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Risk Management in Commercial Banks (A Case Study of Public and Private

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 “RISK MANAGEMENT IN COMMERCIAL BANKS”
(A CASE STUDY OF PUBLIC AND PRIVATE SECTOR BANKS) - ABSTRACT ONLY

Prof. Rekha Arunkumar

Faculty (Finance), MBA Programme

ABSTRACT:

“Banks are in the business of managing risk, not avoiding it…

………
……
……
..”

Risk is the fundamental element that drives financial behaviour. Without risk, the financial
system would be vastly simplified. However, risk is omnipresent in the real world.
Financial Institutions, therefore, should manage the risk efficiently to survive in this highly
uncertain world. The future of banking will undoubtedly rest on risk management dynamics.
Only those banks that have efficient risk management system will survive in the market in
the long run. The effective management of credit risk is a critical component of
comprehensive risk management essential for long-term success of a banking institution.

Credit risk is the oldest and biggest risk that bank, by virtue of its very nature of business,
inherits. This has however, acquired a greater significance in the recent past for various
reasons. Foremost among them is the wind of economic liberalization that is blowing
across the globe. India is no exception to this swing towards market driven economy.
Better credit portfolio diversification enhances the prospects of the reduced concentration
credit risk as empirically evidenced by direct relationship between concentration credit risk
profile and NPAs of public sector banks.

“…
………
………
…A bank’s success lies in its ability to assume and
aggregate risk within tolerable and manageable limits”.

First Author;

Prof. Rekha Arunkumar

Ph.D., from University of Mysore (awaiting result by September ’ 05), PGDCA, M.Com.,
B.B.M.,
Faculty in Finance (10 years of experience),
MBA Programme,
Bapuji Institute of Engineering & Technology (affiliated to Visveswaraya Technical University)
Davangere – 4. Karnataka

Second Author;

Dr. G. Kotreshwar
Ph.D., M.Com., ICWAI.,
Professor of Commerce (25 years of experience)
University of Mysore, Manasagangotri
Mysore – 6.

1
COMPLETE PAPER

RISK MANAGEMENT IN COMMERCIAL BANKS

(A CASE STUDY OF PUBLIC AND PRIVATE SECTOR BANKS)

“Banks are in the business of managing risk, not avoiding it…

………
….…
…..”

1. PREAMBLE:
1.1 Risk Management:
The future of banking will undoubtedly rest on risk management dynamics. Only
those banks that have efficient risk management system will survive in the market in the long
run. The effective management of credit risk is a critical component of comprehensive risk
management essential for long-term success of a banking institution. Credit risk is the oldest
and biggest risk that bank, by virtue of its very nature of business, inherits. This has however,
acquired a greater significance in the recent past for various reasons. Foremost among them
is the wind of economic liberalization that is blowing across the globe. India is no exception
to this swing towards market driven economy. Competition from within and outside the
country has intensified. This has resulted in multiplicity of risks both in number and volume
resulting in volatile markets. A precursor to successful management of credit risk is a clear
understanding about risks involved in lending, quantifications of risks within each item of the
portfolio and reaching a conclusion as to the likely composite credit risk profile of a bank.

The corner stone of credit risk management is the establishment of a framework that
defines corporate priorities, loan approval process, credit risk rating system, risk-adjusted
pricing system, loan-review mechanism and comprehensive reporting system.

1.2 Significance of the study:

The fundamental business of lending has brought trouble to individual banks and
entire banking system. It is, therefore, imperative that the banks are adequate systems for
credit assessment of individual projects and evaluating risk associated therewith as well as the
industry as a whole. Generally, Banks in India evaluate a proposal through the traditional
tools of project financing, computing maximum permissible limits, assessing management
capabilities and prescribing a ceiling for an industry exposure. As banks move in to a new
high powered world of financial operations and trading, with new risks, the need is felt for
more sophisticated and versatile instruments for risk assessment, monitoring and controlling
risk exposures. It is, therefore, time that banks managements equip themselves fully to
grapple with the demands of creating tools and systems capable of assessing, monitoring and
controlling risk exposures in a more scientific manner.

Credit Risk, that is, default by the borrower to repay lent money, remains the most
important risk to manage till date. The predominance of credit risk is even reflected in the
composition of economic capital, which banks are required to keep a side for protection
against various risks. According to one estimate, Credit Risk takes about 70% and 30%
remaining is shared between the other two primary risks, namely Market risk (change in the
market price and operational risk i.e., failure of internal controls, etc.). Quality borrowers
(Tier-I borrowers) were able to access the capital market directly without going through the
debt route. Hence, the credit route is now more open to lesser mortals (Tier-II borrowers).
With margin levels going down, banks are unable to absorb the level of loan losses. There
has been very little effort to develop a method where risks could be identified and measured.
Most of the banks have developed internal rating systems for their borrowers, but there has

2
been very little study to compare such ratings with the final asset classification and also to
fine-tune the rating system. Also risks peculiar to each industry are not identified and
evaluated openly. Data collection is regular driven. Data on industry-wise, region-wise
lending, industry-wise rehabilitated loan, can provide an insight into the future course to be
adopted.

Better and effective strategic credit risk management process is a better way to
manage portfolio credit risk. The process provides a framework to ensure consistency
between strategy and implementation that reduces potential volatility in earnings and
maximize shareholders wealth. Beyond and over riding the specifics of risk modeling issues,
the challenge is moving towards improved credit risk management lies in addressing banks’
readiness and openness to accept change to a more transparent system, to rapidly
metamorphosing markets, to more effective and efficient ways of operating and to meet
market requirements and increased answerability to stake holders.

There is a need for Strategic approach to Credit Risk Management (CRM) in Indian
Commercial Banks, particularly in view of;

(1) Higher NPAs level in comparison with global benchmark

(2) RBI’ s stipulation about dividend distribution by the banks
(3) Revised NPAs level and CAR norms
(4) New Basel Capital Accord (Basel –II) revolution

According to the study conducted by ICRA Limited, the gross NPAs as a proportion
of total advances for Indian Banks was 9.40 percent for financial year 2003 and 10.60 percent
for financial year 20021. The value of the gross NPAs as ratio for financial year 2003 for the
global benchmark banks was as low as 2.26 percent. Net NPAs as a proportion of net
advances of Indian banks was 4.33 percent for financial year 2003 and 5.39 percent for
financial year 2002. As against this, the value of net NPAs ratio for financial year 2003 for
the global benchmark banks was 0.37 percent. Further, it was found that, the total advances of
the banking sector to the commercial and agricultural sectors stood at Rs.8,00,000 crore. Of
this, Rs.75,000 crore, or 9.40 percent of the total advances is bad and doubtful debt. The size
of the NPAs portfolio in the Indian banking industry is close to Rs.1,00,000 crore which is
around 6 percent of India’ s GDP2.

