Credit risk management in vijaya bank
Indian economy today is in the process of becoming a world class economy. The Indian banking industry is making great advancement in terms of quality, quantity, expansion and diversification and is keeping up with the updated technology, ability; stability and thrust of a financial system, where the commercial banks play a very important role emphasize the need of a strong effective control system with extra concern for the risk involved in the business.
In the fast growing world, banks are facing many types of risks among which credit risk stands at the top of the list. One bank was chosen to understand the practices followed by them in depth. Vijaya bank is one of the public sector banks and is supposed to be in line with RBI guidelines. This helped in understanding the credit risk management practices followed by the bank in a better way. GLOBAL SCENARIO The period 2007-2012 underwent financial crisis, also known as the Global Financial Crisis (GFC), or the “Great Recession”, is considered by many economists to be the worst financial crisis since the great depression of the 1930? .
This resulted in the collapse of large financial institutions, the bailout of banks by national Governments, and downturns in stock markets around the world. Even the housing market suffered, resulting in evictions, foreclosures and prolonged unemployment contributing to the failure of key businesses, declines in consumer wealth estimated in trillions of US dollars, and a significant decline in the economic activity, leading to a severe 2008-2012 global recessions. The bursting of the U. S. ousing bubble, which peaked in 2007, caused the values of securities tied to U. S. real estate pricing to plummet, damaging financial institutions globally. The financial crisis was triggered by a complex interplay of valuation and liquidity problems in the United States banking system in 2008. Securities in stock markets suffered large losses during the 2008 and early 2009. Economies worldwide slowed down during this period, as credit tightened and international trade declined. This financial crisis ended by around late 2008 and mid-2009.
The current European sovereign debt crisis is an ongoing financial crisis that has made it difficult or impossible for some countries in the euro area to re-finance their Government debt without the assistance of third parties. From late 2009, fears of a sovereign debt crisis developed among investors as a result of the rising Government debt levels around the world together with a wave of downgrading of Government debt in some European states.
Concerns intensified in early 2010 and thereafter, leading Europe? finance ministers on 9 May 2010 approved a rescue package worth €750 billion to ensure financial stability across Europe creating the European financial stability facility (EFSF). In October 2011 and February 2012, the Euro zone leaders agreed on more measures designed to prevent the collapse of member economies. DOMESTIC SCENARIO Indian banking industry has evolved over a long period of more than two centuries. Despite the recent growth of private banks, the sector is dominated by Government-controlled banks that hold nearly three-fourths of total banks assets.
Indian banking industry is considered to be very stable with healthy balance sheets and low exposure to risky assets. The global financial crises have not affected the Indian banks significantly. Internet, wireless technology and global straight-through processing have created a paradigm shift in the banking industry. In India, the most significant achievement of the financial sector reforms is the improvement in the financial health of commercial banks in terms of capital adequacy, profitability and asset quality as well as greater attention to risk management.
As now banks benchmark themselves against global standards, they have increased the disclosures and transparency in bank balance sheets, the banks also started focusing more on corporate governance. RISKS FACED IN AN ORGANIZATION Risk Management Risk is derived from the Italian word ResCare meaning “to dare”. Risk is “the probability of the unexpected happening – the probability of suffering a loss”. Risk provides the basis for opportunity. Risk is the probable variability of returns. Since it is not always possible or desirable to eliminate risk, understanding it is an important step in determining how to manage it.
Identifying exposures and risks forms the basis for an appropriate financial risk management strategy. In the financial arena, enterprise risks can be broadly categorized as credit risk, market risk, operational risk, strategic risk, funding risk, political and legal risk. TYPES OF RISKS Risk faced by the bank can be segmented into three separable types from the management perspective.. •Risks that can be eliminated or avoided by simple business practices.
