Page 80 - DCOM505_WORKING_CAPITAL_MANAGEMENT

Unit 5: Credit Risk Management

Notes
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Caution The framework should be comprehensive enough to capture all risks a bank is
exposed to and have flexibility to accommodate any change in business activities.

Risk management systems have to fulfill three main functions:
The collection and processing of indicators in accordance with the information needs of
the recipients;

The analysis of changes in the portfolio value depending on changes in defaults in the
credit business and the consolidation of these results into values that are relevant for risk
controlling; and
Monitoring the risks to be able to detect ahead of time if limits are about to be exceeded.
As the implementation of modern IT-based risk management systems is very costly, special
attention has to be paid to their integration in existing processes as well as to their acceptance on
the part of the employees.

5.1.1 Functions of Risk Management

Risk management contains:

1. Identification,
2. Measurement,
3. Aggregation,
4. Planning and management,

5. As well as monitoring of the risks arising in a bank’s overall business.

Notes Risk management is thus a continuous process to increase transparency and to
manage risks.

5.1.2 Categories of Risk

Banking risks can be broadly categorized as under:

1. Credit Risk
2. Interest Rate Risk
3. Market Risk
4. Liquidity Risk

5. Operational Risk
1. Credit Risk: Credit risk is the oldest risk among the various types of risks in the financial
system, especially in banks and financial institutions due to the process of intermediation.
Managing credit risk has formed the core of the expertise of these institutions. While the
risk is well known, growth in the markets, disintermediation, and the introduction of a
number of innovative products and practices has changed the way credit risk is measured
and managed in today’s environment. Credit risk enters the books of a bank the moment

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