the study of risk management and the factors of credit default

7/28/2019 THE STUDY OF RISK MANAGEMENT AND THE FACTORS OF CREDIT DEFAULT

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PREFACE

MBA is a stepping-stone to the management carrier and to develop goodmanager. It is

necessary that the theoretical must be supplemented with exposure to the

real environment.Theoretical knowledge just provides the base and its not sufficient

to produce a good manager thats why practical knowledge is needed.Therefore the

research product is an essential requirement for the student of MBA. This research

project not only helps the student to utilize his skills properly learn field realities but also

provides a chance to the organization tofind out talent among the budding managers inthe very beginning.

Working on a relevant and particular project is a part of parcel of any specialized courses

of MBA to fulfill this requirement as a student of M.B.A.. I have chosen the project of

the study as Risk management and factors of credit defaults by analyzing the results of

logistic regression model using SPSS in Canara bank

Banks have long stood as the repository of the funds to be made available to the needy.

Of late, retail lending process has helped the mass in distress, support and venture out

their dreams. Hence, the banks and other financial institutions have assumed the role of a

money lender over the years. However this blessing has also its shortfalls. The

multitudes of retail lending schemes have also ushered in the pitfalls of defaults. Many a

times, banks do not carefully evaluate the borrowers credit worthiness before granting

loans. This has often resulted in the creation of NPAs or Non-Performing Assets which

are a major liability and set back to the banks. The occurrence of NPA harms the capital

adequacy of banks and hence affects the further lending processes

I hope my effort to shape this project work will yield best possible result and will go a

long way in this direction.

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ACKNOWLEDGEMENT

It was indeed a pleasure for me to work in a prestigious organisation like Canara Bank. It

was a golden chance to have a summer internship in a bank like Canara and Im

thoroughly grateful to Jaipuria Institute of Management for giving me such an

opportunity.

I would also like to express my profound gratitude to Mr.A.K Sachdeva (Senior

Manager.) and the Mr.Y.K Gupta(Manager) Canara Bank Mahanagar Branch, for

providing me with their expert guidance and help wherever needed and for clarifying the

doubts however small it maybe.

Also, I am highly grateful & indebted to staff members of the Canara Bank. I would like

to extent my deep gratitude for their constant supervision, expert guidance, enthusiasm,

continuous encouragement, sharp observation and suggestions. Their keen interest and

support was the driving element in this project report.

I would also like to thank my mentor Dr.Masood Siddiqui for his constant support and

valuable suggestions throughout internship period and in the completion of the project

report. Also, Im thankful to our Dean, Prof. Dheeraj Mishra and all the other facultymembers at JIM,Lucknow who corrected and provided help and assistance at every step.

Lastly, I am highly indebted to my family, without their moral support this project could

not have been possible.

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easy to implement but also does not require additional staff. There are various limitation

of the method suggested because of various constraints I had, like data availability, as an

intern but if implemented will reduce the work load of a manager and henceforth,

promote creation of further standard assets.

The aim of this study is to develop an understanding of the Risk management with

special focus on Credit Risk management and gather knowledge about the various risks

that stand afore the banks in the lending process and the evaluation and possible reasons

for the occurrences of non-performance assets. This is being critically analyzed through

SPSS.

TABLE OF CONTENTS

Chapter IIntroduction

1

Banking System in

India2

About Canara

Bank10

Scope & Importance of

study....17

Objectives.

..18

Chapter II

Evolution, Origin & Development of Risk

management...19

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Risk management underscores the fact that the survival of an organization depends

heavily on its capabilities to anticipate and prepare for the change rather than just

waiting for the change and react to it. The objective of risk management is not to prohibit

or prevent risk taking activity, but to ensure that the risks are consciously taken with full

knowledge, clear purpose and understanding so that it can be measured and mitigated. It

also prevents an institution from suffering unacceptable loss causing an institution to fail

or materially damage its competitive position. Functions of risk management is bank

specific dictated by the size and quality of balance sheet, complexity of functions,

technical/ professional manpower and the status of MIS in place in that bank. Therefore,

banking practices, which continue to be deep routed in the philosophy of securities,

based lending and investment policies, need to change the approach and mind-set, rather

radically, to manage and mitigate the perceived risks, so as to ultimately improve the

quality of the asset portfolio.

To the extent the bank can take risk more consciously, anticipates adverse changes and

hedges accordingly, it becomes a source of competitive advantage, as it can offer its

products at a better price than its competitors.

Although Banks and FIs have the freedom to design and implement their own policies

for recovery and write-off incorporating compromise and negotiated settlements, still itbecomes extremely essential for a bank to avoid giving credit to potential defaulters.

Occurrence of NPA can lead to problems like restriction on flow of cash done by bank

due to the provisions of fund made against NPA, draining of profit, bad effect on

goodwill and on equity value etc.

Non-performing loans epitomize bad investment. They misallocate credit from good

projects, which do not receive funding, to failed projects. Bad investment ends up in

misallocation of capital, and by extension, labour and natural resources. Banks

redistribute losses to other borrowers by charging higher interest rates, lower deposit

rates and higher lending rates repress saving and financial market, which hamper

economic growth.

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The recovery of loan has always been problem for banks and financial institution. To

come out of these first we need to think is it possible to avoid NPA. There may not be

one-size-fits-all risk management module for all the banks to be made applicable

uniformly. Balancing risk and return is not an easy task as risk is subjective and not

quantifiable whereas return is objective and measurable. If there exist a way of

converting the subjectivity of the risk into a number then the balancing exercise would

be meaningful and much easier. Hence, the predictive analysis regarding the default has

a huge scope and is of utmost relevance and importance to the banks.

Banking in India:-

Banking in India originated in the last decades of the 18th century. The first banks were

The General Bank of India, which started in 1786, and Bank of Hindustan, which started

in 1790; both are now defunct. The oldest bank in existence in India is the State Bank of

India, which originated in the Bank of Calcutta in June 1806, which almost immediately

became the Bank of Bengal. This was one of the three presidency banks, the other two

being the Bank of Bombay and the Bank of Madras, all three of which were established

under charters from the British East India Company. For many years the Presidency

banks acted as quasi-central banks, as did their successors. The three banks merged in

1921 to form the Imperial Bank of India, which, upon India's independence, became the

State Bank of India in 1955.

History

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Indian merchants in Calcuttaestablished the Union Bank in 1839, but it failed in 1848 as

a consequence of the economic crisis of 1848-49. The Allahabad Bank, established in

1865 and still functioning today, is the oldest Joint Stock bank in India.(Joint Stock

Bank: A company that issues stock and requires shareholders to be held liable for the

company's debt) It was not the first though. That honor belongs to the Bank of Upper

India, which was established in 1863, and which survived until 1913, when it failed, with

some of its assets and liabilities being transferred to the Alliance Bank of Simla.

Foreign banks too started to app, particularly in Calcutta, in the 1860s. The Comptoire

d'Escompte de Paris opened a branch in Calcutta in 1860, and another in Bombay in

1862; branches in Madras and Pondicherry, then a French colony, followed. HSBC

established itself in Bengalin 1869. Calcutta was the most active trading port in India,mainly due to the trade of the British Empire, and so became a banking center.