The RBI has recently announced that the banks should not pay dividends at more
than 33.33 percent of their net profit. It has further provided that the banks having NPA
levels less than 3 percent and having Capital Adequacy Reserve Ratio (CARR) of more than
11 percent for the last two years will only be eligible to declare dividends without the
permission from RBI3. This step is for strengthening the balance sheet of all the banks in the
country. The banks should provide sufficient provisions from their profits so as to bring
down the net NPAs level to 3 percent of their advances.

NPAs are the primary indicators of credit risk. Capital Adequacy Ratio (CAR) is
another measure of credit risk. CAR is supposed to act as a buffer against credit loss, which is

1
ICRA Limited, (2004), “Report 1 : Global Benchmarking”, IBA Bulletin, special issue, January
2004, pp. 30
2
ICRA Limited, (2004), Op.cit. pp.36
3
Parasmal Jain, (2004), “Basel II Accord : Issues and Suggestions”, IBA Bulletin, June 2004,
pp.9-10.

3
set at 9 percent under the RBI stipulation4. With a view to moving towards International best
practices and to ensure greater transparency, it has been decided to adopt the ’ 90 days’ ‘ over
due’ norm for identification of NPAs from the year ending March 31, 2004.

The New Basel Capital Accord is scheduled to be implemented by the end of 2006.
All the banking supervisors may have to join the Accord. Even the
domestic banks in addition to internationally active banks may have to
conform to the Accord principles in the coming decades. The RBI as the
regulator of the Indian banking industry has shown keen interest in
strengthening the system, and the individual banks have responded in good
measure in orienting themselves towards global best practices.

1.3 Credit Risk Management(CRM) dynamics:

The world over, credit risk has proved to be the most critical of all risks faced by a
banking institution. A study of bank failures in New England found that, of the 62 banks in
existence before 1984, which failed from 1989 to 1992, in 58 cases it was observed that loans
and advances were not being repaid in time 5 . This signifies the role of credit risk
management and therefore it forms the basis of present research analysis.

Researchers and risk management practitioners have constantly tried to improve on

current techniques and in recent years, enormous strides have been made in the art and
science of credit risk measurement and management6. Much of the progress in this field has
resulted form the limitations of traditional approaches to credit risk management and with the
current Bank for International Settlement’ (BIS) regulatory model. Even in banks which
regularly fine-tune credit policies and streamline credit processes, it is a real challenge for
credit risk managers to correctly identify pockets of risk concentration, quantify extent of risk
carried, identify opportunities for diversification and balance the risk-return trade-off in their
credit portfolio.

The two distinct dimensions of credit risk management can readily be identified as
preventive measures and curative measures. Preventive measures include risk assessment,
risk measurement and risk pricing, early warning system to pick early signals of future
defaults and better credit portfolio diversification. The curative measures, on the other hand,
aim at minimizing post-sanction loan losses through such steps as securitization, derivative
trading, risk sharing, legal enforcement etc. It is widely believed that an ounce of prevention
is worth a pound of cure. Therefore, the focus of the study is on preventive measures in tune
with the norms prescribed by New Basel Capital Accord.

The study also intends to throw some light on the two most significant developments
impacting the fundamentals of credit risk management practices of banking industry – New
Basel Capital Accord and Risk Based Supervision. Apart from highlighting the salient
features of credit risk management prescriptions under New Basel Accord, attempts are made
to codify the response of Indian banking professionals to various proposals under the accord.
Similarly, RBI proposed Risk Based Supervision (RBS) is examined to capture its direction
and implementation problems.

4
Information Bureau, (2004), The Economic Times, 4th August 2004, pp.7
5
Prahlad Sabrani, “ Risk Management by Banks in India”, IBA Bulletin, July 2002.
6
Ravi Mohan R., “Credit Risk Management in Bank”, The Chartered Accountant, March 2001.

4
1.4 Objectives of the research:
The present study attempts to achieve the following objectives:
1. Analysis of trends in Non-Performing Assets of commercial banks in India.
2. Analysis of trends in credit portfolio diversification during the post-liberalization period.
3. Studying relationship between diversified portfolio and non-performing assets of public
sector banks vis-à-vis private sector banks.
4. Profiling and analysis of concentration risk in public sector banks vis-à-vis private sector
banks.
5. Evaluating the credit risk management practices in public sector banks vis-à-vis private
sector banks.
6. Reviewing the New Basel Capital Accord norms and their likely impact on credit risk
management practices of Indian commercial banks.
7. Examining the role of Risk Based Supervision in strengthening credit risk management
practices of Indian commercials banks.
8. Suggesting a broad outline of measures for improving credit risk management practices
of Indian commercial banks.

2. THE PROBLEM OF NON-PERFORMING ASSETS

2.1 Introduction:

Liberlization and Globalization ushered in by the government in the early 90s have
thrown open many challenges to the Indian financial sector. Banks, amongst other things,
were set on a path to align their accounting standards with the International standards and by
global players. They had to have a fresh look into their balance sheet and analyze them
critically in the light of the prudential norms of income recognition and provisioning that
were stipulated by the regulator, based on Narasimhan Committee recommendations.

Loans and Advances as assets of the bank play an important part in gross earnings
and net profits of banks. The share of advances in the total assets of the banks forms more
than 60 percent7 and as such it is the backbone of banking structure. Bank lending is very
crucial for it make possible the financing of agricultural, industrial and commercial activities
of the country. The strength and soundness of the banking system primarily depends upon
health of the advances. In other words, improvement in assets quality is fundamental to
strengthening working of banks and improving their financial viability. Most domestic public
sector banks in the country are expected to completely wipeout their outstanding NPAs
between 2006 and 20088.

NPAs are an inevitable burden on the banking industry. Hence the success of a
bank depends upon methods of managing NPAs and keeping them within tolerance level, of
late, several institutional mechanisms have been developed in India to deal with NPAs and

7
Kashinath B.G., (1998) “Reduction of NPAs – legal bottlenecks and amendments suggested”,
Conference paper, BECON 98, pp.137-140
8
Dalbir Singh, (2003), Seminar on “Risk Management in Indian banks’ , Business Line, December
4, 2003, pp. 10

5
there has also been tightening of legal provisions. Perhaps more importantly, effective
management of NPAs requires an appropriate internal checks and balances system in a bank9.

In this background, this chapter is designed to give an outline of trends in NPAs in

Indian banking industry vis-à-vis other countries and highlight the importance of NPAs
management. NPA is an advance where payment of interest or repayment of installment of
principal (in case of Term loans) or both remains unpaid for a period of 90 days 10 (new norms
with effect from 31 st March, 2004) or more.

