Loan policy credit risk management

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Loan policy credit risk management

  1. 1. Loan Policy- Credit Risk Management N.Gopal Deputy General Manager/MOF CAB Pune RBI CAB Pune July 5, 2010 1
  2. 2. RBI CAB Pune July 5, 2010 2
  3. 3.       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 RBI CAB Pune July 5, 2010 3
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  6. 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. RBI CAB Pune July 5, 2010 6
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  8. 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   Result Poor credit culture  Credit culture is largely dependent on the loan policies pursued by a bank RBI CAB Pune July 5, 2010 8
  9. 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  Policies responses had to become dynamic outward and forward looking to meet challenges July 5, 2010 RBI CAB Pune 9
  10. 10. 1. 2. 3. 4. 5. 6. 7. Board & Management Oversight Portfolio Management Management Information Systems Market Analysis Credit Underwriting Standards Portfolio Stress Testing & Sensitivity Analysis Credit Risk Review Function RBI CAB Pune July 5, 2010 10
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  16. 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 RBI CAB Pune July 5, 2010 16
  17. 17. Credit Culture “This is the way we handle credit” Establish Business Priorities Choose Credit Culture Strategies Credit Policy determines the credit culture RBI CAB Pune July 5, 2010 17
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  19. 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 RBI CAB Pune July 5, 2010 19
  20. 20. Overriding objective of credit policy Healthy Balance between  Credit Volumes, Earnings & Asset Quality Within the framework of Regulatory prescriptions, Corporate goals - social responsibilities RBI CAB Pune July 5, 2010 20
  21. 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 RBI CAB Pune July 5, 2010 21
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  23. 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 RBI CAB Pune July 5, 2010 23
  24. 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 RBI CAB Pune July 5, 2010 24
  25. 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   While assessing the adequacy of a loan policy these Do’s and Don’ts should be weighed by the credit grantor  Deterrents to non compliance to these do’s and don’ts RBI CAB Pune July 5, 2010 25
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  27. 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   RBI CAB Pune July 5, 2010 27
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  29. 29.  Policy not to stop with managing transaction risks  Has to address intrinsic risk also  Portfolio perspective  The risk inherent in certain lines of business is known through industry analysis  Industry analysis to look at three vital factors Historic elements Predictive elements Lending elements July 5, 2010 RBI CAB Pune 29
  30. 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 RBI July 5, 2010 30
  31. 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 RBI CAB Pune July 5, 2010 31
  32. 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  RBI CAB Pune July 5, 2010 32
  33. 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 July 5, 2010 RBI CAB Pune 33
  34. 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 July 5, 2010 RBI CAB Pune 34
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  36. 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 July 5, 2010 RBI CAB Pune 36
  37. 37.  Financial Limits      Single & Group       Substantial Exposure July 5, 2010 Maximum limit Aggregate limit Industry wise Sector specific Individual Corporate Partnership Proprietorship Aggregate linked to capital funds RBI CAB Pune 37
  38. 38.  Financial benchmarks with conditions under which deviations can be permitted  Single and Group borrower limits not exceeding what is prescribed by RBI- permissible deviations  Substantial Exposure limit (10% borrowers < 600% of capital)   Industry and sector wise ceilings Limits on sensitive sectors subject to asset price volatility  High risk and low priority sectors  Maturity profile of the loan book RBI CAB Pune July 5, 2010 38
  39. 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 July 5, 2010 RBI CAB Pune 39
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  41. 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. 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   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  RBI CAB Pune July 5, 2010 42
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  44. 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 July 5, 2010 RBI CAB Pune 44
  45. 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? July 5, 2010 RBI CAB Pune 45
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  47. 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 RBI CAB Pune July 5, 2010 47
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  49. 49. Profitability, Customer Friendliness/service, Compliance Capital Conversation   Challenges arise when what the customer needs are not provided for in the policy Trade off business considerations, social responsibility, RBI CAB Pune July 5, 2010 49
  50. 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 RBI CAB Pune July 5, 2010 50
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  52. 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 July 5, 2010 RBI CAB Pune 52
  53. 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? RBI CAB Pune July 5, 2010 53
  54. 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 RBI CAB Pune July 5, 2010 54
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