewed reg ularly to ensure they encompass reasonably probable events that could impact the organization. Pl ans should be tested as to the appropriateness of responses, escalation and communication chan nels and the impact on other parts of the institution. ATMIYA INSTITUTE OF TECHNOLOGY & SCIENCE ( MBA DEPARTMENT ) Page 51

CREDIT RISK CREDIT RISK Credit risk with respect to bank is most simply defined as the risk of a borrowe r s payment default on payment of interest and principal due to the borrower s unwillingness o r inability to service the debt. The higher the credit risk an institution is exposed to, the g reater the losses may be. For banks and most other credit institutions, credit risk is considered to b e the form of risk that can most significantly diminish earnings and financial strength. The effect ive management of credit risk is a critical component of a comprehensive approach to risk manag ement and essential to the long-term success of any banking organization. Banks should als o consider the relationships between credit risk and other risks. Sources of credit risk The credit risk as the figure given below indicates can be divided into three ca tegories. Types of Credit Risk Default Risk Probability of Default Exposure Risk Recovery Risk Exposure at Default Loss Given Default ATMIYA INSTITUTE OF TECHNOLOGY & SCIENCE ( MBA DEPARTMENT ) Page 52

CREDIT RISK Default Risk The default risk is measured by the probability of default occurring during give n period of time. Default risk depends upon credit standing of the borrower. Such credit standing would depend upon factors such as market outlook of borrowing company, quality of management, strengths and weaknesses of the company and certain competitive factors. The measures avai lable are either ratings or historical statistics on default which can be used as proxy fo r default risk. Exposure risk Exposure risk arises due to uncertainty associated with future amount of risk. I t is the amount of risk in the event of default without considering the recoveries. Amortized credit is repaid on the basis of a contractual schedule so that future outstanding balances are known in advance except in case of prepayment for which an option i s provided to the borrower. For all these credit lines for which there is a repayment schedule the exposure risk can be considered as small or negligible as the exposure to such loans can be in cluded at the time of loan pricing. Project financing implies uncertainty in scheduling of the outflows and repaymen ts. In general all the off balance sheet items can generate substantial future exposure. In som e cases such exposure is high e.g. bank s commitment to lend money up to some maximum amount su bject to needs of borrower. However in some cases future exposure is small e.g. guarantee given to third parties. Here the exposure is contingent upon the failure of the borrower to com ply with his obligation. Recovery risk The recoveries in the event of default are not predictable. They depend upon the type of default and numerous other factors such as whether guarantees have been received from th e borrowers, the type of such guarantees and strength of the collateral, covenants, third par ty guarantee and circumstances surrounding default. ATMIYA INSTITUTE OF TECHNOLOGY & SCIENCE ( MBA DEPARTMENT ) Page 53

CREDIT RISK IMPORTANCE OF CREDIT RISK ASSESSMENT Effective credit risk assessment and loan accounting practices should be perform ed in a systematic way and in accordance with established policies and procedures. To be able to prudently value loans and to determine appropriate loan provisions, it is partic ularly important that banks have a system in place to reliably classify loans on the basis of cre dit risk. Larger loans should be classified on the basis of a credit risk grading system. Other, smaller loans may be classified on the basis of either a credit risk grading system or payment del inquency status. Both accounting frameworks and Basel II recognize loan classification systems as tools in accurately assessing the full range of credit risk. Further, Basel II and accoun ting frameworks both recognize that all credit classifications, not only that reflecting severe credit deterioration, should be considered in assessing probability of default and loan impairment. A well-structured loan grading system is an important tool in differentiating th e degree of credit risk in the various credit exposures of a bank. This allows a more accurate dete rmination of the overall characteristics of the loan portfolio, probability of default and ultima tely the adequacy of provisions for loan losses. In describing a loan grading system, a bank should a ddress the definitions of each loan grade and the delineation of responsibilities for the d esign, implementation, operation and performance of a loan grading system. Credit risk grading processes typically take into account a borrower s current fin ancial condition and paying capacity, the current value and reliability of collateral and other b orrower and facility specific characteristics that affect the prospects for collection of principal a nd interest. Because these characteristics are not used solely for one purpose (e.g. credit risk or f inancial reporting), a bank may assign a single credit risk grade to a loan regardless of the purpose f or which the grading is used. Both Basel II and accounting frameworks recognize the use of in ternal (or external) credit risk grading processes in determining groups of loans that woul d be collectively assessed for loan loss measurement. Thus, a bank may make a single determination of groups of loans for collective assessment under both Basel II and the applicable accountin g framework. ATMIYA INSTITUTE OF TECHNOLOGY & SCIENCE ( MBA DEPARTMENT ) Page 54

CREDIT RISK Credit Rating is the main tool to assess credit risk, which helps in measuring t he credit risk and facilitates the pricing of the account. It gives the vital indications of weaknesses in the account. It also triggers portfolio management at the corporate level. Therefore , banks should realize the importance of developing and implementing effective internal credit risk management. It involves evaluating and assessing an institution s risk management, capital adequacy, and asset quality. Risk ratings should be reviewed and updated wheneve r relevant new information is received. All credits should receive a periodic formal review (e. g. at least annually) to reasonably assure that credit risk grades are accurate and up-to-da te. Credit risk grades for individually assessed loans that are either large, complex, higher ri sk or problem credits should be reviewed more frequently. To ensure the proper administration of their various credit risk-bearing portfol io the banks must have the following: A system for monitoring the condition of individual credits, and determining the adequacy of provisions and reserves, An internal risk rating system in managing credit risk. The rating system should be consistent with the nature, size and complexity of a bank s activities, Information systems and analytical techniques that enable the management to meas ure the credit risk inherent in all on-and off-balance sheet activities. The management information system should provide adequate information on the composition of the credit portfolio, including identification of any concentrations of risk, A system for monitoring the overall composition and quality of credit portfolio. Internal credit risk ratings are used by banks to identify gradations in credit risk among their business loans. For larger institutions, the number and geographic dispersion of their borrowers ATMIYA INSTITUTE OF TECHNOLOGY & SCIENCE ( MBA DEPARTMENT ) Page 55

CREDIT RISK makes it increasingly difficult to manage their loan portfolio simply by remaini ng closely attuned to the performance of each borrower. To control credit risk, it is important to identify its gradations among busines s loans, and assign internal credit risk ratings to loans that correspond to these gradations. The u se of such an internal rating process is appropriate and indeed necessary for sound risk manag ement at large institutions. The long-term goal of this analysis is to encourage broader adopti on of sound practices in the use of such ratings and to promote further innovation and enhan cement by the industry in this area. Internal rating systems are primarily used to determine approval requirements an d identify problem loans, while on the other end they are an integral element of credit por tfolio monitoring and management, capital allocation, pricing of credit, profitability analysis, a nd detailed analysis to support loan loss reserving. Internal rating systems being used for the forme r purposes. As with all material bank activities, as sound risk management process should adequ ately illuminate the risks being taken and apply appropriate control allow the institution to bal ance risks against returns and the institution s overall appetite for risk, giving due consideration to the uncertainties faced by lenders and the long-term viability of the bank. Based on the historical data which is both financial and non-financial a score i s arrived at. The borrower is then classified into different classes of credit rating based on the score which is used to determine the rate of interest to be charged. Banking organizations should have strong risk rating systems. These systems shou ld take proper account of the gradations in risk and overall composition of portfolios in originating new loans, assessing overall portfolio risks and concentrations, and reporting on risk profiles to directors and management. Moreover, such rating systems also should play an important role in establishing an appropriate level for the allowance for loan a nd lease losses, conducting internal bank analysis of loan and relationship profitability. . ATMIYA INSTITUTE OF TECHNOLOGY & SCIENCE ( MBA DEPARTMENT ) Page 56