2.2 Trends in NPA levels:

The study has been carried out using the RBI reports on banks (Annual Financial
Reports), information / data obtained from the banks and discussion with bank officials. For
assessing comparative position on CARR, NPAs and their recoveries in all scheduled banks
viz., Public sector Banks, Private sector banks were perused to identify the level of NPAs.
The Table 2.1 lists the level of non-performing assets as percentage of advances of
pubic sector banks and private sector banks. An analysis of NPAs of different banks groups
indicates, the public sector banks hold larger share of NPAs during the year 1993-94 and
gradually decreased to 9.36 percent in the year 2003. On the contrary, the private sector
banks show fluctuating trend with starting at 6.23 percent in the year 1994-95 rising upto
10.44 percent in year 1998 and decreased to 8.08 percent in the year 2002-03.
Table 2.1 Gross and Net Non-Performing Assets (NPAs) as percentage of Advances of Public
Sector Banks and Private Sector Banks : 1994 – 2003

Year / Banks Public Sector Banks Private Sector Banks

Gross NPAs Net NPAs Gross NPAs Net NPAs

1993-94 24.80 14.5 6.23 3.36

1994-95 19.50 10.7 6.47 4.10

1995-96 18.00 8.9 7.45 4.34

1996-97 17.84 9.18 8.49 5.37

1997-98 16.02 8.15 8.67 5.26

1998-99 15.89 8.13 10.44 6.92

1999-00 13.98 7.42 8.17 5.14

2000-01 12.37 6.74 8.37 5.44

2001-02 11.09 5.82 9.64 5.73

2002-03 9.36 4.54 8.08 4.95

9
Pricewaterhouse Coopers, (2004), “Management of Non Performing Assets by Indian Banks”,
IBA Bulletin, Special Issue, January, 2004, pp.61.
10
Tamal Bandyopadhya, (2002), “Debt Wish for ARCs?”, Business Standard, July 4, 2002.

6
Source : Report on Trend and Progress of Banking in India from 1994-2003. Reserve Bank of
India.

Graph 2.1 : Gross NPAs as percentage of advances of

Public and Private Sector Banks : 1994-2003

30.00

25.00

20.00
(in %)

15.00

10.00

5.00

0.00
1994 1995 1996 1997 1998 1999 2000 2001 2002 2003

Year
Public Sector Banks Private Sector Banks

2.3 International comparison of NPA levles:

Comparison of the problem loan levels in the Indian banking system vis-à-vis those
in other countries, particularly those in developed economies, is often made, more so in the
context of the opening up of our financial sector. The data in respect of NPAs level of
banking system available for countries like USA, Japan, Hong Kong, Korea, Taiwan &
Malaysia reveal that it ranged from 1 percent to 8.1 percent during 1993-94, 0.9 percent to 5.5
percent during 1994-95, 0.6 to 3.0 percent during 2000 as against 23.6 percent, 19.5 percent
and 14 percent respectively for Indian banks during this year 11.

The NPAs level in Japan, for example is at 3.3 percent of total loans, it is 3.1 percent
in Hong Kong, 7.6 percent in Thailand, 11.2 percent in Indonesia, and 8.2 percent in Malaysia
during 94-95, whereas the corresponding figure for India is very high at 19.5 percent 12.
According to Ernst & Young13, the actual level of NPAs of banks in India is around
$40 billion, much higher than the government own estimates of $16.7 billion 14 . This
difference is largely due to the discrepancy in the accounting of NPAs followed by India and
rest of the world. According to Ernst & Young, the accounting norms in India are less
stringent than those of the developed economies. Further more, Indian banks also have the
tendency to extend past due loans. Considering India’ s GDP of around $ 470 billion, NPAs
were around 8 percent of the GDP which was better than many Asian economic power houses.
In China, NPAs were around 45 percent of GDP, while equilent figure for Japan was around

11
www.SomeAspectandIssuesRelatingToNPAsInCommercialBanks.htm, (2001), pp.2
12
Katuri Nageswar Rao, (2000), “NPAs Ground realities”, Chartered Financial Analysts, April
2000, pp. 46.
13
Banking Bureau, (2003), “India and Non-Performing Assets”, IBA Bulletin, January 2003,
pp.36
14
Banking Bureau, (2003), Op. cit. pp.36

7
28 percent and the level of NPAs for Malaysia was around 42 percent. On an aggregate level.
Asia’ s NPAs have increased from $ 1.5 trillion in 2000 to $ 2 trillion in 2002- an increase of
33 percent. This accounts for 29 percent of the Asian’ s countries total GDP. As per the E &
Y’ s Asian NPL report for 2002, the global slowdown, government heisting and inconsistency
in dealing with the NPAs problem and lender complacency have caused the region’ s NPAs
problem to increase. However looking from a positive angle, India’ s ordinance, on
Securitization and Reconstruction of Financial Assets and Enforcements of Security Interest
is a step in the right direction. This ordinance will help banks to concentrate on good
business by eliminating the business of bad loans15.

2.4 Reasons for NPAs in India:

An internal study conducted by RBI 16 shows that in the order of prominence, the
following factors contribute to NPAs.
Internal Factors:
* diversion of funds for
- expansion / diversification / modernization
- taking up new projects
- helping promoting associate concerns
* time / cost overrun during the project implementation stage
* business (product, marketing etc) failure
* inefficiency in management
* slackness in Credit Management and monitoring
* inappropriate technology / technical problems
* lack of co-ordination among lenders.
External Factors:
* recession
* input / power shortage
* price escalation
* exchange rate fluctuation
* accident and natural calamities etc.
* changes in government policies in excise / import duties, pollution control
orders etc.

2.5 Conclusion:
Asset quality is one of the important parameters based on which the performance of a
bank is assessed by the regulation and the public. Some of the areas where the Indian
banks identified to for better NPA management like credit risk management, special
investigative audit, negotiated settlement, internal checks & systems for early indication of
NPAs etc.,

3. MANAGEMENT OF CREDIT RISK - A PROACTIVE APPROACH

3.1 Introduction:
Risk is the potentiality that both the expected and unexpected events may have an
adverse impact on the bank’ s capital or earnings. The expected loss is to be borne by the
borrower and hence is taken care by adequately pricing the products through risk premium

15
Banking Bureau, (2003), Op. cit. pp.36
16
Pricewaterhouse Coopers, (2004), Op.cit. pp. 67-68

8
and reserves created out of the earnings. It is the amount expected to be lost due to changes
in credit quality resulting in default. Whereas, the unexpected loss on account of individual
exposure and the whole portfolio is entirely is to be borne by the bank itself and hence is to
be taken care by the capital.

Banks are confronted with various kinds of financial and non-financial risks viz.,
credit, market, interest rate, foreign exchange, liquidity, equity price, legal, regulatory,
reputation, operational etc. These risks are highly interdependent and events that affect one
area of risk can have ramifications for a range of other risk categories. Thus, top management
of banks should attach considerable importance to improve the ability to identify measure,
monitor and control the overall level of risks undertaken.

