Credit Policy

Need for Credit Policy Components of Credit Policy Credit Policy Pursued by the Government Credit Culture

 Lending is an indispensable aspect of banking, and a banker earns bulk of his income through lending.  The other major reason of the lending function is to add value to the bank. By lending the funds mobilized, a bank will be in a position to earn spreads to sustain profitability

Credit policy
 The lending decisions of a bank are guided by its loan policy or credit policy.  The credit policy outlines the crucial lending decisions of a bank. It lays down the rules and regulations that guide the sanctioning of loans.

Credit Execution and Administration

      Loan Decision Loan agreement Terms of loan Repayment schedule Collateral required Other conditions

 However, to sustain profitability, prudent decisions need to be taken both prior to and after sanctioning the credit.  These rules generally relate to the amount of credit to be extended during a financial year, the industries to focus on, the geographical spread, the type of credit to offer, the type of proposals to finance, the disbursal mechanism, the collateral value, the method of pricing, the repayment schedule, the monitoring process, etc.

 These macro and micro level considerations of the lending activity contribute to the achievement of the banks objectives.  The banks management should thus, ensure that lending decisions fall in line with the banks overall objectives.

The policy is laid down by the top management and deals with the following:

       

Exposure levels Credit risk assessment Credit appraisal standards Documentation standards Delegation of powers Pricing Review and renewal of advances Takeover of advances

Credit policy
 The policy also discusses different kinds of advances such as  personal loans, export credit, advances to priority sector and maturity period of banks advances.  In the final pages, the policy details the strengths, weaknesses and the prospects of the bank.

NEED FOR CREDIT POLICY

 The credit policy document is a document which carefully specifies the dos and don'ts while sanctioning the loan proposals.  As loan proposals differ widely from each other, there cannot be a strict methodology for accepting or rejecting the proposals  Instead, guidelines can be given within the credit policy for the decision makers to enable them to screen out loans, which can be out rightly rejected.  Loans that can be sanctioned without any reference to the top management and proposals that require a certain amount of top-level decision-making. topdecision The credit policy of a bank consists of five major components

Credit policy
     a. b. c. d. e. General policies Specific loan categories Miscellaneous loan policies Quality control Other specific issues.

Credit policy
 The process of appraisal remains the same with regard to any proposal analyzing, selecting, sanctioning and monitoring.  The top management sets the exposure limits for individual/company/industry, credit quality of the borrowers, lending rate, and risk level, etc., and enable decentralized decisiondecision-making by the lower level functionaries

COMPONENTS OF CREDIT POLICY

     VOLUME AND MIX OF LOANS GEOGRAPHICAL SPREAD LOAN EVALUATION PROCEDURES MANAGEMENT EVALUATION FUNDAMENTAL ANALYSIS

CREDIT POLICY PURSUED BY THE GOVERNMENT

 The governments in different countries frame their lending structure so as to be consistent with their credit policy.  They decide as to what extent bank credit is to be deployed. Every country has a different policy in this regard. In case of socialist economies such as China and Vietnam, the state banks are forced to lend to the state owned institutions that many a times are in a position to repay the loan.  This sort of directed lending within an economy amounts to a subsidy, whereby the state, which owns all relevant financial institutions, is moving funds from one institution to another

Credit policy
 . In case of countries like India and Sri Lanka, subsidy is given in the form of loans to the farmers, which remain uncollected.  The policy lending is imposed not only on the state owned banks but also on the private commercial banks to a considerable extent.  In countries like United States, certain laws require banks to engage in lending in poorer areas from which they take deposits.  Need administrative guidance to lend to certain companies or sectors favored by the government.

Credit policy
 In India, the National Credit Council that was established in 1968 initially emphasized that commercial banks should extend credit to the two priority areas, i.e. Agriculture and Small Scale Industries (SSIs).  RBI issued guidelines to commercial banks and the lending policy also came in to focus on dispensing credit to agriculture, SSIs and transport operators.  Nationalization of 14 banks in July 1969 (and six in 1980), institutionalization of the policy objective of providing assured financial support to the Priority Sector, as the above activities came to be known, was formalized.