The first entirely Indian joint stock bank was the Oudh Commercial Bank, established in

1881 in Faizabad. It failed in 1958. The next was the Punjab National Bank, established

in Lahorein 1895, which has survived to the present and is now one of the largest banks

in India.

Around the turn of the 20th Century, the Indian economy was passing through a relativeperiod of stability. Around five decades had elapsed since the Indian Mutiny, and the

social, industrial and other infrastructure had improved. Indians had established small

banks, most of which served particular ethnic and religious communities.

The presidency banks dominated banking in India but there were also some exchange

banks and a number of Indian joint stockbanks. All these banks operated in different

segments of the economy. The exchange banks, mostly owned by Europeans,

concentrated on financing foreign trade. Indian joint stock banks were generally

undercapitalized and lacked the experience and maturity to compete with the presidency

and exchange banks. This segmentation let Lord Curzon to observe, "In respect of

banking it seems we are behind the times. We are like some old fashioned sailing ship,

divided by solid wooden bulkheads into separate and cumbersome compartments."

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The period between 1906 and 1911, saw the establishment of banks inspired by the

Swadeshi movement. The Swadeshi movement inspired local businessmen and political

figures to found banks of and for the Indian community. A number of banks established

then have survived to the present such as Bank of India,Corporation Bank, Indian Bank,

Bank of Baroda,Canara Bankand Central Bank of India.

The fervour of Swadeshi movement lead to establishing of many private banks in

Dakshina Kannada and Udupi district which were unified earlier and known by the name

South Canara ( South Kanara ) district. Four nationalised banks started in this district

and also a leading private sector bank. Hence undivided Dakshina Kannada district is

known as "Cradle of Indian Banking".

During the First World War (19141918) through the end of the Second World War

(19391945), and two years thereafter until the independence of India were challenging

for Indian banking. The years of the First World War were turbulent, and it took its toll

with banks simply collapsing despite the Indian economy gaining indirect boost due to

war-related economic activities. At least 94 banks in India failed between 1913 and 1918

as indicated in the following table:

YearsNumber of banks

that failed

Authorised capital

(Rs. Lakhs)

Paid-upCapital

(Rs. Lakhs)

1913 12 274 35

1914 42 710 109

1915 11 56 5

1916 13 231 4

1917 9 76 25

1918 7 209 1

Post-Independence

The partition of India in 1947 adversely impacted the economies of Punjab and West

Bengal, paralyzing banking activities for months. India's independence marked the end

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of a regime of the Laissez-faire for the Indian banking. The Government of India

initiated measures to play an active role in the economic life of the nation, and the

Industrial Policy Resolution adopted by the government in 1948 envisaged a mixed

economy. This resulted into greater involvement of the state in different segments of the

economy including banking and finance. The major steps to regulate banking included:

The Reserve Bank of India, India's central banking authority, was established in

April 1934, but was nationalized on January 1, 1949 under the terms of the

Reserve Bank of India (Transfer to Public Ownership) Act, 1948 (RBI, 2005b).[1]

In 1949, the Banking Regulation Act was enacted which empowered the Reserve

Bank of India (RBI) "to regulate, control, and inspect the banks in India".

The Banking Regulation Act also provided that no new bank or branch of anexisting bank could be opened without a license from the RBI, and no two banks

could have common directors.

Nationalisation

Despite the provisions, control and regulations ofReserve Bank of India, banks in India

except the State Bank of India or SBI, continued to be owned and operated by private

persons. By the 1960s, the Indian banking industry had become an important tool to

facilitate the development of the Indian economy. At the same time, it had emerged as a

large employer, and a debate had ensued about the nationalization of the banking

industry. Indira Gandhi, then Prime Minister of India, expressed the intention of the

Government of India in the annual conference of the All India Congress Meeting in a

paper entitled "Stray thoughts on Bank Nationalisation."The meeting received the paper

with enthusiasm.

Thereafter, her move was swift and sudden. The Government of India issued an

ordinance ('Banking Companies (Acquisition and Transfer of Undertakings) Ordinance,

1969')) and nationalised the 14 largest commercial banks with effect from the midnight

of July 19, 1969. These banks contained 85 percent of bank deposits in the country [2].

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Jayaprakash Narayan, a national leader of India, described the step as a "masterstroke of

political sagacity." Within two weeks of the issue of the ordinance, the Parliament

passed the Banking Companies (Acquisition and Transfer of Undertaking) Bill, and it

received thepresidential approval on 9 August 1969.

A second dose of nationalization of 6 more commercial banks followed in 1980. The

stated reason for the nationalization was to give the government more control of credit

delivery. With the second dose of nationalization, the Government of India controlled

around 91% of the banking business of India. Later on, in the year 1993, the government

mergedNew Bank of India with Punjab National Bank. It was the only merger between

nationalized banks and resulted in the reduction of the number of nationalised banks

from 20 to 19. After this, until the 1990s, the nationalised banks grew at a pace of around4%, closer to the average growth rate of the Indian economy.

Liberalisation

In the early 1990s, the then Narasimha Rao government embarked on a policy of

liberalization, licensing a small number of private banks. These came to be known as

New Generation tech-savvy banks, and included Global Trust Bank (the first of such new

generation banks to be set up), which later amalgamated with Oriental Bank of

Commerce, Axis Bank(earlier as UTI Bank), ICICI BankandHDFC Bank. This move,

along with the rapid growth in the economy of India, revitalized the banking sector in

India, which has seen rapid growth with strong contribution from all the three sectors of

banks, namely, government banks, private banks and foreign banks.

The next stage for the Indian banking has been set up with the proposed relaxation in thenorms for Foreign Direct Investment, where all Foreign Investors in banks may be given

voting rights which could exceed the present cap of 10%, at present it has gone up to

74% with some restrictions.

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The new policy shook the Banking sector in India completely. Bankers, till this time,

were used to the 4-6-4 method (Borrow at 4%; Lend at 6%; Go home at 4) of

functioning. The new wave ushered in a modern outlook and tech-savvy methods of

working for traditional banks. All this led to the retail boom in India. People not just

demanded more from their banks but also received more.

In 2010, banking in India is generally fairly mature in terms of supply, product range and

reach-even though reach in rural India still remains a challenge for the private sector and

foreign banks. In terms of quality of assets and capital adequacy, Indian banks are

considered to have clean, strong and transparent balance sheets relative to other banks in

comparable economies in its region. The Reserve Bank of India is an autonomous body,

with minimal pressure from the government. The stated policy of the Bank on the IndianRupee is to manage volatility but without any fixed exchange rate-and this has mostly

been true.

With the growth in the Indian economy expected to be strong for quite some time-

especially in its services sector-the demand for banking services, especially retail

banking, mortgages and investment services are expected to be strong. One may also

expect M&As, takeovers, and asset sales.

In March 2006, the Reserve Bank of India allowed Warburg Pincus to increase its stake

in Kotak Mahindra Bank (a private sector bank) to 10%. This is the first time an investor

has been allowed to hold more than 5% in a private sector bank since the RBI announced

norms in 2005 that any stake exceeding 5% in the private sector banks would need to be

vetted by them.

In recent years critics have charged that the non-government owned banks are too

aggressive in their loan recovery efforts in connection with housing, vehicle and personal

loans. There are press reports that the banks' loan recovery efforts have driven defaulting

borrowers to suicide.

