CREDIT RISK - MEASUREMENT & MANAGEMENT In the global context, the concept of risk management in bank lending has

become a routine affair though it is still to catch up in the Indian market. Of all the risks banks encounter in their intermediation processes, credit risk poses greater threat to their vulnerability & sustainability. Credit risk arises from the likelihood of borrowers inability to meet payment obligations. Credit risk has got two distinct facets: risk from the macro credit portfolio management perspective; and risk inherent in the individual loan account. 1. Determinants of credit risk: The word risk, be it at Corporate level or at branch level, refers to the variability of expected return. The variability could be either due to non-fructification of expected cash flows or rejection of the product by the market. Here again, the failure to honour the commitments of repayment could arise from: economic and business risk industry risk; and firm level risk. Economic & Business/Industry Risk: Economic risks are more influenced by factors like Government policies - monetary and fiscal measures, investment climate, political happenings, incentives in the form of tax exemptions, changes in import tariffs, etc. Similarly, business/industry risk are also external in nature to the assisted unit. Factors like state of economy, natural calamities, business cycles, industrial recession, excess capacity creation in anticipation of increase in demand, newer and cheaper products replacing the existing one, technology getting obsolete/replaced by cheaper and more effective techniques, over-exposure to a particular industry/group, etc., affect the functioning of the assisted unit, which in turn, inflicts financial damage to the bank These are more of macro level perceptions affecting the credit portfolio of bank as a whole. Firm-level Risk: The firm-level risk, which is unique to each loan proposal, can be segregated into: financial risk cost-based risk fiduciary risk (off balance sheet items) default risk Default, owing to either of these two, results in: o Write off of the asset, if not recovered - direct loss o If recovered late - loss of opportunity for reinvestment and fall in value of money. The happening or otherwise of these risks depends on two aspects: propensity of the borrower to pay; and ability of the borrower to pay. Ability can be estimated at the unit level through financial appraisal techniques etc., but willingness to pay is likely to remain as a subjective assessment. 2. Credit Risk Evaluation Economic and industry risks being more of a macro level perception influenced by events external to the assisted unit as well as the banks, needs to be managed at the corporate level by undertaking continuous research into various government policies, general economy of the country, industry profile, etc. Based on such constant tab on the market happenings, corporate offices formulate credit policy guidelines and circulate the same to branches for compliance/to ensure that the risks are transferred/ minimized/ mitigated. At Corporate level: Credit risk at corporate level is bound to vary between 0 and 1. It means, if the entire loan portfolio is NPA, the risk is 1. On the contrary if there is no NPA, risk is 0. In reality these two are absurd. Based on these probabilistic characteristics and assuming that the existing levels of bad debts etc. are true representative of normal market behaviour, we can work out a possible risk factor index of a banks loan portfolio as under:

Risk factor Index of Loan portfolio at a given time = Cumulative Int. Suspense (k) = cumulative provisions (t) + cumulative write off (t) Outstanding loans (t) + cumulative write off (t) Here as the denominator being the gross outstanding loans, the RFI will always be more than zero but less than 1. This index can aid management in keeping risk element at an acceptable level. Unit level risks are analyzed under the heads Management competence; Commercial aspects; Technical aspects; Financial strength Multivariate Sensitivity Analysis: Fluctuations in profit levels owing to changes in critical parameters Certainty Equivalent Method: By assigning several values to the expected cash flow from a project/return on an investment with explicit probability attached thereto and a mean value of the probability distribution arising from such alternative scenarios is calculated. Such mean would amount to a fair expected return. Adjusted Discount Rate Method: Pre-determined pay back ability. Profitability: Price of lent assets (P) Cost of Funds (C) Burden of servicing (B) Profit = P - (C +B) To sum up, loan asset is created by picking up a reliable customer for an approved purpose where capital can be used to advantage with a scope for repayment within a reasonable period from trading receipts or known maturities due on given dates. Credit Rating: This is yet another technique of credit risk measurement and as a part of risk management, price the product vis--vis the inherent risk. Of late, this technique has almost become formalized among the banks in India though with a distorted focus on financial ratios and operational aspects of the assisted unit. However, in the international markets, credit rating measures are usually structured in the following style to cover the whole gamut of assisted firms business arena.

CREDIT MIGRATION: refers to upgrading or worsening in a credit's ranking and credit grade over time. Credit Migration Risk is the risk that a portfolio's credit quality will materially deteriorate over time without allowing a repricing of the constituent loans to compensate the creditor for the now higher default risk being undertaken. Example of credit migration risk in Student Loan Portfolios: When prepayment penalties are not imposed, a long-dated student loan portfolio is exposed to the risk of retaining a greater proportion of poor credits as time unfolds than was anticipated at origination. And because spreads are inflexible after origination, the creditor may no longer be fairly compensated for default risk.

Credit Monitoring
Credit monitoring is a financial service offered to people who are concerned about fraud andidentity theft. When someone utilizes credit monitoring, an agency keeps an eye on that person's credit report and financial activities, looking for signs that unauthorized activity is occurring. In a sense, credit monitoring could be considered the stepped-up version of checking one's credit report one or two times a year: instead of checking every six months, a credit monitoring agency checks all the time. Financial experts disagree about the efficacy of credit monitoring. Some people feel that such services are extremely valuable, because while they cannot prevent fraud, they can catch it early, before it balloons into a major problem which could require months or years to fix. For people who have been victims of fraud in the past, credit monitoring can also be a useful tool for security, making people feel more comfortable. Opponents argue that credit monitoring services usually don't do anything that a consumer can't do, and that they may miss certain types of fraudulent activity. When someone orders credit monitoring, the services offered can vary. Some agencies simply keep an eye on the person's credit report, looking for tell-tale changes like the presence of new accounts, or an emergence of unusual spending habits. Other services may cross reference, looking for all data linked with a person's name or identity number so that fraudulent accounts are identified even when they do not show up in a credit report. Awareness of the fact that people routinely access their own credit reports has made fraudsters more cautious. Instead of opening an account with all of someone's information, a thief might use a false name and address and a real identity number. The account will be approved because it is linked with a real identity, but the account may not show up on a credit report, because the name and address don't match. This type of account may slip through the cracks at a credit monitoring agency until collection activities begin and the account is traced back to the identity number linked with it. Banks often offer credit monitoring to their patrons, usually for a fee, although sometimes credit monitoring is free with top-tier accounts. It is also possible to secure the services of a credit monitoring agency independently. Identity fraud prevention and protection tends to offer more coverage than a basic credit monitoring plan, since it involves the active pursuit of prevention of identity theft, rather than just passive monitoring of credit reports.