Credit policy
 The formal definition of Priority Sector came into existence.  Retail trade, small business, professional and selfselfemployed persons and educational loans were also included under priority sector. This was in addition to SSIs, Agriculture and allied activities and Transport Operators.  Loans to housing and software sector have been brought under the priority sector.

RBI Guidelines
 As per RBIs guidelines at least 40% of the net bank credit should be given to the priority sector, of which 18% would be for Agriculture and 10% to the weaker sections of the society.  RBI, NABARD and State Level Bankers Committee (SLBC) govern the credit policy and procedures with respect to agricultural sector.  Depending on the segments, the policies and procedures could differ substantially.  The introduction of Service Area Approach in 1989 prompted each banks branch to prepare its own Service Area Plan based on the village profile, skills and available resources. Such Service Area Plans would then be integrated with the annual growth plan of a banks branch.

RBI guidelines
 As per RBIs guidelines at least 40% of the net bank credit should be given to the priority sector, of which 18% would be for Agriculture and 10% to the weaker sections of the society. RBI, NABARD and State Level Bankers Committee (SLBC) govern the credit policy and procedures with respect to agricultural sector.

Rating Criteria for Banks

 The criteria for rating the bank are normally based on the assets, equity, profits, etc.  If the criteria for rating a bank were Return on Equity (ROE) then the bank would easily compromise profitability for safety.  If the criterion is total assets then it is of less significance as it tells very little about either profitability or creditworthiness.  If the criterion is equity, then only the wellwellcapitalized banks may be safe, but they may not be profitable.

Credit rating
 The major drawback in case of these ratings is that they do not take into consideration the environment in which the banks operate. The analysis of the banks should not be in a vacuum. Their favorable financial ratios are to be looked upon and the environment in which they operate should not be overlooked.

CREDIT RATING
 Credit rating is the main tool, which helps in measuring the credit risk and facilitates pricing of a loan.  It gives vital indications of weaknesses in a borrowers profile.  It also gives triggers for portfolio management at corporate level.  Banks should realize the importance of developing and implementing effective internal credit rating systems, and also recognize the role such systems play in credit risk management.  It involves evaluating and assessing an institutions risk management, capital adequacy, and asset quality.

Credit Risk
 For the ongoing administration of their various credit risk-bearing portfolios, risk(a) Banks must have in place a system for monitoring the condition of individual credits, including determining the adequacy of provisions and reserves, (b) Banks should develop and utilize an internal risk rating system in managing credit risk. The rating system should be consistent with the nature, size and complexity of a banks activities,

CREDIT MIS
 c) Banks must have information systems and analytical techniques that enable management to measure the credit risk inherent in all on- and offonoffbalance sheet activities.  The management information system should provide adequate information on the composition of the credit portfolio, including identification of any concentrations of risk, and (d) Banks must have in place a system for monitoring the overall composition and quality of the credit portfolio.

Credit rating
 The rating should consider the banking system of the country in which a bank operates along with the degree of systemic risk implicit in the banking system and the level of sovereign risk in that country.  This is crucial to fully evaluate the creditworthiness of a given bank. To assess the creditworthiness of banks in a particular country, the analyst must therefore have an understanding of the  Economic and political conditions prevailing in the country;  Regulatory regime; and  Credit culture of the banks.

 Different countries have different banking structures. The banking structure plays a vital role in the development of the banking system and this provides easy credit to all the sectors. For instance, a banking system which is highly fragmented and in which banks draw deposits and lend within small geographic areas has more chances of bank failure than a system in which there are a comparatively small number of large, well capitalized banks with nationwide distribution.

CREDIT advantages
 Credit culture refers to the fundamental principles that drive lending activity and how management analyzes risk.  Credit culture encourages the management to maintain asset quality even under pressures to chase bad deals.  The credit culture in the economy also affects the health of the banking system.