CREDIT RISK When making credit rating decisions, banks review credit application and credit reports with respect to financial risk. Once lenders make a yes decision, they review the credi t reports of their customers on a regular basis as they continue to manage their financial ri sk. This process scans credit reports for certain risk characteristics as defined by the lender. Banks pool assets and loans, which have a possibility of default and yet provide the depositors with the assurance of the redemption at full face value. Credit risk, in terms o f possibilities of loss to the bank, due to failure of borrowers/counterparties in meeting commitme nt to the depositors. Credit risk is the most significant risk, more so in the Indian scen ario where the NPA level of the banking system is significantly high. The management of credit risk through an efficient credit administration is a prerequisite for long-term sustainability/ profitability of a bank. A proper credit administration reduces the incidence of credit risk. Credit risk depends on both internal and external factors. Some of the important external factors are state of economy, swings in commodity prices, foreign exchange rates and int erest rates etc. The internal factors may be deficiencies in loan policies and administration of loan portfolio covering areas like prudential exposure limits to various categories, appraisal of borrower s financial position, excessive dependence on collaterals, mechanism of review and post-sanction surveillance, etc. The key issue in managing credit risk is to apply a consistent evaluation and ra ting system to all investment opportunities. Prudential limits need to be laid down o n various aspects of credit viz., benchmarking current ratio, debt-equity ratio, profitability rat io, debt service coverage ratio, concentration limits for group/single borrower, maximum exposure limits to industries, provision for flexibilities to allow variation for very special feat ures. Credit rating may be a single point indicator of diverse risk factors. Management of credit in a bank will require alertness on the part of the staff at all the stages of credit delivery and monitoring process. Lack of such standards in financial institution would increase the prob lem of increasing loan write-offs. The bank can ensure this through credit rating and loan documen tation. ATMIYA INSTITUTE OF TECHNOLOGY & SCIENCE ( MBA DEPARTMENT ) Page 57

CREDIT RISK MANAGING CREDIT RISK Credit risk arises from the potential that an obligor is either unwilling to per form on an obligation or its ability to perform such obligation is impaired resulting in ec onomic loss to the bank. In a bank s portfolio, losses stem from outright default due to inability or unwil lingness of a customer or counter party to meet commitments in relation to lending, trading, s ettlement and other financial transactions. Alternatively losses may result from reduction in portfolio value due to actual or perceived deterioration in credit quality. Credit risk emanates from a bank s dealing with individuals, corporate, financial institutions or a sovereign. For most banks, loans are the largest and most obvious source of cred it risk; however, credit risk could stem from activities both on and off balance sheet. In addition to direct accounting loss, credit risk should be viewed in the conte xt of economic exposures. This encompasses opportunity costs, transaction costs and expenses as sociated with a non-performing asset over and above the accounting loss. Credit risk can be further sub-categorized on the basis of reasons of default. F or instance the default could be due to country in which there is exposure or problems in settle ment of a transaction. Credit risk not necessarily occurs in isolation. The same source that endangers credit risk for the institution may also expose it to other risk. For instance a bad portfolio may a ttract liquidity problem ATMIYA INSTITUTE OF TECHNOLOGY & SCIENCE ( MBA DEPARTMENT ) Page 58

CREDIT RISK Securitisation of Credit Exposures: Important Tool of Credit Risk Management under Basel Accord II Securitisation, as a new Credit Risk Management Product, is the buzzword of the financial services industry today. As a matter of fact, following the age-old system of credit risk management may not always suit the regime of liberalisation, privati sation and globalisation in world economies. It is, therefore, required that banks/cred it institutions should constantly devise newer forms of credit risk management by articulated re search. Several key initiatives taken in this regard finally gave birth to securitization of cre dit exposures by banks/credit institutions under Basel Accord II Risk Management in June 2004. What is Securitisation? Securitisation (of credit exposures of Banks and Credit Institutions) involves a transfer of outstanding balances in Loans/Advances and packaging into transferable and trada ble securities. This enables them to reduce their exposures to particular sectors e.g. Real Esta te as may be considered necessary from their business development angle and, simultaneously t o ensure cash inflows to deal with liquidity crunch and/or for other business reasons. Securitisation is a financing tool. It involves creating, combining and recombini ng of assets and securities. Basel Accord II has considered securitisation aspects in a broader pe rspective as: A Traditional Securitisation is a structure where the cash flow from an underlying pool of exposures is used to service at least two different stratified risk positions or trenches reflecting different degrees of credit risk. Payments to the investors depend upon the perf ormance of the specified underlying exposures, as opposed to being derived from an obligation o f the entity originating those exposures . ATMIYA INSTITUTE OF TECHNOLOGY & SCIENCE ( MBA DEPARTMENT ) Page 59

CREDIT RISK The Accord has also identified another variant of securitisation as Synthetic Sec uritisation, which is akin to a Credit Derivative. In this regard it has been laid down that: A synthetic securitisation is a structure with at least two different stratified risk positi ons to reflect different degrees of credit risk where credit risk of an underlying pool of exposures is t ransferred, in whole or in part, through the use of funded (e.g. credit linked notes) or unfund ed (e.g. credit default swaps) credit derivatives. Components of credit risk management A typical Credit risk management framework in a financial institution may be bro adly categorized into following main components. Board and senior Management s Oversight Organizational structure Systems and procedures for identification, acceptance, measurement, monitoring and control risks. Board and Senior Management s Oversight It is the overall responsibility of bank s Board to approve bank s credit risk strat egy and significant policies relating to credit risk and its management which should be based on the bank s overall business strategy. To keep it current, the overall strategy has to be reviewed by the board, preferably annually. The responsibilities of the Board with regard to cre dit risk management shall, interalia, include: Delineate bank s overall risk tolerance in relation to credit risk. . ATMIYA INSTITUTE OF TECHNOLOGY & SCIENCE ( MBA DEPARTMENT ) Page 60

CREDIT RISK Ensure that bank s overall credit risk exposure is maintained at prudent levels an d consistent with the available capital. Ensure that top management as well as individuals responsible for credit risk management possess sound expertise and knowledge to accomplis the risk managemen t function. Ensure that the bank implements sound fundamental principles tha facilitate the identification, measurement, monitoring and control of credit risk. Ensure that appropriate plans and procedures for credit risk management are in p lace. The very first purpose of bank s credit strategy is to determine the risk appetite of the bank. Once it is determined the bank could develop a plan to optimize return while kee ping credit risk within predetermined limits. The bank s credit risk strategy thus should spell out , The institution s plan to grant credit based on various client segments and products, economic sectors, geographical location, currency and maturity Target market within each lending segment, preferred level of diversification/concentration. Pricing strategy. It is essential that banks give due consideration to their target market while devising credit risk strategy . The strategy should provide continuity in approach and take into account cyclic aspect of country s economy and the resulting shifts in composition and quality of overall c redit portfolio. While the strategy would be reviewed periodically and amended, as deemed necessa ry, it should be viable in long term and through various economic cycles. ATMIYA INSTITUTE OF TECHNOLOGY & SCIENCE ( MBA DEPARTMENT ) Page 61

CREDIT RISK The senior management of the bank should develop and establish credit policies a nd credit administration procedures as a part of overall credit risk management framework and get those approved from board. Such policies and procedures shall provide guidance to the staff on various types of lending including corporate, SME, consumer, agriculture, etc. At minimu m the policy should include Detailed and formalized credit evaluation/ appraisal process. Credit approval authority at various hierarchy levels including authority for ap proving exceptions. Risk identification, measurement, monitoring and control Risk acceptance criteria Credit origination and credit administration and loan documentation procedures Roles and responsibilities of units/staff involved in origination and management of credit. Guidelines on management of problem loans. ATMIYA INSTITUTE OF TECHNOLOGY & SCIENCE ( MBA DEPARTMENT ) Page 62