3.2 Credit Risk:

The major risk banks face is credit risk. It follows that the major risk banks must
measure, manage and accept is credit or default risk. It is the uncertainty associated with
borrower’ s loan repayment. For most people in commercial banking, lending represents the
heart of the Industry. Loans dominate asset holding at most banks and generate the largest
share of operating income. Loans are the dominant asset in most banks’ portfolios,
comprising from 50 to 70 percent of total assets17.

Credit Analysis assigns some probability to the likelihood of default based on

quantitative and qualitative factors. Some risks can be measured with historical and projected
financial data. Other risks, such as those associated with the borrower’ s character &
willingness to repay a loan, are not directly measurable. The bank ultimately compares these
risks with the potential benefits when deciding whether or not to approve a loan.

3.3 Components of credit risk:

The credit risk in a bank’ s loan portfolio consists of three components18;
(1) Transaction Risk
(2) Intrinsic Risk
(3) Concentration Risk
(1) Transaction Risk: Transaction risk focuses on the volatility in credit quality and
earnings resulting from how the bank underwrites individual loan transactions.
Transaction risk has three dimensions: selection, underwriting and operations.
(2) Intrinsic Risk: It focuses on the risk inherent in certain lines of business and loans to
certain industries. Commercial real estate construction loans are inherently more risky
than consumer loans. Intrinsic risk addresses the susceptibility to historic, predictive, and
lending risk factors that characterize an industry or line of business. Historic elements
address prior performance and stability of the industry or line of business. Predictive
elements focus on characteristics that are subject to change and could positively or
negatively affect future performance. Lending elements focus on how the collateral and
terms offered in the industry or line of business affect the intrinsic risk.
(3) Concentration Risk: Concentration risk is the aggregation of transaction and intrinsic
risk within the portfolio and may result from loans to one borrower or one industry,
geographic area, or lines of business. Bank must define acceptable portfolio
concentrations for each of these aggregations. Portfolio diversify achieves an important

17
Timothy W. Koch, (1998), “Overview of credit policy and loan characterstics”, Bank
Management, 3rd Edition, The Dryden Press, Harcourt Brace College Publishers, pp. 629-630.
18
John E. Mckinley & John R. Barrickman, (1994), “Strategic Credit Risk Management-
Introduction”, Robert Morris Associates, , pp. 4-5.

9
 objective. It allows a bank to avoid disaster. Concentrations within a portfolio will
determine the magnitude of problems a bank will experience under adverse conditions.

3.4 Strategic credit risk management:

The post liberalization years have seen significant pressure on banks in India, some
of them repeatedly showing signs of distress. One of the primary reasons for this has been
the lack of effective and strategic credit risk management system. Risk selection, as part of a
comprehensive risk strategy that grows and supports from corporate priorities, is the
foundation for future risk management. This is the underlying premise of an integrated pro-
active approach to risk management and entails a four step process19 :
Step 1. Establishing corporate priorities
Step 2. Choosing the credit culture.
Step 3. Determining credit risk strategy
Step 4. Implementing risk controls
These steps (strategies) focus on reducing the volatility in portfolio credit quality and
bank earning’ s performance. Strategic CRM will provide all bank personnel a clear
understanding of the bank’ s credit culture and of the risk acceptable in the loan portfolio.
Senior management then manages the process and the portfolio to align them with corporate
priorities.

3.5 Conclusion:
Credit Risk Management in today’ s deregulated market is a big challenge. Increased
market volatility has brought with it the need for smart analysis and specialized applications
in managing credit risk. A well defined policy framework is needed to help the operating staff
identify the risk-event, assign a probability to each, quantify the likely loss, assess the
acceptability of the exposure, price the risk and monitor them right to the point where they
are paid off.
The management of banks should strive to embrace the notion of ‘ uncertainty and
risk’ in their balance sheet and instill the need for approaching credit administration from a
‘risk-perspective’ across the system by placing well drafted strategies in the hands of the
operating staff with due material support for its successful implementation.
The principal difficulties with CRM models are obtaining sufficient hard data for
estimating the model parameters such as ratings, default probabilities and loss given default
and identifying the risk factors that influence the parameter, as well as the correlation
between risk factors. Because of these difficulties one should be aware that credit systems
are only as good as the quality of the data behind them.

4. CONCENTRATION RISK PROFILE OF INDIAN COMMERCIAL BANKS

4.1 Introduction:

“Risk selection is more important than risk management

in determining a bank’s credit performance”20.

Credit risk strategy results from a bank’ s tolerance for risk as evidenced by how it
selects, manages, and diversifies risk. Banks are moving away from a buy-and-hold strategy
with respect to their loans. They are now syndicating risk, distributing the risk to enhance the
value of their portfolio. When originating a loan, banks need evaluate how much incremental
risk they are adding, how much they need to be compensated for taking that risk. Many banks

19
John E. Mckinley & John R. Barrickman, (1994), Op. cit. pp. 3-8.
20
John E. Mckinley & John R. Barrickman, (1994)“Strategic Credit Risk Management”, Robert
Morris Associates, pp. 36

10
look at each credit inside than across the enterprise to understand the incremental risk that the
new loan is adding the loans.
Portfolio theory applies equally to collections of credit risks as to equity and other
investments. The purpose of having a portfolio of assets, instead of a single asset, is to
reduce risk through diversification without sacrificing the rate of return 21 . An efficient
portfolio achieves a specified rate of return with the minimum possible risk for specified level
of risk of for the maximum possible rate of return. The principle, which underlines portfolio
management, is ‘ diversification of risk22’ .
The objective of this chapter is to present a general framework for quantification of
concentration risk followed by concentration risk profiling of public sector banks vis-à-vis
private sector banks; and to explore the relationship between concentration risk profile and
NPAs level.

4.2 Concentration risk:

A new methodology adopted to evaluate the volatility in portfolio performance

predicated on the risk profile of the institution. The banking industry has relied heavily on
prior experience as a predictor of future credit performance. Concentration risk 23 is the
aggregation of transaction and intrinsic risk within the portfolio and may result from loans to
one borrower or one industry, geographic area, or line of business. Senior management must
define acceptable portfolio concentrations for each of these aggregations.

The most conservative banks manage borrower exposure through restrictive house
limits and maximum exposure to industries and lines of business. Many banks also have
wisely sought to mitigate risk through geographic diversification. Aggressive banks have
traditionally accepted hogs ‘ shares’ of individual borrower, lines of business, and industry
exposures. Managing concentration limits will become a high priority for these lenders in the
future because of the lingering pain from lessons leaned in commercial real estate, energy etc.