Adoption of banking technology

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The IT revolution had a great impact in the Indian banking system. The use of computers

had led to introduction of online banking in India. The use of the modern innovation and

computerisation of the banking sector of India has increased many folds after the

economic liberalisation of 1991 as the country's banking sector has been exposed to the

world's market. The Indian banks were finding it difficult to compete with the

international banks in terms of the customer service without the use of the information

technology and computers.

The RBI in 1984 formed Committee on Mechanisation in the Banking Industry (1984)

whose chairman was Dr C Rangarajan, Deputy Governor, Reserve Bank of India. The

major recommendations of this committee was introducing MICR Technology in all the

banks in the metropolis in India. This provided use of standardized cheque forms andencoders.

In 1988, the RBI set up Committee on Computerisation in Banks (1988) headed by Dr.

C.R. Rangarajan which emphasized that settlement operation must be computerized in

the clearing houses of RBI in Bhubaneshwar, Guwahati, Jaipur, Patna and

Thiruvananthapuram.It further stated that there should be National Clearing of inter-city

cheques at Kolkata,Mumbai,Delhi,Chennai and MICR should be made Operational.It

also focused on computerisation of branches and increasing connectivity among

branches through computers.It also suggested modalities for implementing on-line

banking.The committee submitted its reports in 1989 and computerisation began form

1993 with the settlement between IBA and bank employees' association.

In 1994, Committee on Technology Issues relating to Payments System, Cheque

Clearing and Securities Settlement in the Banking Industry (1994) was set up with

chairman Shri WS Saraf, Executive Director, Reserve Bank of India. It emphasized on

Electronic Funds Transfer (EFT) system, with the BANKNET communications network

as its carrier. It also said that MICR clearing should be set up in all branches of all banks

with more than 100 branches.

Committee for proposing Legislation On Electronic Funds Transfer and other Electronic

Payments (1995)[11] emphasized on EFT system. Electronic banking refers to DOING

BANKING by using technologies like computers, internet and networking, MICR,EFT

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so as to increase efficiency, quick service, productivity and transparency in the

transaction.

Apart from the above mentioned innovations the banks have been selling the third party

products like Mutual Funds, insurances to its clients. Total numbers of ATMs installed in

India by various banks as on end March 2005 is 17,642.The New Private Sector Banks in

India is having the largest numbers of ATMs which is fol off site ATM is highest for the

SBI and its subsidiaries and then it is followed by New Private Banks, Nationalised

banks and Foreign banks. While on site is highest for the Nationalised banks of India.

BANK GROUPNUMBER OF

BRANCHES

ON SITE

ATM

OFF

SITE

ATM

TOTAL

ATM

NATIONALISED BANKS 33627 3205 1567 4772

STATE BANK OF INDIA 13661 1548 3672 5220

OLD PRIVATE SECTOR

BANKS4511 800 441 1241

NEW PRIVATE SECTOR

BANKS1685 1883 3729 5612

FOREIGN BANKS 242 218 579 797

CANARA BANK

HISTORY

Canara Bank (Canara), one of the biggest commercial banks in India, was established in

1906 atMangalore, Karnataka by Mr.AmmembalSubbaRaoPai. He had envisioned the

bank to not only offer financial services but also fulfill social causes such as removal of

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superstitions and ignorance, promotion of habit of saving, providing assistance to the

people in need and develop a sense of humanity among the people. The Bank has gone

through the various phases of its growth trajectory over hundred years of its existence.

Growth of Canara Bank was phenomenal, especially after nationalization in the year

1969, attaining the status of a national level player in terms of geographical reach and

clientele segments. Eighties was characterized by business diversification for the Bank.

In June 2006, the Bank completed a century of operation in the Indian banking industry.

The eventful journey of the Bank has been characterized by several memorable

milestones. Canara has a panIndia presence with a network of 3,046 branches as on

March 31, 2010. Thebanks branches are wellspread across metropolitan, urban, semi

urban and rural areas.

The bank boasts of having the maximum number of ATM installations among all the

nationalized banks summing up to more than 2000 of them at 698 centres. Also, 1351

branches of the bank provide Internet and Mobile Banking (IMB) services, while

Anywhere Banking services are being provided at 2027 of its branches. All the

branches of Canara Bank are enabled with Real Time Gross Settlement (RTGS) and

National Electronic Fund Transfer (NEFT) transaction facilities, insuring smooth and

swift money transfer from any corner of the nation to another corner.Apart from setting other benchmarks in the field of providing comprehensive banking

services to the consumers, Canara Bank has a number of achievements to its credit,

which include being the first bank in India to have launched Inter-City ATM network,

being the first bank to have been awarded ISO Certification for one of its branches,

providing credit card for farmers for the first time in India along with offering

Agricultural Consultancy Services

Significant milestones

1st July 1906 Canara Hindu Permanent Fund Ltd. formally registered with a capital of

2000 shares of 50/- each, with 4 employees.

1910 Canara Hindu Permanent Fund renamed as Canara Bank Limited

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1969 14 major banks in the country, including Canara Bank, nationalized on July 19

1976 1000th branch inaugurated

1983 Overseas branch at London inaugurated

Cancard (the Banks credit card) launched

1984 Merger with the Laksmi Commercial Bank Limited

1985 Commissioning of Indo Hong Kong International Finance Limited

1987 Canbank Mutual Fund &Canfin Homes launched

1989 Canbank Venture Capital Fund started

1989-90 Canbank Factors Limited, the factoring subsidiary launched

1992-93Became the first Bank to articulate and adopt the directive principles of Good

Banking.

1995-96 Became the first Bank to be conferred with ISO 9002 certification for one of its

branches in Bangalore

2001-02Opened a 'Mahila Banking Branch', first of its kind at Bangalore, for catering

exclusively to the financial requirements of women clientele.

2002-03Maiden IPO of the Bank

2003-04 Launched Internet Banking Services

2004-05 100% Branch computerization

2005-06Entered 100th Year in Banking Service. Launched Core Banking Solution inselect branches. Number One Position in Aggregate Business among Nationalized

Banks.

2006-07 Retained Number One Position in Aggregate Business among Nationalized

Banks. Signed MoUs for Commissioning Two JVs in Insurance and Asset Management

with international majors viz., HSBC (Asia Pacific) Holding and RobecoGroep N.V

respectively.

2007-08 Launching of New Brand Identity.Incorporation of Insurance and Asset

Management JVs. Launching of 'Online Trading' portal. Launching of a Call Centre.

Switchover to Basel II New Capital Adequacy Framework.

2008-09The Bank crossed the coveted 3 lakh crore in aggregate business. The Banks

3rd foreign branch at Shanghai commissioned.

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2009-10 The Banks aggregate business crossed 4 lakh croremark.

Net profit of the Bank crossed 3000 crore. The Banks branch network crossed the 3000

mark.

2010-11 The Banks aggregate business crossed 5 lakh croremark. Net profit of the

Bank crossed 4000 crore. 100% coverage under Core Banking Solution. The Banks 4th

foreign branch at Leicester and a Representative office at Sharjah, UAE, opened. The

Bank raised 1993 crore under QIP. Govt. holding reduced to 67.72% post QIP.

2011-12 Total number of branches reached 3600. The Banks 5th foreign branch at

Manama, Bahrain opened. .