CREDIT RISK Organizational Structure To maintain bank s overall credit risk exposure within the parameters set by the b oard of directors, the importance of a sound risk management structure is second to none . While the banks may choose different structures, it is important that such structure shoul d be commensurate with institution s size, complexity and diversification of its activi ties. It must facilitate effective management oversight and proper execution of credit risk ma nagement and control processes. Each bank, depending upon its size, should constitute a Credit Risk Management C ommittee (CRMC), ideally comprising of head of credit risk management Department, credit department and treasury. This committee reporting to bank s risk management committee should be empowered to oversee credit risk taking activities and overall credit risk manag ement function. The CRMC should be mainly responsible for The implementation of the credit risk policy / strategy approved by the Board. Monitor credit risk on a bank-wide basis and ensure compliance with limits appro ved by the Board. Recommend to the Board, for its approval, clear policies on standards for presen tation of credit proposals, financial covenants, rating standards and benchmarks. Decide delegation of credit approving powers, prudential limits on large credit exposures, standards for loan collateral, portfolio management, loan review mech anism, risk concentrations, risk monitoring and evaluation, pricing of loans, provision ing, regulatory/legal compliance etc. Further, to maintain credit discipline and to enunciate credit risk management a nd control process there should be a separate function independent of loan origination func tion. Credit ATMIYA INSTITUTE OF TECHNOLOGY & SCIENCE ( MBA DEPARTMENT ) Page 63

CREDIT RISK policy formulation, credit limit setting, monitoring of credit exceptions / expo sures and review /monitoring of documentation are functions that should be performed independentl y of the loan origination function. For small banks where it might not be feasible to establis h such structural hierarchy, there should be adequate compensating measures to maintain credit dis cipline introduce adequate checks and balances and standards to address potential confli cts of interest. Ideally, the banks should institute a Credit Risk Management Department (CRMD). Typical functions of CRMD include: To follow a holistic approach in management of risks inherent in banks portfolio and ensure the risks remain within the boundaries established by the Board or Credit Risk Management Committee. The department also ensures that business lines comply with risk parameters and prudential limits established by the Board or CRMC. Establish systems and procedures relating to risk identification, Management Information System, monitoring of loan / investment portfolio quality and early warning. The department would work out remedial measure when deficiencies/proble ms are identified. The Department should undertake portfolio evaluations and conduct comprehensive studies on the environment to test the resilience of the loan portfolio. Notwithstanding the need for a separate or independent oversight, the front offi ce or loan origination function should be cognizant of credit risk, and maintain high level of credit discipline and standards in pursuit of business opportunities. ATMIYA INSTITUTE OF TECHNOLOGY & SCIENCE ( MBA DEPARTMENT ) Page 64

CREDIT RISK Systems and procedures Credit Origination. Banks must operate within a sound and well-defined criteria for new credits as w ell as the expansion of existing credits. Credits should be extended within the target mark ets and lending strategy of the institution. Before allowing a credit facility, the bank must ma ke an assessment of risk profile of the Customer/transaction. This may include Credit assessment of the borrower s industry, and macro economic factors. The purpose of credit and source of repayment. The track record / repayment history of borrower. Assess/evaluate the repayment capacity of the borrower. The Proposed terms and conditions and covenants. Adequacy and enforceability of collaterals. Approval from appropriate authority While structuring credit facilities institutions should appraise the amount and timing of the cash flows as well as the financial position of the borrower and intended purpose of the funds. It is utmost important that due consideration should be given to the risk reward trade off in granting a credit facility and credit should be priced to cover all embedded costs. Relev ant terms and conditions should be laid down to protect the institution s interest. ATMIYA INSTITUTE OF TECHNOLOGY & SCIENCE ( MBA DEPARTMENT ) Page 65

CREDIT RISK Institutions have to make sure that the credit is used for the purpose it was bo rrowed. Where the obligor has utilized funds for purposes not shown in the original proposal, inst itutions should take steps to determine the implications on creditworthiness. In case of corpora te loans where borrower own group of companies such diligence becomes more important. Instituti ons should classify such connected companies and conduct credit assessment on consolidated/ group basis. Institution should not over rely on collaterals / covenant. Although the importa nce of collaterals held against loan is beyond any doubt, yet these should be considered as a buffe r providing protection in case of default, primary focus should be on obligor s debt servicing ability and reputation in the market. Limit setting An important element of credit risk management is to establish exposure limits f or single obligors and group of connected obligors. Institutions are expected to develop t heir own limit structure while remaining within the exposure limits set by State Bank of Pakist an. The size of the limits should be based on the credit strength of the obligor, genuine requir ement of credit, economic conditions and the institution s risk tolerance. Appropriate limits shoul d be set for respective products and activities. Institutions may establish limits for a spec ific industry, economic sector or geographic regions to avoid concentration risk. Some times, the obligor may want to share its facility limits with its related c ompanies. Institutions should review such arrangements and impose necessary limits if the transactions are frequent and significant Credit limits should be reviewed regularly at least annually or more frequently if obligor s credit quality deteriorates. All requests of increase in credit limits should be substa ntiated. ATMIYA INSTITUTE OF TECHNOLOGY & SCIENCE ( MBA DEPARTMENT ) Page 66

CREDIT RISK Credit Administration. Ongoing administration of the credit portfolio is an essential part of the credi t process. Credit administration function is basically a back office activity that support and con trol extension and maintenance of credit. A typical credit administration unit performs following f unctions: Documentation. It is the responsibility of credit administration to ensure compl eteness of documentation (loan agreements, guarantees, transfer of title of collaterals etc) in accordance with approved terms and conditions. Outstanding documents should be tracked and followed up to ensure execution and receipt. Credit Disbursement. The credit administration function should ensure that the loan application has proper approval before entering facility limits into computer systems. Disbursement should be effected only after completion of covenants, and receipt of collateral holdings. In case of exceptions necessary approval should be obtained from competent authorities. Credit monitoring. After the loan is approved and draw down allowed, the loan should be continuously watched over. These include keeping track of borrowers compliance with credit terms, identifying early signs of irregularity, conducting periodic valuation of collateral and monitoring timely repayments. ATMIYA INSTITUTE OF TECHNOLOGY & SCIENCE ( MBA DEPARTMENT ) Page 67

CREDIT RISK Loan Repayment. The obligors should be communicated ahead of time as and when th e principal/markup installment becomes due. Any exceptions such as non-payment or late payment should be tagged and communicated to the management. Proper records and updates should also be made after receipt. Maintenance of Credit Files. Institutions should devise procedural guidelines an d standards for maintenance of credit files. The credit files not only include all correspondence with the borrower but should also contain sufficient information necessary to assess financial health of the borrower and its repayment performan ce. It need not mention that information should Managing credit risk. Collateral and Security Documents. Institutions should ensure that all security documents are kept in a fireproof safe under dual control. Registers for documen ts should be maintained to keep track of their movement. Procedures should also be established to track and review relevant insurance coverage for certain facilities/collateral. Physical checks on security documents should be conducted on a regular basis. Measuring credit risk The measurement of credit risk is of vital importance in credit risk management. A number of qualitative and quantitative techniques to measure risk inherent in credit portf olio are evolving. To start with, banks should establish a credit risk rating framework across all type of credit activities. Among other things, the rating framework may, incorporate: Business Risk o Industry Characteristics o Competitive Position (e.g. marketing/technological edge) o Management ATMIYA INSTITUTE OF TECHNOLOGY & SCIENCE ( MBA DEPARTMENT ) Page 68

CREDIT RISK Financial Risk o Financial condition o Profitability o Capital Structure o Present and future Cash flows Internal risk rating. Credit risk rating is summary indicator of a bank s individual credit exposure. An internal rating system categorizes all credits into various classes on the basis of underlying c redit quality. A well-structured credit rating framework is an important tool for monitoring and controlling risk inherent in individual credits as well as in credit portfolios of a bank or a bu siness line. The importance of internal credit rating framework becomes more eminent due to the f act that historically major losses to banks stemmed from default in loan portfolios. Whil e a number of banks already have a system for rating individual credits in addition to the ris k categories prescribed by SBP, all banks are encouraged to devise an internal rating framewo rk. An internal rating framework would facilitate banks in a number of ways such as Credit selection Amount of exposure Tenure and price of facility Frequency or intensity of monitoring Analysis of migration of deteriorating credits and more accurate computation of future loan loss provision Deciding the level of Approving authority of loan. Managing credit risk ATMIYA INSTITUTE OF TECHNOLOGY & SCIENCE ( MBA DEPARTMENT ) Page 69