Risks that can be transferred to other business participants (e. g. insurance policy) and, •Risks that can be actively managed at the Bank level. Risk is any real or potential event, action or omission, internal or external, which will have an adverse impact on the achievement of bank’s defined objectives. It is inherent in every business. Risk cannot be totally eliminated but is to be managed. Risks are to be categorized as high risk, medium risk and low risk and managed. Risks can be classified into three categories: •Credit risk •Market risk (interest rate risk, liquidity risk) •Operational risk CREDIT RISK
Credit risk is the “possibility of loss from a credit transaction”. In a bank’s portfolio, losses stem from outright default due to inability or unwillingness of a customer or counterparty to meet commitments in relation to lending, trading, settlement and other financial transactions. Credit risk emanates from bank? s dealings with individuals, corporate, bank, financial institution or a sovereign. Credit risk includes the following: •Credit growth in the organisation and composition of the credit folio in terms of sectors, centres, and size of borrowing activities so as to assess he extent of credit concentration.
Credit quality in terms of standard, sub-standard, doubtful and loss-making assets. •Extent of the provisions made towards poor quality credits. •Volume of off-balance-sheet exposures having a bearing on the credit portfolio. MARKET RISK Market risk is the possibility of loss to a bank caused by changes in the market variables. Market risk is the risk to the banks earnings and capital due to changes in the market level of interest rates or prices of securities, foreign exchange and equities, as well as the volatilities of those prices.
Operational risk is the “risk of direct or indirect loss resulting from inadequate or failed internal processes, people, and systems or from external events”. RISK MANAGEMENT PROCESS The word “process” connotes a continuing activity or function towards a particular result. The process is the vehicle to implement an organisation’s risk principles and policies, aided by organisational structure. In general, the process can be summarised as follows: •Risk identification. •Risk measurement. •Risk monitoring. •Risk control. VIJAYA BANK INTRODUCTION
Vijaya Bank is a nationalized scheduled commercial bank. The bank celebrated its platinum jubilee last financial year as it was established in 1931. The bank was nationalized on 15. 4. 1980 under the banking companies (Acquisition & Transfer undertakings) Act, 1980 and Nationalized banks (Management & Miscellaneous Provisions) Scheme 1980. The bank is also governed by the Banking Regulation Act, 1949 and is engaged in various businesses as fully defined under Section 6 of the said Act. Presently the Govt. Of India’s share in the Bank’s equity works out to 53. 87%.
The bank is managed by a duly constituted Board of directors. The present strength of Board of directors of the bank is 12, comprising of 2 executive and 10 non-executive directors having expertise in various fields. ORGANISATIONAL STRUCTURE The organisational structure of the bank consists of three tiers viz. , Head office, Regional offices and branches. The Head office is in Bangalore. The bank has 20 regional offices to exercise immediate supervision and control over the branches under their jurisdiction. All regional offices are headed by experienced executives in senior/top management grade.
Further, as the extended wings of the central inspection department, the bank has set up 9 regional inspectorates. HISTORY Vijaya Bank was founded on 23rd October 1931 by late Shri Attavara Balakrishna Shetty and other enterprising farmers in Mangalore, Karnataka. The objective of the founders was essentially to promote banking habit, thrift and entrepreneurship among the farming community of Dakshina Kannada District in Karnataka State. The bank became a scheduled bank in 1958. Vijaya Bank steadily grew into a large All India Bank, with 9 smaller banks merging with it during the 1963-68.
The credit for this merger as well as growth goes to late Shri M. Sunder Ram Shetty, who was then the Chief Executive of the bank. The bank was nationalised on 15th April 1980. The bank has built a network of 1250 branches, 48 extension counters and 663 ATMs as at 31. 10. 2011, that span all 28 states and 4 union territories in the country. FOUNDING PRINCIPLE To promote banking habit, thrift and entrepreneurship among the farming community of Dakshina Kannada District in Karnataka state. CREDIT RISK MANAGEMENT PRACTICES IN VIJAYA BANK The bank’s net profit has seen a growth of 234% and the total business is up by 16%.
The banks deposits are up by 13% and gross advances are up by 19%. The credit risk exposure is increased to 80064. 90 as of Sep, 30 2011. The credit risk of the bank has decreased over the past five years. They have installed an integrated risk management system in line with BASEL II norms and RBI guidelines. They follow strict hedging policies to reduce credit risk of the bank. They take financial collaterals and guarantees to hedge their credit risk. Hence all the policies and strategies have led to a sound credit risk management system.