Canara Banks rating reflects its strong market position, adequate capitalization levels,

and comfortable liquidity profile. The rating also factors the banks business profile that

is supported by a good resources position, as well as its better asset quality as compared

to its peers. Crisil also considers the Government of Indias (GoI) majority ownership of

Canara Bank to be a positive rating factor. The banks earnings profile is characterized

by moderate although improving profitability.

Among the Top 5 banks in India

Canara is Indias fifth largest bank in terms of asset size; as on March 31, 2010, it had an

asset base ofaround Rs 2.6 trillion. It is one of the few national players in the bankingindustry with a network of more than 3000 branches spread all across the country.

Canara Banks strong market position is underpinned by its nationwide presence and its

large and diversified balance sheet. This strong market position gives Canara Bank

significant advantages in raising resources, besides bringing in diversity of assets.

The banks strong market position is underpinned by its market share of over4.8% in

deposits and advances, and its panIndia branch network. The banks advances and

depositsregistered a compound annual growth rate (CAGR) of 20% and 18%,

respectively, over the past threeyears. Deposits and advances grew 25.5% and 22.5%,

respectively, yearonyear in FY10. Canara'srevenue profile is diversified across

businesses, products, and geographies. As on March 31, 2010,retail advances constituted

15% of the bank's total advances, against an industry average of around20%. Housing

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loans (direct) accounted for 42% of the retail portfolio as compared to 37% on March

31,2009.

Support from majority owner, Government of India

The Government of India (GoI) is the majority owner of Canara, with ~73.2% stake as

on March 31,2010. This gives the bank stability both on an ongoing basis and in the

event of distress. The flexibility provided by GoIs additional stake over the minimum

required holding of 51% and the banks strong

TierI base provides it with sufficient ability to absorb assetside risks. Canara's stated

posture is tomaintain a capital adequacy ratio (CAR) of above 12%. Further, GoI has

reiterated that it will takemeasures to maintain public sector banks' (PSBs) overall CAR

at around 12%, so that these banks cangrow their balance sheets and remain competitive.

Strategic tieups with international players

In 2007, Canara formed a joint venture with M/s RobecoGroep NV, for managing assets

of CanbankMutual Fund (since renamed as Canara Robeco Mutual Fund). The joint

venture gets sales support fromthe vast network of the bank. Canara also floated an

insurance JV along with HSBC Insurance (AsiaPacific) Holding Ltd and Oriental Bank

of Commerce, another nationalised bank. The company wasincorporated in September2007. Canara holds 51% stake in the insurance JV.

Adequate capitalisation levels

Canara Banks capital position is characterised by a moderate Tier I capital ratio,

reasonably large capital base, and comfortable networth coverage of net non-performing

assets (NPAs). At 7.85 per cent as at March 31, 2003, Canara Banks Tier I capital

adequacy ratio is moderate and is comparable with that of the better public sector banks.

Canara Banks reasonably large capital base of Rs 41.49 billion as at March 31, 2003

provides comfort against large asset-related shocks. The net worth coverage for net

NPAs at 2.85 times provides substantial comfort to its existing capital position.

Good resource and liquidity profile

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Canara Banks good resource profile accrues from its large and geographically well-

diversified deposit base (which emanates from its national presence), healthy resource

mix, and steady growth in deposits. Further, a significant proportion of the banks

branches (42 per cent) are in the semi-urban and rural areas, which provides it with a

relatively stable source of funds, given the limited presence of the new private sector

banks in these areas.

Canara provides various banking products and services, primarily in India and the

overseas market. In FY10, treasury operations contributed ~25% of total revenue,

retailbanking ~26%, corporate/ wholesale banking ~46% and others ~3%. Apart from

banking operations, Canara also offers factoring, insurance asset management, and retail

institutional broking services through subsidiaries and associates. In addition to overseas

branches in London, Leicester, Shangai and Hong Kong, the bank has operations

inRussia in partnership with State Bank of India. Further, the bank offers NRI services

such as deposits, loans and advances, remittance facilities, and consultancy services,

aswell as safe custody, nomination facility, attorney ship services, facilities for returning

Indians, safe deposit lockers, and investment products.

The bank provides a range of alternative delivery channels, which includes over 2,000

automated teller machines (ATMs) covering 728 centres, 1,959 branchesprovidingInternet and mobile banking (IMB) services and 2,091 branches offering

anywhere banking services. Canara was the first Indian bank to launch an intercity

ATM network. As onMarch 31, 2010, the bank had 3,046 branches well spread across

metropolitan, urban, semiurban and rural areas. The bank's international operations are

supported by 395correspondent banks spread across 80 countries. As of March 31, 2010,

Canara had 43,380 employees.

Canara Banks liquidity position continues to be comfortable, and is supported by a

steady growth in deposits, access to the inter-bank call money market, and investments

above regulatory requirements in highly liquid Government Securities. Canara Bank

made a net profit of Rs.3,283crore in 2011-12, a decline of 23 per cent over the previous

year. The growth of deposits and advances during the past year was in low double-

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digits.Total provisions amounted to Rs.2,660crore, of which NPAs accounted for

Rs.1,294 crore.

The bank had a net interest margin of 2.50 per cent in 2012, as compared to 3.12 per

cent, a year earlier. The board has maintained the dividend at Rs.11 per share for 2011-

12.

Today, Canara Bank occupies a premier position in the comity of Indian banks. With an

unbroken record of profits since its inception, Canara Bank has several firsts to its credit.

These include:

Launching of Inter-City ATM Network

Obtaining ISO Certification for a Branch

Articulation of Good Banking Banks Citizen Charter

Commissioning of Exclusive Mahila Banking Branch

Launching of Exclusive Subsidiary for IT Consultancy

Issuing credit card for farmers

Providing Agricultural Consultancy Services

Over the years, the Bank has been scaling up its market position to emerge as a major

'Financial Conglomerate' with as many as nine subsidiaries/sponsored institutions/joint

ventures in India and abroad. As at March 2010, the Bank has further expanded its

domestic presence, with 3043 branches spread across all geographical segments.

Not just in commercial banking, the Bank has also carved a distinctive mark, in various

corporate social responsibilities, namely, serving national priorities, promoting rural

development, enhancing rural self-employment through several training institutes and

spearheading financial inclusion objective. Promoting an inclusive growth strategy,

which has been formed as the basic plank of national policy agenda today, is in fact

deeply rooted in the Bank's founding principles. "A good bank is not only the financial

heart of the community, but also one with an obligation of helping in every possible

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manner to improve the economic conditions of the common people". These insightful

words of Canara bank founder continue to resonate even today in serving the society

with a purpose. The growth story of Canara Bank in its first century was due, among

others, to the continued patronage of its valued customers, stakeholders, committed staff

and uncanny leadership ability demonstrated by its leaders at the helm of affairs. The

bank strongly believes that the next century is going to be equally rewarding and

eventful not only in service of the nation but also in helping the Bank emerge as a

"Global Bank with Best Practices". This justifiablebelief is founded on strong

fundamentals, customer centricity, enlightened leadership and a family like work culture.