4.3 Concentration risk strategy:

The bank does have an opportunity to reduce their concentration in one line of
business or industry. Outstanding would have to be replaced with more lending focused on
lower risk lines of business and borrowers. Banks must constantly monitor the risk profile to
determine it future lending practices are consistent with the desired risk profile24.
Selecting a Risk Strategy:
Using the risk profile as a frame of reference, management should select a risk
strategy that will be consistent with long-term objectives for portfolio quality and
performance. The three variable risk strategies in order of riskiness are: Conservative,
Managed and Aggressive. The selection of the appropriate strategy depends on a bank’ s
priorities and risk appetite. Most often, the choice is not made as part of a formal process but
evolves as the bank seeks its desired risk posture through its lending practices. Consequently,

21
Ravimohan R, (2001), “A New Perspective – CRM in Banks”, The Chartered Accountant,
March 2001.
22
Joseph F. Sinkey, Jr., (1998), “Commercial Bank Financial Management – In the Financial
Services Industry”, Fifth Edition, Prentice-Hall International Inc. New Jersey. pp. 403.
23
John E. Mckinley & John R. Barrickman, (1994) Op.cit. pp.41
24
John E. Mckinley & John R. Barrickman, (1994), Op.cit. pp50

11
few banks have a clear picture of the risk profile that will emerge. A selection of risk strategy
with specific implementation plans provides a much better idea of the future risk profile.
The following guidance should help in understanding, which strategy best serves
managements intent;
(i) Conservative : Accepts relatively low levels of transaction, intrinsic and concentration
risk. The strategy normally supports a values-driven culture.
(ii) Managed: Accepts relatively low levels of risk in two categories but high levels in one
category. For example: a bank that takes conservative levels of concentration and transaction
risk but is more aggressive with intrinsic risk. The strategy normally promotes the immediate
performance culture.
(iii) Aggressive: Accepts relatively low levels of risk in one category, more aggressive risk in
two categories. An example would be a bank that closely manages transaction risk but
accepts higher levels of intrinsic and concentration risk. This strategy is normally employed
in a production driven culture.
Obviously, credit volatility rises as the levels and categories of risk are increased.
The aggressive strategy requires more careful management because it operates closer to the
danger zone. If risk in all three categories reaches high levels, the bank’ s credit volatility
becomes so great in a downturn that capital adequacy and survival could become real issues.

4.4 Impact of concentration risk on NPAs level:

The concentration risk is an important component of the credit risk and is prompted
by the concentration of the credit portfolio in one or two occupations or industries. It is
desirable to achieve a diversified credit portfolio in order to minimize the occupation-wise
concentration risk as well as industry-wise concentration risk. It has been the experience of
the commercial banks that higher NPAs level is generally associated with high degree of
concentration risk-both occupation-wise and industry-wise. In order to analyse the observed
relationship between NPAs level and concentration risk, the relevant data is presented in this
section.
The highest level of NPAs, i.e., 24.8 percent in the year 1994 corresponds to the
maximum index value in the same year. Similarly, the minimum level of NPAs, i.e., 9.36
percent in the year 2003 corresponds to the lowest index value in the same year. Overall, the
decrease in occupation-wise concentration risk is matched by the corresponding decrease in
NPAs level.

An attempt was made to quantify the relationship between concentration-index and

NPAs level by way of coefficient of correlation and the results found to be satisfactory in
reinforcing our earlier observations. Table 4.1 lists the results.

Table 4.1 : Coefficient of correlation between Concentration-Index and NPAs for the
period 1994 – 2003
Public Sector Banks Private Sector
Banks

(a) Occupation-wise concentration risk

Coefficient of correlation = r 0.80 0.67

12
 Coefficient of determination = r 2 0.64 0.45

(b) Industry-wise concentration risk

Coefficient of correlation = r 0.89 -0.52
2
Coefficient of determination = r 0.78 0.27

As observed earlier, there exists a strong positive relationship between occupation-

wise concentration-index and NPAs level in case of both the public sector banks and private
sector banks with the coefficient of correlation value being 0.80 and 0.67 respectively. This
is confirmed by the higher values of coefficient of determination of 0.64 and 0.45 for public
sector banks and private sector banks respectively. Similarly, there exists a strong positive
relationship between industry-wise concentration-index and NPAs level in case of public
sector banks as confirmed by a very high value of r2 = 0.78. But this is not clearly
pronounced in the case of private sector banks as indicated by lower value of r 2 = 0.27.

4.5 Conclusion:

Concentration risk is a very significant component of overall credit risk profile of a

banking institution. A prudent credit risk management is based on the principle of diversified
portfolio to avoid concentrations in any one or couple of occupations or industry. Trends in
concentration risk profile of public sector banks during the post-liberalization period clearly
indicate a paradigm shift in the portfolio approach to credit risk management. The
occupation-wise and industry-wise concentrations reduced significantly during the study
period. On the contrary, the trends in concentration risk profile of private sector banks
signify an opposite direction. The occupation-wise concentration risk increased substantially
from 37 percent in 1999 to 59 percent in 2003.

Both the approaches suggested for quantification of concentration risk yielded

satisfactory results. Under the profile-score method, with a score of less than 10 for public
sector banks, and more than 10 for private sector banks, it is concluded that public sector
bank’ s risk profile is low while that of private sector bank’ s risk is moderate. Similarly,
under the concentration-index method it was found that there exists strong relationship
between occupation-wise concentration risk profile and NPAs level with higher values of
coefficient of determination of 0.64 and 0.45 for public sector banks and private sector banks
respectively. Similarly, strong positive relationship between industry-wise concentration risk
and NPAs level in case of public sector banks, as confirmed by high value of r 2 =0.78. But
same is not pronounced in case of private sector banks.

Based on these results it can be concluded that

1. “The declining trends in Non-Performing Assets (NPAs) in public sector banks

during the post-liberalization period is an outcome mainly caused by the
improved credit portfolio diversification”.

2. “The concentration risk profile of credit portfolio of private sector banks is

higher than that of public sector banks impacting adversely the NPAs level of
private sector banks vis-à-vis public sector banks”.

13
5. CREDIT RISK MANAGEMENT PRACTICES IN COMMERCIAL BANKS - AN
EVALUATION

5.1 Introduction:

The objective of this chapter is to evaluate the credit risk management practices in
public sector banks vis-à-vis private sector banks based on primary data. Primary data
have been collected from the credit department executives serving in public and private sector
banks at head office level and regional office level in Karnataka with the help of predesigned
questionnaires. In this case, direct interview method has been followed for data accuracy and
to get first-hand information from respondents about credit risk management practices.

5.2 Sample data:

The study has analyzed the credit portfolio risk management policies and practices of
21 Banks of which 12 are public sector banks and 9 private sector banks. Though it was
originally aimed to cover 20 percent of over 800 credit department executives in the selected
banks, it was possible to get the response of only about 10 percent of the number. Credit
department executives were not easily accessible. They were found either closeted in a
meeting or busy otherwise. Therefore, the generalizations formulated here are based on the
opinions of this small number.

5.3 Analysis of CRM practices:

This section is devoted for analysis of CRM practices in public sector banks vis-à-vis
private sector banks. For this purpose, various issues covered include scope for NPAs
reduction, credit risk measurement, credit evaluation processes, credit rating system and
training in credit risk assessment.

