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CREDIT RISK

A

GRAND PROJECT REPORT

ONCREDIT RISK

With reference to

PUBLIC AND PRIVATE BANKS

PREPARED BY

ALPESH JETHAVAROLL NO. 24MBA Sem. IV (2008-10)

SEAT NO: 40694

GUIDED BY

MR. NISHANT VACHHANI

ATMIYA INSTITUTE OF TECHNOLOGY & SCIENCE

SUBMITTED TO

SAURASHTRA UNIVERSITY

DEPARTMENT OF BUSINESS MANAGEMENTRAJKOT

ATMIYA INSTITUTE OF TECHNOLOGY & SCIENCE ( MBA DEPARTMENT )



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PREFACE

In todays 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 worldthrough Grand Project. The MBA program provides its students with an in-depth study ofvarious managerial activities that are performed in an organization.

A detailed analysis of managerial activities conducted in various departments like,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, how 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 Industries with theField of the Hows the works of Trade Finance Activity in Banks.




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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 Project.

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 isnecessary forthis 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 in a for givenschedule. Thanks for their benevolent support and kind attention. Their valuable

guidance ateach 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 or indirectlyinvolved in the preparation of this report.

ALPESH JETHAVA




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DECLERATION

I undersigned, ALPESH JETHAVA, the student of ATMIYA INSTITUTE OF TECHNOLOGY

AND SCIENCE (Department of Management) hereby declare that STUDY CREDIT RISKreport is my own work. Report has not been published anywhere. This has been undertaken forthe purpose of partial fulfilment of Saurashtra University requirement for the award of theDegree of Master of Business Administration.

DATE: __________________ PLACE: _________________

SIGN OF STUDENT,

(ALPESH JETHAVA)




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EXECUTIVE SUMMARY

The grand project training of my MBA Programmed was conducted at I have chosen thisproject with the reason that i want to expand our knowledge about banking industry.By doing project on credit risk I learnt so many lessons. What is the importantof its in ourcountrys economy. In today business world, this aspect need very much important tounderstand.During the Training period I have been aware about the concept of credit risk and its importantand 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 frompublic sectornamely.

1. State bank of India2. Bank of Baroda3. Union bank of IndiaAnd three from private sector namely,

1. ICICI bank2. HDFC bank3. Axis bank




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TABLE OF CONTENT

CH.NO PARTICULARS PAGE NO.1 Introduction 8

Origin of the word bank 8History of banking in India 92 Nationalised banks 13State bank of india 17Bank of baroda 20Union bank of india 22Icici bank 24Axis bank 27Hdfc bank 303 Types of loan 331 personal loan 332 vehical loan 36

3 home loan 374 business loan 405 education loan 424 Background of the risk 445 Introduction risk and risk management 466 Credit risk 52Importance of credit risk management 54Managing credit risk 58Securities of credit exposures 59System and procedures 65Credit derivatives 74




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Credit risk monitoring and control 80Risk review 837 NPA 84

8 Research methodology 88Primary objectives 88Types of research 88Source of data 89Data collection 89Analysis 90Findings 102Suggestion 103Limitation 1049 Conclusion 10510 Bibliography 10611 Annexture 107




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INTRODUCTION

ORIGIN OF THE WORD "BANK"

After commerce and the arts had revived in Italy, the business of banking was resumed. Theword "bank" is commonly regarded as derived from the Italian word banco, a bench-the Jews inLombardy 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 circumstance wehave our word bankrupt. But while this is the derivation generally accepted, some writers have

asserted that a more accurate explanation of the use of the word "bank" is thatwhich makes itsynonymous with the Italian Monte (Latin Mons, Metritis), a mound, heap, or bank. Thus theItalian Monte di Pieta and the French Mont de Piete signify "a Charity Bank." Bacon and Evelynuse the word in the same sense. Bacon says: "Let it be no bank or common stock,but every manis master of his own money." Evelyn, referring to the Monte di Pieta at Padua, writes: "There is acontinual 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

aggregatesum called, metaphorically a Mount or Bank.




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HISTORY OF BANKING IN INDIA

Without a sound and effective banking system in India it cannot have a healthy economy. Thebanking system of India should not only be hassle free but it should be able tomeet newchallenges posed by the technology and any other external and internal factors.

For the past three decades India's banking system has several outstanding achievements to itscredit. The most striking is its extensive reach. It is no longer confined to only metropolitans orcosmopolitans in India. In fact, Indian banking system has reached even to the remote 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 dividends with thenationalisation of 14 major private banks of India.

Not long ago, an account holder had to wait for hours at the bank counters for getting a draft orfor withdrawing his own money. Today, he has a choice. Gone are days when the most efficientbank transferred money from one branch to other in two days. Now it is simple asinstantmessaging or dials a pizza. Money has become the order of the day.

The first bank in India, though conservative, was established in 1786. From 1786till today, thejourney of Indian Banking System can be segregated into three distinct phases. They are asmentioned below:

Early phase from 1786 to 1969 of Indian Banks Nationalisation of Indian Banks and up to 1991 prior to Indian banking sector Reforms. 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, PhaseII and Phase III.




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Phase I

The General Bank of India was set up in the year 1786. Next came Bank of Hindust

an andBengal Bank. The East India Company established Bank of Bengal (1809), Bank of Bombay(1840) and Bank of Madras (1843) as independent units and called it Presidency Banks. Thesethree banks were amalgamated in 1920 and Imperial Bank of India was establishedwhich startedas private shareholders banks, mostly Europeans shareholders.

In 1865 Allahabad Bank was established and first time exclusively by Indians, Punjab NationalBank Ltd. was set up in 1894 with headquarters at Lahore. Between 1906 and 1913,

Bank ofIndia, Central Bank of India, Bank of Baroda, Canara Bank, Indian Bank, and Bankof Mysorewere set up. Reserve Bank of India came in 1935.

During the first phase the growth was very slow and banks also experienced periodic failuresbetween 1913 and 1948. There were approximately 1100 banks, mostly small. To streamline thefunctioning and activities of commercial banks, the Government of India came upwith TheBanking Companies Act, 1949 which was later changed to Banking Regulation Act 1949 as per

amending Act of 1965 (Act No. 23 of 1965). Reserve Bank of India was vested withextensivepowers for the supervision of banking in India as the Central Banking Authority.

During those days public has lesser confidence in the banks. As an aftermath depositmobilization was slow. Abreast of it the savings bank facility provided by the Postal departmentwas comparatively safer. Moreover, funds were largely given to traders.




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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 large scale especiallyin rural and semi-urban areas. It formed State Bank of India to act as the principal agent of RBIand to handle banking transactions of the Union and State Governments all over the country.

Seven banks forming subsidiary of State Bank of India was nationalised in 1960 on 19th July,1969, major process of nationalisation was carried out. It was the effort of thethen Prime

Minister of India, Mrs. Indira Gandhi. 14 major commercial banks in the countrywerenationalised.Second phase of nationalisation Indian Banking Sector Reform was carried out in1980 withseven more banks. This step brought 80% of the banking segment in India under Governmentownership.

The following are the steps taken by the Government of India to Regulate BankingInstitutionsin 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 Indiarose toapproximately 800% in deposits and advances took a huge jump by 11,000%.

Banking in the sunshine of Government ownership gave the public implicit faith and immenseconfidence about the sustainability of these institutions.




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Phase III

This phase has introduced many more products and facilities in the banking secto

r in its reformsmeasure. In 1991, under the chairmanship of M Narasimham, a committee was set upby hisname which worked for the liberalisation of banking practices.

The country is flooded with foreign banks and their ATM stations. Efforts are being put to give asatisfactory service to customers. Phone banking and net banking is introduced.The entiresystem became more convenient and swift. Time is given more importance than money.

The financial system of India has shown a great deal of resilience. It is sheltered from any crisistriggered by any external macroeconomics shock as other East Asian Countries suffered. This isall due to a flexible exchange rate regime, the foreign reserves are high, the capital account is notyet fully convertible, and banks and their customers have limited foreign exchange exposure.




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Nationalisation

The nationalisation of banks in India took place in 1969 by Mrs. Indira Gandhi t

he then primeminister. It nationalised 14 banks then. These banks were mostly owned by businessmen andeven 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 IndiaBefore the steps of nationalisation of Indian banks, only State Bank of India (SBI) wasnationalised. It took place in July 1955 under the SBI Act of 1955. Nationalisation of Seven StateBanks 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 ofthe top fivebanks worldwide. It serves 90 million customers through a network of 9,000 branches and itoffers --either directly or through subsidiaries --a wide range of banking services.




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The second phase of nationalisation of Indian banks took place in the year 1980.Seven morebanks were nationalised with deposits over 200crores. Till this year, approximat

ely 80% of thebanking segment in India was under Government ownership.

After the nationalisation of banks in India, the branches of the public sector banks rose toapproximately 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 IndiaScheduled Banks in India constitute those banks which have been included in theSecondSchedule of Reserve bank of India (RBI) Act, 1934. RBI in turn includes only those banks in thisschedule 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 network of 64,918branches. The scheduled commercial banks in India comprise of State bank of Indi

a and itsassociates (8), nationalized banks (19), foreign banks (45), private sector banks (32), cooperative banks and regional rural banks.

"Scheduled banks in India" means the State Bank of India constituted under the State Bank ofIndia Act, 1955 (23 of 1955), a subsidiary bank as defined in the State Bank ofIndia (SubsidiaryBanks) Act, 1959 (38 of 1959), a corresponding new bank constituted under section 3 of theBanking Companies (acquisition and Transfer of Undertakings) Act, 1970 (5 of 1970), or under




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section 3 of the Banking Companies (Acquisition and Transfer of Undertakings) Act, 1980 (40of 1980), or any other bank being a bank included in the Second Schedule to the

Reserve Bankof 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) of section 5 ofthe 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 BankATMIYA INSTITUTE OF TECHNOLOGY & SCIENCE ( MBA DEPARTMENT )



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· 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 LtdThe 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.




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STATE BANK OF INDIA

The evolution of State Bank of India can be traced back to the first decade of the 19th century. Itbegan with the establishment of the Bank of Calcutta in Calcutta, on 2 June 1806. The bank wasredesigned as the Bank of Bengal, three years later, on 2 January 1809. It was the first ever joint-stock bank of the British India, established under the sponsorship of the Government of Bengal.Subsequently, the Bank of Bombay (established on 15 April 1840) and the Bank ofMadras(established on 1 July 1843) followed the Bank of Bengal. These three banks dominated the

modern banking scenario in India, until when they were amalgamated to form the Imperial Bankof India, on 27 January 1921.

An important turning point in the history of State Bank of India is the launch of the first FiveYear Plan of independent India, in 1951. The Plan aimed at serving the Indian economy ingeneral and the rural sector of the country, in particular. Until the Plan, thecommercial banks ofthe country, including the Imperial Bank of India, confined their services to the urban sector.Moreover, they were not equipped to respond to the growing needs of the economic

revivaltaking shape in the rural areas of the country. Therefore, in order to serve theeconomy as awhole and rural sector in particular, the All India Rural Credit Survey Committee recommendedthe formation of a state-partnered and state-sponsored bank.

The State Bank of India emerged as a pacesetter, with its operations carried outby the 480offices comprising branches, sub offices and three Local Head Offices, inheritedfrom theImperial Bank. Instead of serving as mere repositories of the community's savings and lending tocreditworthy parties, the State Bank of India catered to the needs of the customers, by bankingpurposefully. The bank served the heterogeneous financial needs of the planned economicdevelopment.




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Branches

The corporate center of SBI is located in Mumbai. In order to cater to different

functions, thereare several other establishments in and outside Mumbai, apart from the corporatecenter. Thebank boasts of having as many as 14 local head offices and 57 Zonal Offices, located at majorcities throughout India. It is recorded that SBI has about 10000 branches, wellnetworked to caterto its customers throughout India.