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Scope Importance and Objective of Study

During the last decade, importance of risk management in credit has increased for both

borrowers and lenders, especially, in the developing countries. For this reason, banks and

financial institutions started to revise their lending policies. There are basically six

functional responsibilities associated with credit lending activities;

(1)Assessment of the customers credit risk,

(2) Making the credit granting decision with regard to credit terms and, where relevant,

credit limits,

(3) Collecting receivables (debts) as the fall due and taking action against defaulters,(4) Monitoring customer behavior and compiling management information,

(5) Bearing the risk of default or bad debt,

The study focuses on collecting statistical data on consumer behavior, evaluating the

collected data and trying to find managerial outcomes. These outcomes enable financial

institutions to evaluate alternative lending policies and minimize their credit default risks

in credit types such as home loans, car loans, and personal loans. More specifically, this

study aims to examine the relationship between the consumer credit payment

performance and some demographic variables (such as marital status, sex, residential

status, occupation, Education) and some financial variables (such as income, loan size,

interest rate, credit category).

The present study is important for two reasons. First, many previous studies and

financial institutions have focused on the relationship between lenders decision and the

characteristics of the consumer credit applicants rather than the relationship between

payment performance of the consumer credit and their characteristics. It is, of course,

important to get some information about the relationship between characteristics of

people apply for consumer credit (applicants) and to whom the credit will be given.

However, it is equally beneficial to have an idea about the relationship between the

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characteristics of people that are already accepted (clients) and whether they are paying

back their loans on time or not i.e. payment performance.

To some extent, this kind of testing whether the decision of accepting/rejecting (or the

decision criteria) the applicants is the right one or not we dont know correctly.

Therefore, investigating the effects of some characteristics of credit clients on clients

payment performance becomes crucial.

Second, by ranking customers according to predicted default probabilities, a bank will

have a chance to minimize the expected default or misclassification.

As a reaction to an increasing competition and bankruptcies, banks all over the world

are trying hard to improve the process of loan origination in corporate banking.

Practitioners estimate that improvements in risk management can decrease credit losses

by 20 to 40%.

OBJECTIVES:-

To formulate a method so as to identify the potential NPAs and the factors

responsible loan defaults with the help of logistic regression model

To have in-depth understanding of the different type of risks that pose threat to

banks.

To have profound understanding existing system of risk management prevailing

in the bank.

Getting a real time exposure of the corporate world and the processes in the

company which will help me in relating the classroom teaching with the practical

world for the better understanding of things.

Having an experience in a Banking company will help me in pursuing a career in

this industry which has a very high growth potential and an immense career

opportunities in the near future.

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EVOLUTION, ORIGIN & DEVELOPMENT OF

RISK MANAGEMENT

The word risk is derived from an Italian word risicare which means, "to dare". This

means that risk is more a choice than a fate. Extending this analogy further we can

say that risk is not something to be faced but a set of opportunities open to choice.

There is no single definition that captures the entire spectra of what constitutes risk. The

Bank for International Settlement (BIS) definition, which is widely accepted, reads thus

"Risk is the threat that an event or action will adversely affect an organizations ability to

achieve its objectives and successfully execute its strategies".

A very wider definition of risk is Risk is nothing but the certainty of anexposure to

uncertainty.

Risk Management:-

Managing the risks commences with the task of identifying all the possible risks in our

activities. The next task would be to list out the controls in place against each of the

identified risks. Making an assessment of the controls in place versus the identified risks

for adequacy follows this.

The risk identification and assessment is a dynamic exercise and must be carried out at

regular intervals aiming at continuous refinement of our procedures in tune with the risks

perceived. Risks also need to be measured to not only ascertain their financial impact on

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our resources but also to aid in pricing our products. Finally a system should be in place

to monitor/review the above processes.

History of Risk Management in Banks: The origin and development of risk

management in Banks in a chronological order. For this purpose the subject is divided

into the following periods,

1970s and BCBS, Basel Accord I, Events of 1990s, Basel Accord II

1970s and BCBS:: The first major Bank event that opened the eyes of financial sector

was that of Bank Herstatt of Germany, which was forced by German regulators intoliquidation. The G-10 countries and Luxembourg formed a committee under the auspices

of Bank for International Settlements (BIS), called Basel Committee on Banking

Supervision (BCBS) to promote stability in the global banking system. The committee

meets regularly four times a year. It has about thirty technical working groups and task

forces, which also meet regularly. The two main objectives of the committee at the time

of its formation were

No foreign Banking system should escape supervision

Supervision must be adequate for all Banks operating internationally

BCBS engaged itself in formulating standards, guidelines and best practices with the

expectation that respective central banks will implement them to best suit their national

systems.

Basel Accord I:: Pursuing the goal of creating a level competitive field for all Banks,BCBS published a credit risk framework to guide the allocation of capital reserves for all

internationally active Banks. This popularly came to be known as Basel I accord. The

Basle I framework defined two minimum standards for acceptable Capital adequacy

requirements.

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Risk based capital ratio & Asset to capital multiple

Risk based capital ratio is defined as the ratio of capital to risk weighted assets. Assets

means both on balance sheet items(Loans, advances and investments etc) and off balance

sheet exposures(Guarantees and Letters of credit etc).As per the accord Banks had to

hold a minimum capital of 8% over the risk weighted assets. Out of the minimum capital

to be held at least 4% of it should be in the form of Tier I capital. The asset to capital

multiple was set at 12.5.Tier II capital is limited to 100% of Tier I capital

Capital Adequacy Ratio(CAR) = Capital divided by Credit risk

Capital = Tier I Capital + Tier II Capital

Credit risk = Sum of Risk Weighted Assets (RWA)

Risk Weighted assets = Exposure X Supervisor determined risk weights.

Capital ratio Minimum 8% as per Basel. and 9% as per RBI

In India Basel I accord, was implemented through the Narasimham Committee

Recommendations introducing Prudential Norms such as Asset Classification, Income

Recognition & Capital Adequacy Ratio. CAR of 9 % was stipulated by Reserve Bank of

India. Basel I met the following objectives:

o Strengthened the capital base of Banks

o Created clear and uniform guidelines for all Banks world over

o Reduced competitive distortion among banks

Capital brought in by the above formula is known as Regulated Capital as risk weights

are prescribed by the regulator of the respective countries ( In India RBI)

Events of 1990s:: In the 1990s many loss incidents were witnessed in the financial

sector. Failure of Barings Bank, BCCI, Sumitomo Bank and Daiwa Bank are some of the

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examples. BCBS continued its efforts to suggest measures and remedies to strengthen

the Banking system world over. In January 1996 BCBS came out with amendment to the

1988 accord to incorporate Market risks.

Accordingly RBI introduced Asset Liability Management for Banks in India to address

Liquidity and Interest rate risks with effect from 1.04.1999.

Basel New Accord:: Towards the end of 20th century banking operations witnessed

significant changes like::

Deregulated environment

Liberalization, Privatization and Globalization

Technology boost leading to introduction of sophisticated and complex products

Expansion and foray into new types of activities

Basel I though a revolutionary move of earlier times, it suffered from many

shortcomings which have ignored the above changes. The short comings of Basel I

are:

Non-recognition of Operational risk

Ignoring of the Risk management advancements

Capital reserve inaccuracies

In 1999 BCBS came out with fresh proposals to align the capital held by banks more

closely with the risks faced by them. This is popularly known as Basel New Accord. The

proposals had three stages of consultation and have finally found approval on

26.06.2004.The proposals of the new accord have to be implemented by 01 04 2007.

