Page 92 - DCOM505_WORKING_CAPITAL_MANAGEMENT

Unit 5: Credit Risk Management

Self Assessment Notes

State whether the following statements are true or false:
11. In an expert system, the decision to lend is taken by the lending officer who is expected to
possess expert knowledge of assessing the credit worthiness of the customer.

12. Rating is the process by which an alphabetic or numerical rating is assigned to a credit
facility extended by a bank to a borrower.

5.5 Summary

Risks are usually defined by the adverse impact on profitability of several distinct sources
of uncertainty. Risk Management is a discipline at the core of every financial institution
and encompasses all the activities that affect its risk profile.
A risk management framework encompasses the scope of risks to be managed, the process/
systems and procedures to manage risk and the roles and responsibilities of individuals
involved in risk management.
Credit risk arises from the potential that an obligor is either unwilling to perform on an
obligation or its ability to perform such obligation is impaired resulting in economic loss
to the bank. Credit risk can be segmented into two major segments viz. intrinsic and
portfolio (or concentration) credit risks.
Credit Risk Management covers the decision-making process, before the credit decision is
made, and the follow-up of credit commitments, plus all monitoring and reporting
processes.
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.

Banks are increasingly facing credit risk (or counterparty risk) in various financial
instruments other than loans, including acceptances, interbank transactions, trade financing,
foreign exchange transactions, financial futures, swaps, bonds, equities, options, and in
the extension of commitments and guarantees, and the settlement of transactions.
There are three basic approaches to credit risk measurement at individual loan intrinsic
level that are used for various types of loans such as commercial loans, project and
infrastructure finance, consumer and retail loans.

5.6 Keywords

Credit risk: Credit risk is the risk that a borrower will not repay a loan according to the terms of
the loan, either defaulting entirely or making late payments of interest or principal.
Expected losses: Expected losses are those that the bank knows with reasonable certainty will
occur and are typically reserved for in some manner.
Interest Rate Risk: Interest Rate Risk (IRR) arises as a result of change in interest rates on rate
earning assets and rate paying liabilities of a bank.

Liquidity Risk: Liquidity risk is defined as the possibility that the bank would not be able to
meet the commitments in the form of cash outflows with the available cash inflows.
Operational Risk: Operational risk is emerging as one of the important risks financial institutions
worldwide are concerned with.

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