Description
Describing the helps in understanding the credit risk.
CREDIT RISK MANAGEMENT
CREDIT RISK
? The RBI’s guidance note on credit risk defines credit
risk as the
? “possibility of losses associated with diminution of
credit quality of borrowers or counterparties”.
LOAN LOSSES
? Two types of losses are possible in respect of a
borrower or class of borrowers:
? Expected Losses [EL] ? Unexpected Losses [UL]
EXPECTED LOSSES [EL]
? These are part of the normal business risks banks carry
and can be provided for ? EL is a function of three parameters:
? Probability of Default [PD] ? Exposure at default [EAD] ? Loss Given Default [LGD]
EXPECTED LOSSES AND CREDIT RISK
? EL can be modelled
? EL = PD X EAD XLGD ? EL can be aggregated at level of individual loans or at
portfolio level ? Does EL constitute credit risk?
CREDIT RISK DEFINED
PROBABILITY THAT A BORROWER OR A COUNTERPARTY WILL FAIL TO MEET OBLIGATIONS IN ACCORDANCE WITH AGREED TERMS
CREDIT RISK MANAGEMENT
? MEANS….. ? Managing risks in individual credits or transactions ? Managing risks in the credit portfolio ? Managing the inter relationships between credit risk and other risks
MANAGING CREDIT RISK
Establishing an appropriate credit risk environment Operating a sound credit granting process
Ensuring adequate controls over credit risk
Maintaining appropriate credit administration, measurement and monitoring processes
BASEL COMMITTEE- PRINCIPLES OF CREDIT RISK MANAGEMENT
? According to the Committee, a comprehensive credit risk management program will address the following four areas:
? Establishing an appropriate credit risk environment; ? Operating under a sound credit granting process; ? Maintaining an appropriate credit administration,
measurement and monitoring process; and ? Ensuring adequate controls over credit risk. ? These practices should also be applied in conjunction with sound practices related to the assessment of asset quality, the adequacy of provisions and reserves, and the disclosure of credit risk
PROVISIONING FOR EXPECTED LOSSES
? International Accounting practices set forth standards for
estimating the impairment of a loan for general financial reporting purposes. ? Regulators are expected to follow these standards ‘to the letter’ for determining the provisions and allowances for loan losses. ? According to these standards, a loan is ‘impaired’ when, based on current information and events, it is probable that the creditor will be unable to collect all amounts [interest and principal] due in line with the terms of the loan agreement. Such assets are also called ‘criticized’ or ‘non performing’ assets.
A BASIC MODEL FOR QUANTIFYING CREDIT RISK
? Classifying loans and advances into performing or non performing would help a bank determine the amount of provisioning to be made ? Based on level of NPAs, credit risk can be quantified. A basic model would be:
= [PBT / NPA]
CREDIT RISK MODELS
? Techniques to calculate PD are of two kinds: ? Empirical - These models use historical default rates associated with each ‘score’ to identify the characteristics of defaulting counterparties. ? Market based - These models use counterparty market data (e.g. bond or credit default swap spreads, volatility of equity market value) to infer the likelihood of default.
CREDIT RISK TRANSFERS
? Credit risk can be hedged through two popular
methods:
? Loan sales ? Credit derivatives
CREDIT DERIVATIVES
? A credit derivative is a security with a pay-off linked to a credit related event, such as borrower default, credit rating downgrades, or a structural change in a security containing credit risk.
? In credit derivatives, there is a party [or a bank] trying to transfer credit risk, called protection buyer, and there is a counterparty [another bank]
trying to acquire credit risk, called protection seller.
Securitisation
? is the process of pooling and repackaging of homogenous
illiquid financial assets into ? marketable securities that can be sold to investors.
SECURITISATION
? (i) SPV is created to hold title to assets underlying securities;
? (ii) the originator or holder of assets sells the assets (existing or future) to the SPV;
? (iii) the SPV, with the help of an investment banker,
issues securities which are distributed to investors; and ? (iv) the SPV pays the originator for the assets with the proceeds from the sale of securities.
PRUDENTIAL NORMS IN INDIA- LOANS AND ADVANCES
? The RBI issues detailed guidelines periodically on the
following aspects
? Asset Classification ? Income recognition ? Provisioning
ASSET CLASSIFICATION- INDIA
? An asset [ including a leased asset] becomes non
performing when it ceases to generate income for the bank ? Loan assets are categorized as follows:
? Standard [Performing Assets]
? Non Performing Assets [NPAs]
? ? ?
Sub-standard (NPA ? 12 months) Doubtful [ if sub standard > 12 months]) Loss [irrecoverable]
PRESENT PROVISIONING NORMS- INDIA – subject to change
Loan Classification Standard Assets Sub standard assets Doubtful Assets (secured) Provision % 0.40 - 1 10
20 30
? 1 year 1year – 3 years ? 3 years [revised wef 1st apr 05] 100
Doubtful Assets (unsecured) Loss Assets 100
100
INCOME RECOGNITION- INDIA
? Based on the record of recovery
? Income from NPAs not recognized on accrual basis ? When a credit facility is first classified as Non
Performing, unrealized interest accrued & credited to P&L a/c in the previous year is reversed or provided for
SECURITIZATION- INDIA
? June 2002 – SECURITISATION AND RECONSTRUCTION FINANCIAL ASSETS AND ENFORCEMENT OF SECURITY INTEREST ORDINANCE ? Securitisation companies can be incorporated under the Companies Act with permission from RBI ? NPAs and standard assets can be securitized ? Bank is called ‘originator’ ? Borrower is called ‘ obligor’
doc_956582394.ppt
Describing the helps in understanding the credit risk.