ATM Services

SBI provides easy access to money to its customers through more than 8500 ATMs i

n India. TheBank also facilitates the free transaction of money at the ATMs of State Bank Group, whichincludes the ATMs of State Bank of India as well as the Associate Banks State Bank ofBikaner & Jaipur, State Bank of Hyderabad, State Bank of Indore, etc. You may also transactmoney through SBI Commercial and International Bank Ltd by using the State BankATM-cum-Debit (Cash Plus) card.

Subsidiaries

The State Bank Group includes a network of eight banking subsidiaries and several non-bankingsubsidiaries. Through the establishments, it offers various services including merchant bankingservices, fund management, factoring services, primary dealership in governmentsecurities,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)




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State Bank of Patiala (SBP)State Bank of Saurashtra (SBS)State Bank of Travancore (SBT)

Products And Services

Personal Banking

SBI Term Deposits SBI Loan for PensionersSBI Recurring Deposits Loan against Mortgage of PropertySBI Housing Loan against Shares & DebenturesSBI Car Loan Rent plus SchemeSBI Educational Loan Medi-Plus Scheme

Other Services

Agriculture/Rural BankingNRI ServicesATM ServicesDemat ServicesCorporate BankingInternet BankingMobile BankingInternational BankingSafe Deposit LockerSBI Vishwa Yatra Foreign Travel CardBroking Services




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BANK OF BARODA

Type PublicBSE & NSE:BOB}Founded 1908Headquarters Bank of Baroda,Baroda Corporate Centre,Plot No -C-26, G -Block,Bandra Kurla Complex,Mumbai IndiaKey people M D Mallya, Chairman & Managing DirectorIndustry BankingCapital 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 assets as Rs. 1,43,146 Crores as on 31st of March 2007. The bank was founded by Maharaja SayajiraoGaekwad III (also known as Shrimant Gopalrao Gaekwad), the then Maharaja of Baroda on 20thof July 1908 with a paid capital of Rs. 10 Lacs. From its introduction in a smal

l building ofBaroda, the bank has come a long way to achieve its current position as one of the mostimportant banks in India. On 19th of July 1969, Bank of Baroda was nationalizedby theGovernment of India along with 13 other commercial banks.




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Financial Details

As of March 2007, the bank had total deposits worth Rs. 1,24,915 Crores while it

had a totalnumber of 2956 branches located worldwide as on April 2009, out of which 626 were located inMetro cities, 524 in Urban areas, 642 in Semi-Urban locations, 1092 in Rural areas and 72 werelocated outside India. The bank has 10 Zonal Offices and 43 Regional Offices which help itcontrol its operations nationally.

International Presence

Along with a huge network of its branches spread across India, Bank of Baroda ha

s its overseasbranches located in 14 other countries, which include Bahamas, Bahrain, Belgium,China, FijiIslands, Hong Kong, Mauritius, Republic of South Africa, Seychelles, Singapore,Sultanate ofOman, United Arab Emirates, United Kingdom and United States of America. Apart from it, thebank has established its subsidiaries in 7 countries viz. Botswana, Ghana, Guyana, Kenya,Tanzania, Trinidad & Tobago and Uganda, and its representative offices in 3 countries which areAustralia, Malaysia and Thailand.

Other Details

Bank of Baroda had a total workforce of 38063 employees offering their servicesto theinstitution as of September 2006. Out of these, 13525 were Officers, 16497 wereClerks while8041 were Sub-Staff members.

The bank offers a wide array of customized and specialized services to meet thediverse needs ofits customers, and these services have been categorized into Personal Banking, BusinessBanking, Corporate Banking, International Banking, Treasury Banking and Rural Bankingservices.




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UNION BANK OF INDIA

Type PublicHeadquarters Mumbai, IndiaKey people Mavila Vishwanathan Nair (Chair)Industry FinancialCommercial banksRevenue USD 1.23 billionNet income USD 0.16 billionEmployees 25,630Website www.unionbankofindia.co.in

Union Bank of India (UBI) is one of India's largest state-owned banks (the gover

nment owns55.43% of its share capital), is listed on the Forbes 2000. It has assets of USD13.45 billion andall the bank's branches have been networked with its 1135 ATMs. Its online Telebanking facilityis available to all its Core Banking Customers -individual as well as corporate.It hasrepresentative offices in Abu Dhabi, United Arab Emirates, and Shanghai, PeoplesRepublic ofChina, and a branch in Hong Kong. Because of its acronym UBI, the public sometimes confusesit with United Bank of India




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History

1919 UBI was registered on November 11, 1919 as a limited company in Mumbai. It

wasinaugurated by Mahatma Gandhi. 1947 UBI had only 4 branches -3 in Mumbai and 1 in Saurashtra, all concentratedin keytrade centres. 1975 The Government nationalized UBI. At the time of its nationalization, UBI had 240branches in 28 states.After nationalization, UBI merged in Belgaum Bank, a private sector bank established in1930.

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

Indiaafter the discovery of extensive irregularities at the non-scheduled bank. Sikkim Bankhad eight branches located in the North-east, which was attractive to UBI. 2007 UBI opened representative offices in Abu Dhabi, United Arab Emirates, andShanghai, 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 SydneyATMIYA INSTITUTE OF TECHNOLOGY & SCIENCE ( MBA DEPARTMENT )



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ICICI BANK

Type PrivateBSE & NSE:ICICI, NYSE: IBNKeypeopleK.V.Kamath,ChairmanChanda Kochhar, Managing Director & CEOSandeep Bakhshi, Deputy Managing DirectorN.S. Kannan, Executive Director & CFOK. Ramkumar, Executive DirectorIndustry BankingInsurance

Capital Markets and allied industriesProducts Loans, Credit Cards, Savings, Investmentvehicles, Insurance etc.Revenue . USD 15.06 billionTotalassets. 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 financialinstitution, in 1994. Four years later, when the company offered ICICI Bank's shares to the

public, ICICI's shareholding was reduced to 46%. In the year 2000, ICICI Bank offered made anequity offering in the form of ADRs on the New York Stock Exchange (NYSE), therebybecoming the first Indian company and the first bank or financial institution from non-Japan Asiato be listed on the NYSE. In the next year, it acquired the Bank of Madura Limited in an all-stock amalgamation. Later in the year and the next fiscal year, the bank made secondary marketsales to institutional investors.

With a change in the corporate structure and the budding competition in the Indian Bankingindustry, the management of both ICICI and ICICI Bank were of the opinion that amerger




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between the two entities would prove to be an essential step. It was in 2001 that the Boards ofDirectors of ICICI and ICICI Bank sanctioned the amalgamation of ICICI and two o

f its wholly-owned retail finance subsidiaries, ICICI Personal Financial Services Limited andICICI CapitalServices Limited, with ICICI Bank. In the following year, the merger was approved by itsshareholders, the High Court of Gujarat at Ahmedabad as well as the High Court of Judicature atMumbai and the Reserve Bank of India.

Present Scenario

ICICI Bank has its equity shares listed in India on Bombay Stock Exchange and th

e NationalStock Exchange of India Limited. Overseas, its American Depositary Receipts (ADRs) are listedon the New York Stock Exchange (NYSE). As of December 31, 2008, ICICI is India'ssecond-largest bank, boasting an asset value of Rs. 3,744.10 billion and profit after tax 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 bank has 1,420

branches and about 4,644 ATMs. Talking about foreign countries, ICICI Bank has made itspresence felt in 18 countries -United States, Singapore, Bahrain, Hong Kong, SriLanka, Qatarand Dubai International Finance Centre and representative offices in United ArabEmirates,China, South Africa, Bangladesh, Thailand, Malaysia and Indonesia. The Bank proudly holds itssubsidiaries in the United Kingdom, Russia and Canada out of which, the UK subsidiary hasestablished branches in Belgium and Germany.

Products & Services

Personal Banking

· Deposits· Loans· CardsATMIYA INSTITUTE OF TECHNOLOGY & SCIENCE ( MBA DEPARTMENT )



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· Investments· Insurance· Demat Services

· Wealth ManagementNRI Banking

· Money Transfer· Bank Accounts· Investments· Property Solutions· Insurance· LoansBusiness Banking

· Corporate Net Banking

· Cash Management· Trade Services· FXOnline· SME ServicesATMIYA INSTITUTE OF TECHNOLOGY & SCIENCE ( MBA DEPARTMENT )



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Type Public BSE: 532215Founded Ahmedabad, 1994.

Headquarters Mumbai, IndiaKey people Shikha Sharma, MD & CEOIndustry FinancialCommercial banksEmployees 13,389 (2007)Website www.axisbank.com

Axis Bank was formed as UTI when it was incorporated in 1994 when Government ofIndiaallowed private players in the banking sector. The bank was sponsored together by theadministrator of the specified undertaking of the Unit Trust of India, Life Insu

rance Corporationof India (LIC) and General Insurance Corporation ltd. and its subsidiaries namely Nationalinsurance company ltd., the New India Assurance Company, the Oriental InsuranceCorporationand United Insurance Company Ltd. However, the name of UTI was changed because of thedisagreement on terms and conditions of the bank authority over certain stipulations includingroyalty charged over the name from UTI AMC. The bank also wanted to have a new name fromits pan-Indian as well as international business perspective. So from July 30, 2007 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, LICcontributing Rs.

7.5 crore and GIC and its four subsidiaries contributing Rs. 1.5 crores, the bank came inoperation with its first registered office at Ahmedabad . Today, Axis Bank has more than 726ATMIYA INSTITUTE OF TECHNOLOGY & SCIENCE ( MBA DEPARTMENT )



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branch offices and Extension Counters spread over 341 cities, towns and villagesof the country.Presently, the authorized share capital of Axis Bank is Rs. 300 Crores and the p

aid up sharecapital is Rs. 232.86 Crores. The Axis bank is currently capitalized with Rs. 282.65 Crores witha public holding of 57.05% apart from the promoters. The FY2009 shows a net profit of Rs.

500.86 crore up by 63.24% yoy over the Net Profit of Rs. 306.83 crores for the third quarter oflast year.Axis Bank: Facilities and Services

Axis Bank its customers with all kinds of facilities that should be provided by

a modern Bank. Itdeals with personalized as well as commercial banking. It has one of the largestspread ATMnetwork 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 Foreign Banks· Letter of Credit· Bank Guarantee· Solvency CertificatesPersonal Facilities

· Home Loans· Personal LoansATMIYA INSTITUTE OF TECHNOLOGY & SCIENCE ( MBA DEPARTMENT )



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· 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 AccountATMIYA INSTITUTE OF TECHNOLOGY & SCIENCE ( MBA DEPARTMENT )



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HDFC BANK

Founded 1994Founder(s) Mr Deepak Parekh of HDFCHeadquarters Mumbai, IndiaKey people Mr. Aditya Puri, Managing DirectorMr. Harish Engineer, Executive DirectorIndustry BankingInsuranceCapital Markets and allied industriesProducts Financial servicesRevenue . 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 CorporationLimited (HDFC), India's premier housing finance company. It was among the firstcompanies toreceive an 'in principle' approval from the Reserve Bank of India (RBI) to set up a bank in theprivate sector. The Bank commenced its operations as a Scheduled Commercial Bankin January1995 with the help of RBI's liberalization policies.

In a milestone transaction in the Indian banking industry, Times Bank Limited (promoted byBennett, Coleman & Co. / Times Group) was merged with HDFC Bank Ltd., in 2000. This wasthe first merger of two private banks in India. As per the scheme of amalgamation approved bythe shareholders of both banks and the Reserve Bank of India, shareholders of Times Bankreceived 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 tomore than1,000. The amalgamated bank emerged with a strong deposit base of around Rs. 1,22,000 croreand net advances of around Rs. 89,000 crore. The balance sheet size of the combined entity is




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over Rs. 1,63,000 crore. The amalgamation added significant value to HDFC Bank in terms ofincreased branch network, geographic reach, and customer base, and a bigger pool

of skilledmanpower.