These proposals stand on three reinforcing pillars namely

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Minimum Capital Requirements

Supervisory Review

Market Discipline

Pillar I Minimum Capital Requirements:: Prescribes the various approaches in the

order of risk sensitivity for measuring credit and operational risk, thus enabling banks to

move from Regulated Capital to Economic Capital.

Pillar II Supervisory Review:: This pillar of the Accord aims at not only ensuring

that Banks are capital adequate in terms of risks faced but also encourages them to use

better risk management techniques in monitoring and managing their risks. Another

important aspect of pillar II is the assessment of compliance with the minimum standards

and disclosure requirements for pursuing advanced measurement approaches as

mentioned above. National supervisor i.e., Reserve Bank of India will ensure that these

requirements are met both as qualifying criteria and on a continuous basis.

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RISK MANAGEMENT IN BANKS

Operating in a liberalized & globalized environment banks are exposed to various kinds

of risks that can emanate from financial & non-financial factors. Generally risks faced by

banks are grouped in clearly identifiable categories which include

a) credit risk b) market risk and c) operational risk.

With progressive de-regulation, cross border dealings, globalization, introduction of

wide range of products & services, improvement in technology & communications,

significant changes have occurred in the balance sheets of banks. Risks faced by banks

have now increased manifold posing significant challenges to both banks & supervisors.

To respond to these challenges there have been various supervisory initiatives to

introduce better operating standards in banks, greater transparency & sensitivity towards

risk management by banks.

The risks faced by banks can be categorized under two risk groups:

1) Business risks which are inherent in the activities that banks undertake.

2) Control risks that arise out of inadequacy, break down or absence of variouscontrols that are used to mitigate business risks.

Inherent business risks include credit risk, market risk, liquidity risk, operational risk,

strategy & business environment risk, group risk etc.

Control risks include breakdown of internal controls & risk related to organization

structure & management.

The impact of losses on account of various risks get reflected in a banks earnings &

capital. As such, while earnings & capital do not represent risk per se, since they bear the

impact of various risks their assessment in relation to risk management is important.

Hence capital & earnings have been included under business risks.

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i) CREDIT RISK:: Credit risk represents the major risk faced by banks

on account of nature of their business activity, which includes dealing with or lending to

a corporate, another bank, financial institution or a country. Credit risk may be carried in

banking book or the trading book or in the off balance sheet items. Credit risk includes:

a) COUNTER PARTY RISK- The possibility that a borrower or counter party will

fail to meet obligations in accordance with agreed terms. It may also be reflected in

the down grading of the standing of the counter party making him more vulnerable to

possibility of defaults.

b) PORTFOLIO RISK Due to adverse credit distribution, credit Concentration /

investment concentration .

c) COUNTRY RISK The possibility that a country will be unable to service or repay

its debts to foreign lenders in a timely manner.

ii) MARKET RISK:: Market risk is the potential of erosion of income or market

value of an asset arising due to changes in market variables such as interest rate, foreignexchange rate, equity prices & commodity prices.

a) Interest rate risk The risk in the erosion of earnings due to variation in

the interest rate with in a given time zone. Interest rate risk may arise on account of gap

or mismatch risk, basis risk, embedded options risk, yield curve risk etc.

b) Foreign exchange risk The holdings of foreign exchange assets or

liabilities, not been hedged against movement in exchange rates. This position is

referred to as open position. Forex risk affects both spot & forward positions of the bank.

Forex risk includes settlement risk, time zone risk & translation risk.

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c) Equity price risk- Potential of an institution to suffer losses on its exposure to

capital markets, from adverse movements in the prices of equity.

d) Commodity price risk The potential of adverse movements in prices of physical

products, which are or can be traded in the secondary markets like agricultural

products, minerals & oils, precious metal.

iii). LIQUIDITY RISK Possibility that a bank may be unable to meet its liabilities as

they become due for payment or may be able to fund the liabilities at a cost much higher

than the normal cost. The risk arises due to mismatch in the timing if inflows & outflows

of funds, and from funding of long term assets from short term liabilities. Surplus

liquidity could also represent a loss to the bank in terms of earnings missed & hence an

earning risk.

iv). STRATEGY & BUSINESS ENVIRONMENT RISK May arise due to

inappropriate or non-viable business strategy adopted by the bank/ its absence altogether

& the business environment that the bank operates in, including the business cycle that

the economy may be passing through. A dynamic & viable medium term strategy

formulated on the basis of proper research & planning, identifying target areas, markets,products, customer base etc is necessary for effective risk management. Lack of the same

may pose a significant risk to the earnings & viability of the bank.

v). OPERATIONAL RISK May arise due to inadequate or failed internal processes,

people & systems or from external events. It includes People risk ( incompetence, frauds,

work environment, motivation ), Operational control risk ( failure of operational

controls, volumes ),Model risk ( model application error, methodology error ). Apart

from the above the following are also covered under operational risk.

a) Legal risk May arise due to the possibility of actions of a bank not being in

conformity with the laws of a country or being in violation thereof. The bank can also

experience legal risk when customers approach court of law for redressal of their

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grievances where transactions with its counter parties are not supported by proper

documents or the terms of the contract are unclear or even due to lack of well established

legal pronouncements in cases where issues involved are nebulous.

b) Reputational risk The financial implications of a moral obligation cast on

a bank in the environment it is functioning or by virtue of its association with another

organization is called reputational risk. Reputational risk is the potential of suffering loss

due to significant negative public opinion, bad or wrong publicity.

c) Technological risk Arising out of IT related factors like validity of IT

systems, back up & disaster recovery systems, failure of systems, security of systems,

programming errors etc. It can also arise due to obsolescence of technology being used,

technology not being in alignment with business needs or adoption of untried & untested

technology, inability of the staff to respond to new technology etc.

vi). GROUP RISK Arising on account of financial implications being cast on the bank

due to its obligations to other entities in the group or due to contagion effect. A bank

may have various domestic/over seas subsidiaries dealing in mutual funds, merchant

banking services, housing finance, gilt securities, banking services etc. Since there are,as yet, no rigorous capital adequacy norms & prudential regulations governing

subsidiaries, the parent bank is exposed to the risk of rescue operations whenever a

subsidiary runs in to losses/ needs fresh injection of funds.

vii). EARNINGS RISK It can be assessed through assessment of fund cost & return,

assessment of earnings & expenses and assessment of earnings quality & stability.

viii). CAPITAL INADEQUACY RISK Capital of bank is a cushion against

unexpected losses. The volume of capital determines the direction & magnitude of future

growth of business of a bank. Though capital does not represent business risk, since it

bears the impact of other risks its adequacy or inadequacy is a material in the risk

assessment of a bank.

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CONTROL RISKS.

i) Internal control risk Arising on account of failure of internal control system

of the bank. Weakness in internal controls have been historically recognized as a high

risk factor. It requires special attention due to its high potential to inflict heavy losses on

a bank on account of failure of various control systems.

ii) Organization risk Arising on account of organizational bottlenecks in the form

of inadequate or inappropriate structure in relation to its business and the quality of its

external & internal relationships. The organization structure needs to be clear and in tune

with the legal & business requirements of the bank .The organization should be flexible

to meet the challenges.

iii) Management risk Arising out of poor quality and lack of integrity of

management. It is reflected in quality of senior management personnel, their leadership,

competence, integrity and their effectiveness in strategizing, delivering & dealing with

the problems.

iv) Compliance risk Arising out of non-compliance with various requirements onaccount of authorisation, statutory requirements, prudential operations & supervisory

directives/guidance.