CREDIT RISK MANAGEMENT
CREDIT RISK
? The RBI’s guidance note on credit risk defines credit
risk as the
? “possibility of losses associated with diminution of
credit quality of borrowers or counterparties”.
LOAN LOSSES
? Two types of losses are possible in respect of a
borrower or class of borrowers:
? Expected Losses [EL] ? Unexpected Losses [UL]
EXPECTED LOSSES [EL]
? These are part of the normal business risks banks carry
and can be provided for ? EL is a function of three parameters:
? Probability of Default [PD] ? Exposure at default [EAD] ? Loss Given Default [LGD]
EXPECTED LOSSES AND CREDIT RISK
? EL can be modelled
? EL = PD X EAD XLGD ? EL can be aggregated at level of individual loans or at
portfolio level ? Does EL constitute credit risk?
CREDIT RISK DEFINED
PROBABILITY THAT A BORROWER OR A COUNTERPARTY WILL FAIL TO MEET OBLIGATIONS IN ACCORDANCE WITH AGREED TERMS
CREDIT RISK MANAGEMENT
? MEANS….. ? Managing risks in individual credits or transactions ? Managing risks in the credit portfolio ? Managing the inter relationships between credit risk and other risks
MANAGING CREDIT RISK
Establishing an appropriate credit risk environment Operating a sound credit granting process
Ensuring adequate controls over credit risk
Maintaining appropriate credit administration, measurement and monitoring processes
BASEL COMMITTEE- PRINCIPLES OF CREDIT RISK MANAGEMENT
? According to the Committee, a comprehensive credit risk management program will address the following four areas:
? Establishing an appropriate credit risk environment; ? Operating under a sound credit granting process; ? Maintaining an appropriate credit administration,
measurement and monitoring process; and ? Ensuring adequate controls over credit risk. ? These practices should also be applied in conjunction with sound practices related to the assessment of asset quality, the adequacy of provisions and reserves, and the disclosure of credit risk
PROVISIONING FOR EXPECTED LOSSES
? International Accounting practices set forth standards for
estimating the impairment of a loan for general financial reporting purposes. ? Regulators are expected to follow these standards ‘to the letter’ for determining the provisions and allowances for loan losses. ? According to these standards, a loan is ‘impaired’ when, based on current information and events, it is probable that the creditor will be unable to collect all amounts [interest and principal] due in line with the terms of the loan agreement. Such assets are also called ‘criticized’ or ‘non performing’ assets.
A BASIC MODEL FOR QUANTIFYING CREDIT RISK
? Classifying loans and advances into performing or non performing would help a bank determine the amount of provisioning to be made ? Based on level of NPAs, credit risk can be quantified. A basic model would be:
= [PBT / NPA]
CREDIT RISK MODELS
? Techniques to calculate PD are of two kinds: ? Empirical - These models use historical default rates associated with each ‘score’ to identify the characteristics of defaulting counterparties. ? Market based - These models use counterparty market data (e.g. bond or credit default swap spreads, volatility of equity market value) to infer the likelihood of default.
CREDIT RISK TRANSFERS
? Credit risk can be hedged through two popular
methods:
? Loan sales ? Credit derivatives
CREDIT DERIVATIVES
? A credit derivative is a security with a pay-off linked to a credit related event, such as borrower default, credit rating downgrades, or a structural change in a security containing credit risk.
? In credit derivatives, there is a party [or a bank] trying to transfer credit risk, called protection buyer, and there is a counterparty [another bank]
trying to acquire credit risk, called protection seller.
Securitisation
? is the process of pooling and repackaging of homogenous
illiquid financial assets into ? marketable securities that can be sold to investors.
SECURITISATION
? (i) SPV is created to hold title to assets underlying securities;
? (ii) the originator or holder of assets sells the assets (existing or future) to the SPV;
? (iii) the SPV, with the help of an investment banker,
issues securities which are distributed to investors; and ? (iv) the SPV pays the originator for the assets with the proceeds from the sale of securities.
PRUDENTIAL NORMS IN INDIA- LOANS AND ADVANCES
? The RBI issues detailed guidelines periodically on the
following aspects
? Asset Classification ? Income recognition ? Provisioning
ASSET CLASSIFICATION- INDIA
? An asset [ including a leased asset] becomes non
performing when it ceases to generate income for the bank ? Loan assets are categorized as follows:
? Standard [Performing Assets]
? Non Performing Assets [NPAs]
? ? ?
Sub-standard (NPA ? 12 months) Doubtful [ if sub standard > 12 months]) Loss [irrecoverable]
PRESENT PROVISIONING NORMS- INDIA – subject to change
Loan Classification Standard Assets Sub standard assets Doubtful Assets (secured) Provision % 0.40 - 1 10
20 30
? 1 year 1year – 3 years ? 3 years [revised wef 1st apr 05] 100
Doubtful Assets (unsecured) Loss Assets 100
100
INCOME RECOGNITION- INDIA
? Based on the record of recovery
? Income from NPAs not recognized on accrual basis ? When a credit facility is first classified as Non
Performing, unrealized interest accrued & credited to P&L a/c in the previous year is reversed or provided for
SECURITIZATION- INDIA
? June 2002 – SECURITISATION AND RECONSTRUCTION FINANCIAL ASSETS AND ENFORCEMENT OF SECURITY INTEREST ORDINANCE ? Securitisation companies can be incorporated under the Companies Act with permission from RBI ? NPAs and standard assets can be securitized ? Bank is called ‘originator’ ? Borrower is called ‘ obligor’
doc_956582394.ppt