Business Focus

HDFC Bank deals with three key business segments -Wholesale Banking Services, RetailBanking Services, Treasury. It has entered the banking consortia of over 50 corporates forproviding working capital finance, trade services, corporate finance and merchant banking. It isalso 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 inthe Indiancorporate to small & mid-sized corporates and agri-based businesses. For these customers, theBank provides a wide range of commercial and transactional banking services, includingworking capital finance, trade services, transactional services, cash management, etc. The bank is

also a leading provider of structured solutions, which combine cash management services withvendor and distributor finance for facilitating superior supply chain managementfor its corporatecustomers. HDFC Bank has made significant inroads into the banking consortia ofa number ofleading Indian corporates including multinationals, companies from the domesticbusinesshouses and prime public sector companies. It is recognized as a leading providerof cashmanagement and transactional banking solutions to corporate customers, mutual funds, stockexchange members and banks.

Retail Banking Services

The objective of the Retail Bank is to provide its target market customers a full range of financialproducts and banking services, giving the customer a one-stop window for all his/her bankingrequirements. The products are backed by world-class service and delivered to customers




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through the growing branch network, as well as through alternative delivery channels likeATMs, Phone Banking, Net Banking and Mobile Banking.

HDFC Bank was the first bank in India to launch an International Debit Card in association withVISA (VISA Electron) and issues the MasterCard Maestro debit card as well. The Banklaunched its credit card business in late 2001. By March 2009, the bank had a total card base(debit and credit cards) of over 13 million. The Bank is also one of the leadingplayers in themerchant acquiring business with over 70,000 Point-of-sale (POS) terminals for debit / creditcards acceptance at merchant establishments. The Bank is well positioned as a le

ader in variousnet based B2C opportunities including a wide range of internet banking servicesfor FixedDeposits, Loans, Bill Payments, etc.




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TYPES OF LOAN

PERSONAL LOANS

In todays world, no matter how much you earn, you may find that it is not enoughto meet yourneeds. Yesterdays luxuries have become todays necessities. Owning a good car, having yourown house or traveling the world are decisions which are made without much thinking? Simplybecause these are a few material comforts that are a must for any family. In order to meet theseneeds, even the woman of the house works. It is not uncommon to find both parents working atjobs which demand a lot of time, but which also bring in a steady income. Howeve

r, you maystill find that even with the steady money coming in, there are expenses of a slightly biggerproportion such as a wedding, or annual families get together which cannot be financed withwhat is at hand. What can a person do in such a circumstance? Read below about personal loanswhich panacea for all these troubles.

In such a situation where getting a huge amount of money is a must, one can apply for a personalloan. A personal loan is a loan taken from a credible authority, such as a bankor a moneylender,

and which is repaid back over a fixed period of time, and with interest. The reasons for taking apersonal 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 history, one can find thatthe lending authorities in earlier times used to be the religious temples and few money lenderswho used to charge high rate of interests and the borrower was always under pressure of howrepay the debt. Even back then, there were records of loans being paid back withrich harvestsand interest rates being charged. The terms and conditions of each loan and themethod ofrepayment varied from person to person.




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Current scenario:

Today, when a person wants a loan, he goes to a bank with which s/he has a perso

nal account orto a credible money lender. Although there are any high profile lenders in the market, it may bedifficult to get a loan from them as they often have very stringent parameters that need to be met.It however, is much easier to get a loan from an online moneylender or any othersuch authority.Loans are also given to people who have a bad credit score, or who have a bankruptcy status. Itis important to know the profile of the creditor properly, as there are a lot offraudsters in themarket.

Types of Personal loans: -There are two kinds of personal loans that one can avail of in themarket. Different terminology is used for different types of personal loans however broadly thereare only two categories i.e. unsecured loans and secured loans.

The first is called an Unsecured Loan. As the name suggests, an unsecured loan is a loan,which is given without any collateral as a security for example a house, or anyother asset. Thisworks well for people who wish to take a loan but who do not have the required assets to fall

back on. As there is no collateral which is offered here, generally the money one can apply for inthe loan is also of a lower amount, while the Annual Percentage Rate may be quite high. Peoplewho have a bad credit score and also who have a mortgage to pay or who have applied for manyloans can avail of this type of loan. However there are a few conditions which need to befulfilled. A regular source of income needs to be shown, as a background check would be carriedout by the lender. Also, proof that an applicant has stayed at the same place ofresidence foratleast three years is also a must. It is found that married people who have a steady source ofincome are generally the people who are most preferred by lenders as they are more credible innature. 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 secured againstsome kind of collateral, which in most cases is the house that the applicantlives in. These kinds of loans are believed to be more risk free, and alsowith the popularity of the Internet..




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Points to keep in mind: No matter what kind of loan you decide to go for, it isstill borrowedmoney 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 nottake a huge amount if you feel you may not be able to repay it within the specified timeframe.4. Take a look at your finances and note down your monthly expenses. Being in control of yourexpenses helps you plan ahead better.5. It is important to search the market properly for a reputed and credible moneylender. Go in for

a moneylender who makes you comfortable and who willingly answers any questionsyou mighthave.6. Read the documents carefully before signing anything, and make sure you ask the relevantquestions to clear any doubts you may have.7. Analyzing the market and various options would help you understand the ratesthat are there inthe market, the time frame in which you can apply for the amount, and also the maximumamount you can apply for.8. Do not hesitate to meet up with as many moneylenders as possible, as talkingwith 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 andto hunt aroundfor good deals.ATMIYA INSTITUTE OF TECHNOLOGY & SCIENCE ( MBA DEPARTMENT )



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VEHICLE LOAN

A loan is a type of debt. Like all debt instruments, a loan entails the redistri

bution of financialassets over time, between the and the . The borrower initially receives an amountof moneyfrom the lender, which they pay back, usually but not always in regular installments, to thelender. This service is generally provided at a cost, referred to as interest onthe debt. Thus, anAUTO 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 likepurchase of ahouse or may be the expense over his own education. Hence, it comes with no bigsurprise thatmost people cant afford to pay for their new vehicle.

The concept of fast loans was especially designed for the fast approval of the required funds forthe borrowers. The loan seeker can avail the following advantages while considering the optionof fast loans: The loan seeker can apply online for the loan. The loan lender receives your request

application for the grant of loan in just no time, i.e. with a single click of the mouse.

Hence, the processing time for the application reduces manifold, provided the details given bythe applicant are authentic. So, the borrower must look out for providing his details correctly byfilling the form online, in full conscious. Fast loans save the time wasted otherwise for thevaluation of the collateral. This is because, the lender already knows the caremodel and its make(as mentioned by the applicant in the loan form), he can quickly decide over theloan amount tobe 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 choiceATMIYA INSTITUTE OF TECHNOLOGY & SCIENCE ( MBA DEPARTMENT )



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HOME LOAN

One such loan which is very common now days is the home loan which is usually ta

ken by theborrowers on behalf of their salaries. Since construction of home requires heavyvolume of cash,such loans help the constructor of the home not to spend this huge amount at once rather he hasto spend no amount but borrow the required amount which can be repaid in easy installmentswhenever he has a funds. This is according to the mutual agreement between the two. Everyoneis keen to procure a good accommodation i.e. flat, a banglaw for them. A regularsource ofincomes as a proof has to be shown to get such loans. A second type of loan is H

ome ownersloan in which one can avail loan by mortgaging his current accommodation. Sometimes a loan isprovided to repay a previous loan which was taken during the construction of thehouse.

But the under the situation, the amount of loan can be availed only till the extent it covers thevalue 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 forbuying a property as this process involves huge funds. One is able to finance the expenditurethrough these loans rather than withdrawing a large amount from the bank at once. The majoradvantage of taking such loan is that these kinds of loans usually carry low rates of interests asthey are secured loans. They usually have liberal terms and conditions of repayment. Unlikeunsecured loans a large amount can be borrowed in forms of such loans and repayment for thesecan be done through easy installments. One needs to have a good credit history and minimumborrowing in the past to secure such loans. In this case one should go in for home owner loans asthese loan are even given to people who have had bad credit history because of the fact that theseunsecured 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 such loans haveflexible approach. It can be used for number of purposes like purchase of a car,for financing atrip, financing the education expenses of the children, renovation or improvement of their house.

One can look for lenders easily as lending is being done online too and comparison should bemade between different home loans available and the best option should be taken



up.

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



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Types of Home Loans

One can make additions to the original home for increasing the value of the prop

erty byimproving the home and these loans prove to be a boom in this case too because of their taxdeductible 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 isrequired to gethome improvement loans. Since it makes a less risky task for the companies as itinvolves lowerrate of interest. The basic condition to acquire such loan is that one must owna home and musthold 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 typeAny of these could be used for any fresh constructions, renovations, refurnishing your bedroom,kitchen, garage, bathroom, swimming pool etc. One needs to have an equity in thehouse if onewishes to renovate, in case a traditional home improvement loan is being considered consistingof one fifth of the cost of the house. The already constructed equity and thoseacquired by the

changes in the home are to be taken as security for the repayment of loan. Lender is the firmproviding the loan. In an home improvement loan, the firm will issue first or second lieu whichempowers its right over property till the debt is repaid.

Generally home improvement loan is for a period of ten years or less but could be extended tofifteen years depending on the programme and lender at once disposal. FHA title1 Homeimprovement loan can be distinguished from traditional Home improvement loan asthe former isa government plan.

Although FHA loan does not allow luxury remodeling but can be used for inevitable repairs andrestoring good conditions. This is the general method followed as equity in thehome is wishedfor this type of the loan and traded outcomes of the past is generally not an issue. FHA title loancan be repaid for the period as long as 2020 years, if the owner has kept his credit in adequatestanding, that happens lately. In case decision to buy a first home is made or still in investigating




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phase, local or state community should be checked for programmes available for the first timebuyers 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 borrowing theloan. In case due to negligence on avoid this factor he/she may become liable topayhigher interest because of high principal amount he had borrowed.2. Secondly interest factor. Higher interest loans should be avoided. Hence careful selectionshould be done.3. Thirdly, according to ones comfort and source of payment, one should select t

he loanwith low amount of down payments.4. The lender should be a reputed and faithful one before mortgaging any security with thelender one should confirm their reliability.5. The amount of loan to be taken should be assessed and accordingly one shouldselect alender who provides the cheapest interest loan.6. The instruction and terms of the loan should be read with extra attention soas tominimise 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 suchloans 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 loan to beborrowed. The utmost important factor to be kept in mind is the rate of interest. The other factorlike terms and conditions of the loan and the duration of repayment should alsobe taken care of.The collateral security to be mortgaged is another feature of secured loans to be thought of .Hence a careful study has to made regarding amount required, repayment ability of the customerand security available to borrow a loan.




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BUSINESS LOAN

With lesser and lesser jobs available, people are trying to start their own busi

ness to earn aliving. Running your own business has its own ups and downs. In business profession anindividual being the sole owner of the business has to control it himself and take all decisionsindependently unlike any job where work is performed as per the guidelines givenas per theauthority. But starting of a business and running it successfully involves manycomplicatedprocedures. In fact it is a risk taking venture. Even the smallest of a wrong decision taken ,maylead to heavy losses and for this purpose small business loans have been introdu

ced to enable theowner of business to obtain the required funds whenever they are in need of money which provesto be a valuable source.

To start a business a person requires huge funds which may be obtained through various 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 institutions which may be

in the form of secured business loans which requires something as collateral security or it may bein the form of unsecured business loan which is required for the purpose of carrying out a petitebusiness task and such loan depends on the financial status of the borrower, apart from theunsecured business loans government is also providing financial assistance for carrying outminute business tasks. Such government loans are provided for the prosperous future of thesociety. In majority cases such loans provided depends on the financial status of the individual.

