Structural Liquidity Gap Report is prepared based on the residual maturity of all assets and liabilities. If inflow (Assets) is less than outflow (liabilities) there will be liquidity problem. Such mismatch should be within the tolerance limit. Liquidity Risk is managed by matching assets and liabilities by their residual maturity.
Rate Sensitivity Gap Report is prepared based on re-pricing i.e., when the interest rate on asset or liability gets reset. A positive gap means more assets get re-priced than liabilities and is good under increasing interest rate scenario. The reverse is desirable under declining interest rate scenario. Interest Rate Risk is managed by:
• Changing rates by different basis points.
• Changing rates at different reference dates.
• Changing Composition of assets and liabilities.
Duration Gap Analysis is the weighted average maturity of the fixed income security. Maturity weighted with net present value at market rate of discount. Different assets and liabilities are having varying duration and therefore this can give a better estimate of risk. Modified Duration is a tool used to assess the changes in interest rate on income.
Simulation models are used to gauge the effect of market interest rate variations on reported earnings/economic values over different time zones. It is a series of "What if" analysis of the impact of rate changes, taking into account different balance sheet structures.
Data Collection
Asset Liability gap reports are based on outflow and inflow of assets and liabilities. The outflows and inflows depend on the residual maturity of assets and liabilities. For the purpose, the processing of data/information is collected from the various sources as under:-
• Investment portfolio from Specialized Integrated Treasury Branch.
• Term Deposits (census data) details are captured through Regional Offices (who obtain Branch-wise information) through in-house ALMAN Package.
• Advances details through ASCROM system.
Collection of such voluminous data requires time and maintaining/updating the same is a mammoth task.
However, a sound database is a pre-requisite covering 100% of assets and liabilities. Staffs at various levels are to attach requisite importance in timely furnishing correct and validated data for use at Corporate Office level, so that that desired benefits could be reaped by using the data in the decision making process.
Utility of Census Data
Some of the major utility at the branches and other levels of the Census data generated for the purpose of ALM function at Corporate Centre are:
• Census data is a treasure of information, which can be used for business development and monitoring at various levels.
• The extent of deposits to be mobilised can be obtained from the census data.
• List of receipts maturity next month, next year is readily available and therefore branches can write to depositors to renew the receipts, for better customer service.
• Helps in identifying scheme-wise and ownership group-wise list of deposits thereby enabling deposit mobilisation.
• Enables monitoring of increase in number of accounts/ customers.
• Overdue deposits can be identified and depositors intimated of the status.
• Generation of actual cost of term deposits will help in proper control/monitoring of the same.
• Estimation of interest expense due to interest rate change possible with amount maturing during the next year and the expected renewal.
• Customer Profile can be generated.
• Area-wise deposits mobilised can be generated to identify potential areas for business development.
• Receipt-wise interest payable, half-yearly will help branches either to credit interest or to make provision.
The aforesaid are only few of the utility of the ALM census data and the ALMAN package is capable of generating other useful reports also.
Credit Risk
In the course of bank's Lending, a number of risks are involved. In addition to the risks related to creditworthiness of the counterparty, the banks are also exposed to interest rate, forex, country risks etc., Credit Risk involves inability or unwillingness of a customer or counterparty to meet commitments in relation to lending, trading, hedging, settlement and other financial transactions. The objective of credit risk management is to minimize the risk and maximize bank's risk adjusted rate of return by assuming and maintaining credit exposure within the acceptable parameters.
Credit Risk comprises of transaction risk or Default risk and Portfolio risk. Portfolio risk further comprises of Intrinsic Risk and Concentration Risk. Credit Risk depends on both external and internal factors. External factors are economy, government policies etc., while Internal factors are loan policies, setting and monitoring of prudential concentration limits, appraisal quality, appropriate pricing etc.
Credit risk may take the following forms:
• In the case of direct lending - Principal and or interest amount may not be
repaid.
• In the case of guarantees or letters of credit - funds may not be forthcoming
from the constituents upon crystallization of the liability.
• In the case of Treasury Operations - the payment or series of payments due
from the counterparties under the respective contracts may not be forthcoming
or ceases.
• In the case of securities trading businesses - funds/securities settlement may
not be effected.
• In the case of Cross Border Exposure - the availability and free transfer of
foreign currency funds may either cease or restrictions may be imposed by the
sovereign.
Credit Risk Measurement & Monitoring
Reserve Bank of India in their guidance note on credit risk highlights the following broad framework in respect of credit risk measurement and monitoring procedures.
• Banks should establish proactive Credit Risk Management practices.
• Banks should have a system of checks and balance for extension of credit viz.,
Separation of credit risk management from credit sanction, multiple credit
approvers, independent audit and risk review.
• Every obligor and facility must be assigned a risk rating.
• Mechanism to price facilities depending on risk grading.
• Banks should ensure consistent standards for loan origination, documentation etc.,
• Banks should have a consistent approach towards early problem recognition,
classification of problem exposures and remedial action.
• Banks should maintain a diversified portfolio of risk assets.
• Banks should set Credit Risk limits like borrower limit, industry limits etc.,
• Banks to report comprehensive set of credit risk data into independent risk
system.
• Systems to be put in place for monitoring financial performance of customers
and for controlling outstanding within limits.
• Conservative Provisioning Policy for NPA Advances.