CRM perform index – Public and Private sector banks:

The questionnaire was designed with a focus on standards of CRM practices envisaged
under the New Basel Capital Accord. The important parameters of performance standards
considered for analysis included the following table.

Table 5.1 CRM Performance Index

Public and Private sector banks
Performance Index ( % )
Sl. Performance Evaluation Public Sector Private Sector
No. Banks Banks
1 Project appraisal procedures 58 49
2 Availability of comprehensive data 46 39
3 Risk based loan pricing 48 40
4 Deployment of information technology 46 57
5 Efficacy of Internal credit rating system 54 50
6 Sharing experience with other lenders over 40 36
problem loans
7 Practice of fine-tuning loan policies 55 46
8 Internal audit of CRM procedures 42 49
9 Bank credit standards 51 48
10 Credit decision: merit v/s extraneous 60 46
considerations
11 Frequency of credit portfolio reviews 61 58

14
 12 Renewal of borrowers limits 34 42
13 Periodical review of customer credit ratings 33 57
Total 632 617
Performance Index 49 47

Overall CRM performance is at below the satisfactory level for both the public and
private sector banks. Furthermore, with performance index score of 49 percent and 47
percent for public sector banks and private sector banks respectively, there is no significant
difference between public sector banks and private sector banks as regards CRM performance.

5.4 Conclusion:

The analysis of the primary data revealed some interesting aspects about the credit
risk management practices of commercial banks in India. The important among them are
listed below:
(1) More popular credit evaluation techniques like Altman’ s Z score model, J.P.
Morgan credit matrix, Zeta analysis do not find a place in the credit evaluation tool
kit of the commercial banks in India.
(2) Employees are not given enough training to enhance their conceptual understanding
of credit risk and improving their skills in handling it.
(3) The leverage provided by information technology for efficient credit risk
administration is not satisfactorily harnessed by commercial banks in India,
particularly in public sector banks.
(4) The availability of comprehensive data for credit evaluation is far from satisfactory
in commercial banks in India.
(5) Overall CRM performance of commercial banks in India as against the standard set
out under New Basel Capital Accord is not satisfactory.
(6) With CRM performance Index of 49 percent in public sector banks and 47 percent in
private sector banks respectively, the performance of public sector banks is at par
with the performance of private sector banks.
Based on these findings it can be concluded that;

1. “Credit risk management practices of commercial banks in India do not meet

the standards set out under the New Basel Capital Accord”.

2. “There exists no marked difference between public sector banks and private
sector banks as regards their credit risk management performance”.

6. RISK BASED SUPERVISION PROBLEMS AND PROSPECTS

Changes over the past ten years in the banking system have been dramatic.
Advances in technology, closer interrelations among economies, liberalization and
deregulation etc. have made the world of banking a far more complex place. The system of
annual inspection of banks by RBI may soon be a thing of the past. The central bank is
expected to follow a system of random and more frequent inspections based on the risk
profile of individual banks. RBI insisted that all commercial banks move towards the system

15
of Risk- Based Supervision (RBS) by January 1st 2003 25 , its inspections would be more
focused on areas of potential risk such as credit risk, market risk and operational risk. Based
on the guidelines to be drafted by the RBI all banks have to submit information to the central
bank periodically. With this information, bankers believe that the RBI will always be in the
know as how particular bank is operating and can monitor its performance almost on a day-to-
day basis.
RBI inspections, both on-site and off-site can be conducted as and when the central
bank deems necessary and could be as often as possible based on RBI’ s risk perception of a
bank. “After the recent scams, the RBI wants to tighten norms so that the central bank is
informed well in advance about any irregularity 26 ”. The Basel Committee on Banking
Supervision had advocated Risk- Based Supervision of banks and this has been put to practice
in various countries. Now RBI has come with a discussion paper on “Move towards Risk
Based Supervision of Banks” in Aug 2001 and RBI roll out the process and implemented
from the financial year April 200427. This chapter describes the main features of proposed
RBS and analyses the responses of executives to the modalities of implementing it.

In moving towards a Risk Based Supervision of banks the goal of Reserve Bank of
India and the concern of banks converge in a common point: we want strong, healthy
institutions that offer loans to worthy borrowers who in turn repay the loan interest, so that
the bank can build its capital base and provide a reasonable return to its shareholders. If the
goal can be achieved, the public, including both borrowers and depositors, will be better
served through a network of safe and sound financial institutions that properly identify,
measure, monitor and control their risks. The risk based supervision project would lead to
prioritization of selection and determining frequency and length of supervisory cycle, targeted
appraisals, and allocation of supervisory resources in accordance with the risk perception of
the supervised institutions. The RBS will also facilitate the implementation of the
supervisory review pillar of the New Basel Capital Accord, which requires that national
supervisors set capital ratios for banks based on their risk profile.

Private sector banks executives are not in-favour for implementation of RBS as
vindicated by the sample data according to which 94 percent (an average) of them are against the
various proposals of RBS. This negative response reflect the reservations hosted by the private
sector banks in general about the various proposals coming from a Central Bank leading to more
interfere in their internal affairs. On the other hand, the public sector banks show a different
scenario as they have almost balanced opinion in favour of RBS.

7. NEW BASEL CAPITAL ACCORD - IMPLICATIONS FOR CRM PRACTICES

OF COMMERCIAL BANKS IN INDIA

7.1 Introduction:

One of the most crucial methods of risk control in banks and financial institutions
around the world is regulatory capital requirement, which is vital in reducing the risk of bank
insolvency and the potential cost of a bank’ s failure for its customers.

25
Rajalakshmi Menon, (2002), “RBI may shift to risk-based supervision of banks”, Business Line,
July 3, 2002, pp.10.
26
Rajalakshmi Menon, (2002), Op.cit. pp.10
27
Pathrose P.P. (2002), Op.cit pp.21

16
 The Basel Committee of the Bank for International Settlements (The Committee) that
sets the capital adequacy requirements for banks and other financial institutions drew up
Basel Accord-I in 1988 28 . This Accord recommends a method of relating the capital
requirement of banks to their assets, using a simple system of risk weights and minimum
capital ratio of 8 percent. This Accord provides a standard approach to measuring credit,
market risk of the banks to arrive at the minimum capital requirement.

Basel-I have served the banking world for over 10 years. The business of banking,
risk management practices, supervisory approaches and financial markets have seen a sea
change over the years. In 1996, the initial Accord was extended to include market risk that
banks incur in their trading account. The BCBS (Basel Committee on Banking Supervision)
brought out a consultative paper on New Capital Adequacy framework in June 1999, followed
by second and third consultative package in January 2001 and April 200329. Implementation
is expected to take effect in member countries by 2006. Banks in India will not meet a 2006
deadline for implementing the revised Basel Capital Accord and will need at least two
additional years to comply with the new international banking rules30. The Basel II Accord
will put further pressure on banks requiring them to also hold capital to offset operational risk
that the Committee expects on an average to constitute approximately 20 percent of the
overall capital requirement.