The basis for which a business may require a loan may vary. Some of the most common businessloans available to business owners are:

· AcquirementATMIYA INSTITUTE OF TECHNOLOGY & SCIENCE ( MBA DEPARTMENT ) Page 40



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· 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 financingATMIYA INSTITUTE OF TECHNOLOGY & SCIENCE ( MBA DEPARTMENT ) Page 41



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EDUCATION LOAN

EVER increasing demand for education loan can be analyzed from the fact that the

expenses ofHigher education have become unbearable and which has now become a necessity. Due to thismany institutions have come forward with a view to provide financial help to students .Theseinstitutions provide better opportunities to students to avail the required finances .These financesenable the students to compete their education without any hindrance. Students even ensure alucrative future for themselves as many companies are coming up these days whichdemandqualified 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 the tuition fees butalso the others benefits like hostel fee, expenses of books and all other expenses related toeducation. Education Loans Enquiry Form

Education loans can be classified into two types known as scheduled loans and unscheduledloans. Education loans imposes no mental stress on borrower, as the borrower canrepay itwhenever he becomes self reliant to pay back the amount. The student can repay the loan after

getting a fixed source of employment.

The only disadvantage is that the rate of interest is much higher as compared toothers but it hasmany advantages like the loan can be obtained easily as it involves no securityand more over itcan be obtained in minimum time period. Education loans fulfill the requirementsof anindividual whenever required. Student takes up the responsibility of repaying the loan which alsoreduces the financial stress of the parents.

The other source of finances can be borrowing the required funds from the borrower. However ifthe borrower prefers borrowing from the borrower instead of education loans thenhe can beduped by the borrower. Borrower might acquire education loans at competitive rate of interestand at longer and on long credit terms. However if you are a prospective borrower, then you canbargain the interest rate in comparison with less educated credit borrower.




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Types of Education Loans: Education loans are classified into two categories:

· Secured Education Loans

· Unsecured Education LoansAssets are kept as collateral in secured education loan and the funds are available for long periodand more over the rate of interest is lower .The reason behind this advantage isthat the lender isfree from any kind of risks. Another advantage is that by personal conversationwith the buyersrate of interest can be reduced.

However under unsecured loan no asset has to be kept as collateral security. Therate of interestis much higher as compared to secured since no collateral is demanded in this ca

se. The rate ofinterest is not always higher as they can be obtained from lenders in competitive market.Education loan is considered must today for a student to complete his higher education. Thesedays there are many sources available for a student to obtain the loan. They have muchopportunity available to themselves to acquire the loan. To achieve a prospective future there aretwo main sources from where education loans can be acquired to obtain the financial assistancewhich will enable to furnish a beautiful future for yourself.

The two main sources are discussed bellow:

· Government Lenders· Private LendersSince loans of subsidized nature are provided by the government, so students generally prefer tofinance from government lenders. Subsidized funds are managed and controlled bytheconcerned government and the ministry of finance in rest of the countries and they are availableat cheaper rates.

However, private lenders charge rate of interest based on education loans. Thereis a Federalizedprogram of education prevailing under this which is very useful as it offers reasonable andflexible opportunities related to educational loans. Students are charged very low rate of interestunder this program which also offers the opportunity of repaying the amount in the long run.




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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 wayof charge on thefundamental/ basic i.e. in the case of business it is the Capital, which is thecushion that protectsthe liability holders of an institution. These risks are inter-dependent and events affecting onearea of risk can have ramifications and penetrations for a range of other categories of risks.Foremost thing is to understand the risks run by the bank and to ensure that therisks are properlyconfronted effectively controlled and rightly managed. Each transaction that the

bank undertakeschanges 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 continuously updatethe risk calculations. Hence, providing real time risk information is one of thekey challenges ofrisk management exercise. Till recently all the activities of banks were regulated and henceoperational environment was not conducive risk taking. Better insight, sharp intuition and longer

experience were adequate to manage the limited risks.

Business is the art of extracting money from others pocket, sans resorting toviolence. But profiting in business without exposing to risk is like trying to live without beingborn. Every one knows that risk taking is failure prone as otherwise it would betreated as suretaking. Hence risk is inherent in any walk of life in general and in financial sectors in particular.Of late, banks have grown from being a financial intermediary into a risk intermediary at present.In the process of financial intermediation, the gap of which becomes thinner andthinner, banksare exposed to severe competition and hence are compelled to encounter various types offinancial and non-financial risks. Risks and uncertainties form an integral partof banking whichby nature entails taking risks.

Business grows mainly by taking risk. Greater the risk, higher the profit andhence the business unit must strike a trade off between the two. The essential functions of riskmanagement are to identify measure and more importantly monitor the profile of the bank. While




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Non-Performing Assets are the legacy of the past in the present, Risk Managementsystem is thepro-active action in the present for the future. Managing risk is nothing but ma

naging the changebefore the risk manages. While new avenues for the bank has opened up they havebrought withthem new risks as well, which the banks will have to handle and overcome.




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INTRODUCTION TO RISK AND RISK MANAGEMENT

Risk

Risks are usually defined by the adverse impact on profitability of several distinct sources ofuncertainty.

While the types and degree of risks an organization may be exposed to depend upon a number offactors such as its size, complexity business activities, volume etc, it is believed that generallythe banks face Credit, Market, Liquidity, Operational, Compliance / legal / regulatory andreputation risks. Before overarching these risk categories, given below are some

basics about riskManagement 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 encompasses all theactivities that affect its risk profile. It involves identification, measurement, monitoring andcontrolling risks to ensure that

The individuals who take or manage risks clearly understand it. The organizations Risk exposure is within the limits established by Board of Dire

ctors. Risk taking Decisions are in line with the business strategy and objectives setby 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 riskThe acceptance and management of financial risk is inherent to the business ofbanking and banks roles as financial intermediaries. Risk management ascommonly perceived does not mean minimizing risk; rather the goal of riskmanagement is to optimize risk-reward trade -off. Notwithstanding the fact that




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banks are in the business of taking risk, it should be recognized that aninstitution need not engage in business in a manner that unnecessarily imposesrisk upon it: nor it should absorb risk that can be transferred to other partici

pants. Rather itshould accept those risks that are uniquely part of thearray of banks services.

In every financial institution, risk management activities broadly take place simultaneously atfollowing different hierarchy levels.

Strategic level: It encompasses risk management functions performed by seniormanagement and BOD. For instance definition of risks, ascertaining institutionsriskappetite, formulating strategy and policies for managing risks and establish ade

quatesystems and controls to ensure that overall risk remain within acceptable leveland thereward compensate for the risk taken. Macro Level: It encompasses risk management within a business area or across businesslines. Generally the risk management activities performed by middle management orunits devoted to risk reviews fall into this category. Micro Level: It involves On-the-line risk management where risks areactually created.This is the risk management activities performed by individuals who take risk on

organizations behalf such as front office and loan origination functions.ATMIYA INSTITUTE OF TECHNOLOGY & SCIENCE ( MBA DEPARTMENT ) Page 47



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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 / lossesLehman Brothers 2005 Survey

The results of the survey provided the following observations :

Rating (96%), maturity (56%), and asset types (48%) are the factors considered by mostinsurers in determining product pricing default charges for bonds Asset type (56%), rating (52%), and subordination (44%) are the factors considered bythe 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 bondsATMIYA INSTITUTE OF TECHNOLOGY & SCIENCE ( MBA DEPARTMENT ) Page 48



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For commercial mortgage loan investments, insurers rely on their own experiencemostwhen assessing default rates and recovery rates.

Risk management framework

The risk management framework and sophistication of the process, and internalcontrols, used tomanage risks, depends on the nature, size and complexity of institutions activities. Nevertheless,there are some basic principles that apply to all financial institutions irrespective of their size andcomplexity of business and are reflective of the strength of an individual bank's risk managementpractices.

A risk management framework encompasses the scope of risks to be managed, theprocess/systems and procedures to manage risk and the roles and responsibilitiesof individualsinvolved in risk management. The framework should be comprehensive enough to capture allrisks a bank is exposed to and have flexibility to accommodate any change in business activities.

An effective risk management framework includes:

a) Clearly defined risk management policies and procedures covering risk identification,acceptance, measurement, monitoring, reporting and control.

b) A well constituted organizational structure defining clearly roles and responsibilities ofindividuals involved in risk taking as well as managing it. Banks, in addition to risk managementfunctions for various risk categories may institute a setup that supervises overall riskmanagement at the bank.

c) There should be an effective management information system that ensures flowof informationfrom operational level to top management and a system to address any exceptionsobserved.There should be an explicit procedure regarding measures to be taken to addresssuch deviations.




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d) The framework should have a mechanism to ensure an ongoing review of systems,policiesand 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 tocontrol risks.Further a true assessment of risk gives management a clear view of institutions standing andhelps in deciding future action plan. To adequately capture institutions risk exposure, riskmeasurement should represent aggregate exposure of institution both risk type and business lineand encompass short run as well as long run impact on institution.

To the maximum possible extent institutions should establish systems / models that quantify theirrisk profile, however, in some risk categories such as operational risk, quantification is quitedifficult and complex. Wherever it is not possible to quantify risks, qualitative measures shouldbe adopted to capture those risks. Whilst quantitative measurement systems support effectivedecision-making, better measurement does not obviate the need for well-informed,qualitativejudgment. Consequently the importance of staff having relevant knowledge and expertise cannot

be undermined.

Independent review

One of the most important aspects in risk management philosophy is to make surethat thosewho take or accept risk on behalf of the institution are not the ones who measure, monitor andevaluate the risks. Again the managerial structure and hierarchy of risk reviewfunction may varyacross banks depending upon their size and nature of the business, the key is independence. Tobe effective the review functions should have sufficient authority, expertise and corporate statureso that the identification and reporting of their findings could be accomplishedwithout anyhindrance. The findings of their reviews should be reported to business units, SeniorManagement and, where appropriate, the Board.




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Contingency planning

Institutions should have a mechanism to identify stress situations ahead of time

and plans to dealwith such unusual situations in a timely and effective manner. Stress situationsto which thisprinciple applies include all risks of all types. For instance contingency planning activitiesinclude disaster recovery planning, public relations damage control, litigationstrategy,responding to regulatory criticism etc. Contingency plans should be reviewed regularly to ensurethey encompass reasonably probable events that could impact the organization. Plans should betested as to the appropriateness of responses, escalation and communication chan

nels and theimpact on other parts of the institution.




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CREDIT RISK

Credit risk with respect to bank is most simply defined as the risk of a borrowe

rs paymentdefault on payment of interest and principal due to the borrowers unwillingness or inability toservice the debt. The higher the credit risk an institution is exposed to, the greater the losses maybe. For banks and most other credit institutions, credit risk is considered to be the form of riskthat can most significantly diminish earnings and financial strength. The effective managementof credit risk is a critical component of a comprehensive approach to risk management andessential to the long-term success of any banking organization. Banks should als

o consider therelationships between credit risk and other risks.

Sources of credit risk

The credit risk as the figure given below indicates can be divided into three categories.

Types of Credit Risk

Default RiskProbability of Default

Exposure RiskRecovery RiskExposure at Default

Loss Given Default




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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 standingwould dependupon factors such as market outlook of borrowing company, quality of management,strengthsand weaknesses of the company and certain competitive factors. The measures available areeither ratings or historical statistics on default which can be used as proxy for default risk.

Exposure risk

Exposure risk arises due to uncertainty associated with future amount of risk. It is the amount ofrisk in the event of default without considering the recoveries.

Amortized credit is repaid on the basis of a contractual schedule so that futureoutstandingbalances are known in advance except in case of prepayment for which an option is provided tothe borrower. For all these credit lines for which there is a repayment schedulethe exposure riskcan be considered as small or negligible as the exposure to such loans can be included at the timeof loan pricing.

Project financing implies uncertainty in scheduling of the outflows and repayments. In generalall the off balance sheet items can generate substantial future exposure. In some cases suchexposure is high e.g. banks commitment to lend money up to some maximum amount subject toneeds of borrower. However in some cases future exposure is small e.g. guaranteegiven to thirdparties. Here the exposure is contingent upon the failure of the borrower to comply with hisobligation.

Recovery risk

The recoveries in the event of default are not predictable. They depend upon thetype of defaultand numerous other factors such as whether guarantees have been received from the borrowers,the type of such guarantees and strength of the collateral, covenants, third party guarantee andcircumstances surrounding default.




