CREDIT RISK IN INDIAN BANKING SYSTEM

BY:

NOOPUR GUPTA (12MBA021)

RISHIKA SINGHAL (12MBA028)

RISK MANAGEMENT IN INDIAN BANKS

Banking is the business of money where high risks are involved

An element of risk is inherent in the banking operations. They have to manage and balance risk.

Risk may be defined as an exposure to a transaction with loss, which occurs with some probability and which can be expected, measured and minimised.

CREDIT RISK

Bank Credit means the amount of credit available to a company or individual from banking system. It is the aggregate of the amount of funds financial institutions are willing to provide to an individual or organisation.

Credit risk refers to the risk that a borrower will default on any type of debt by failing to make payments which it is obligated to do. 

Credit risk is risk due to uncertainty in a counterparty’s (also called an obligor’s or credit’s) ability to meet its financial obligations

The risk is primarily that of the lender and includes lost principal and interest, disruption to cash flows, and increased collection costs.

EXAMPLES OF CREDIT RISK A consumer may fail to make a payment

due on a mortgage loan, credit card, or any other loan

An insolvent insurance company does not pay a policy obligation

An insolvent bank won't return funds to a depositor

A government grants bankruptcy protection to an insolvent consumer or business

ASSESSMENT OF CREDIT RISK

In assessing credit risk from a single counterparty, an institution must consider three issues:

Default Probability: What is the likelihood that the counterparty will default on its obligation either over the life of the obligation or over some specified horizon, such as a year?

Credit Exposure: In the event of a default, how large will the outstanding obligation be when the default occurs?

Recovery Rate: In the event of a default, what fraction of the exposure may be recovered through bankruptcy proceedings or some other form of settlement?

TYPES OF CREDIT RISK

Credit Default Risk

The risk of loss arising from a debtor being unlikely to pay its loan obligations in full or the debtor is more than 90 days past due on any material credit obligation; default risk may impact all credit-sensitive transactions, including loans, securities and derivatives.

Concentration Risk

The risk associated with any single exposure or group of exposures with the potential to produce large enough losses to threaten a bank's core operations. It may arise in the form of single name concentration or industry concentration.

Country Risk

The risk of loss arising from a sovereign state freezing foreign currency payments (transfer/conversion risk) or when it defaults on its obligations (sovereign risk); this type of risk is prominently associated with the country's macroeconomic performance and its political stability.

MITIGATING CREDIT RISK

Risk-based pricing: Lenders generally charge a higher interest rate to borrowers who are more likely to default, a practice called risk-based pricing. Lenders consider factors relating to the loan such as loan purpose, credit rating, etc. and estimates the effect on yield (credit spread).

Covenants: Lenders may write stipulations on the borrower, called covenants, into loan agreements: Periodically report its financial condition Refrain from paying dividends, repurchasing

shares, borrowing further, or other specific, voluntary actions that negatively affect the company's financial position

Tightening: Lenders can reduce credit risk by reducing the amount of credit extended, either in total or to certain borrowers.

Diversification: Lenders to a small number of borrowers (or kinds of borrower) face a high degree of unsystematic credit risk, called concentration risk. Lenders reduce this risk by diversifying the borrower pool.

Deposit insurance: Many governments establish deposit insurance to guarantee bank deposits of insolvent banks. Such protection discourages consumers from withdrawing money when a bank is becoming insolvent, to avoid a bank run, and encourages consumers to hold their savings in the banking system instead of in cash.

THANK YOU