CREDIT RISK The Architecture of internal rating system The decision to deploy any risk rating architecture for credits depends upon two basic aspects a) The Loss Concept and the number and meaning of grades on the rating continuum corresponding to each loss concept. b) Whether to rate a borrower on the basis of point in time philosophy through the cycle approach. or

A rating system with large number of grades on rating scale becomes more expensi ve due to the fact that the cost of obtaining and analyzing additional information for fine gr adation increases sharply. However, it is important that there should be sufficient gradations to permit accurate characterization of the under lying risk profile of a loan or a portfolio of loa ns The operating Design of Rating System . As with the decision to grant credit, the assignment of ratings always involve e lement of human judgment. Even sophisticated rating models do not replicate experience and judgm ent rather these techniques help and reinforce subjective judgment. Banks thus design the o perating flow of the rating process in a way that is aimed promoting the accuracy and consistency of the rating system while not unduly restricting the exercise of judgment. Key issues relatin g to the operating design of a rating system include what exposures to rate; the organization s divis ion of responsibility for grading; the nature of ratings review; the formality of the p rocess and specificity of formal rating definitions. ATMIYA INSTITUTE OF TECHNOLOGY & SCIENCE ( MBA DEPARTMENT ) Page 70

CREDIT RISK What Exposures are rated? Ideally all the credit exposures of the bank should be assigned a risk rating. H owever given the element of cost, it might not be feasible for all banks to follow. The banks may decide on their own which exposure needs to be rated. The decision to rate a particular loan cou ld be based on factors such as exposure amount, business line or both. Generally corporate and commercial exposures are subject to internal ratings and banks use scoring models for consu mer / retail loans. The rating process in relation to credit approval and review. Ratings are generally assigned /reaffirmed at the time of origination of a loan or its renewal /enhancement. The analysis supporting the ratings is inseparable from that requi red for credit appraisal. In addition the rating and loan analysis process while being separate are intertwined. The process of assigning a rating and its approval / confirmation goes along wit h the initiation of a credit proposal and its approval. Generally loan origination function (whether a relationship The credit risk exposure involves both the probability of Default (PD) and loss in the event of default or loss given default (LGD). The former is specific to borrower while th e later corresponds to the facility. The product of PD and LGD is the expected loss. Poi nt in time means to grade a borrower according to its current condition while through the c ycle approach grades a borrower under stress conditions. Manager or credit staff initiates a loan proposal and also allocates a specific rating. This proposal passes through the credit approval process and the rating is also approved or re calibrated simultaneously by approving authority. The revision in the ratings can be used t o upgrade the rating system and related guidelines. ATMIYA INSTITUTE OF TECHNOLOGY & SCIENCE ( MBA DEPARTMENT ) Page 71

CREDIT RISK How to arrive at ratings The assignment of a particular rating to an exposure is basically an abbreviatio n of its overall risk profile. Theoretically ratings are based upon the major risk factors and th eir intensity inherent in the business of the borrower as well as key parameters and their int ensity to those risk factors. Major risk factors include borrowers financial condition, size, industr y and position in the industry; the reliability of financial statements of the borrower; quality o f management; elements of transaction structure such as covenants etc. A more detail on the su bject would be beyond the scope of these guidelines, however a few important aspects are a) Banks may vary somewhat in the particular factors they consider and the weight they give to each factor. b) Since the rater and reviewer of rating should be following the same basic tho ught, to ensure uniformity in the assignment and review of risk grades, the credit policy should explicitly define each risk grade; lay down criteria to be fulfilled while assigning a particular grade, as well as the circumstances under which deviations from criteria can take place. c) The credit policy should also explicitly narrate the roles of different parties involved in the rating process. d) The institution must ensure that adequate training is imparted to staff to ensure uniform ratings e) Assigning a Rating is basically a judgmental exercise and the models, external ratings and written guidelines/benchmarks serve as input. f) Institutions should take adequate measures to test and develop a risk rating system prior to adopting one. Adequate validation testing should be conducted during the design phase as well as over the life of the system to ascertain the applicability of the system to t he institution s portfolio. ATMIYA INSTITUTE OF TECHNOLOGY & SCIENCE ( MBA DEPARTMENT ) Page 72

CREDIT RISK Institutions that use sophisticated statistical models to assign ratings or to c alculate probabilities of default, must ascertain the applicability of these models to their portfolios . Even when such statistical models are found to be satisfactory, institutions should not use the output of such models as the sole criteria for assigning ratings or determining the probabiliti es of default. It would be advisable to consider other relevant inputs as well. Ratings review The rating review can be two-fold: a)Continuous monitoring by those who assigned the rating. The Relationship Manag ers (RMs) generally have a close contact with the borrower and are expected to keep an eye on the financial stability of the borrower. In the event of any deterioration the ratin gs are immediately revised /reviewed b) Secondly the risk review functions of the bank or business lines also conduct periodical review of ratings at the time of risk review of credit portfolio. Risk ratings should be assigned at the inception of lending, and updated at leas t annually. Institutions should, however, review ratings as and when adverse events occur. A separate function independent of loan origination should review Risk ratings. As part of portfolio monitoring, institutions should generate reports on credit exposure by risk grad e. Adequate trend and migration analysis should also be conducted to identify any deterioration in credit quality. Institutions may establish limits for risk grades to highlight concentration in particular rating bands. It is important that the consistency and accuracy of ratings is examined periodi cally by a function such as an independent credit review group For consumer lending, institutions ma y adopt creditscoring models for processing loan applications and monitoring credit quality. I nstitutions should apply the above principles in the management of scoring models. Where the model is relatively new, institutions should continue to subject credit applications to rigorous rev iew until the model has stabilized. ATMIYA INSTITUTE OF TECHNOLOGY & SCIENCE ( MBA DEPARTMENT ) Page 73

CREDIT RISK Credit derivatives Credit derivatives EVERY silver lining has a cloud. The much-hyped market for cr edit derivatives, which allow users to buy or sell credit risk, seems to be thriving. In mid-July the International Swaps and Derivatives Association (ISDA), a trade association, iss ued a new master agreement intended to standardise contracts for credit derivatives as ISDA ha s done in the past for other sorts of derivative. And this month CreditTrade, a new Int ernet-based exchange, started trading, among other products, credit derivatives. Another, Cr editex, is due to do the same later this year. But the market is mostly shrouded in gloom. Having grown at a giddy pace at firs t, dealers at many banks though not those at J.P. Morgan, by far the market leader say that the nu mber of deals has fallen by half at least in the past year. Activity in the past three m onths has been especially sluggish. Why so? Credit derivatives are simple and attractive enough in theory. For examp le, the buyer of a default swap, the most popular sort, pays the seller a fee so that, if a borro wer defaults, the seller takes over the debt at face value. But the protection the swaps provide h as proved full of holes. There is, for a start, the issue of what constitutes a default. Last year , when Russia defaulted on its domestic debts, those who had bought default protection on its foreign debts claimed that a general credit event had occurred, so the swap-sellers should cough up. The sellers, begged to differ. Lawyers were summoned . Then there is market manipulation. Most default swaps are settled physically: th e buyer has to deliver securities or loans if a borrower defaults. He can choose to deliver a n umber of different types, but this incurs the risk that the hedge he has bought does not exactly ma tch his exposure. Specifying more exactly the security that is deliverable helps to reduce that ri sk, but increases another: that the seller can push its price up. If the protection-buyer does not have the securities, he must buy them in the market. The seller can buy (and many have) the securitie s himself (especially if he has sold more swaps than there are underlying securities). ATMIYA INSTITUTE OF TECHNOLOGY & SCIENCE ( MBA DEPARTMENT ) Page 74