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IMPORTANCE OF CREDIT RISK ASSESSMENT

Effective credit risk assessment and loan accounting practices should be performed in asystematic way and in accordance with established policies and procedures. To beable toprudently value loans and to determine appropriate loan provisions, it is particularly importantthat banks have a system in place to reliably classify loans on the basis of credit risk. Largerloans should be classified on the basis of a credit risk grading system. Other,smaller loans maybe classified on the basis of either a credit risk grading system or payment delinquency status.

Both accounting frameworks and Basel II recognize loan classification systems astools inaccurately assessing the full range of credit risk. Further, Basel II and accounting frameworksboth recognize that all credit classifications, not only that reflecting severecredit deterioration,should be considered in assessing probability of default and loan impairment.

A well-structured loan grading system is an important tool in differentiating the degree of creditrisk in the various credit exposures of a bank. This allows a more accurate determination of theoverall characteristics of the loan portfolio, probability of default and ultima

tely the adequacy ofprovisions for loan losses. In describing a loan grading system, a bank should address thedefinitions of each loan grade and the delineation of responsibilities for the design,implementation, operation and performance of a loan grading system.

Credit risk grading processes typically take into account a borrowers current financial conditionand paying capacity, the current value and reliability of collateral and other borrower and facilityspecific characteristics that affect the prospects for collection of principal and interest. Becausethese characteristics are not used solely for one purpose (e.g. credit risk or financial reporting), abank may assign a single credit risk grade to a loan regardless of the purpose for which thegrading is used. Both Basel II and accounting frameworks recognize the use of internal (orexternal) credit risk grading processes in determining groups of loans that would be collectivelyassessed for loan loss measurement. Thus, a bank may make a single determinationof groups ofloans for collective assessment under both Basel II and the applicable accounting framework.




CREDIT RISK

Credit Rating is the main tool to assess credit risk, which helps in measuring the creditrisk and facilitates the pricing of the account. It gives the vital indications

of weaknesses in theaccount. It also triggers portfolio management at the corporate level. Therefore, banks shouldrealize the importance of developing and implementing effective internal creditriskmanagement. It involves evaluating and assessing an institutions risk management,capitaladequacy, and asset quality. Risk ratings should be reviewed and updated whenever relevant newinformation is received. All credits should receive a periodic formal review (e.g. at leastannually) to reasonably assure that credit risk grades are accurate and up-to-da

te. Credit riskgrades for individually assessed loans that are either large, complex, higher risk or problemcredits should be reviewed more frequently.

To ensure the proper administration of their various credit risk-bearing portfolio thebanks 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

beconsistent with the nature, size and complexity of a banks activities, Information systems and analytical techniques that enable the management to measurethe credit risk inherent in all on-and off-balance sheet activities. Themanagement information system should provide adequate information on thecomposition of the credit portfolio, including identification of anyconcentrations 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 creditrisk among theirbusiness loans. For larger institutions, the number and geographic dispersion oftheir borrowers




CREDIT RISK

makes it increasingly difficult to manage their loan portfolio simply by remaining closely attunedto the performance of each borrower.

To control credit risk, it is important to identify its gradations among business loans, and assigninternal credit risk ratings to loans that correspond to these gradations. The use of such aninternal rating process is appropriate and indeed necessary for sound risk management at largeinstitutions. The long-term goal of this analysis is to encourage broader adoption of soundpractices in the use of such ratings and to promote further innovation and enhancement by theindustry in this area.

Internal rating systems are primarily used to determine approval requirements and identifyproblem loans, while on the other end they are an integral element of credit portfolio monitoringand management, capital allocation, pricing of credit, profitability analysis, and detailed analysisto support loan loss reserving. Internal rating systems being used for the former purposes. Aswith all material bank activities, as sound risk management process should adequately illuminatethe risks being taken and apply appropriate control allow the institution to balance risks against

returns and the institutions overall appetite for risk, giving due considerationto the uncertaintiesfaced by lenders and the long-term viability of the bank.

Based on the historical data which is both financial and non-financial a score is arrived at. Theborrower is then classified into different classes of credit rating based on thescore which is usedto determine the rate of interest to be charged.

Banking organizations should have strong risk rating systems. These systems should take properaccount of the gradations in risk and overall composition of portfolios inoriginating new loans, assessing overall portfolio risks and concentrations, andreporting on riskprofiles to directors and management. Moreover, such rating systems also shouldplay animportant role in establishing an appropriate level for the allowance for loan and lease losses,conducting internal bank analysis of loan and relationship profitability..




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When making credit rating decisions, banks review credit application and creditreports withrespect to financial risk. Once lenders make a yes decision, they review the credi

t reports oftheir customers on a regular basis as they continue to manage their financial risk. This processscans credit reports for certain risk characteristics as defined by the lender.

Banks pool assets and loans, which have a possibility of default and yet providethe depositorswith the assurance of the redemption at full face value. Credit risk, in terms of possibilities ofloss to the bank, due to failure of borrowers/counterparties in meeting commitment to thedepositors. Credit risk is the most significant risk, more so in the Indian scen

ario where the NPAlevel of the banking system is significantly high. The management of credit riskthrough anefficient credit administration is a prerequisite for long-term sustainability/profitability of abank. A proper credit administration reduces the incidence of credit risk.

Credit risk depends on both internal and external factors. Some of the importantexternal factorsare state of economy, swings in commodity prices, foreign exchange rates and interest rates etc.The internal factors may be deficiencies in loan policies and administration ofloan portfolio

covering areas like prudential exposure limits to various categories, appraisalof borrowersfinancial position, excessive dependence on collaterals, mechanism of review andpost-sanctionsurveillance, etc.

The key issue in managing credit risk is to apply a consistent evaluation and ratingsystem to all investment opportunities. Prudential limits need to be laid down on various aspectsof credit viz., benchmarking current ratio, debt-equity ratio, profitability ratio, debt servicecoverage ratio, concentration limits for group/single borrower, maximum exposurelimits toindustries, provision for flexibilities to allow variation for very special features. Credit ratingmay be a single point indicator of diverse risk factors. Management of credit ina bank willrequire alertness on the part of the staff at all the stages of credit deliveryand monitoringprocess. Lack of such standards in financial institution would increase the problem of increasingloan write-offs. The bank can ensure this through credit rating and loan documentation.




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MANAGING CREDIT RISK

Credit risk arises from the potential that an obligor is either unwilling to perform on anobligation or its ability to perform such obligation is impaired resulting in economic loss to thebank.

In a banks portfolio, losses stem from outright default due to inability or unwillingness of acustomer or counter party to meet commitments in relation to lending, trading, settlement andother financial transactions. Alternatively losses may result from reduction inportfolio value due

to actual or perceived deterioration in credit quality.

Credit risk emanates from a banks dealing with individuals, corporate, financialinstitutions or asovereign. For most banks, loans are the largest and most obvious source of credit 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 context of economicexposures. This encompasses opportunity costs, transaction costs and expenses associated with anon-performing asset over and above the accounting loss.

Credit risk can be further sub-categorized on the basis of reasons of default. For instance thedefault could be due to country in which there is exposure or problems in settlement of atransaction.

Credit risk not necessarily occurs in isolation. The same source that endangerscredit risk for theinstitution may also expose it to other risk. For instance a bad portfolio may attract liquidityproblem




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Securitisation of Credit Exposures:Important Tool of Credit Risk Managementunder Basel Accord II

Securitisation, as a new Credit Risk Management Product, is the buzzword of thefinancialservices industry today. As a matter of fact, following the age-old system ofcredit risk management may not always suit the regime of liberalisation, privatisationand globalisation in world economies. It is, therefore, required that banks/credit institutionsshould constantly devise newer forms of credit risk management by articulated research. Severalkey initiatives taken in this regard finally gave birth to securitization of credit 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 atransfer ofoutstanding balances in Loans/Advances and packaging into transferable and tradable securities.This enables them to reduce their exposures to particular sectors e.g. Real Estate as may beconsidered necessary from their business development angle and, simultaneously to ensure cashinflows to deal with liquidity crunch and/or for other business reasons.

Securitisation is a financing tool. It involves creating, combining and recombining of assets andsecurities. Basel Accord II has considered securitisation aspects in a broader perspective as: ATraditional Securitisation is a structure where the cash flow from an underlyingpool ofexposures is used to service at least two different stratified risk positions ortrenches reflectingdifferent degrees of credit risk. Payments to the investors depend upon the performance of thespecified underlying exposures, as opposed to being derived from an obligation of the entityoriginating those exposures.




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The Accord has also identified another variant of securitisation as Synthetic Securitisation, which is akin to a Credit Derivative. In this regard it has been laid down that:

A syntheticsecuritisation is a structure with at least two different stratified risk positions to reflect differentdegrees of credit risk where credit risk of an underlying pool of exposures is transferred, inwhole or in part, through the use of funded (e.g. credit linked notes) or unfunded (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

adlycategorized into following main components.

Board and senior Managements Oversight Organizational structure Systems and procedures for identification, acceptance, measurement,monitoring and control risks.Board and Senior Managements Oversight

It is the overall responsibility of banks Board to approve banks credit risk strategy andsignificant policies relating to credit risk and its management which should bebased on the

banks overall business strategy. To keep it current, the overall strategy has tobe reviewed by theboard, preferably annually. The responsibilities of the Board with regard to credit riskmanagement shall, interalia, include:

Delineate banks overall risk tolerance in relation to credit risk..ATMIYA INSTITUTE OF TECHNOLOGY & SCIENCE ( MBA DEPARTMENT ) Page 60



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Ensure that banks overall credit risk exposure is maintained at prudent levels andconsistent 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 managementfunction. Ensure that the bank implements sound fundamental principles tha facilitate theidentification, measurement, monitoring and control of credit risk. Ensure that appropriate plans and procedures for credit risk management are in place.The very first purpose of banks credit strategy is to determine the risk appetiteof the bank.Once it is determined the bank could develop a plan to optimize return while keeping credit riskwithin predetermined limits. The banks credit risk strategy thus should spell out

,

The institutions plan to grant credit based on various client segmentsand products, economic sectors, geographical location, currency andmaturity Target market within each lending segment, preferred level ofdiversification/concentration. Pricing strategy.It is essential that banks give due consideration to their target market whiledevising credit risk strategy.

The strategy should provide continuity in approach and take into account cyclic

aspect ofcountrys economy and the resulting shifts in composition and quality of overall credit portfolio.While the strategy would be reviewed periodically and amended, as deemed necessary, it shouldbe viable in long term and through various economic cycles.




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The senior management of the bank should develop and establish credit policies and creditadministration procedures as a part of overall credit risk management framework

and get thoseapproved from board. Such policies and procedures shall provide guidance to thestaff on varioustypes of lending including corporate, SME, consumer, agriculture, etc. At minimum the policyshould include

Detailed and formalized credit evaluation/ appraisal process. Credit approval authority at various hierarchy levels including authority for approvingexceptions. Risk identification, measurement, monitoring and controlRisk acceptance criteria Credit origination and credit administration and loan documentation

procedures Roles and responsibilities of units/staff involved in origination andmanagement of credit. Guidelines on management of problem loans.ATMIYA INSTITUTE OF TECHNOLOGY & SCIENCE ( MBA DEPARTMENT ) Page 62



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Organizational Structure

To maintain banks overall credit risk exposure within the parameters set by the b

oard ofdirectors, the importance of a sound risk management structure is second to none. While thebanks may choose different structures, it is important that such structure should becommensurate with institutions size, complexity and diversification of its activities. It mustfacilitate effective management oversight and proper execution of credit risk management andcontrol 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, creditdepartmentand treasury. This committee reporting to banks risk management committee shouldbeempowered to oversee credit risk taking activities and overall credit risk management 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 approved by

the Board. Recommend to the Board, for its approval, clear policies on standards for presentation ofcredit proposals, financial covenants, rating standards and benchmarks. Decide delegation of credit approving powers, prudential limits on large creditexposures, standards for loan collateral, portfolio management, loan review mechanism,risk concentrations, risk monitoring and evaluation, pricing of loans, provisioning,regulatory/legal compliance etc.Further, to maintain credit discipline and to enunciate credit risk management and controlprocess there should be a separate function independent of loan origination function. Credit




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policy formulation, credit limit setting, monitoring of credit exceptions / exposures and review/monitoring of documentation are functions that should be performed independentl

y of the loanorigination function. For small banks where it might not be feasible to establish such structuralhierarchy, there should be adequate compensating measures to maintain credit disciplineintroduce adequate checks and balances and standards to address potential conflicts 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

andensure the risks remain within the boundaries established by the Board or CreditRiskManagement Committee. The department also ensures that business lines comply with risk parameters andprudential limits established by the Board or CRMC. Establish systems and procedures relating to risk identification, ManagementInformation System, monitoring of loan / investment portfolio quality and earlywarning. The department would work out remedial measure when deficiencies/problemsare identified. The Department should undertake portfolio evaluations and conduct comprehensivestudies on the environment to test the resilience of the loan portfolio.