The bank has put in place a robust risk management architecture with due focus not only on capital optimisation, but also on profit maximization, i. e. to do maximum business out of the available capital which in turn maximize profit or return on equity. In capital planning process, the bank reviews: •Current capital requirement of the bank •The targeted and sustainable capital in terms of business strategy and risk appetite. Capital need and capital optimization are monitored periodically by the CapitalPlanning Committee comprising Top Executives.
Sensitivity analysis is conducted quarterly on the movement of Capital Adequacy Ratio, considering the projected growth in advances, investments in Subsidiaries/ Joint Ventures and the impact of Basel II framework etc. The Committee takes into consideration various options available for capital augmentation in tune with business growth and realignment of Capital structure duly undertaking the scenario analysis for capital optimization. CRAR of the Bank is projected to be well above the 12% in the medium term horizon of 3 years, as prescribed in the ICAPP Policy.
The Bank’s policies maintain moderation in risk appetite and a healthy balance between risk and return in a prudent manner. The primary risk management goals are to maximize value for share holders within acceptable parameters and to the requirements of regulatory authorities, depositors and other stakeholders. The guiding principles in risk management of the Bank comprise of Compliance with regulatory and legal requirements, achieving a balance between risk and return, ensuring independence of risk functions, and aligning risk management and business objectives.
The Credit Risk Management process of the Bank is driven by a strong organizational culture and sound operating procedures, involving corporate values, attitudes, competencies, employment of business intelligence tools, internal control culture, effective internal reporting and contingency planning. The overall objectives of the Bank? s Credit Risk Management are to: •Ensure credit growth, both qualitatively and quantitatively that would be sectorally balanced, diversified with optimum dispersal of risk. •Ensure adherence to the regulatory prudential norms on exposures and portfolios. Adequately enable to price various risks in the credit exposure.
Form part of an integrated system of risk management encompassing identification, measurement, monitoring and control. POLICIES, STRATEGIES AND PROCESSES The Board of directors and Risk management Committee of the Board gives directions, the Credit Risk management committee headed by Chairman and Managing Director ensures its implementation. The bank has defined policy guidelines for Credit Risk Management, Collateral Management and Credit Risk Mitigation (CRM), Ratings, etc.
The bank has taken up implementation of Integrated Risk Management system through six solutions for Credit Risk Rating, Credit Risk, Market Risk, Operational Risk, and ALM & FTP to move towards advanced BASEL II norms. The Income recognition and Asset classification norms of Banks? policy are in tune with RBI guidelines. Ninety days delinquency norm is followed to classify assets as performing & non-performing. The data is audited and adequate provisions for both performing and non-performing assets are made. For restructured assets additional provision is made and the bank also has a general floating provision.
CREDIT RISK MITIGATION •The general principles, like having a specific lien, requisite minimum margin stipulation, valuation, legal certainty, documentation, periodical inspection, easy liquidity etc. as enumerated in BASEL II final guidelines of RBI has been used for credit risk mitigation techniques. •All the prescribed haircuts with adjustments for currency mismatch and maturity mismatch are done. •The financial collaterals are netted out of the credit exposure before assigning the risk weights. The effect of credit risk mitigation system is not double counted.
The financial collaterals taken include: 1. Bank’s own term deposits . Cash margin 3. Life policies 4. NSCs 5. KVPs 6. Gold benchmarked at 99. 99 purity For each separate credit risk portfolio, the total exposure covered by eligible financial collateral after the application of haircuts is shown in the Table below: Credit Risk Exposure Exposure CRM (fin. Collaterals)Net exposure Loans and advances54303. 652659. 09 51644. 56 Non fund based5261. 22 767. 564493. 66 Investment 20500. 03 0. 0020500. 03 Total80064. 90 3426. 6576638. 25 CREDIT RATING FRAMEWORK Credit Rating Framework (CRF) is one of the risk measurement techniques the banks use to a great extent under risk management system.