Recognising the importance of Basel-II and the need for a reasonable timeframe to
switch over, the RBI has already initiated discussions in several areas well in time. The
adoption and implementation of the new capital accord by all banks in India may further
result in the improvement in our country rating which, in turn, will increase our competency
to adopt the new accord.

7.2 The New Basel Capital Accord(Basel -II):

The New Accord is being proposed to introduce greater risk sensitivity. The New
Accord provides a spectrum of approaches from simple to advance methodologies for the
advancement of both credit and operational risks in determining capital levels.

The new accord is built around the THREE Pillars as shown in Figure 7.1 31:
(1) Pillar-I : Minimum Capital Requirement
(2) Pillar-II : Supervisory Review
(3) Pillar-III : Market Discipline

7.3 New Basel Accord – Issues in the Indian context:

The Accord, aims at boosting the safety of the world banking system. Regulators in
both India and China are anxious to nudge their banks on to the proposed risk-based capital
regime, to ensure that they are competitive and managed to the highest standards32. True,

28
Geetha Bellu, (2003), “Discloures in the forefront”, Decan Herald, Monday, October 6, 2003,
pp.1 .
29
Geetha Bellu, (2003), Op.cit. pp.1
30
Gautam Chakravorthy, (2003), “Indian banks not ready for capital rule deadline”, International
Herald Tribune, Wednesday, Septermber 24, 2003.
31
BIS, (2003), “An overview of the New Basel Capital Accord”, IBA Bulletin, September 2003,
pp.33-34
32
Melvyn Westlake, (2003), “India, China still undecided on adopting new accord”, Gulf News,
September, 2003, pp. 1.

17
banks in these two Asian giants may not all be ready to adopt the full rigorous of the accord
dubbed Basel II from the outset, at the end of 2006. The RBI agrees with committee’ s view
that the focus of the New Accord may be primarily on Internationally Active Banks, that is,
those with 20% of the business from foreign operations. SBI’ s Chairman Mr. A.K. Purwar
says that SBI’ s International operations (India’ s largest bank) contribute about 6% of its
business33. So the new accord feared by many central banks, including the RBI. In this regard,
RBI is of the view that all banks with cross border business exceeding 20% of the total
business may be defined as ‘ Internationally Active’ banks and ‘ Significant’ banks may be
defined as those banks with complex structures and whose market share in the total assets of
the domestic banking system exceed 1 percent 34.

The Basel II accord is a challenge to Indian banks. Indian Banks are conceptually and
academically ready to adopt the new norms. It would involve shift in direct supervisory focus
away to the implementation issue and also there are lot of difficulties and issues in its
implementation in the Indian Context35. These difficulties like availability of historical data,
higher risk wrights for sovereign, cost factor, technological up-gradation, diversified products,
legal and regulatory guidelines, higher risk weight to small and medium enterprises, credit
rating etc.

7.4 Conclusion:

The response to Basel Accord II reforms world over is not uniform and spontaneous.
Basel-II is known for complicated risk management models and complex data requirements.
Big international banks, as those in the US, prefer this new version, as they perceive that their
superior technology and systems would make them Basel compliant and provide an edge in
the competitive environment, in the form of lower regulatory capital.

Indian banks do not perceive any immediate value in the new norms as they are
globally insignificant players with simple and straight forward balance-sheet structures. This
is clearly vindicated by the sample study according to which 57 per cent of the executives of
public sector banks are sceptical about Basel Accord II norms, particularly in respect of
investment cost and the complexity of proposed internal rating system. As against this, the
private sector banks with supposedly more investment in technology related infrastructure are
in favour of the proposals under New Basel Capital Accord as vindicated by the sample study
according to which 67 percent of executives of private sector banks are in-favour for New
Basel Capital Accord.

However, putting Basel II in place is going to be far more challenging than Basel I.
The adoption of Basel II will boost good Risk Management practices and good corporate
governance in banks. However, the cost of putting in place robust system today is viewed in
an increasingly number of countries as a price worth paying to prevent such crisis. Assuming
that the banks can get over the technological and operational hurdles, switching over to Basel
II norms can no doubt turn the Indian banks, mainly the public sector banks, more efficient
and competitive globally. This, in turn, will help strengthen the financial sector to undertake
further reforms including capital account convertibility more confidently.

33
Information Bureau, (2003), “SBI to be Basel-II compliant: Purwar”, The Hindu Business Line,
September 2003.
34
Information Bureau, (2003), “Testing waters: RBI to meet bank CEOs on Basel II soon”, The
Economic Times, September 19, 2003.
35
Parasmal Jain, (2004), Op.cit. pp.8-10

18
8. FINDINGS, SUGGESTIONS & CONCLUSION:

8.1 SUMMARY OF FINDINGS:

The trends in NPAs level, CRM practices of commercial banks and the response to
reforms under Basel Accord II and Risk Based Supervision were examined and compared
between public sector banks and private sector banks in this study. The analysis of secondary
and primary data resulted in satisfactory results, a summary of which is presented in the
following paragraphs.

(1) While NPAs level of public sector banks did register a clear decreasing trend during
the post-liberalization period, NPAs level of private sector banks remained constant
during this period.
(2) The concentration risk profile of private sector banks is found to be higher than that of
public sector banks.
(3) In case of public sector banks, there exists a strong relationship between NPAs level and
credit portfolio diversification as vindicated by higher co-efficient of correlation values.
The decrease in NPAs level is caused by reduction in concentration risk. This
relationship is however, not clearly pronounced in case of private sector banks.
(4) Credit risk management performance of commercial banks in India is not satisfactory.
(5) There exists no marked difference between public sector banks and private sector banks
as regards their credit risk management performance:
(6) Though the private sector banks executives are not in-favour of implementation of Risk
Based Supervision, yet they are receptive to the proposals under New Basel Capital
Accord. This is vindicated by sample data according to which only 6 percent of
respondents have expressed their concurrence with RBS and the remaining 94 percent of
them opposing it. In contrast, 67 percent of the respondents expressed their concurrence
to the proposals under NBCA and remaining 33 percent of respondents opposing it.
(7) The executives of public sector banks have almost balanced their opinions in-favour of
RBS and New Accord. While 54 percent of them expressed their concurrence to the
proposals under RBS, 43 percent of them agree with the proposed reforms under NBCA.

8.2 SUGGESTIONS:
(1) Achieving a better portfolio equilibrium:
Commercial banks need to diversify further to achieve a better credit portfolio
equilibrium. The share of transport operations and finance occupations in case of public
sector banks was very minimal i.e., 1.21 percent and 6.53 percent respectively as on March 31,
2003. Similarly, in case of private sector banks, the share of occupations like transport and
finance was very minimal at 1.52 percent and 6.46 percent respectively as on March 31, 2003.

