OPTIMAL CREDIT ALLOCATION

&
MANAGEMENT
 Introduction
• Credit refers to
• Short Term Loans & Advances
• Medium / Long Term Loans
• Off-Balance Sheet Transactions
• Management refers to
• Pre-sanction appraisal
• Documentation
• Disbursement and Disbursal
• Post-lending supervision and control
 Approach for safety of loans

• Safety of loans is directly related

• to the basis on which decision to lend is taken
• Type and quantum of credit to be provided
• Terms and conditions of the loan
Approach for safety of loans (Contd.)

• Two-pronged approach
• Pre-Sanction appraisal
• To determine the ‘bankability’ of each loan proposal
• Post-Sanction control
• To ensure proper documentation, follow-up and supervision
 Pre-Sanction appraisal
• Concerned with measurement of risk(iness) of a loan proposal
• Requirements are:
• Financial data of past and projected working results
• Detailed credit report is compiled on the borrower / surety
• Market reports
• Final / audited accounts
• Income tax and other tax returns / assessments
• Confidential reports from other banks and financial institutions
• Credit Report (CR) needs to be regularly updated
• Appraisal should reveal whether a loan proposal is a fair banking
risk
 Post-Sanction appraisal

• Depends to large extent upon findings of pre-sanction

appraisal
• Requirements are:
• Documentation of the facility and ‘after care’ follow- up
• Supervision through monitoring of transactions in loan amount
• Scrutiny of periodical statements submitted by the borrower
• Physical inspection of securities and books of accounts of the
borrower
• Periodical reviews etc.
 Bankers’ Credit Report

• Includes seeking information including other banks –

(writing or over telephone etc.)
• Sharing of information could be a sensitive issue
• Advisable to take an undertaking from customers
• Make the condition as part of account opening form or
loan application
 Types of loans and advances

• Working Capital Finance

• Extended to meet day-to-day short term operational
requirements (sales & purchase of commodities, purchase
of raw materials etc.)
• Loan for setting up new project, expansion and
diversification of existing project etc.
• Short term or medium term
 Loans and Advances (Contd.)

 Difference between Loans and Advances

◦ Loans are extended in accounts in which no drawings are
permitted to the borrowers
◦ Generally there is one debit to principal amount to loan
account – though disbursal in stages is possible depending on
the need of the borrower
◦ For operational purposes loan can be credited to a special
account where withdrawal from time to time can be done by the
party depending upon his requirements
◦ In case of advances, the sanctioned limit is placed at the
disposal of the borrower, subject to terms of sanction, in
running accounts which can be drawn upon by cheques by the
borrower
 Loans and Advances (Contd.)

 Working capital finance in form of loan is also

known as demand loan
 As an advance it is commonly known as cash credit
facility
 Banks apart from working capital and medium term
and long term finance may also extend casual
overdrafts to approved customers
◦ In current accounts
◦ Loans against security of shares, FDs, housing loans etc.
 Conditions determining future
trends
• Three factors which can undergo changes:
• Prospects
• Future risk profile
• Repayment capacity
Tools for determining future trends

 Financial Analysis – past and projected

 Credit rating
 Assessment of credit needs
 Terms of sanction
 Documentation and creation of security interest
 Post-lending supervision – 3 stages
◦ Regular surprise verification of security
◦ Stock audit
◦ Obtaining and scrutiny of control statement (stock statements,
financial statements)
 Repayment and / or rollover
 Risks in Bank Lending

• Credit Risk
• Market Risk
• Operational Risk
 Credit Risk

• RBI defines credit risk as:

• the possibility of losses associated with diminution in the credit
quality of borrowers or counterparties. 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. Alternatively,
losses result from reduction in portfolio value arising from actual or
perceived deterioration in credit quality.
 Credit Risk Management

• Credit risk is defined, “as the potential that a

borrower or counter-party will fail to meet its
obligations in accordance with agreed terms”
• It is the probability of loss from a credit transaction
 Credit Risk Management
 According to Reserve Bank of India, the following are the
forms of credit risk:
◦ Non-repayment of the principal of the loan and/or the interest on it
◦ Contingent liabilities like letters of credit/guarantees issued by the
bank on behalf of the client and upon crystallization amount not
deposited by the customer
◦ In the case of treasury operations, default by the counter-parties in
meeting the obligations
◦ In the case of securities trading, settlement not taking place when it is
due
◦ In the case of cross-border obligations, any default arising from the
flow of foreign exchange and/or due to restrictions imposed on
remittances out of the country
 Policy Framework

