Pre ClassPPT 3

8/11/2019 Pre ClassPPT 3

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Credit Risk

Credit Risk is defined as "The inability or

unwillingness of the customer or counter party

to meet commitments in relation to lending,

hedging, settlement and other financialtransactions.

o Credit risk emanates when the counter party is

unwilling or unable to meet or fulfill thecontractual obligations/commitments thereby

leading to defaults.


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Variants

Credit Risk

TransactionRisk

Default RiskDown Grade

Risk

Port Folio Risk

ConcentrationRisk

Systemic Risk


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Default Risk

Credit Default Risk Is the probability that the

counter party will fail to meet his payment

obligations as per agreement.

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.


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Default Risk

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

Post sanction surveillance


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Default Risk

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Outdated production process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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Default Risk

External Factors-Applicable both to the borrowerand Banks:

Credit worthiness of the counter party

Interest rate risk Forex risk

Country risk

Economic scenario

Government policies

Trade restrictions.


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Down Grade Risk

Rating down grade riskThis is the probability that the credit risk measure of the counter party asmeasured by a credit rating system ,worsens during the loan period andmarket value of the asset falls due to rating down grade.

Status of the credit exposure may not remain the same.

Quality of the credit exposure may improve on account of variousfactors.

Quality of the credit exposure may deteriorate .

Improvement in the credit quality indicated by the upward movementof the rating of the party is called upward migration.

Deterioration in the quality of the credit exposure as indicated by thedown ward movement of the credit rating is called down wardmigration.


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Down Grade Risk

When the quality of the exposure deteriorates

as indicated by the down ward migration of

the rating, the exposure needs more

provision.

Down grade risk also calls for more capital

allocation


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Portfolio Risk

At the portfolio level, the risk may be concentration risk or systemicrisk. The concentration risk may be by way of:

Industry/Activity

Loan size

Distribution in a region

Security

Loan Ratio

Repayment period

Interest rate

Purpose Income level

It would be prudent to set overall as also individual sub limits for eachof the concentration classes


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Systemic Risk

The portfolio quality may deteriorate in spite ofproper diversification. This may be due tovarious factors beyond the control of the

Borrower and the causes may be many andvaried such as-

Interest rate

Exchange rate Government policy

Inflation Etc

Pre ClassPPT 3

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