Page 85 - DCOM505_WORKING_CAPITAL_MANAGEMENT

Working Capital Management

Notes 5.3.1 Tools of Credit Risk Management

The instruments and tools, through which credit risk management is carried out, are detailed
below:
1. Exposure Ceilings: Prudential Limit is linked to Capital Funds – say 15% for individual
borrower entity, 40% for a group with additional 10% for infrastructure projects undertaken
by the group, Threshold limit is fixed at a level lower than Prudential Exposure; Substantial
Exposure, which is the sum total of the exposures beyond threshold limit should not
exceed 600% to 800% of the Capital Funds of the bank (i.e. six to eight times).

2. Review/Renewal: Multi-tier Credit Approving Authority, constitution wise delegation of
powers, Higher delegated powers for better-rated customers; discriminatory time schedule
for review/renewal, Hurdle rates and Bench marks for fresh exposures and periodicity for
renewal based on risk rating, etc are formulated.

3. Risk Rating Model: Set up comprehensive risk scoring system on a six to nine point scale.
Clearly define rating thresholds and review the ratings periodically preferably at half
yearly intervals. Rating migration is to be mapped to estimate the expected loss.

4. Risk-based scientific pricing: Link loan pricing to expected loss. High-risk category
borrowers are to be priced high. Build historical data on default losses. Allocate capital to
absorb the unexpected loss. Adopt the RAROC framework.
5. Portfolio Management The need for credit portfolio management emanates from the
necessity to optimize the benefits associated with diversification and to reduce the potential
adverse impact of concentration of exposures to a particular borrower, sector or industry.
Stipulate quantitative ceiling on aggregate exposure on specific rating categories,
distribution of borrowers in various industry, business group and conduct rapid portfolio
reviews. The existing framework of tracking the non-performing loans around the balance
sheet date does not signal the quality of the entire loan book. There should be a proper &
regular ongoing system for identification of credit weaknesses well in advance. Initiate
steps to preserve the desired portfolio quality and integrate portfolio reviews with credit
decision-making process.
6. Loan Review Mechanism: This should be done independent of credit operations. It is also
referred as Credit Audit covering review of sanction process, compliance status, review of
risk rating, pick up of warning signals and recommendation of corrective action with the
objective of improving credit quality. It should target all loans above certain cut-off limit
ensuring that at least 30% to 40% of the portfolio is subjected to LRM in a year so as to
ensure that all major credit risks embedded in the balance sheet have been tracked. This is
done to bring about qualitative improvement in credit administration. Identify loans
with credit weakness. Determine adequacy of loan loss provisions. Ensure adherence to
lending policies and procedures. The focus of the credit audit needs to be broadened from
account level to overall portfolio level. Regular, proper & prompt reporting to Top
Management should be ensured. Credit Audit is conducted on site, i.e. at the branch that
has appraised the advance and where the main operative limits are made available.
However, it is not required to visit borrower’s factory/office premises.

5.3.2 Risk Rating Model

Credit Audit is conduced on site, i.e. at the branch that has appraised the advance and where the
main operative limits are made available. However, it is not required to risk borrowers’ factory/
office premises. As observed by RBI, Credit Risk is the major component of risk management
system and this should receive special attention of the Top Management of the bank. The process

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