CREDIT RISK Business has been further dented this year, argues Sanjeev Gupta, the head of cr edit derivatives at Credit Suisse First Boston, because credit spreads the extra amount that corpor ate bonds yield over government bonds have been high and volatile. Default swaps in essence grant an option on default to the buyer of protection. These options become more valuable the more volatile a market becomes. So the default swaps themselves have become pricier. And, he suggests, many banks the main buyers of credit derivatives may have got rid of many of the exposures they no longer want. Credit derivatives AFTER all the credit disasters that have afflicted internatio nal lenders in recent months, one might have expected some people at least to be looking smug. These farsighted folk had bought insurance against their borrowers defaulting, by dabbling in the growing market for credit derivatives. Much of the insurance covered loans to risky emer ging markets. Sure enough, two of those markets Russia and Indonesia have, in effect, defaulted. B ut unfortunately perspicacity has not been rewarded. Many of the insured have found themselves with less protection than they thought or even with none at all. Lawyers have been called in to try to sort out the mess in several disputed deal s; one banker forecasts a miasma of litigation . Many disputes involve Credit Suisse First Boston , which was the biggest actor in the Russian market. The most popular type of credit derivative is a default swap. In theory, the dea l is simple. The seller of the swap agrees that, should a borrower default, he will take over the debt at face value; in return he collects a fee from his counterparty. The great attraction of this is to allow both sides to take a pure view of a borrower s credit risk (which has usually been bundled to gether, for example in a bond, with interest-rate risk). This has made the swaps appealing to banks that want to buy protection for their loan portfolios, or to take credit risk without having to finance it which has become expensive for many banks lately. Traders wanting to take a punt purely on borrower s creditworthiness have also been keen. Many default swaps were embedded in bonds (so-called credit-linked notes) that p aid a big interest rate so long as, say, Russia did not default. The market has grown rapi dly, especially in ATMIYA INSTITUTE OF TECHNOLOGY & SCIENCE ( MBA DEPARTMENT ) Page 75

CREDIT RISK Asia, where concerns about default have been greatest. According to the British Bankers Association, the volume of outstanding credit-derivative contracts has doubled o ver the past year. Unfortunately, the market has hit a couple of snags. Simple in theory, default s waps are anything but in practice. The market has always been inefficiently priced. The buyer of t he insurance is, after all, also taking a credit risk on the insurer. But the prices charged by t he providers of such guarantees do not reflect their different credit-standings. Recently, however, two new questions have come to the fore: how to define a defa ult, and how to settle the deals. The first question has caused huge headaches for buyers of swaps on sovereign borrowers. Whether Indonesia s restructuring constituted default has bee n a matter of heated debate. Russia s position is even more contentious. It has defaulted on its domestic debts, but, so far, has maintained payments on its foreign ones. Does this constitute w hat the market dubs a credit event i.e., something going badly wrong on the foreign debt too? If so, the swaps written on it would be triggered. Buyers of insurance think just such an ev ent has taken place; sellers, not surprisingly, do not. Swap agreements are horribly vague on the subject. Passing on the risks Banks are making increasing use of a new type of derivative to reduce their expo sure to the oldest of all financial risks OCCASIONALLY infamous increasingly ubiquitous derivatives have transformed finan cial markets. There is now a vast array of swaps options and so on that allow investo rs to avoid at a price the risk that interest rates currencies and asset prices will rise or fall. Until recently however there has been a big gap in this rich selection: a lack of a thriving market in derivatives that give a bank the ability to lay off its credi t risk-the danger that a borrower will simply fail to meet interest payments or repay a debt. Invented about five years ago credit derivatives are a variety of instruments an d ATMIYA INSTITUTE OF TECHNOLOGY & SCIENCE ( MBA DEPARTMENT ) Page 76

CREDIT RISK techniques designed to separate and then transfer the credit risk of underlying instruments such as loans or bonds. Although they are still small beer-mere billions in a trillio n-dollar worlddemand for them has been growing steadily: CIBC Wood Gundy a Canadian investment bank estimates that from almost nothing in 1993 the market in credit derivatives has grown to around $ 40 billionof outstanding transactions half of which have involved the credit r isk of developing countries' debts. Credit risk has bedevilled intermediaries ever since dern banking has been built on the sensible notion that a large group ss risky than holding a single one: although some of the borrowers y do should be more than offset by the interest received from those the first loan was made. Mo of loansheld together is le will go bust the damage the that do not.

Even so some banks have still come a-cropper often because their portfolio of lo ans was too heavily concentrated in a single geographical region or industry; in such cases when times are hard for one borrower the chances are that all of them are suffering leaving the bank exposed to widespread defaults. Examples abound of institutions humbled in recent years by concentrations of credit risk from America's Citibank to Britain s Barclays as well as almost the entire Japanese banking system. Stung by these huge loan losses big banks are keen to manage credit risk more ef ficiently. They have tried both to set interest rates that better reflect borrowers' relative ri skiness and to reduce the degree of concentration in theirportfolios. But until recently there was lit tle scope for them to unload their credit risk directly. For one thing borrowers have resisted the development of a secondary market for bank loans (one exists but it is tiny and deals mainly with troubled loans). Firm s are gener ally unwilling to see their debt sold on. Banks have also been reluctant sellers on the ground tha t dumping a customer's debt would risk losingthem more than just lending business-the chance to underwrite a future share issue say or lucrative advisory work. Protecting the relationship was given a higher priority than offloading some of the credit risk. ATMIYA INSTITUTE OF TECHNOLOGY & SCIENCE ( MBA DEPARTMENT ) Page 77

CREDIT RISK A seal of approval Credit derivatives could change all that. One reason that they are blossoming is that several big firms have begun to make markets in them improving overall liquidity. Another is that regulators have begun to contemplate the implications of their widespread use. In recent mo nths the New York Federal Reserve Bank and the Office of the Comptroller of the Currency two bank regulators have issued supervisory guidelines to their charges explaining credit derivatives and describing how they are being used by some banks for risk management. Not surprisingly the mechanics of some credit derivatives can be complicated. Bu t what they achieve is simple enough. If a bank thinks it is overexposed to a big borrower i t can use a credit swap say to reduce its risk. Basically the bankpays a small regular fee to its c ounterparty on the swap. If the borrower in question defaults then the counterparty compensates the bank for its losses. All this can be done without offending the borrower who need not be told of the transaction. Credit derivatives can be used to limit a bank's exposure to entire industries o r even countries as well as to individual borrowers. As Charles Smithson of CIBC Wood Gundy points o ut an Italian bank is likely to be best placed to make loans to Italian companies. But it may make more sense for say an American bank to hold some of the credit risk associated with the Ita lian bank s loans in order to diversify its own portfolio. A credit swap would allow it to do this without having to buy the Italian loans lock stock and barrel. Nor are banks the only ones interested in the credit-derivatives market. Hedge f unds have also become keen participants because it is a way for them to gain exposure to assets other than equities and bonds. As the chart above shows this has been an attractive proposi tion in recent years: risk-adjusted returns on loans have been greater than those on equities a nd other assets. Moreover by using credit derivatives investors in bonds can punt solely on a fir m's credit standing without having to worry about the effect of changes in interest rates a s well. ATMIYA INSTITUTE OF TECHNOLOGY & SCIENCE ( MBA DEPARTMENT ) Page 78

CREDIT RISK Blythe Masters of JP Morgan an American bank points out that as credit derivativ es become more popular they are causing important changes in credit pricing. At present bo rrowers sometimes raise money at different rates in different markets: each rate reflect s in effect a different price for the borrower's credit. Credit derivatives create an opportun ity to arbitrage these inefficiencies away. Given all these benefits why have credit derivatives been relatively slow to tak e off? One reason is that shortly after their invention the reputation of all derivatives was batt ered by disputes involving their use at American firms such as Gibson Greetings and Procter & Gam ble. It has taken time to convince banks and other potential users that credit derivatives a re benign. ATMIYA INSTITUTE OF TECHNOLOGY & SCIENCE ( MBA DEPARTMENT ) Page 79