RISK MANAGEMENT ARCHITECTURE:

The effectiveness of risk management systems depends to a large extent on having in

place appropriate and effective risk management architecture. It should at the minimum

include the following:

i) Risk management policies.

ii) Board of directors & Senior management commitment.

iii) Effective organization structure for risk management.

iv) Effective risk management processes & systems.

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v) Human resources & training.

vi) In-house monitoring.

RISK MANAGEMENT POLICIES: Bank should have appropriate risk management

policies in place. The risk management policy document should broadly cover the

followings:

a) Identify the risks that are to be measured & monitored.

b) Define risk tolerance level for the bank.

c) Specify the methodology for measuring the various risks and specifically approve the

methodology or models to be used.

d) Provide for exception reporting to top management when the allocated limits are

breached.

e) Indicate the process to be adopted for immediate corrective action.

f) Set up an organizational structure for risk management including delegation of

powers & responsibilities for risk monitoring & control.

g) Provide detailed guidelines for proper data collection, collation & updating.

h) Specify a separate organizational unit for validation & review of the risk monitoring

techniques used.

i) Specify system for comprehensive review of risk management & risk control &

report to the board.

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BOARD OF DIRECTORS AND SENIOR MANAGEMENT COMMITMENT: The

Board should set various risk limits by assessing the banks risk appetite, skills available

& risk bearing capacity represented by capital. It should also set up appropriate

procedures for management of the risks. This calls for clear lines of responsibility for

managing risk, adequate systems for measuring risk, appropriately structured limits on

risk taking, effective internal controls & a comprehensive risk reporting process.

The Board should ensure that senior management attends to its responsibilities

concerning risk management & internal control and frequently reviews the effectiveness

of the system. It also needs to make a periodical review of risk management policies,

control systems in place, clarity of various reporting lines, adequacy of monitoring

mechanisms, adherence to policies, procedures & limits by operational departments and

adequacy of management responses on identified weaknesses.

RISK MANAGEMENT ORGANIZATION : At the apex of the risk management

organization of a bank should be the Risk Management Committee, which generally

comprises the Managing Director, Heads of business units of the bank and Head of Risk

Management. It can also include some members of the Board. The RMC is responsible

for supervising the activities & operations of all committees entrusted with riskmanagement functions with in the bank. These committees include Credit Risk

Management Committee, Asset Liability Management Committee and the Operational

Risk Control Function.

The Risk Management Department supports the activities of Risk Management

Committee through research on & analysis of risks, reporting risk positions & making

recommendations as to the level & degree of risk to be assumed. RMD has the

responsibility to identify, measure & monitor the risks faced by the bank, develop &

issue policies and procedures, verify the models that are to be used for risk measurement

& pricing complex products and identify new risks as a result of emerging markets &

new products.

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Under RMD, there may be independent groups/departments for supporting the

committees for specific risks ie. Credit risk, Market risk and Operational risk.

The Credit Risk Management Department may be supported by Risk Planning Cell,

Risk Assessment & Monitoring Cell, Risk Analytic Cell & Credit Risk Systems Cell.

RISK MANAGEMENT PROCESSES & SYSTEMS:

a) Risk Identification: The first step for risk management process is to identify all risks

to which the bank is exposed. The activities undertaken by the bank as well as the new

activities that the bank proposes to enter in to as observed from the balance sheet & other

records should be systematically examined to identify all kinds of risks faced by the

bank. The bank will have to proceed in systematic manner across all its activities both

on assets and liabilities, including off balance-sheet items to ensure that there is no

activity of the bank omitted from risk management.

b) Risk measurement: Banks should have proper systems in place to measure the risks

identified as arising from various activities. For this, banks may develop risk

management techniques that are appropriate to the size & complexities of theirportfolios, resources & data availability. The methodologies of risk measurement may

range from a simple assessment on the basis of certain qualitative & quantitative criteria

compared with certain pre-set standards/bench marks to sophisticated

statistical/mathematical models.

c) For measuring credit risk traditional methods involve financial analysis in

conjunction with credit rating framework to arrive at risk aggregation, pricing & other

decisions. On the other hand there are several other new techniques in the nature of

quantitative models using econometric, mathematical programming or simulation

methodologies for decision making.

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d) For interest rate/forex/market risk measurement, some of the standard techniques

used are maturity gap analysis, duration gap analysis, value-at-risk approach etc.

e) Risk monitoring & control: Controlling the risk with in the parameters & limits set

by the Competent Authority is the ultimate objective of the risk management exercise.

Risk monitoring & control involves

i) Limit setting each bank should determine for itself what is the maximum level of

risk it can face given the level of its capital. Fixation of risk level has a great

significance since capital is subject to erosion if risks actually materialise. The limits

could be fixed in terms portfolio standards for credit risk or setting limit for value at risk

in respect of credit risk, earning risk & market risk.

ii).Monitoring once limits are fixed, the actual performance/utilization needs to be

compared against the limits for risk monitoring. The results of such comparisons will

reveal the exceptions, which may be investigated for reasons of material deviations and

reported to the proper authority for remedial action. Tracking of risk migrations upward

or downward is another aspect of risk mitigation.

iii).Reporting & MIS the existence of strong MIS that captures relevant information

and data is an important pre-requisite for effective risk control. However, the accuracy of

data, the frequency of revision of data/information and its timely availability are

important factors that determine the efficacy of the risk monitoring & control process.

iv). Risk mitigation the essential aspect of risk monitoring & control is to take

corrective action for bringing down risk to manageable levels if it is considered high.

The various ways of risk mitigation are reduction in exposure to a particular industry,

stepping up of recoveries to bring down NPAs, acceptance of collaterals, reducing open

positions in foreign currencies .etc.

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HUMAN RESOURCES & TRAINING:: with banks gradually refining their risk

management systems & the impending introduction of risk based supervision of banks

by RBI, the need of understanding the risks m the process of their management &

control and the increasing use of sophisticated tools for measuring & managing the

risks, bank should have specialised staff adequately trained to discharged various risk

management functions.

Since specialization develops over time, identification and positioning core staff for risk

management as well as availability of second line of support are crucial for effective risk

management.

IN-HOUSE MONITORING:: The risk management process needs to be reviewed

periodically by an independent group of executives to ensure that all important elements

of risk management process are functioning effectively/efficiently and the risk as

measure through the process is the actual risk/close to the actual risks faced by Bank.

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CREDIT RISK

The banks and financial institution have faced difficulties over the years for several

reasons. The major causes continue to be directly related to the low quality of credit,poor portfolio risk management besides insensitivity to changes in economic and other

circumstances. Loans and Advances are the most obvious source of Credit Risk.

Focused attention on credit delivery, recovery and review are pre requisite for effective

Credit Management. Therefore Credit Risk is the critical component of Integrated Risk

Management. The success of integrated Risk Management largely depends on effective

handling of Credit Risk.

Definition of Credit Risk: Credit Risk is defined as The inability or unwilling ness

of the customer or counter party to meet commitments in relation to lending,

hedging, settlement and other financial transactions.

