Risk in Bank Lending

8/8/2019 Risk in Bank Lending

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RISKS IN BANK LENDING



TYPES OF RISKS

Banks face many risks which impact their balance

sheet, transactions, operations and liquidity.

Balance sheet risks arise out of mismatches

between the interest rate structure, maturity and

currency of assets & liabilities which are ²

± Credit Risks

± Market Risks ± Operational Risks



CREDIT RISK

´ Credit risk taking is the process of determining

the credit-worthiness of borrowers and

financing them at price which matches their

risk profile

´ Definition as per Basel Committee

« ´the potential that a bank borrower or counterparty

will fail to meet its obligations in accordance with

agreed termsµ



Definition as per RBI guidelines

± ´Credit Risk is possibility of losses associated

with diminution in the credit quality of borrowersor counterparties. In a bank, losses stem fromoutright default due to inability or unwillingnessof a customer or counterparty to meet

commitments in relation to lending, trading,settlement and other financial transactions oralternatively, losses resulting from reductions inportfolio value arising from actual or perceiveddeterioration in credit quality. Credit riskemanates from banks dealings with anindividual, corporate, bank, financial institutionor a sovereign



´ Credit risk may take the following forms:

« Principal and or interest amount not repaid

« Funds may not be forthcoming from constituents

upon crystallization of liability

« The payment or series of payments due from the

counter parties under the respective contractsmay not be forthcoming or ceases

« Funds / securities settlement may not be

effected

« The availability and free transfer of foreign

currency funds may either cease or restrictions

may be imposed by the sovereign



´ Components

«Default Risk

²A borrower or counter party is unable or unwilling to

meet commitments on a loans, swap / option,

settlement or other financial transaction

« Portfolio Risk

²Arises from the composition or concentration of the

banks· exposure to various sectors



Factors

± Internal Factors

Loan pricing Decision-taking time

Service quality

Deficiencies in credit appraisal

Poor risk pricing

Ineffective supervision

Absence of timely loan reviews / renewals

± External Factors

State of economy

Size of fiscal deficits Changes in monetary and credit stance of the Central

Bank

Changes in regulatory environment



Managing of Factors ± Internal Factors

Proactive Loan policy Good quality in credit analysis

Loan monitoring

Development of sound credit culture

± External Factors

Loan policy with built-in flexibility to meet changing times Periodic review of loan policy having guidelines for

± Creation of diversified loan portfolio

± Norms for scientific credit appraisal for assessing financial,techno-economic and commercial viability

± Norms for exposure

± Norms for sectoral deployment of funds ± Strong monitoring and internal control system

± Delegation and accountability



M ARKET RISK

´ the possibility of loss to banks caused by

changes in the market variables.

´

Market risk arises from adverse changes inmarket variables

« Interest rate

« Foreign exchange rate

«Commodity price

« Equity price



TYPES OF M ARKET RISK

´ Liquidity Risk

´ Interest Rate Risk

´ Foreign Exchange Rate Risk´ Commodity Price Risk

´ Equity Price Risk



LIQUIDITY RISK

´ Liquidity is the ability of banks to efficiently meet

« deposit and other liability payments

« fund growth of the loan portfolio

«

funding of off-balance sheet claims if arises´ Liquidity risk arises from a mismatch in the

maturities of assets and liabilities

´ Comprises of

« Funding risk« Time risk

«Call risk



INTEREST RATE RISK

´ The exposure of bank·s financial condition to

movements in interest rates

´ Timing differences in the maturity and re-

pricing of the banks· assets, liabilities andoff balance sheet positions.

´ Re-pricing mismatches can expose banks·

income and underlying economic value tounexpected volatility as interest rates

fluctuate



Asset-Liability Management System formeasuring cash flow mismatches at differenttime bands

Identifying future behavior of assets, liabilitiesand off-balance sheet items based on Past experience

Trend analysis

Assumptions

These also require continuous review and finetuning to achieve close-to-reality predictions

M ANAGEMENT OF LIQUIDITYAND

INTEREST RATE RISKS



Asset-Liability Management Committee(ALCO)

Transparent and comprehensive market risk

management policies, procedures,prudential risk limits, review mechanisms

and reporting & auditing systems



Tracking impact of Prepayment of loans

Closure of high-value / bulk deposits

Exercising of put / call options on derivative instruments

Watch on

Seasonal / cyclical pattern of loans / deposits

Potential liquidity needs of meeting withdrawals on un-availed credit limits

New loan demands

Compliance with loan policy

Potential deposit losses

Statutory obligations for investments etc

Documents

Risk in Bank Lending