CREDIT RISK MANAGEMENT

WHAT IS CREDIT RISK? Probability of loss from a credit transaction is the plain vanilla definition of credit risk. According to the Basel Committee, Credit Risk is most simply defined as the potential that a borrower or counter-party will fail to meet its obligations in accordance with agreed terms. The Reserve Bank of India (RBI) has defined credit risk as the probability of losses associated with diminution in the credit quality of borrowers or counter-parties. Though credit risk is closely related with the business of lending (that is BANKS) it is Infact applicable to all activities of where credit is involved (for example, manufactures /traders sell their goods on credit to their customers).the first record of credit risk is reported to have been in 1800 B.C.

CREDIT RISK MANGEMENT----FUNCTIONALITY The credit risk architecture provides the broad canvas and infrastructure to effectively identify, measure, manage and control credit risk --- both at portfolio and individual levels--- in accordance with a banks risk principles, risk policies, risk process and risk appetite as a continuous feature. It aims to strengthen and increase the efficacy of the organization, while maintaining consistency and transparency. Beginning with the Basel Capital Accord-I in 1988 and the subsequent Barings episode in1995 and the Asian Financial Crisis in1997, the credit risk management function has become the centre of gravity , especially in a financially in services industry like banking.

DISTINCTION BETWEEN CREDIT MANGEMENT AND CREDIT RISK MANAGEMENT Although credit risk management is analogous to credit management, there is a subtle difference between the two. Here are some of the following:

CREDIT MANAGEMENT 1. It involves selecting and identifying the borrower/counter party. 2. It revolves around examining the three

CREDIT RISK MANAGEMENT 1. It involves identifying and analyzing risk in a credit transaction. 2. It revolves around measuring, managing

Ps of borrowing: people (character and and controlling credit risk in the context of an capacity of the borrower/guarantor), purpose organizations credit philosophy and credit (especially if the project/purpose is viable or appetite. not), protection (security offered, borrowers capital, etc.) 3. It is predominantly concerned with the probability of repayment. 4. Credit appraisal and analysis do not 3. It is predominantly concerned with probability of default. 4. Depending on the risk manifestations of an

usually provide an exit feature at the time of exposure, an exist route remains a usual option sanction. 5. The standard financial tools of assessment for credit management are through the sale of assets/securitization. 5. Statistical tools like VaR (Value at Risk),

balance CVaR (Credit Value at Risk), duration and

sheet/income statement, cash flow statement simulation techniques, etc. form the core of coupled with computation of specific credit risk management.

accounting ratios. It is then followed by postsanction supervision and a follow-up

mechanism (e.g. inspection of securities, etc.). 6. It is more backward-looking in its in terms of studying of 6. It is forward looking in its assessment,

assessment,

the looking, for instance, at a likely scenario of an the adverse outcome in the business.

antecedents/performance borrower/counterparty.