This document outlines the key components of an effective loan policy for credit risk management. It discusses the importance of having a written loan policy that establishes credit standards, procedures for managing delinquent loans, and target customer profiles. The policy should set prudential limits on loan concentrations, define appropriate collateral and credit rating standards, and provide guidelines for different business segments. Regular reviews and updates are needed to ensure the policy stays dynamic and aligned with regulatory requirements and market conditions. The overall goal is for the loan policy to balance risk and returns while guiding responsible credit expansion.

1. Loan Policy- Credit Risk Management
N.Gopal
Deputy General Manager/MOF
CAB Pune
RBI CAB Pune
July 5, 2010
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3. 
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Loan policy- Genesis, Importance- Credit risk
Management
Need for loan policy
Ingredients of a good loan policy
Loan Policy and risk Management
Prudential ceilings and loan policy
Final Analysis
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6. Credit sanctioning guidelines, and the written
documentation setting forth standards as determined by a
bank's senior management.
A bank's loan policy also establishes minimum credit
standards for taking on loans.
It sets policies and procedures in treatment of delinquent
loans, and the type of customer a bank wants as a
borrower.
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8. 1980s
The world and the way of banking changed
American banking history witnessed several credit induced
bank disasters
 E.g. Continental, Sea First and Texan Banks
 1990s Credit freeze due to East Asian Crisis
 2000 GTB’s credit induced problems
 Lessons
 The common “triggers of crisis” Aggressive and unplanned
lending
 Credit concentration failure to diversify,
 Risky practices, inadequate monitoring
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Result
Poor credit culture
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Credit culture is largely dependent on the loan policies
pursued by a bank
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9.  First
six years of the millennium saw
paradigms shifts in bank lending
 India became more closely
integrated to the global economy
 Interest rates moved both ways
 Traditional avenues for lending slowed down
 Competition
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Policies responses had to become dynamic
outward and forward looking to meet challenges
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10. 1.
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7.
Board & Management Oversight
Portfolio Management
Management Information Systems
Market Analysis
Credit Underwriting Standards
Portfolio Stress Testing & Sensitivity Analysis
Credit Risk Review Function
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16.  Theory
Broadly defining the credit culture
Broadly laying out the external-internal environment
 Lookups
Statutory issues & Regulatory
Market, present environment
 Studies
 Industry, survey etc
 Setting
up Risk Appetite
Fixation of internal norms & prudential ceilings
Deciding on risk rating
 Implementation
Laying out procedures, appraisal standards, schematic
issues
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17. Credit Culture “This is the way we handle
credit”
Establish Business
Priorities
Choose Credit
Culture
Strategies
Credit Policy determines the credit culture
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19.  Based on Corporate priorities
 Credit Culture could be one of four
types
CORPORATE PRIORITY
CULTURE
Emphasis on asset quality , long term
growth
Values Driven (Conservative,
Prudent)
Short term gains
Earnings Driven (Regardless
of risk)
Market share, Size
Volume Driven /Aggressive
No clear priorities
Unfocussed
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20. Overriding objective of credit policy
Healthy Balance between
 Credit Volumes, Earnings & Asset Quality
Within the framework of
Regulatory prescriptions,
Corporate goals - social responsibilities
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21.  Credit
expansion
Steady expansion, sustained, continuous & prudent growth
Steady rise in profits but emphasis on
 Quality Assets
 Profitable Relationships
 Statutory
and Regulatory line
This philosophy seeks to instill a value driven credit
culture
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23. RBI’s Guidelines on Risk Management Systems in Banks require a
typical Credit Policy to cover:
 Standards of presentation of credit proposals, financial covenants
 Rating standards and benchmarks
 Prudential limits on large credits and asset concentrations
 Standards for Loan collateral, Loan Review Mechanism
Pricing of loans, risk monitoring and evaluation
 Legal and regulatory compliances
Delegation of credit sanctioning powers
Prohibition on lending
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24.  No
ambiguity in postulations- chance for different
understanding interpretations
 Loan policy must clearly mark the boundaries
Government
 RBI
 Bank
 Loan
policy should ideally list out restrictions that
credit grantors can refer
 Loan policy must provide for exceptions- list out if
possible
 Loan policy must also lay down the levels of authority
for certain credit decisions
Regulatory reviews, inspections also provide opportunities for
aligning loan policy to regulatory thinking
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25. Sector specific guidelines should also contain Do’s and
Don’ts based on present environment, statutory and
regulatory guidelines
e.g.
 Financing Real Estate, Capital Markets, bill discounting,
NBFC lending etc
 Ban on lending to units producing ozone depleting
substances is an instance of statutory restriction
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While assessing the adequacy of a loan policy these Do’s
and Don’ts should be weighed by the credit grantor
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Deterrents to non compliance to these do’s and don’ts
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27. Target markets, industry and business sectors are
identified
 Sectoral study
 Trends in consumption, impact on a sector
 Growth potential, capital investment,
 Delinquencies

