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Credit Risk
• Risk of loss that may occur from failure of the counter - party
to make payments
• It includes non performance by a counter party in a variety of
Off Balance Sheet contracts such as forward contracts /
interest rate swaps, etc.
• Differs from market risk due to obligor behavior
considerations -
The five “C’s” of Credit - Capital, Capacity, Condition,
Collateral and Character
•
Credit events include bankruptcy, failure to pay, loanrestructuring, loan moratorium, accelerated loan payments
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Types of Credit Risk
Borrower
Risk
Portfolio
Risk
Industry
Risk
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Borrower risk / Counter part / Default risk
• The risk that one party in a contract will default or
otherwise not fulfill his/her obligations (more than 90
days)
• For example, if A agrees to lends funds to B up to a
certain amount, there is an expectation that A will
provide the cash, and B will pay those funds back.
There is still the counterparty risk assumed by them both. B might default on the loan and not pay A back
or A might stop providing the agreed upon funds
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Intrinsic / Industry Risk
• It focuses on the risk inherent in certain lines of
business and loans to certain industries
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Concentration / Portfolio Risk
• The risk associated with single exposure or group of
exposures with the potential to produce large losses to
threaten a bank's core operations
• It may arise in the form of single name concentration
or industry concentration
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Tools of Credit Risk Management
ExposureCeilingLimits
Risk ratingmodel
Portfoliomanagement
Risk basedscientific pricing
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Credit Exposure Ceiling
• The exposure ceiling limits would be :
- 15 % of capital funds in case of a single borrower
- 40 % of capital funds in the case of a borrower group
with additional 10% for infrastructure projectsundertaken by the group
•The threshold limit should not exceed six to eighttimes of the capital funds of the bank
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Risk Rating Model
• It is a setup of comprehensive risk scoring system ona six to nine point scale
•RAM is an internal rating software offered byCRISIL designed to assist a bank or financialinstitution in complying with the requirements under the internal ratings based approach
• RAM is the largest deployed Internal risk ratingsolution in India
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Risk Based Scientific Pricing
• Measurement of loan risk in terms of interest ratesand other fees
•The interest rate on a loan is determined the timevalue of money and the lender's estimate of the
probability
• Factors for consideration :- Borrower's credit score
- Employment status
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Portfolio Management
• It benefits adverse impact of concentration of
exposures to a particular borrower, sector or industry
• The distribution of borrowers in various industry, business group and conduct of rapid portfolio reviews
helps to mitigate credit risk
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