This is used primarily to standardize and uniformly communicate the judgment in credit selection procedure and not as a substitute to the vast lending experience accumulated by the Bank’s professional staff. CREDIT RISK MANAGEMENT FRAMEWORK AT VIJAYA BANK As per RBI guidelines on Integrated Risk Management of Banks, all exposures across the Bank have to be risk rated. In this regard, IBM-BCS, Bank appointed Consultants recommended the following in respect of Credit Risk Management Framework for the Bank. SANCTIONING POWER DETAILS OF EXPOSURES COVEREDRATING MODEL DGM AND ABOVE Typically large value xposures (i. e. , above Rs. 200 lakhs)CRISIL?
Risk Assessment Model CM/DM AND AGM Typically medium sized exposures (i. e. , above Rs. 30 lakhs)Manual Rating Model BRANCH POWER ACCOUNT Typically small value exposuresPortfolio Model Approach PROCESSES AND PRACTICES OF CREDIT RISK MANAGEMENT •The bank has understood the need for credit risk management as described by RBI. •They have identified the types of risks and are disclosed in the BASEL II disclosures every quarter appropriately in the banks website. •Credit risk faced by the bank is properly identified which includes the following: 1.
The gross credit risk exposure has grown to Rs. 80064. 90 crore as of 30. 9. 2011 which is a 29% increase from the previous year that is 30. 9. 2010. 2. Credit quality has is standard due to their sound credit risk management system. 3. They have made sufficient provisions for NPAs, NPIs and depreciation. 4. Volume of off-balance sheet exposures for both financial collateral and guarantee covered credit portfolio together is Rs. 136281. 33 crore as of 30. 9. 2011 as against Rs. 101320. 2 crore as of 30. 9. 2010. •The bank decides on how much risk to take based on their risk appetite.
The bank’s risk management policy is fine tuned to include credit appraisal standard like benchmark/hurdle ratios on key financial indicators, internal ceilings, prudential norms, etc. besides covering exposure ceiling for sensitive sectors such as capital market, real estate and commodity sector. •The credit risk exposure for the last five years is shown in the figure below: Figure: Credit risk exposure of the bank for the last five years (Source: Balance sheet of Vijaya bank CREDIT RISK MITIGATION •Based on the policies strategies are developed by the bank to mitigate credit risk. Credit risk is mitigated by appropriate credit appraisal systems before lending and proper collateral or guarantees are taken to hedge the risk. •Integrated risk management system is put in place for better management of credit risk and a risk rating software is installed which is developed by CRISIL in compliance with RBI guidelines. •The risk management function is reviewed periodically usually every quarter. •The rating system for term loans is annual. •The risk weights of the bank’s products are shown in the figure below: Figure: Risk weights of the bank’s products (Source: Vijaya bank website) FINDINGS
The bank has a documented credit risk management policy. •The bank uses credit rating system to assess credit risk as a part of loan lending mechanism. •They use standardised approach for credit risk measurement currently and are fine tuning to upgrade to advanced approaches as per RBI guidelines. •They have implemented an integrated risk management system as per RBI guidelines •They mitigate credit risk exposure through diversification, collaterals and guarantees. •The credit risk exposure of the bank has decreased considerably in the last five years indicating a sound risk management policy. The risk weights associated with the banks? products are in line with RBI guidelines. •They have regular trainings for their credit risk management teams on the policies and guidelines.
They rely on ratings provided by CRISIL/CARE/ICRA as per RBI guidelines. RECOMMENDATIONS They can invest in securitisation as securitisation exposures are nil. •They have to start preparing for BASEL III norms which might come into effect in the near future. •They can further decrease their credit risk exposures with better credit risk management policies and advanced approaches as per RBI guidelines.
Bank should include credit risk component in yearly forecast based on multiple market scenarios CONCLUSION The bank follows a sound credit risk management and credit risk mitigation policy which is proven by the decreasing credit risk exposure of the bank for the past five years. The bank has adhered to RBI guidelines and implemented BASEL II norms and an integrated risk management system and risk rating software. The credit risk policies and strategies of the bank have improved over years and the bank is in a better position. The study shows that compliance with BASEL II norms helps the banks to improve their profitability through better credit risk management systems.