Conclusions
 Translating experiences into policy
 Industry Study
 Products, Capital investment, Sunrise/sunset
 Turnover, Labour, locational concentration
 Market, fashion trends etc
 Seasonality
 Regulatory environment
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29. 
Policy not to stop with managing transaction risks
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Has to address intrinsic risk also
 Portfolio perspective
 The risk inherent in certain lines of business is known
through industry analysis
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Industry analysis to look at three vital factors
Historic elements
Predictive elements
Lending elements
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30.  Historic Risk Elements should look at:
 Financials: capital, cash flows, w.c. cycle
Stability: demand, growth
Longevity of the industry: demand, trend need etc
 Predictive Risk Elements would include:
 Structure: constitution
Diversity: concentration
Entry barriers- political, financial, feasibility
Product Life cycle- ever in demand, seasonal etc
Economic Vulnerability, Political CABRegulatory risks,
/ Pune
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31.  Lending
elements
 Collaterals-availability, acceptability
 Security- legal issues,
Valuation –
Delivery – Loan or an advance
Industry study should be periodically reviewed and
factored into the policy
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32. In real life policy setting industry analysis may or may not
be documented on these rigorous lines
 In any case a careful consideration of all three risk
elements go into the industry limits fixed by each bank
 This is based on the lending experience and business
expectations that the bank has
 It is intrinsic risks in sectors like real estate and capital
markets that explains the regulatory concern about build
up of asset concentrations in these areas
 Inspection and Audit to help verification/validation
whether the intrinsic risk in industries with higher
exposure limits have been assessed by the bank
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33. 
Identify focus areas
broad confines of strategy,
study, restrictions etc.

Identify
macro economic trends,
regulatory stance
bank’s own experience
core competencies
Retail for instance became a focus area for banks after the
interest rate deregulation and the slow down in corporate
borrowings
 SMEs, Agriculture and Micro Finance are today perceived
to be major business opportunities
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34.  Each
bank has its strong points and core
competencies
 Public sector banks have a strong rural and semi
urban presence and a history of success in
agricultural and rural credit
 Banks in Western India have a predominant
presence in sugar sector
 Credit Policy to draw on such strengths
 It should also leverage on sector specific regulatory
incentives and relaxations extended from time to
time
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36. Prudential limits
limiting magnitude of credit risk
Dispersion of credit risk- prevents concentration
DeterminantsCredit culture
Risk appetite
Regulatory dictates
Prevailing Industry and Economic Conditions
Loan policy should articulate the rationale behind the
limits, for better appreciation and understanding
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37. 
Financial Limits
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Single & Group
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Substantial Exposure
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Maximum limit
Aggregate limit
Industry wise
Sector specific
Individual
Corporate
Partnership
Proprietorship
Aggregate linked to
capital funds
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38.  Financial
benchmarks with conditions under which
deviations can be permitted
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Single and Group borrower limits not exceeding what
is prescribed by RBI- permissible deviations
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Substantial Exposure limit (10% borrowers < 600% of
capital)
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Industry and sector wise ceilings
Limits on sensitive sectors subject to asset price
volatility
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High risk and low priority sectors
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Maturity profile of the loan book
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39. 
Limit setting is unique to each bank
 It has to balance risk control against growth imperatives
 The limits set should reflect the legacy issues in the
portfolio
 There should be higher limits for areas where Bank has a
natural advantage
 Lower limits and ban in sectors where the Bank’s prior
experience has been adverse
 Limit setting is dynamic and on-going
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41.  Tool
for the measurement of credit risk
 To enable an informed and considered credit
decision as ‘good ‘ or ‘bad’
 To appropriately price loan products
“BCBS defines credit rating as summary indicator of
risk inherent in individual credit signifying the risk of
loss due to default of a counterparty by considering
qualitative and quantitative information

42. Policy should provide for rating of all loan accounts- very
little exceptions
 The rating should consist of 8-9 parameters (minimum)
 Policy to specify minimum entry rating i.e. Hurdle Rate
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 Policy to lay down exceptions to Hurdle rate
 Policy to lay down procedures to handle accounts which fall below
hurdle rating
Annual review of ratings- Quarterly, half yearly updates
 Study of Rating migration
 Pricing linked to Rating
 Mapping of external ratings to internal ratings
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44. A
good loan policy to provide leeway for
 It
should balance the risk and returns on the retail
front
 Schematic
Lending
Directed credit flow to certain sectors
 Housing, farming, SME, retail, personal loans, special
tie-ups etc
 Retail loans under various products and schemes
designed by the Bank
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45.  Returns
from
retail/schematic
lending
commensurate with risks?
 Schemes to match customer expectations?
 Standard of Due Diligence and KYC?
 Outsourcing risks adequately addressed?
 Delinquencies under control in specific product
categories?
 What is the growth in terms of size, earnings and
quality?
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47.  Take
over route to grow business
 Policy to clearly lay down ground rules
What type of borrower accounts
What level of exposures
Take over from whom
Take over standards
Pricing
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49. Profitability,
Customer Friendliness/service,
Compliance
Capital Conversation
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Challenges arise when what the customer needs are not
provided for in the policy
Trade off business considerations, social responsibility,
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50.  Area
of potential conflict in perceptions differences
between regulator and banks
 Every
policy has to provide for exceptions
 RBI the regulator also recognizes this
 But question is how far and how much
 Deviations/
exceptions dictated by business needs
 Extent
of their impact on risk profile to be seen
 Within
the overall credit culture of the bank
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52.  Credit
Policy serves a ‘Gate Keeping’ function
 Defines thrust areas in relation to credit culture,
profit objectives and regulatory directions
 Defines acceptable levels of risk by identifying
industry segments for fresh exposures
 Prevents risk concentrations and ensures
diversification by setting limits on sectors and
individual transactions
 It provides pricing strategies through the use of
Credit Risk Rating framework
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53.  Knowledge is the most potent of risk mitigant
Does the policy provide for dissemination of
knowledge on credit?
Is the policy in itself, - Comprehensive,
Articulate, accurate and
 User friendly?
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54. 
An ideal loan policy should
 Create right for business growth
 Maintain quality of assets
 Provide platform for good procedures/process
 Ensure regulatory and statutory compliances
 Be the platform for Credit Risk Management
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