Notwithstanding the need for a separate or independent oversight, the front office or loanorigination function should be cognizant of credit risk, and maintain high levelof creditdiscipline and standards in pursuit of business opportunities.




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Systems and procedures

Credit Origination.

Banks must operate within a sound and well-defined criteria for new credits as well as theexpansion of existing credits. Credits should be extended within the target markets and lendingstrategy of the institution. Before allowing a credit facility, the bank must make an assessment ofrisk profile of the Customer/transaction. This may include

Credit assessment of the borrowers 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 authorityWhile structuring credit facilities institutions should appraise the amount andtiming of the cashflows as well as the financial position of the borrower and intended purpose ofthe funds. It isutmost important that due consideration should be given to the risk reward trade off in grantinga credit facility and credit should be priced to cover all embedded costs. Relevant terms andconditions should be laid down to protect the institutions interest.




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Institutions have to make sure that the credit is used for the purpose it was borrowed. Where theobligor has utilized funds for purposes not shown in the original proposal, inst

itutions shouldtake steps to determine the implications on creditworthiness. In case of corporate loans whereborrower own group of companies such diligence becomes more important. Institutions shouldclassify such connected companies and conduct credit assessment on consolidated/group basis.

Institution should not over rely on collaterals / covenant. Although the importance of collateralsheld against loan is beyond any doubt, yet these should be considered as a buffer providing

protection in case of default, primary focus should be on obligors debt servicingability and

reputation in the market.

Limit setting

An important element of credit risk management is to establish exposure limits for singleobligors and group of connected obligors. Institutions are expected to develop their own limitstructure while remaining within the exposure limits set by State Bank of Pakistan. The size ofthe limits should be based on the credit strength of the obligor, genuine requir

ement of credit,economic conditions and the institutions risk tolerance. Appropriate limits should be set forrespective products and activities. Institutions may establish limits for a specific industry,economic sector or geographic regions to avoid concentration risk.

Some times, the obligor may want to share its facility limits with its related companies.Institutions should review such arrangements and impose necessary limits if thetransactions arefrequent and significant

Credit limits should be reviewed regularly at least annually or more frequentlyif obligors creditquality deteriorates. All requests of increase in credit limits should be substantiated.




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Credit Administration.

Ongoing administration of the credit portfolio is an essential part of the credi

t process. Creditadministration function is basically a back office activity that support and control extension andmaintenance of credit. A typical credit administration unit performs following functions:

Documentation. It is the responsibility of credit administration to ensure completenessof documentation (loan agreements, guarantees, transfer oftitle of collaterals etc) in accordance with approved terms and conditions.Outstanding documents should be tracked and followed up to ensureexecution and receipt.Credit Disbursement. The credit administration function should ensurethat the loan application has proper approval before entering facility limits

into computer systems. Disbursement should be effected only aftercompletion of covenants, and receipt of collateral holdings. In case ofexceptions necessary approval should be obtained from competentauthorities. Credit monitoring. After the loan is approved and draw down allowed, theloan should be continuously watched over. These include keeping track ofborrowers compliance with credit terms, identifying early signs ofirregularity, conducting periodic valuation of collateral and monitoring timelyrepayments.ATMIYA INSTITUTE OF TECHNOLOGY & SCIENCE ( MBA DEPARTMENT ) Page 67



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Loan Repayment. The obligors should be communicated ahead of time as and when theprincipal/markup installment becomes due. Any exceptions such as non-payment orlate

payment should be tagged and communicated to the management. Proper records andupdates should also be made after receipt. Maintenance of Credit Files. Institutions should devise procedural guidelines andstandards for maintenance of credit files. The credit files not only include all correspondence with the borrower but should also contain sufficient informationnecessary to assess financial health of the borrower and its repayment performance. Itneed not mention that information should Managing credit risk. Collateral and Security Documents. Institutions should ensure that all securitydocuments are kept in a fireproof safe under dual control. Registers for documen

tsshould be maintained to keep track of their movement. Procedures should also beestablished to track and review relevant insurance coverage for certainfacilities/collateral. Physical checks on security documents should be conductedon aregular basis.Measuring credit risk

The measurement of credit risk is of vital importance in credit risk management.A number ofqualitative and quantitative techniques to measure risk inherent in credit portfolio are evolving.To start with, banks should establish a credit risk rating framework across all

type of creditactivities. Among other things, the rating framework may, incorporate:

Business Risk

o Industry Characteristicso Competitive Position (e.g. marketing/technological edge)o ManagementATMIYA INSTITUTE OF TECHNOLOGY & SCIENCE ( MBA DEPARTMENT ) Page 68



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Financial Risk

o Financial condition

o Profitabilityo Capital Structureo Present and future Cash flowsInternal risk rating.Credit risk rating is summary indicator of a banks individual credit exposure. Aninternal ratingsystem categorizes all credits into various classes on the basis of underlying credit quality. Awell-structured credit rating framework is an important tool for monitoring andcontrolling riskinherent in individual credits as well as in credit portfolios of a bank or a business line. The

importance of internal credit rating framework becomes more eminent due to the fact thathistorically major losses to banks stemmed from default in loan portfolios. While a number ofbanks already have a system for rating individual credits in addition to the risk categoriesprescribed by SBP, all banks are encouraged to devise an internal rating framework. An internalrating 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 accuratecomputation of future loan loss provision Deciding the level of Approving authority of loan.Managing credit riskATMIYA INSTITUTE OF TECHNOLOGY & SCIENCE ( MBA DEPARTMENT ) Page 69



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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 ratingcontinuum corresponding to each loss concept.

b) Whether to rate a borrower on the basis of point in time philosophy orthrough the cycle approach.

A rating system with large number of grades on rating scale becomes more expensive due to thefact that the cost of obtaining and analyzing additional information for fine gr

adation increasessharply. However, it is important that there should be sufficient gradations topermit accuratecharacterization of the under lying risk profile of a loan or a portfolio of loans

The operating Design of Rating System

.As with the decision to grant credit, the assignment of ratings always involve element of humanjudgment. Even sophisticated rating models do not replicate experience and judgment rather

these techniques help and reinforce subjective judgment. Banks thus design the operating flow ofthe rating process in a way that is aimed promoting the accuracy and consistencyof the ratingsystem while not unduly restricting the exercise of judgment. Key issues relating to the operatingdesign of a rating system include what exposures to rate; the organizations division ofresponsibility for grading; the nature of ratings review; the formality of the process andspecificity of formal rating definitions.




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What Exposures are rated?

Ideally all the credit exposures of the bank should be assigned a risk rating. H

owever given theelement of cost, it might not be feasible for all banks to follow. The banks maydecide on theirown which exposure needs to be rated. The decision to rate a particular loan could be based onfactors such as exposure amount, business line or both. Generally corporate andcommercialexposures are subject to internal ratings and banks use scoring models for consumer / retailloans.

The rating process in relation to credit approval and review.

Ratings are generally assigned /reaffirmed at the time of origination of a loanor its renewal/enhancement. The analysis supporting the ratings is inseparable from that required for creditappraisal. In addition the rating and loan analysis process while being separateare intertwined.The process of assigning a rating and its approval / confirmation goes along with the initiation ofa credit proposal and its approval. Generally loan origination function (whethera relationship

The credit risk exposure involves both the probability of Default (PD) and loss

in the event ofdefault or loss given default (LGD). The former is specific to borrower while the latercorresponds to the facility. The product of PD and LGD is the expected loss. Point in timemeans to grade a borrower according to its current condition while through the cycle approachgrades a borrower under stress conditions.

Manager or credit staff initiates a loan proposal and also allocates a specificrating. This proposalpasses through the credit approval process and the rating is also approved or recalibratedsimultaneously by approving authority. The revision in the ratings can be used to upgrade therating system and related guidelines.




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How to arrive at ratings

The assignment of a particular rating to an exposure is basically an abbreviatio

n of its overallrisk profile. Theoretically ratings are based upon the major risk factors and their intensityinherent in the business of the borrower as well as key parameters and their intensity to those riskfactors. Major risk factors include borrowers financial condition, size, industry and position inthe industry; the reliability of financial statements of the borrower; quality of management;elements of transaction structure such as covenants etc. A more detail on the subject would bebeyond the scope of these guidelines, however a few important aspects are

a) Banks may vary somewhat in the particular factors they consider andthe weight they give to each factor.

b) Since the rater and reviewer of rating should be following the same basic thought, to ensureuniformity in the assignment and review of risk grades, the credit policy shouldexplicitly defineeach risk grade; lay down criteria to be fulfilled while assigning a particulargrade, as well as thecircumstances 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 toensure 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 ratingsystem prior toadopting one. Adequate validation testing should be conducted during the designphase as wellas over the life of the system to ascertain the applicability of the system to the institutionsportfolio.




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Institutions that use sophisticated statistical models to assign ratings or to calculate probabilitiesof default, must ascertain the applicability of these models to their portfolios

. Even when suchstatistical models are found to be satisfactory, institutions should not use theoutput of suchmodels as the sole criteria for assigning ratings or determining the probabilities of default. Itwould 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 eyeon thefinancial stability of the borrower. In the event of any deterioration the ratings are immediatelyrevised /reviewed

b) Secondly the risk review functions of the bank or business lines also conductperiodicalreview of ratings at the time of risk review of credit portfolio.

Risk ratings should be assigned at the inception of lending, and updated at least annually.

Institutions should, however, review ratings as and when adverse events occur. Aseparatefunction independent of loan origination should review Risk ratings. As part ofportfoliomonitoring, institutions should generate reports on credit exposure by risk grade. Adequate trendand migration analysis should also be conducted to identify any deterioration incredit quality.Institutions may establish limits for risk grades to highlight concentration inparticular ratingbands.It is important that the consistency and accuracy of ratings is examined periodically by a functionsuch as an independent credit review group For consumer lending, institutions may adopt credit-scoring models for processing loan applications and monitoring credit quality. Institutions shouldapply the above principles in the management of scoring models. Where the modelis relativelynew, institutions should continue to subject credit applications to rigorous review until the modelhas stabilized.




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Credit derivatives

Credit derivatives EVERY silver lining has a cloud. The much-hyped market for creditderivatives, which allow users to buy or sell credit risk, seems to be thriving.In mid-July theInternational Swaps and Derivatives Association (ISDA), a trade association, issued a newmaster agreement intended to standardise contracts for credit derivativesas ISDA has donein the past for other sorts of derivative. And this month CreditTrade, a new Internet-basedexchange, started trading, among other products, credit derivatives. Another, Creditex, is due to

do the same later this year.But the market is mostly shrouded in gloom. Having grown at a giddy pace at first, dealers atmany banksthough not those at J.P. Morgan, by far the market leadersay that the number ofdeals has fallen by half at least in the past year. Activity in the past three months has beenespecially sluggish.

Why so? Credit derivatives are simple and attractive enough in theory. For example, the buyer ofa default swap, the most popular sort, pays the seller a fee so that, if a borrower defaults, the

seller takes over the debt at face value. But the protection the swaps provide has proved full ofholes. There is, for a start, the issue of what constitutes a default. Last year, when Russiadefaulted on its domestic debts, those who had bought default protection on itsforeign debtsclaimed that a general credit event had occurred, so the swap-sellers should coughup. Thesellers, begged to differ. Lawyers were summoned .