CREDIT RISK CREDIT RISK MONITORING & CONTROL Credit risk monitoring refers to incessant monitoring of individual credits incl usive of OffBalance sheet exposures to obligors as well as overall credit portfolio of the b ank. Banks need to enunciate a system that enables them to monitor quality of the credit portfolio on day-to-day basis and take remedial measures as and when any deterioration occurs. Such a sy stem would enable a bank to ascertain whether loans are being serviced as per facility term s, the adequacy of provisions, the overall risk profile is within limits established by management and compliance of regulatory limits. Establishing an efficient and effective credit monitoring system would help seni or management to monitor the overall quality of the total credit portfolio and its trends. Con sequently the management could fine tune or reassess its credit strategy /policy accordingly b efore encountering any major setback. The banks credit policy should explicitly provid e procedural guideline relating to credit risk monitoring. At the minimum it should lay down procedure relating to a) The roles and responsibilities of individuals responsible for credit risk monitoring b) The assessment procedures and analysis techniques (for individual loans & overall portfolio) c) The frequency of monitoring d) The periodic examination of collaterals and loan covenants e) The frequency of site visits f) The identification of any deterioration in any loan ATMIYA INSTITUTE OF TECHNOLOGY & SCIENCE ( MBA DEPARTMENT ) Page 80

CREDIT RISK Given below are some key indicators that depict the credit quality of a loan: a. Financial Position and Business Conditions. The most important aspect about a n obligor is its financial health, as it would determine its repayment capacity. Consequently institutions need carefully watch financial standing of obligor. The Key financial performance ind icators on profitability, equity, leverage and liquidity should be analyzed. While making s uch analysis due consideration should be given to business/industry risk, borrowers position with in the industry and external factors such as economic condition, government policies, regulation s. For companies whose financial position is dependent on key management personnel and/ or shareholders. b. Conduct of Accounts. In case of existing obligor the operation in the account would give a fair idea about the quality of credit facility. Institutions should monitor the obligor s account activity, repayment history and instances of excesses over credit limits. For tr ade financing, institutions should monitor cases of repeat extensions of due dates for trust re ceipts and bills. c. Loan Covenants. The obligor s ability to adhere to negative pledges and financi al covenants stated in the loan agreement should be assessed, and any breach detected should be addressed promptly. d. Collateral valuation. Since the value of collateral could deteriorate resulti ng in unsecured lending, banks need to reassess value of collaterals on periodic basis. The freq uency of such valuation is very subjective and depends upon nature of collaterals. For instanc e loan granted against shares need revaluation on almost daily basis whereas if there is mortga ge of a residential property the revaluation may not be necessary as frequently. In case of credit facilities secured against inventory or goods at the obligor s p remises, appropriate inspection should be conducted to verify the existence and valuation of the collateral. And if such goods are perishable or such that their value diminish rapidly (e.g. electronic parts/equipments), additional precautionary measures should be taken. ATMIYA INSTITUTE OF TECHNOLOGY & SCIENCE ( MBA DEPARTMENT ) Page 81

CREDIT RISK External Rating and Market Price of securities such as TFCs purchased as a form of lending or long-term investment should be monitored for any deterioration in credit rating of the issuer, as well as large decline in market price. Adverse changes should trigger additional effort to review the creditworthiness of the issuer. ATMIYA INSTITUTE OF TECHNOLOGY & SCIENCE ( MBA DEPARTMENT ) Page 82

CREDIT RISK RISK REVIEW The institutions must establish a mechanism of independent, ongoing assessment o f credit risk management process. All facilities except those managed on a portfolio basis sho uld be subjected to individual risk review at least once in a year. The results of such review sh ould be properly documented and reported directly to board, or its sub committee or senior manage ment without lending authority. The purpose of such reviews is to assess the credit administr ation process, the accuracy of credit rating and overall quality of loan portfolio independent of r elationship with the obligor. Institutions should conduct credit review with updated information on the obligo r s financial and business conditions, as well as conduct of account. Exceptions noted in the credit monitoring process should also be evaluated for impact on the obligor s creditworthiness. Cre dit review should also be conducted on a consolidated group basis to factor in the business connections among entities in a borrowing group. As stated earlier, credit review should be performed on an annual basis, however more frequent review should be conducted for new accounts where institutions may not be famili ar with the obligor, and for classified or adverse rated accounts that have higher probabili ty of default. For consumer loans, institutions may dispense with the need to perform credit re view for certain products. However, they should monitor and report credit exceptions and deterior ation. Delegation of authority Banks are required to establish responsibility for credit sanctions and delegate authority to approve credits or changes in credit terms. It is the responsibility of banks bo ard to approve the overall lending authority structure, and explicitly delegate credit sanctioning authority to senior management and the credit committee. ATMIYA INSTITUTE OF TECHNOLOGY & SCIENCE ( MBA DEPARTMENT ) Page 83

CREDIT RISK Lending authority assigned to officers should be commensurate with the experienc e, ability and personal character. It would be better if institutions develop risk-based author ity structure where lending power is tied to the risk ratings of the obligor. Large banks may adopt multiple credit approvers for sanctioning such as credit ratings, risk approvals etc to institut e a more effective system of check and balance. The credit policy should spell out the escalation process to ensure appropriate reporting and approval of credit extension beyond prescribed limits. The policy should also sp ell out authorities for unsecured credit (while remaining within SBP limits), approvals of disbursements excess over limits and other exceptions to credit policy. In cases where lending authority is assigned to the loan originating function, t here should be compensating processes and measures to ensure adherence to lending standards. Th ere should also be periodic review of lending authority assigned to officers. Managing credits problem The institution should establish a system that helps identify problem loan ahead of time when there may be more options available for remedial measures. Once the loan is iden tified as problem, it should be managed under a dedicated remedial process. A bank s credit risk policies should clearly set out how the bank will manage prob lem credits. Banks differ on the methods and organization they use to manage problem credits. Responsibility for such credits may be assigned to the originating business function, a special ized workout section, or a combination of the two, depending upon the size and nature of the credit and the reason for its problems. When a bank has significant credit-related problems, it is important to segregate the workout function from the credit origination function. The additio nal resources, expertise and more concentrated focus of a specialized workout section normally improve collection results. ATMIYA INSTITUTE OF TECHNOLOGY & SCIENCE ( MBA DEPARTMENT ) Page 84

CREDIT RISK A problem loan management process encompass following basic elements. a. Negotiation and follow-up. Proactive effort should be taken in dealing with o bligors to implement remedial plans, by maintaining frequent contact and internal records o f follow-up actions. Often rigorous efforts made at an early stage prevent institutions from litigations and loan losses b. Workout remedial strategies. Some times appropriate remedial strategies such as restructuring of loan facility, enhancement in credit limits or reduction in int erest rates help improve obligor s repayment capacity. However it depends upon business condition, the nature of problems being faced and most importantly obligor s commitment and willingness to repay the loan. While such remedial strategies often bring up positive results, instit utions need to exercise great caution in adopting such measures and ensure that such a policy m ust not encourage obligors to default intentionally. The institution s interest should be the primary consideration in case of such workout plans. It needs not mention here that comp etent authority, before their implementation, should approve such workout plan. c. Review of collateral and security document. Institutions have to ascertain th e loan recoverable amount by updating the values of available collateral with formal va luation. Security documents should also be reviewed to ensure the completeness and enforceability of contracts and collateral/guarantee. d. Status Report and Review Problem credits should be subject to more frequent r eview and monitoring. The review should update the status and development of the loan acco unts and progress of the remedial plans. Progress made on problem loan should be reported to the senior management. ATMIYA INSTITUTE OF TECHNOLOGY & SCIENCE ( MBA DEPARTMENT ) Page 85