• Strategy and Policy:

• Credit policies and procedures of banks should necessarily
have the following elements:
• Written policies defining target markets, risk acceptance criteria,
credit approval authority, credit origination and maintenance
procedures and guidelines for portfolio management and
remedial management
• Systems to manage problem loans to ensure appropriate
restructuring schemes
• A conservative policy for the provisioning of non-performing
advances should be followed
 Policy Framework (Contd.)

• Strategy and Policy:

• Credit policies and procedures of banks should necessarily
have the following elements:
• Consistent approach towards early problem recognition,
classification of problem exposures, and remedial action
• Maintain a diversified portfolio of risk assets in line with the
capital desired to support such a portfolio
• Procedures and systems, which allow for monitoring
financial performance of customers and for controlling
outstanding within limits
 Policy Framework (Contd.)

• Organizational Structure
• Banks should have an independent group responsible for
the CRM
• Responsibilities to include formulation of credit policies,
procedures and controls extending to all of its credit risk
arising from corporate banking, treasury, credit cards,
personal banking, trade finance, securities processing,
payments and settlement systems
• Board of Directors should have the overall responsibility
for management of risks
 Policy Framework (Contd.)

• Operations / Systems
• Credit process typically involves the following phases:
• Relationship management phase, that is, business development
• Transaction management phase to cover risk assessment,
pricing, structuring of the facilities, obtaining internal approvals,
documentation, loan administration and routine monitoring and
measurement, and
• Portfolio management phase to entail the monitoring of
portfolio at a macro level and the management of problem
loans.
 Credit Risk Rating Framework

• Use of credit rating models and credit rating analysts

• Loans to individuals or small businesses, credit
quality is assessed through credit scoring which is
based on a standard formulae which incorporates
party’s information viz. annual income, existing
debts, other details such as homes (rented or owned)
etc.
 Credit Risk Limits

• Bank generally sets an exposure credit limit for each

counterparty to which it has credit exposure
• Depending on the assessment of the borrower
(commercial as well as retail) a credit exposure limit is
decided for the customer, however, within the
framework of a total credit limit for the individual
divisions and for the company as a whole
 Credit Risk Limits

• Also within the limit as per RBI, i.e. not more than
15% of capital to individual borrower and not more
than 40% of capital to a group borrower
• Threshold limits are set which are dependent upon
• Credit rating of the borrower
• Past financial records
• Willingness and ability to repay
• Borrower’s future cash flow projections
 Risk Mitigants

• Credit risk mitigation means reduction of credit risk in an

exposure by a safety net of tangible and realisable
securities including third-party approved
guarantees/insurance
• Various risk mitigants are:
• Collateral (tangible, marketable) securities
• Guarantees
• Credit derivatives
• On-balance-sheet netting
 Risk Mitigants (Contd.)

• Conditions for use of credit risk mitigants

• All documentation used in collateralized transactions must
be binding on all parties and must be legally enforceable in
all relevant jurisdictions
• Banks must have properly reviewed all the documents and
should have appropriate legal opinions to verify such, and
ensure its enforceability
 Components of Credit Risk

• Default Risk – Risk that a borrower or counterparty is

unable to meet its commitment
• Portfolio Risk – Risk which arises from the composition
/ concentration of bank’s exposure to various sectors
• Two factors affect credit risk
• Internal Factors – Bank specific
• External factors – State of economy, size of fiscal deficit etc.
 Managing Internal Factors

• Adopting proactive loan policy

• Good quality credit analysis
• Loan monitoring
• Sound credit culture
 Managing External Factors

• Well diversified loan portfolio

• Scientific credit appraisal for assessing financial and
commercial viability of loan proposal
• Norms for single and group borrowers
• Norms for sectoral deployment of funds
• Strong monitoring and internal control systems
• Delegation and accounatbility
Thank You