Then there is market manipulation. Most default swaps are settled physically: the buyer has todeliver securities or loans if a borrower defaults. He can choose to deliver a number of differenttypes, but this incurs the risk that the hedge he has bought does not exactly match his exposure.Specifying more exactly the security that is deliverable helps to reduce that risk, but increasesanother: that the seller can push its price up. If the protection-buyer does nothave the securities,he must buy them in the market. The seller can buy (and many have) the securities himself(especially if he has sold more swaps than there are underlying securities).




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Business has been further dented this year, argues Sanjeev Gupta, the head of credit derivativesat Credit Suisse First Boston, because credit spreadsthe extra amount that corpor

ate bondsyield over government bondshave been high and volatile. Default swaps in essencegrant anoption on default to the buyer of protection. These options become more valuablethe morevolatile a market becomes. So the default swaps themselves have become pricier.And, hesuggests, many banksthe main buyers of credit derivativesmay have got rid of manyof theexposures they no longer want.

Credit derivatives AFTER all the credit disasters that have afflicted internatio

nal lenders inrecent months, one might have expected some people at least to be looking smug.These farsighted folk had bought insurance against their borrowers defaulting, bydabbling in the growingmarket for credit derivatives. Much of the insurance covered loans to risky emerging markets.Sure enough, two of those marketsRussia and Indonesiahave, in effect, defaulted. Butunfortunately perspicacity has not been rewarded. Many of the insured have foundthemselveswith less protection than they thoughtor even with none at all.

Lawyers have been called in to try to sort out the mess in several disputed deal

s; one bankerforecasts a miasma of litigation. Many disputes involve Credit Suisse First Boston, which wasthe biggest actor in the Russian market.

The most popular type of credit derivative is a default swap. In theory, the deal is simple. Theseller of the swap agrees that, should a borrower default, he will take over thedebt at face value;in return he collects a fee from his counterparty. The great attraction of thisis to allow both sidesto take a pure view of a borrowers credit risk (which has usually been bundled together, forexample in a bond, with interest-rate risk).

This has made the swaps appealing to banks that want to buy protection for theirloan portfolios,or to take credit risk without having to finance itwhich has become expensive formany bankslately. Traders wanting to take a punt purely on borrowers creditworthiness havealso been keen.Many default swaps were embedded in bonds (so-called credit-linked notes) that paid a biginterest rate so long as, say, Russia did not default. The market has grown rapidly, especially in




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Asia, where concerns about default have been greatest. According to the BritishBankers Association, the volume of outstanding credit-derivative contracts has doubled o

ver the pastyear.

Unfortunately, the market has hit a couple of snags. Simple in theory, default swaps are anythingbut in practice. The market has always been inefficiently priced. The buyer of the insurance is,after all, also taking a credit risk on the insurer. But the prices charged by the providers of suchguarantees do not reflect their different credit-standings.

Recently, however, two new questions have come to the fore: how to define a defa

ult, and howto settle the deals. The first question has caused huge headaches for buyers ofswaps onsovereign borrowers. Whether Indonesias restructuring constituted default has been a matter ofheated debate. Russias position is even more contentious. It has defaulted on itsdomestic debts,but, so far, has maintained payments on its foreign ones. Does this constitute what the marketdubs a credit eventi.e., something going badly wrongon the foreign debt too? If so,theswaps written on it would be triggered. Buyers of insurance think just such an event has taken

place; sellers, not surprisingly, do not. Swap agreements are horribly vague onthe subject.

Passing on the risks

Banks are making increasing use of a new type of derivative to reduce their exposure to theoldest of all financial risks

OCCASIONALLY infamous increasingly ubiquitous derivatives have transformed financialmarkets. There is now a vast array of swaps options and so on that allow investors to avoid at aprice the risk that interest rates currencies and asset priceswill rise or fall. Until recently however there has been a big gap in this richselection: a lack of athriving market in derivatives that give a bank the ability to lay off its credit risk-the danger thata borrower will simply fail to meet interest payments or repay a debt.

Invented about five years ago credit derivatives are a variety of instruments and




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techniques designed to separate and then transfer the credit risk of underlyinginstruments suchas loans or bonds. Although they are still small beer-mere billions in a trillio

n-dollar world-demand for them has been growing steadily: CIBC Wood Gundy a Canadian investmentbankestimates that from almost nothing in 1993 the market in credit derivatives hasgrown to around$ 40 billionof outstanding transactions half of which have involved the credit risk of developingcountries' debts.

Credit risk has bedevilled intermediaries ever since the first loan was made. Modern banking hasbeen built on the sensible notion that a large group of loansheld together is le

ss risky thanholding a single one: although some of the borrowers will go bust the damage they do should bemore than offset by the interest received from those that do not.

Even so some banks have still come a-cropper often because their portfolio of loans was tooheavily concentrated in a single geographical region or industry; in such caseswhen times arehard for one borrower the chances are that all of them are suffering leaving thebank exposed towidespread defaults. Examples abound of institutions humbled in recent years byconcentrations

of credit risk from America's Citibank to Britains Barclays as well as almost theentire Japanesebanking system.

Stung by these huge loan losses big banks are keen to manage credit risk more efficiently. Theyhave tried both to set interest rates that better reflect borrowers' relative riskiness and to reducethe degree of concentration in theirportfolios. But until recently there was little scope for them tounload their credit risk directly.

For one thing borrowers have resisted the development of a secondary market forbank loans(one exists but it is tiny and deals mainly with troubled loans). Firms are generally unwilling tosee their debt sold on. Banks have also been reluctant sellers on the ground that dumping acustomer's debt would risk losingthem more than just lending business-the chanceto underwritea future share issue say or lucrative advisory work. Protecting the relationshipwas given a higherpriority than offloading some of the credit risk.




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A seal of approval

Credit derivatives could change all that. One reason that they are blossoming is

that several bigfirms have begun to make markets in them improving overall liquidity. Another isthat regulatorshave begun to contemplate the implications of their widespread use. In recent months the NewYork Federal Reserve Bank and the Office of the Comptroller of the Currency twobankregulators have issued supervisory guidelines to their charges explaining creditderivatives anddescribing 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 theyachieve is simple enough. If a bank thinks it is overexposed to a big borrower it can use a creditswap say to reduce its risk. Basically the bankpays a small regular fee to its counterparty on theswap. If the borrower in question defaults then the counterparty compensates thebank for itslosses. All this can be done without offending the borrower who need not be toldof thetransaction.

Credit derivatives can be used to limit a bank's exposure to entire industries or even countries as

well as to individual borrowers. As Charles Smithson of CIBC Wood Gundy points out an Italianbank is likely to be best placed to make loans to Italian companies. But it maymake more sensefor say an American bank to hold some of the credit risk associated with the Italian banks loansin order to diversify its own portfolio. A credit swap would allow it to do thiswithout having tobuy the Italian loans lock stock and barrel.

Nor are banks the only ones interested in the credit-derivatives market. Hedge funds have alsobecome keen participants because it is a way for them to gain exposure to assetsother thanequities and bonds. As the chart above shows this has been an attractive proposition in recentyears: risk-adjusted returns on loans have been greater than those on equities and other assets.Moreover by using credit derivatives investors in bonds can punt solely on a firm's creditstanding without having to worry about the effect of changes in interest rates as well.




CREDIT RISK

Blythe Masters of JP Morgan an American bank points out that as credit derivatives becomemore popular they are causing important changes in credit pricing. At present bo

rrowerssometimes raise money at different rates in different markets: each rate reflects in effect adifferent price for the borrower's credit. Credit derivatives create an opportunity to arbitragethese inefficiencies away.

Given all these benefits why have credit derivatives been relatively slow to take off? One reasonis that shortly after their invention the reputation of all derivatives was battered by disputesinvolving their use at American firms such as Gibson Greetings and Procter & Gam

ble. It hastaken time to convince banks and other potential users that credit derivatives are benign.




CREDIT RISK

CREDIT RISK MONITORING & CONTROL

Credit risk monitoring refers to incessant monitoring of individual credits inclusive of Off-Balance sheet exposures to obligors as well as overall credit portfolio of the bank. Banks need toenunciate a system that enables them to monitor quality of the credit portfolioon day-to-daybasis and take remedial measures as and when any deterioration occurs. Such a system wouldenable a bank to ascertain whether loans are being serviced as per facility terms, the adequacy ofprovisions, the overall risk profile is within limits established by managementand compliance of

regulatory limits.

Establishing an efficient and effective credit monitoring system would help senior managementto monitor the overall quality of the total credit portfolio and its trends. Consequently themanagement could fine tune or reassess its credit strategy /policy accordingly beforeencountering any major setback. The banks credit policy should explicitly provide proceduralguideline relating to credit risk monitoring. At the minimum it should lay downprocedurerelating to

a) The roles and responsibilities of individuals responsible for credit riskmonitoring

b) The assessment procedures and analysis techniques (for individualloans & 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




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 isits financial health, as it would determine its repayment capacity. Consequentlyinstitutions needcarefully watch financial standing of obligor. The Key financial performance indicators onprofitability, equity, leverage and liquidity should be analyzed. While making such analysis dueconsideration should be given to business/industry risk, borrowers position within the industryand external factors such as economic condition, government policies, regulations. Forcompanies whose financial position is dependent on key management personnel and/

orshareholders.b. Conduct of Accounts. In case of existing obligor the operation in the accountwould give afair idea about the quality of credit facility. Institutions should monitor theobligors accountactivity, repayment history and instances of excesses over credit limits. For trade financing,institutions should monitor cases of repeat extensions of due dates for trust receipts and bills.c. Loan Covenants. The obligors ability to adhere to negative pledges and financial covenantsstated in the loan agreement should be assessed, and any breach detected should

be addressedpromptly.d. Collateral valuation. Since the value of collateral could deteriorate resulting in unsecuredlending, banks need to reassess value of collaterals on periodic basis. The frequency of suchvaluation is very subjective and depends upon nature of collaterals. For instance loan grantedagainst shares need revaluation on almost daily basis whereas if there is mortgage of a residentialproperty the revaluation may not be necessary as frequently.In case of credit facilities secured against inventory or goods at the obligors premises,appropriate inspection should be conducted to verify the existence and valuationof the collateral.And if such goods are perishable or such that their value diminish rapidly (e.g.electronicparts/equipments), additional precautionary measuresshould be taken.




CREDIT RISK

External Rating and Market Price of securities such as TFCs purchased as a formof lending orlong-term investment should be monitored for any deterioration in credit rating

of the issuer, aswell as large decline in market price. Adverse changes should trigger additionaleffort to reviewthe creditworthiness of the issuer.




CREDIT RISK

RISK REVIEW

The institutions must establish a mechanism of independent, ongoing assessment o

f credit riskmanagement process. All facilities except those managed on a portfolio basis should be subjectedto individual risk review at least once in a year. The results of such review should be properlydocumented and reported directly to board, or its sub committee or senior management withoutlending authority. The purpose of such reviews is to assess the credit administration process, theaccuracy of credit rating and overall quality of loan portfolio independent of relationship with theobligor.

Institutions should conduct credit review with updated information on the obligors financialand business conditions, as well as conduct of account. Exceptions noted in thecredit monitoringprocess should also be evaluated for impact on the obligors creditworthiness. Credit reviewshould also be conducted on a consolidated group basis to factor in the businessconnectionsamong entities in a borrowing group.

As stated earlier, credit review should be performed on an annual basis, howevermore frequent

review should be conducted for new accounts where institutions may not be familiar with theobligor, and for classified or adverse rated accounts that have higher probability of default.

For consumer loans, institutions may dispense with the need to perform credit review for certainproducts. However, they should monitor and report credit exceptions and deterioration.

Delegation of authority

Banks are required to establish responsibility for credit sanctions and delegateauthority toapprove credits or changes in credit terms. It is the responsibility of banks board to approve theoverall lending authority structure, and explicitly delegate credit sanctioningauthority to seniormanagement and the credit committee.