As credit is considered to be the core business of banking, necessary attention has to be directed towards managing the risk involved in credit, encompassing:
• Carefully formulated scheme of lending powers.
• Setting-up of Prudential Limits
• Measurement of risk through credit rating/scoring.
• Risk pricing on a scientific basis
• Portfolio Management and quantifying the risk through estimating expected loan
losses and
• Controlling through effective Loan Review Mechanism.
Discretionary Lending Powers
A carefully formulated scheme of delegation of power allows multi-tier sanction of lending, where the loans are sanctioned according to the authority. Bank also revises such powers as and when required depending on the business needs of the bank. Lending Powers are to be exercised judiciously.
Prudential Limits
In order to limit the magnitude of credit risk, prudential limits are laid down on various aspects of credit. These limits illustratively include -
• Single/Group borrower limits.
• Substantial Exposure limit
• Restriction on the maximum exposure limit to various industries, sector, negative list industries etc.
Necessary exposure caps are also placed in the bank.
Risk Rating
Credit Rating framework is the basic element for developing a credit risk management system. Rating framework is primarily driven by a need to standardize and uniformly communicate the judgment in lending and IS NOT A SUBSTITUTE to the vast lending experience accumulated by the bankers.
The end use of credit rating framework is: -:
• Individual credit selection, wherein either a borrower or a particular exposure/ facility is rated.
• In Commercial Loans, the rating outcome can be used for Pricing.
• Tracking of Migration in rating and calculation of expected loan losses.
• Portfolio Level analysis.
• Surveillance, monitoring and internal MIS.
• Assessment of aggregate risk profile of the bank.
Bank has devised -2- Credit Rating Models for Commercial Lending, which are basically designed to reveal the overall risk of lending. It is expected that the rating outcome reflect the underlying credit risk of the loan book. A number of qualitative and quantitative aspects have gone into finalization of the models.
For performing the Credit Risk Management functions, the operating units are to gear-up to meet the objectives of standardization and uniformity in lending judgments.
Risk Pricing
Risk-Return Trade off is the basic tenet of risk management. In an ideal risk-return setting, borrowers with weak financial position should be placed in high credit risk category and should be priced high.
Bank is likely to move to advanced/scientific system of pricing once the new rating models are used for some desirable period, wherein Probability of Default (PD) would be derived from the past behaviour of the loan portfolio.
The spread of the asset portfolio across the risk-rating scale and the trends in rating migration allows the bank to determine the level of provisioning required, (in addition to the regulatory minimum), to absorb unanticipated erosions in credit quality. The extent of provisioning shall be estimated from the Expected Loss on Default. These probabilities can be arrived only after significant empirical details/historical data by establishing strong, structured and sound MIS. For this, a reasonable understanding of rating, its importance for Risk Management is pre-requisite and operational staffs has to put in best of their efforts to appreciate the immediate and urgent need.
Banks which are advanced in their systems have put in place Risk Adjusted Return on Capital (RAROC) framework for pricing of loans, which calls for data on portfolio behaviour and allocation of capital commensurate with credit risk inherent in loan proposals.
Portfolio Management
Portfolio Management techniques help in gauging asset quality. The Portfolio Review Cell, which is part of Risk Management Department, is assigned the responsibility of periodic monitoring of the portfolio. The portfolio quality is evaluated by regular tracking of non-performing loans, sector-wise lending etc., which provides insight into the nature and composition of loan portfolio. Some of the measure for Portfolio Management is:
• Quantitative ceiling on exposure across rating categories.
• Industry-wise evaluation of rating distribution of borrowers
• Monitoring concentration by Industry Group, Geographical location etc.,
Many of the Internationally active banks have adopted credit risk models for evaluation of credit portfolio. To name a few, J.P. Morgan's "CreditMetrics", Credit Suisse's "CreditRisk+". As stated above, over a period of time bank may look into the aspect of using appropriate models.
Management Information System (MIS)
As stated above, it is quite obligatory that the officials involved at the Branch, Regional, Zonal and Corporate Centre appreciate the need for a strong MIS and prepare themselves for building a strong, structured and sound MIS system.
Risk Aggregation
Assessing and aggregating the risk profile of the bank is the ultimate aim of the bank. This is relevant for portfolio level analysis. For instance, the spread of credit exposures across various rating categories, the mean and standard deviation of losses occurring in each rating and the overall migration of exposures would give the aggregated credit risk for the entire credit portfolio of the bank. The risk models shall be of help for this process.
Loan Review Mechanism/ Credit Audit
Credit Audit examines compliance with extant sanction and post-sanction process/procedures laid down by the bank from time to time. Objectives of Credit Audit are:
• Improvement in the quality of credit portfolio
• Review sanction process and compliance status of large loans
• Feedback on regulatory compliance
• Independent review of Credit Risk Assessment.
• Pick-up early earning signals and suggest remedial measures
• Recommend corrective action to improve credit quality, credit administration
and credit skills of staff etc., Bank has introduced Credit Audit in respect of
accounts as under:-
• All existing accounts with sanctioned limit (funded and non-funded) of Rs.10
crore and above.
• All fresh sanction with a cut-off limit (funded and non-funded) of Rs.5 crore
and above.
• 5% of remaining accounts on random selection basis with sanctioned limit of
Rs.1 crore and above but below Rs.10 crores.