CREDIT RISK NPA The Banks in India Face the problems of swelling non-performing assets (NPAs) an d the issue is becoming more and more unmanageable. The NPAs have direct impact on banks profit ability, liquidity and equity. The NPAs of Indian Banks are relatively huge by internatio nal standard. Therefore the biggest ever challenge that the banking industry now faces is mana gement of NPAs. It is true that banks have to restrict their lending operations to secured advances only with adequate collateral securities. In this connection banks must aware of the problems and recovery legislations of NPAs Non performing assets means an advance where payment of interest or repayment of ins tallments of principal or both remains for a period of more than 180 days. The magnitude of NPAs have a direct impact on banks profitability as legally the y are not allowed to book income on such accounts and at the same time banks are forced to make provision on such assets as per the RBI guidelines. The Indian Banking sector is facing a serious situation in view of the mounting NPAs which are the tune of Rs.56, 000 crores i n March 2002.NPAs is an important parameter in the analysis of financial performance of banks. The reduction of NPAs is necessary to improve profitability of the banks and comply with capital adequacy norms. Therefore, to solve the problems of existing NPAs, quality of appraisal supervis ion and follow up should be improved. The NPAs can be avoided at the initial stage of credit co nsideration by putting rigorous and appropriate credit appraisal mechanism. This is in order to recover the NPA debt, the judicial systems should revamped and is essential to enforce the SARFA ESI Act with more stringent provisions to realize the securities and personal assets of the d efaulters. ATMIYA INSTITUTE OF TECHNOLOGY & SCIENCE ( MBA DEPARTMENT ) Page 86

CREDIT RISK Reasons: Various studies have been conducted to analysis the reasons for NPA. What ever m ay be complete elimination of NPA is impossible. The reasons may be widely classified in two: (1) Over hang component (2) Incremental component Over hang component is due to the environment reasons, business cycle etc. Incremental component may be due to internal bank management, credit policy, ter ms of credit etc. Asset Classification: The RBI has issued guidelines to banks for classification of assets into four ca tegories. 1. Standard assets: A standard asset is one with respect to which no default in repayment in princip al or payment of interest is perceived, and which does not disclose any problems nor carry more t han normal risk attached to the business. 2. Substandard assets: Sub standard asset is one that has been classified as NPA for a period not excee ding 12 months, where the terms of the agreement regarding interest or principal have been reneg otiated after the commencement of operation until the expiry of one year of satisfactory performan ce. 3. Doubtful assets: A doubtful asset means term loan or any other asset that remains substandard ass et for a period exceeding 12 months. 4. Loss assets: Loss asset is one where loss has been identified by internal or external auditor s or the RBI inspector to the extent amount has not been written off. ATMIYA INSTITUTE OF TECHNOLOGY & SCIENCE ( MBA DEPARTMENT ) Page 87

CREDIT RISK RESEARCH METHODOLOGY PRIMARY OBJECTIVES To find out and understand credit risk faced by the Indian Banks To identify the causes of the credit risk To understand various methodologies used by the banks to measure the credit risk To study Credit Risk Management Tools used by the banks to mitigate the risk Type of research Research design is a specification of methods & procedures for acquiring the inf ormation needed for solving the problem. It is a master plan or a model to conduct the formal in vestigations. There are mainly 2 types of research designs: Exploratory Descriptive This project is based on exploratory study. Since exploratory research design he lps in exploring or searching through a problem or situation to provide insights & understanding this study also provide the same about the credit risk management. ATMIYA INSTITUTE OF TECHNOLOGY & SCIENCE ( MBA DEPARTMENT ) Page 88

CREDIT RISK Sources of data The next step is to determine the sources of data to be used. There are mainly 2 sources of data: 1. Primary data 2. Secondary data Primary data is the data which is data observed or collected directly from first -hand experience. We have collected our data by questionnaire for achieving our primary objective. Secondary data is the data that has been collected by some one else and already existed in one or the other form. Our report is based on the statistical tools & data collection f rom various sources. Data Collection 1. Sampling Plan: Sampling Procedure: We followed the convenient type of sampling procedure. Sampling Unit: three from public sector namely, 1. State bank of India 2. Bank of baroda 3. Union bank of India And three from private sector namely, 3. ICICI bank 4. HDFC bank 5. Axis bank ATMIYA INSTITUTE OF TECHNOLOGY & SCIENCE ( MBA DEPARTMENT ) Page 89

CREDIT RISK ANALYSIS Q: Which kind of loan(s) do you offer? Interpretation: Home loan, Business loan, and Vehicle loan are provided by all b anks that is SBI, BOB, UBI, ICICI, HDFC, & AXIS BANK. However, Education loan is not provided by ICICI & AXIS BANK. ATMIYA INSTITUTE OF TECHNOLOGY & SCIENCE ( MBA DEPARTMENT ) Page 90

CREDIT RISK Q: According to you, which loan is more secured? Interpretation: According to SBI, BOB, UBI, ICICI, HDFC, & AXIS BANK, home loan and vehicle loan are more secured. According to UBI, Education loan is also more sec ured and according to AXIS BANK, Business loan is mo8re secured. Q: Which criteria(s) you most prefer before giving Home loan? ATMIYA INSTITUTE OF TECHNOLOGY & SCIENCE ( MBA DEPARTMENT ) Page 91

CREDIT RISK Interpretation: All banks give most preference to income for home loan. Moreover , HDFC, AXIS & ICICI gives preference to property. While ICICI & AXIS BANK also gives pr eference to past record. No bank prefer guarantee. Q: Which criteria(s) you most prefer before giving Education loan? Interpretation: UBI & BOB give first preference to property. SBI give preference to income. HDFC give preference to guarantee. SBI give preference to past record. ATMIYA INSTITUTE OF TECHNOLOGY & SCIENCE ( MBA DEPARTMENT ) Page 92

CREDIT RISK Q: Which criteria(s) you most prefer before giving Business loan? Interpretation: All banks give preference to past record most. Moreover, UBI, IC ICI, BOB & AXIS BANK gives preference to income and property.UBI & HDFC give preference to guarantee. Q: Which criteria(s) you most prefer before giving Vehicle loan? ATMIYA INSTITUTE OF TECHNOLOGY & SCIENCE ( MBA DEPARTMENT ) Page 93

CREDIT RISK Interpretation: All banks give preference to income most. Moreover, SBI, HDFC, A XIS & ICICI give second preference to past record. Q: What is minimum and maximum amount you sanction? HOME LOAN Public sector Min. amount Max. amount State bank of India 1 lac No limit Union bank of India 3 lac No limit Bank of baroda 2 lac No limit Private sector Icici bank 1 lac No limit Hdfc bank 5 lac No limit Axis bank 2 lac No limit BUSINESS LOAN Public sector Min. amount Max. amount State bank of India 20000 No limit Union bank of India 30000 No limit Bank of baroda 25000 200 lacs Private sector Icici bank 50000 No limit Hdfc bank 1 lac No limit Axis bank 1 lac No limit ATMIYA INSTITUTE OF TECHNOLOGY & SCIENCE ( MBA DEPARTMENT ) Page 94

CREDIT RISK EDUCATION LOAN Public sector Min. amount Max. amount State bank of India As per fees 10 lacs Union bank of India -90% of fees Bank of baroda 1 lac 10 lacs Private sector Icici bank N/A N/A Hdfc bank 1 lac No limit Axis bank N/A N/A VEHICLE LOAN Public sector Min. amount Max. amount State bank of India 25000 No limit Union bank of India 20000 No limit Bank of baroda 20000 No limit Private sector Icici bank 25000 No limit Hdfc bank 20000 No limit Axis bank 25000 No limit ATMIYA INSTITUTE OF TECHNOLOGY & SCIENCE ( MBA DEPARTMENT ) Page 95

CREDIT RISK Q: Do you take any collateral for loan(s)? Interpretation: SBI, UBI, BOB & HDFC take collaterals for Home loan. SBI, UBI, B OB & AXIS BANK takes collaterals for Business loan. SBI, UBI, BOB take collateral for Education loan. UBI, HDFC & ICICI take collaterals for Vehicle loan. ATMIYA INSTITUTE OF TECHNOLOGY & SCIENCE ( MBA DEPARTMENT ) Page 96