CREDIT RISK

Lending authority assigned to officers should be commensurate with the experience, ability andpersonal character. It would be better if institutions develop risk-based author

ity structure wherelending power is tied to the risk ratings of the obligor. Large banks may adoptmultiple creditapprovers for sanctioning such as credit ratings, risk approvals etc to institute a more effectivesystem of check and balance.

The credit policy should spell out the escalation process to ensure appropriatereporting andapproval of credit extension beyond prescribed limits. The policy should also spell outauthorities for unsecured credit (while remaining within SBP limits), approvals

of disbursementsexcess over limits and other exceptions to credit policy.

In cases where lending authority is assigned to the loan originating function, there should becompensating processes and measures to ensure adherence to lending standards. There shouldalso be periodic review of lending authority assigned to officers.

Managing credits problem

The institution should establish a system that helps identify problem loan aheadof time when

there may be more options available for remedial measures. Once the loan is identified asproblem, it should be managed under a dedicated remedial process.

A banks credit risk policies should clearly set out how the bank will manage problem credits.Banks differ on the methods and organization they use to manage problem credits.Responsibilityfor such credits may be assigned to the originating business function, a specialized workoutsection, or a combination of the two, depending upon the size and nature of thecredit and thereason for its problems. When a bank has significant credit-related problems, itis important tosegregate the workout function from the credit origination function. The additional resources,expertise and more concentrated focus of a specialized workout section normallyimprovecollection results.




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 toimplement remedial plans, by maintaining frequent contact and internal records of follow-upactions. Often rigorous efforts made at an early stage prevent institutions fromlitigations andloan lossesb. Workout remedial strategies. Some times appropriate remedial strategies suchasrestructuring of loan facility, enhancement in credit limits or reduction in interest rates helpimprove obligors repayment capacity. However it depends upon business condition,the nature

of problems being faced and most importantly obligors commitment and willingnessto repay

the loan. While such remedial strategies often bring up positive results, institutions need toexercise great caution in adopting such measures and ensure that such a policy must notencourage obligors to default intentionally. The institutions interest should bethe primaryconsideration in case of such workout plans. It needs not mention here that competent authority,before their implementation, should approve such workout plan.c. Review of collateral and security document. Institutions have to ascertain the loan

recoverable amount by updating the values of available collateral with formal valuation. Securitydocuments should also be reviewed to ensure the completeness and enforceabilityof contractsand collateral/guarantee.d. Status Report and Review Problem credits should be subject to more frequent review andmonitoring. The review should update the status and development of the loan accounts andprogress of the remedial plans. Progress made on problem loan should be reportedto the seniormanagement.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) and the issue isbecoming more and more unmanageable. The NPAs have direct impact on banks profitability,liquidity and equity. The NPAs of Indian Banks are relatively huge by international standard.Therefore the biggest ever challenge that the banking industry now faces is management ofNPAs. It is true that banks have to restrict their lending operations to securedadvances onlywith adequate collateral securities.

In this connection banks must aware of the problems and recovery legislations ofNPAs Nonperforming assets means an advance where payment of interest or repayment of installments ofprincipal or both remains for a period of more than 180 days.

The magnitude of NPAs have a direct impact on banks profitability as legally they are notallowed to book income on such accounts and at the same time banks are forced tomakeprovision on such assets as per the RBI guidelines. The Indian Banking sector isfacing a serioussituation in view of the mounting NPAs which are the tune of Rs.56, 000 crores i

n March2002.NPAs is an important parameter in the analysis of financial performance ofbanks. Thereduction of NPAs is necessary to improve profitability of the banks and complywith capitaladequacy norms.

Therefore, to solve the problems of existing NPAs, quality of appraisal supervision and followup should be improved. The NPAs can be avoided at the initial stage of credit consideration byputting rigorous and appropriate credit appraisal mechanism. This is in order torecover the NPAdebt, the judicial systems should revamped and is essential to enforce the SARFAESI Act withmore stringent provisions to realize the securities and personal assets of the defaulters.




CREDIT RISK

Reasons:

Various studies have been conducted to analysis the reasons for NPA. What ever m

ay becomplete elimination of NPA is impossible. The reasons may be widely classifiedin two:

(1) Over hang component(2) Incremental componentOver hang component is due to the environment reasons, business cycle etc.Incremental component may be due to internal bank management, credit policy, terms of creditetc.

Asset Classification:

The RBI has issued guidelines to banks for classification of assets into four categories.

1. Standard assets:A standard asset is one with respect to which no default in repayment in principal or payment ofinterest is perceived, and which does not disclose any problems nor carry more than normal riskattached 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 renegotiated after thecommencement of operation until the expiry of one year of satisfactory performance.

3. Doubtful assets:A doubtful asset means term loan or any other asset that remains substandard asset for a periodexceeding 12 months.

4. Loss assets:Loss asset is one where loss has been identified by internal or external auditors or the RBIinspector 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 riskType of research

Research design is a specification of methods & procedures for acquiring the information neededfor solving the problem. It is a master plan or a model to conduct the formal investigations.

There are mainly 2 types of research designs:

Exploratory DescriptiveThis project is based on exploratory study. Since exploratory research design helps in exploringor searching through a problem or situation to provide insights & understandingthis study alsoprovide the same about the credit risk management.




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 data2. Secondary dataPrimary 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 alreadyexisted in one orthe 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 India2. Bank of baroda3. Union bank of India

And three from private sector namely,3. ICICI bank4. HDFC bank5. Axis bankATMIYA 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 banks that isSBI, BOB, UBI, ICICI, HDFC, & AXIS BANK. However, Education loan is not providedbyICICI & AXIS BANK.




CREDIT RISK

Q: According to you, which loan is more secured?Interpretation: According to SBI, BOB, UBI, ICICI, HDFC, & AXIS BANK, home loanand

vehicle loan are more secured. According to UBI, Education loan is also more secured andaccording 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

eferenceto 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 preferenceto income.HDFC give preference to guarantee. SBI give preference to past record.




CREDIT RISK

Q: Which criteria(s) you most prefer before giving Business loan?Interpretation: All banks give preference to past record most. Moreover, UBI, ICICI, BOB &

AXIS BANK gives preference to income and property.UBI & HDFC give preference toguarantee.

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, AXIS &ICICI give second preference to past record.

Q: What is minimum and maximum amount you sanction?HOME LOANPublic sector Min. amount Max. amountState bank of India 1 lac No limitUnion bank of India 3 lac No limitBank of baroda 2 lac No limitPrivate sectorIcici bank 1 lac No limitHdfc bank 5 lac No limitAxis bank 2 lac No limit

BUSINESS LOAN

Public sector Min. amount Max. amountState bank of India 20000 No limitUnion bank of India 30000 No limitBank of baroda 25000 200 lacsPrivate sectorIcici bank 50000 No limitHdfc bank 1 lac No limitAxis bank 1 lac No limit




CREDIT RISK

EDUCATION LOAN

Public sector Min. amount Max. amountState bank of India As per fees 10 lacs

Union bank of India -90% of feesBank of baroda 1 lac 10 lacsPrivate sectorIcici bank N/A N/AHdfc bank 1 lac No limitAxis bank N/A N/A

VEHICLE LOAN

Public sector Min. amount Max. amountState bank of India 25000 No limit

Union bank of India 20000 No limitBank of baroda 20000 No limitPrivate sectorIcici bank 25000 No limitHdfc bank 20000 No limitAxis bank 25000 No limit




CREDIT RISK

Q: Do you take any collateral for loan(s)?Interpretation: SBI, UBI, BOB & HDFC take collaterals for Home loan. SBI, UBI, BOB &

AXIS BANK takes collaterals for Business loan. SBI, UBI, BOB take collateral forEducationloan. UBI, HDFC & ICICI take collaterals for Vehicle loan.




CREDIT RISK

Q: Your loan is how much percentage of your deposits?05

10152025301banks%of depositssbiubibobicici

hdfcaxisInterpretation: From above graph, we can interpret that ICICI BANK, AXIS BANK givinghigh percentage of loan with respect to their deposits so it is risky while UBI& BOB giving lesspercentage of deposits so they playing little bit safe.

Q: What percentage of customers default?0123

4561banks%of defaultersbiubibobicicihdfcaxisATMIYA INSTITUTE OF TECHNOLOGY & SCIENCE ( MBA DEPARTMENT ) Page 97



CREDIT RISK

Interpretation: From above graph we can interpret that defaulter ratio in publicsector banks issomewhat high as compare to private banks. From our sample size, SBI has highest

defaulterratio that is 5% & AXIS BANK has lowest ratio that is 0.01% which indicates goodrecoverychannel.

Q: If customer default how long you wait for due?Interpretation: From above graph, we can interpret those public banks such as SBI, UBI, BOBwait up to just 1 month if customer defaults than it started proceeds towards recovery part whileprivate bank like HDFC waits up to 3 months & ICICI waits for more than 3 months.




CREDIT RISK

Q: How you recover from defaulter?Interpretation: From above graph we can interpret that most of public sectors banks prefer to

give legal notice to defaulter first then start further proceedings for recoverywhile private bankslike ICICI & HDFC prefer to send their recovery agent for recovery from defaulter and BOBalso 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 banks have theirown field officer for recovery task while private sector banks have their recove

ry agent forrecovery task

Q: What are your norms for commission to recovery agent?Interpretation: From above graph, we can interpret that generally banks pay commission totheir 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, & HDFC,invite bid for auction of the recovered property & recovered their due while AXI

S BANK acts asper court order.




CREDIT RISK

FINDINGS

From our project, we have found out that generally all banks provide home loan,businessloan, education loan & vehicle loan. According to our survey, home loan is found more secured among four loans we havetaken. We have found that generally while giving home loan banks give first preferencetocustomers income, for education loan their property & for business loan give firstpreference to their past record. Generally, public banks have their own in collection team for recovery & private

bankshave 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 there iswide scope in education loan. As education is prior thing for being successful in a life. Most of the banks from our survey did not specify their maximum limit about sanctioningloan so there should be some specify limit which lead to reduce their default ratio. 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 reducetheir

waiting time up to 1 month or less than 1 month. Only union bank of India taking collateral for education loan, no other bank takescollateral 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 that branch.Therefore, result we obtained might not reflect perfect picture of completely bankingsystem.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 mannerthat unnecessarily imposes credit risk upon it; nor should it absorb risk that can be efficientlytransferred to other participants. The banks need efficient credit risk management system thatallows them to identify current and potential sources of risk and to take stepsnecessary todeal with them.

From above study we conclude that credit risk management is most important aspectof banking industry.The standardization of credit process and contracts to prevent inefficient or incorrect

financial decisions Credit risk can be mitigated by altering the borrowing terms, collateral securities andcredit quality and rating by the bank.ATMIYA INSTITUTE OF TECHNOLOGY & SCIENCE ( MBA DEPARTMENT ) Page 105



CREDIT RISK

BIBLIOGRAPHYwebsites

www.rbi.comwww.statebankofindia.comwww.unionbankofindia.co.inwww.bankofbaroda.comwww.icicibank.comwww.axisbank.comwww.hdfcbank.com

BooksIndian finanacial system Bharti Phathak , pearson Education, New Delhi,2008Indian Finanacial System M.Y.Khan , Tata McGrawHill ,New Delhi , 20001




CREDIT RISK

ANNEXUREQUESTIONNAIRESurvey on credit risk management by banks

These details are used for academic purpose only. It will not be disclosed to any 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




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 specifyQ: 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 specifyQ: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 specifyQ: 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 specifyATMIYA INSTITUTE OF TECHNOLOGY & SCIENCE ( MBA DEPARTMENT ) Page 108



CREDIT RISK

Q: 10 What percentage of customers default?Ans: Please specifyQ: 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 specifyQ: 15 how you deal with Mortgaged property?Ans: (A) Direct sales ( )(B) Auction ( )(C) Scrap ( )(D) If other, please specifyATMIYA INSTITUTE OF TECHNOLOGY & SCIENCE ( MBA DEPARTMENT ) Page 109