(a) In India now the services sector (including transportation, financial services etc.,) is
playing an important role and in fact it accounts for about one half of India’ s GDP
and this sector is also generating more income and more employment opportunities.
Banks will, therefore, have to sharpen their credit assessment skills by providing
better training to enhance their conceptual understanding of credit risk and improving
their skills in handling it which lay more emphasis in providing finance to the wide
range of activities in the services sector.
(b) Retail loans are also a relatively small fraction of the Indian banking system’ s total
loans and advances. In India retail loans constitute about 5 percent of aggregate
GDP compared to an average of around 30 percent for other Asian economies. The
implication of all this data is that the retail market is relatively ‘ under-penetrated’
and has significant potential for growth both for public and private sector banks.

19
 (c) Retail products help banks in diversifying their risk by spreading credit to widely
dispersed set of individual customers. Retail loans offers banks the opportunity to
cross sell various other value added services and retail products like insurance and
mutual fund to the depositors.

(2) Establishing Risk Management Information System (RMIS):

The effectiveness of risk management depends on efficient information system,
computerization and networking of the branch activities. An objective and
reliable database has to be built up for which bank has to analyse its own past
performance data relating to loan defaults, operational losses etc.
(a) Added to IT expenditure is the cost and effort of training and redeployment of
manpower. Besides training in the ‘ hard’ aspects of understanding risk and using
software, it is also need for building in a risk orientation in individual officers at the
operating level, to create awareness about credit assessment skills and risk mitigation
processes is needed.
(b) Public sector banks need to set up modern IT infrastructure in place within one to
two years in line with foreign and new generation private banks. There is a need of
centralized database so that core banking solution can be implemented.

(3) Redesigning the Internal Rating System:

In order to ensure a systematic and consistent credit assessment process within the
bank, a robust and auditable rating system must be in place. A list of credit drivers or factors
that influence the creditworthiness of a barrower / company with a weight assigned on
measurable element data like financial ratios and subjective elements like management
quality, industry prospects etc., The Basel Committee set up by BIS has been urging banks to
set up internal systems to measure and manage credit risk. It is important that Indian banks
use credit ratings available from agencies in conjunction with their internal models to
measure credit risk.
(4) Early Warning Signals:
It is essential to identify signs of distress or early recognition of problem loans. The need for
early identification of problem loans has been established as one of the
principles of the Basel Committee for the management of credit risk. Problem
loans most commonly arise from a cash crisis facing the borrower. As the
crisis develops, internal and external signs emerge, often subtly.
A typical Early Warning Signals process is listed below:
a. Continuous Monitoring by Loan Officers
b. Scheduled Loan Reviews
c. External Examination
d. Loan Covenants
e. Warning Signs
f. Asset Classification and Downgrade Report

8.3 CONCLUSION:

Credit risk management in today’ s deregulated market is a challenge. The very

complexion of credit risk is likely to undergo a structural change in view of migration of Tier-
I borrowers and, more particularly, the entry of new segments like retail lending in the credit
portfolio. These developments are likely to contribute to the increased potential of credit risk
and would range in their effects from inconvenience to disaster. To avoid being blindsided,

20
banks must develop a competitive Early Warning System (EWS) which combines strategic
planning, competitive intelligence and management action. EWS reveals how to change
strategy to meet new realities, avoid common practices like benchmarking and tell executives
what they need to know – not what they want to hear.

The reputation of a bank is very important for corporate clients. A corporation seeks
to develop relationship with a reputable banking entity with a proven track record of high
quality service and demonstrated history of safety and sound practices. Therefore, it is
imperative to adopt the advanced Basel-II methodology for credit risk. The Basel Committee
has acknowledged that the current uniform capital standards are not sensitive and suggested a
Risk Based Capital approach. Reserve Bank of India’ s Risk Based Supervision reforms are a
fore-runner to the Basel Capital Accord-II. For banks in India with the ‘ emerging markets’
tag attached to them going down the Basel-II path could be an effective strategy to compete in
very complex global banking environment. Indian banks need to prepare themselves to be
competed among the world’ s largest banks. As our large banks consolidate their balance
sheets size and peruse aspirations of large international presence, it is only expected that they
adopt the international best practices in credit risk management.

“……
.……
………
……A bank’s success lies in its ability to assume and
aggregate risk within tolerable and manageable limits”.

BIBLIOGRAPHY:

Books:
Bidani S.N., (2002), “Managing Non-Performing Assets in Banks”, Vision Books publishers,
Ref:#8-02-06-12, pp.71-74.
Eddie Cade, (1997), “Managing Banking Risks”, First Edition, Woodhead Publishing Ltd., In
association with The Chartered Institute of Bankers, England, pp. 104 – 144.
James T. Gleason, (2001), “ Risk – The New Management Imperative in Finance”, Jaico
Publishing house, pp. 13-19. & 113-121.
Johan E.Mckinley & John. R. Barrickman, (1994), “Strategic Credit Risk Management”,
Robert Morris Association, Philadelphia, pp. 1-12, 20-27, 36-42, 62-68.
Joseph F. Sinkey, Jr., (1998), “Commercial Bank Financial Management – In the Financial
Services Industry”, Fifth Edition, Prentice-Hall International Inc., New Jersey. pp. 22-35,
/213-220 and 404-408.
Timolthy W.Koch, (1998), “ Bank Management”, Library of Congress Cataloging-in-
Publication Data, pp. 431-440.
Timothy W. Koch, (1998), “Bank Management - Overview of credit policy and loan
characterstics”, Third Edition, The Dryden Press, Harcourt Brace College Publishers, pp.
431-440 and 629-630.
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Agarwal P. and Srikanth V (2002), “A question of Reliability”, Economic Times, July 24,
2002.
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pp.36

21
 ICRA Limited “Global Benchmarking”, IBA Bulletin, January 2004, Vol XXVI. No.1, pp. 26.
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presented at BECON’ 98 conference, pp. 54-61
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www.BaselAccord.htm, (2002), “Risk Management systems in Banks”, pp.1-15.
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Risk Evaluation – A new perspective”, The Hindu, May 27.
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First Author;

Prof. Rekha Arunkumar

Ph.D., from University of Mysore (awaiting result by September ’ 05), PGDCA, M.Com.,
B.B.M.,
Faculty in Finance (10 years of experience),
MBA Programme,
Bapuji Institute of Engineering & Technology (affiliated to Visveswaraya Technical University)
Davangere – 4. Karnataka

Second Author;

Dr. G. Kotreshwar
Ph.D., M.Com., ICWAI.,
Professor of Commerce (25 years of experience)
University of Mysore, Manasagangotri
Mysore – 6.

Submitted to

Review Committee
Ninth Capital Market Conference
Indian Institute of Capital Market
(December 19-20, 2005)
Mumbai.

22

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