CREDIT RISK Q: Your loan is how much percentage of your deposits? 0 5 10 15 20 25 30 1 banks %of deposits sbi ubi bob icici hdfc axis Interpretation: From above graph, we can interpret that ICICI BANK, AXIS BANK gi ving high percentage of loan with respect to their deposits so it is risky while UBI & BOB giving less percentage of deposits so they playing little bit safe. Q: What percentage of customers default? 0 1 2 3 4 5 6 1 banks %of defaulter sbi ubi bob icici hdfc axis ATMIYA INSTITUTE OF TECHNOLOGY & SCIENCE ( MBA DEPARTMENT ) Page 97

CREDIT RISK Interpretation: From above graph we can interpret that defaulter ratio in public sector banks is somewhat high as compare to private banks. From our sample size, SBI has highest defaulter ratio that is 5% & AXIS BANK has lowest ratio that is 0.01% which indicates good recovery channel. Q: If customer default how long you wait for due? Interpretation: From above graph, we can interpret those public banks such as SB I, UBI, BOB wait up to just 1 month if customer defaults than it started proceeds towards re covery part while private bank like HDFC waits up to 3 months & ICICI waits for more than 3 months . ATMIYA INSTITUTE OF TECHNOLOGY & SCIENCE ( MBA DEPARTMENT ) Page 98

CREDIT RISK Q: How you recover from defaulter? Interpretation: From above graph we can interpret that most of public sectors ba nks prefer to give legal notice to defaulter first then start further proceedings for recovery while private banks like ICICI & HDFC prefer to send their recovery agent for recovery from defaulte r and BOB also charge penalty to default customer for remaining due. Q: Do you have In house collection team or recovery agent ? ATMIYA INSTITUTE OF TECHNOLOGY & SCIENCE ( MBA DEPARTMENT ) Page 99

CREDIT RISK nterpretation: From above graph we can interpret that generally public sector ba nks have their own field officer for recovery task while private sector banks have their recove ry agent for recovery task Q: What are your norms for commission to recovery agent? Interpretation: From above graph, we can interpret that generally banks pay comm ission to their recovery agent on the basis of amount that they can recover from defaulter . Q: How you deal with recovered property? ATMIYA INSTITUTE OF TECHNOLOGY & SCIENCE ( MBA DEPARTMENT ) Page 100

CREDIT RISK Interpretation: From above graph we can interpret that SBI, BOB, UBI, ICICI, & H DFC, invite bid for auction of the recovered property & recovered their due while AXI S BANK acts as per court order. ATMIYA INSTITUTE OF TECHNOLOGY & SCIENCE ( MBA DEPARTMENT ) Page 101

CREDIT RISK FINDINGS From our project, we have found out that generally all banks provide home loan, business loan, education loan & vehicle loan. According to our survey, home loan is found more secured among four loans we hav e taken. We have found that generally while giving home loan banks give first preference to customer s income, for education loan their property & for business loan give firs t preference to their past record. Generally, public banks have their own in collection team for recovery & private banks have their recovery agent. In case of default, most banks recovered from mortgaged property by auction sale . ATMIYA INSTITUTE OF TECHNOLOGY & SCIENCE ( MBA DEPARTMENT ) Page 102

CREDIT RISK SUGGESTIONS We suggest to ICICI and AXIS bank to provide education loan to the customer as t here is wide scope in education loan. As education is prior thing for being successful i n a life. Most of the banks from our survey did not specify their maximum limit about sanc tioning loan so there should be some specify limit which lead to reduce their default ra tio. In case of defaulter ICICI BANK and AXIS bank wait for three months or more than three months which is long time as compare to other banks so they should reduce their waiting time up to 1 month or less than 1 month. Only union bank of India taking collateral for education loan, no other bank tak es collateral for the same so they should take collateral as a guarantee. ATMIYA INSTITUTE OF TECHNOLOGY & SCIENCE ( MBA DEPARTMENT ) Page 103

CREDIT RISK LIMITATIONS One of the limitations was to get the proper & trustworthy data. Time was the biggest constraint to our project. It was not possible to visit each branch of banks so we can get data of only tha t branch. Therefore, result we obtained might not reflect perfect picture of completely ba nking system. ATMIYA INSTITUTE OF TECHNOLOGY & SCIENCE ( MBA DEPARTMENT ) Page 104

CREDIT RISK CONCLUSION The banking industry recognizes that an institution need not engage in business in a manner that unnecessarily imposes credit risk upon it; nor should it absorb risk that c an be efficiently transferred to other participants. The banks need efficient credit risk manageme nt system that allows them to identify current and potential sources of risk and to take steps necessary to deal with them. From above study we conclude that credit risk management is most important aspec t of banking industry. The standardization of credit process and contracts to prevent inefficient or in correct financial decisions Credit risk can be mitigated by altering the borrowing terms, collateral securit ies and credit quality and rating by the bank. ATMIYA INSTITUTE OF TECHNOLOGY & SCIENCE ( MBA DEPARTMENT ) Page 105

CREDIT RISK BIBLIOGRAPHY websites www.rbi.com www.statebankofindia.com www.unionbankofindia.co.in www.bankofbaroda.com www.icicibank.com www.axisbank.com www.hdfcbank.com Books Indian finanacial system Indian Finanacial System Bharti Phathak , pearson Education, New Delhi,2008 M.Y.Khan , Tata McGrawHill ,New Delhi , 20001

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CREDIT RISK ANNEXURE QUESTIONNAIRE Survey on credit risk management by banks These details are used for academic purpose only. It will not be disclosed to an y other party. Personal details: Name: Organization: Designation: Q: 1 Which kind of loan(s) you offer? Ans: (A) Home loan ( ) (B) Business loan ( ) (C) Education loan ( ) (D) Vehicle loan ( ) Q: 2 According to you, which loan is more secured? Ans: (A) Home loan ( ) (B) Business loan ( ) (C) Education loan ( ) (D) Vehicle loan ( ) Q:3 Which criteria(s) you most prefer before giving Home loan? Ans: (A) Income ( ) (B) Property ( ) (C) Guarantee ( ) (D) Past record ( ) (E) If other please specify ATMIYA INSTITUTE OF TECHNOLOGY & SCIENCE ( MBA DEPARTMENT ) Page 107

CREDIT RISK Q: 4 Which criteria(s) you most prefer before giving Education loan? Ans: (A) Income ( ) (B) Property ( ) (C) Guarantee ( ) (D) Past record ( ) (E) If other please specify Q: 5 Which criteria(s) you most prefer before giving Business loan? Ans: (A) Income ( ) (B) Property ( ) (C) Guarantee ( ) (D) Past record ( ) (E) If other please specify Q:6 Which criteria(s) you most prefer before giving Vehicle loan? Ans: (A) Income ( ) (B) Property ( ) (C) Guarantee ( ) (D) Past record ( ) (E) If other please specify Q: 7 What is minimum and maximum amount you sanction? Ans: (A) Minimum (B)Maximum Q: 8 Do you take any collateral for loan(s)? Ans: (A) Home loan ( ) (B) Business loan ( ) (C) Education loan ( ) (D) Vehicle loan ( ) Q: 9 Your loan is how many percentage of your deposits? Ans: Please specify ATMIYA INSTITUTE OF TECHNOLOGY & SCIENCE ( MBA DEPARTMENT ) Page 108

CREDIT RISK Q: 10 What percentage of customers default? Ans: Please specify Q: 11 If customer default how long you wait for due? Ans: (A) Less than 15 days ( ) (B) Up to 1 month ( ) (C) Up to 3 months ( ) (D) More than 3 months ( ) Q: 12 How you recover from defaulter? Ans: (A) Legal notice ( ) (B) Penalty ( ) (C) Recovery agent ( ) (D) If other, please specify ( ) Q: 13 Do you have In house collection team or recovery agent ? Ans: (A)Yes( ) (B)No( ) If yes please specify Q: 14 What are your norms for commission to recovery agent? Ans: (A) Fix percentage ( ) (B) Percentage of recovery ( ) (C) If other please specify Q: 15 how you deal with Mortgaged property? Ans: (A) Direct sales ( ) (B) Auction ( ) (C) Scrap ( ) (D) If other, please specify ATMIYA INSTITUTE OF TECHNOLOGY & SCIENCE ( MBA DEPARTMENT ) Page 109