Hence credit risk emanates when the counter party is unwilling or unable to meet or

fulfill the contractual obligations/ commitments thereby leading to defaults. Credit Risk

of a Bank depends upon several External and Internal factors. These External or Internal

factors are related both to the borrower & the bank.

Internal factors (Applicable to Banks):: Deficient loan policies, Inadequately defined

powers for sanction of loans, Absence of prudential credit concentration limits, Absence

of credit committees, Deficiency in credit appraisal systems, Excessive dependence on

collaterals, Inadequate/lack of risk pricing, Absence of loan review mechanism and post

sanction surveillance

External factors (Applicable to Borrowers) :: Inadequate technical know-how,

Locational disadvantages, Outdated production process, High input costs, Break Even

Point being very high, Uneconomic size of plant, Large investment in Fixed Assets,

Over estimation of demand, wide swings in commodity or equity prices.

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8. Transaction Risk: The very nature of transaction some times has an intrinsic

risk like:

Granting of clean or unsecured loan

Discounting of a supply bill

Book debt finance to individuals & proprietary concerns

9. Economic Scenario /Government Policies/ Trade Restrictions: The changes in

economic scenario or the Government policies or the trade restrictions imposed by

different countries which are beyond the control of either the Bank or the Borrower may

adversely affect the business or activity which might cause default leading to Credit

Risk.

Credit risk is having two components. The first is the solvency aspect of credit risk,

which relates to the risk that the borrower is unable to repay in full the sum outstanding.

The second is the liquidity aspect of credit risk that arises when the payment due from

the borrower are delayed leading to cash flow problems for the lender. The liquidity and

solvency risks are closely related.

In order to meet the short liquidity needs, a firm may have to undertake fire-sale of

assets which might fetch a lower amount for the assets sold as compared to the sale of

assets under normal circumstances. This could lead to a situation of technical

insolvency where the realizable value of assets may be less than the value of liabilities.

This problem is more pronounced in case of banks as their balance sheet contains assets (

like loans and investment etc ) which fluctuate in value where as the value of deposits

remains constant and in fact might grow on account of interest element. Thus what may

appear to be liquidity risk in the beginning may turn in to solvency risk over a period of

time.

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of Expected Losses and Unexpected Losses. In turn these are calculated by Probability

of Default (PD), Loss Given Default(LGD) and Exposure at Default (EAD)

Banks which comply with certain minimum requirements like Comprehensive Credit

rating system shall be permitted to adopt the Foundation Approach. Under this approach,

the rating system adopted by the banks shall be capable of quantifying the Probability of

Default, whereas the LGD and EAD are provided by RBI.

Under Advanced Measurement Approach, banks will be allowed to use the internal for

calculation of PD, EAD, LGD for assigning the risk weights and they will be validated

by RBI.

However for adopting the IRB Approach, banks should build up historical data base on

the Portfolio quality/Provisioning/Write offs etc.

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NON-PERFORMING ASSETSAll the risk management activities are done in order to avoid the occurrence of potential

default or occurrence of Non-performing Assets. A Non-performing asset (NPA) is

defined as a credit facility in respect of which the interest and/or instalment of principal

has remained past due for a specified period of time. For the identification of NPA

and with a view to moving towards international best practices and to ensure greater

transparency, it has been decided to adopt the 90 days overdue norm for identification,

from the year ending March 31, 2004. Accordingly, with effect from March 31, 2004, a

non-performing asset (NPA) shall be a loan or an advance where;

Interest and/or installment of principal remain overdue for a period of more than

90 days in respect of a term loan,

The account remains out of order for a period of more than 90 days, in respect

of an Overdraft/Cash Credit (OD/CC),

The bill remains overdue for a period of more than 90 days in the case of bills

purchased and discounted,

Interest and/or installment of principal remains overdue for two harvest seasons

but for a period not exceeding two half years in the case of an advance granted for

agricultural purposes, and

Any amount to be received remains overdue for a period of more than 90 days in

respect of other accounts.

The banking industry has undergone a sea change after the first phase of economicliberalization in 1991 and hence credit management. While the primary function of

banks is to lend funds as loans to various sectors such as agriculture, industry, personal

loans, housing loans etc., in recent times the banks have become very cautious in

extending loans. An NPA is defined as a loan asset, which has ceased to generate any

income for a bank whether in the form of interest or principal repayment. As per the

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prudential norms suggested by the Reserve Bank of India (RBI), a bank cannot book

interest on an NPA on accrual basis. In other words, such interests can be booked only

when it has been actually received. Therefore, this has become what is called as a

critical performance area of the banking sector as the level of NPAs affects

theprofitability of a bank.

Therefore, an NPA account not only reduces profitability of banks by provisioning in the

profit and loss account, but their carrying cost is also increased which results in excess

&avoidable management attention. Apart from this, a high level of NPA also puts strain

on the banks net worth because banks are under pressure to maintain a desired level of

Capital Adequacy and in the absence of comfortable profit level; banks eventually look

towards their internal financial strength to fulfill the norms thereby slowly eroding the

net worth.

Today the Net NPAs of Indian PSBs (which account for around three-fourths of the total

assets of Indian banking industry) are as low as 0.72 per cent and gross NPAs are at 2.5

per cent. However, NITSURE (2007) contends that once there is a slowdown in private

expenditure and corporate earnings growth, companies on these banks books will not be

in a position to service their debts on time and there is a strong likelihood of generation

of new NPAs. Moreover, he also suggests that with rising interest rates in the

government bond market, the banks treasury incomes have declined considerably. Sobanks will not have enough profits to make provisions for NPAs. Under these

circumstances, management of NPAs is a difficult task.

Classification

Banks are required to classify non-performing assets further into the following three

categories based on the period for which the asset has remained non-performing and the

realisability of the dues:

Sub-standard Assets

Doubtful Assets

Loss Assets

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Sub-standard: The account holder comes in this category when they dont pay three

installment continuously after 90 days and upto 1year. for this category bank has

made 10% provision of funds from their profit(10% of its reserves.) to meet the

losses generated from NPA.In the case of term loan, if installments of principal are

overdue for more than one year but not exceeding two years, it is to be treated as

sub-standard asset. An asset where the terms of the loan agreement regarding interest

and principal have been re-negotiated or re-scheduled should be classified as sub-

standard and should remain in such category for at least two years of satisfactory

performance under the re-negotiated or rescheduled terms. In other words, the

classification of assets should not be upgraded merely as a result of re-scheduling

unless there is satisfactory compliance of the above condition.

Doubtful NPA: An asset, which remains NPA for more than two years. Here too,

rescheduling does not entitle a bank to upgrade the quality of an advance

automatically.In the case of a term loan, if installments of principal are overdue for more

than two years, it is to be treated as doubtful.Under doubtful NPA there are three sub

categories :

D1 i.e. up to 1 year : 20% provision is made by the banks

D2 i.e. up to 2 year: 30% provision is made by the bank

D3 i.e. up to 3 year : 100% provision is made by the bank.

Loss Assets: Under this 100% provision is made. When account holder comes in this

category their account can be written off by the banks. After this the assets are handed

over to recovery agents for sale. An asset where loss has been identified by the bank or

internal/

the study of risk management and the factors of credit default

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