CREDIT RISK MANAGEMENT

Silpa Cherian

Chapter 1. Introduction

1.1 Background of the study
Banks in general face 3 types of risks: Credit risk, market risk, operating risk. y Credit risk is risk due to uncertainty in a counterparty's (also called an obligor's or credit's) ability to meet its obligations. y Investments are risky because of the change in their prices. This volatility in the value of a bank's investment is known as the market risk, as it is driven by the market. y Several events that are neither due to default by third party nor because of the variation of the market may arise. These events are called operational risks and can be attributed to internal systems, processes, people and external factors.
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1.2 Background of the topic
Credit risk is defined as when the borrower or counterparty fails to meet its obligations in accordance with agreed terms. y Aim of CRM: to maximize a bank's risk-adjusted rate of return by maintaining credit risk exposure within acceptable parameters. y The effective management of credit risk is essential to the long-term success of any banking organization.
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1.3 Nature of study
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A descriptive study is conducted to study the ³Credit Risk Management´ of Federal Bank Ltd., Aluva.

1.4 Objectives
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Primary Objectives: To study the credit risk management operations (assessment & procedures) in Federal Bank Ltd. To study different kinds of risks existing in Federal bank ltd. Secondary Objectives: To study the effect on risk management in capital adequacy ratio of Federal Bank. To identify the effect of Basel II norms regarding risk management in banks. To study the impact of asset quality on credit risk management of the bank. To analyze actual credit exposure of the bank.

Chapter 2. Industry/ Company profile

1.1 Industry Profile
The financial services sector contributes 19% India's GDP in FY 10. y Second-largest component after trade, hotels, transport and communication.
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History Of Banking in India
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Journey of Indian Banking system can be segregated into 3 distinct phases: PHASE I: 1786- The General Bank of India, Bank of Hindustan, Bengal Bank 1809- East India Company established Bank of Bengal 1840- Bank of Bombay 1843- Bank of Madras 1865- Allahabad Bank 1894- Punjab National Bank Ltd. 1906-1913- Bank of India, Central bank of India, Bank of Baroda, Canara Bank, Indian Bank, Bank of Mysore 1920- Imperial Bank of India 1935- RBI Growth was slow & experienced periodic failures b/w 1913- 1948. Approximately 1,100 banks, mostly small.

History of banking in India
The Banking Companies Act, 1949 y Banking Regulation Act, 1949
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PHASE II:

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Nationalization of Indian banks & up to 1991 prior to Indian Banking sector reforms. 1955- Nationalized Imperial Bank of India 1960- 7 subsidiaries of SBI nationalized 19th July, 1969- 14 banks nationalized 1980- 7 banks nationalized (80% of banking segment ± Gov. owned) Nationalization lead to increase in deposits & advances.

History of banking in India
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PHASE III: New phase of Indian Banking system with advent of Indian Financial & Banking Sector Reforms after 1991. Introduced many products & facilities in banking sector. 1991- Narasimham Committee was setup New phase brought in many changes: Foreign banks ATM stations Customer service Phone banking Net banking

Current Scenario in Banking Scenario
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IT based ³Core Banking solutions´ BPR implementation 88 scheduled commercial banks 28 public sector banks 29 private banks 31 foreign banks 65,000 branches 21,000 ATMs

2.2 Company Profile
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1931- Incorporated as Travancore Federal Bank Ltd. Founder- K.P. Hormis 1945-Renamed as The Federal Bank Ltd. Annual turnover- Rs. 75,000 crores. Wide network 600 branches is almost all important cities with more than 375 branches in Kerala. 30% deposits by NRIs CRISIL rating as P1+

Growth of Federal Bank Ltd.
Branches No. of units by 2002 No. of units by 2003 No. of units by 2004 No. of units by 2005 No. of units by 2006 No. of units by 2007 No. of units by 2008 No. of units by 2009 No. of units by 2010 412 420 440 456 472 536 600 669 737 ATM 36 119 204 255 320 391 517 690 775

900 800 700 600 500 400 300 200 100 0 No. of No. of No. of No. of No. of No. of No. of No. of No. of units units units units units units units units units by by by by by by by by by 2002 2003 2004 2005 2006 2007 2008 2009 2010 Branches ATM 

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VISION: Develop into a stronger and more efficient and profitable financial institution with a growing share of the market, providing an expanding range of products and services to a growing clientele within and outside the country, adopting best industry practices and employing contemporary technology, and be counted among the top private banks in the country. MISSION: Devote balanced attention to the interest and expectations of stakeholders, and in particular: share holders, customers & employees. Pursue excellence in various facets of banking. Adopt best industry practises. MOTTO: ´Your perfect banking partner.µ

Organization Structure

BOARD OF DIRECTORS

MANAGING DIRECTOR & CEO

EXECUTIVE DIRECTORS

BUSINESS DEPARTMENTS WITH BUSINESS RESPONSIBILITIES WHOLESALE BANKING

SUPPORT DEPARTMENTS Information Technology Dept Operations Dept

CONTROL DEPARTMENT Inspection & Audit Dept Vigilance Dept

AUTHORITIES WITH BUSINESS RESPONSIBILITIES Regional Heads

Large Corporate Dept Treasury Dept PERSONAL BANKING Retail Business Dept NRI Service Dept BUSINESS BANKING SME & Agri Business Dept Asset Recovery Dept

Human Resources Dept Legal Dept Finance & Accounts Dept Corporate Service Dept Corporate Planning Dept

Integrated Risk Mgt Dept
Secretarial Dept CEO s Secretariat

Integrated Risk Management Department

Functions:
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Overall management of risks faced by the bank. Meeting risk management guidelines of the RBI. Presenting quarterly progress to the board on implementation of RM guidelines of RBI & reporting such progress reports to RBI on quarterly or other prescribed intervals. Implementing suitable framework for mitigating operational risks. Risk aggregation & capital allocation. Initiating all other functions related to risk management.

Hierarchy of IRMD
EXECUTIVE DIRECTOR

RISK MANAGEMENT COMMITTEE

CREDIT RISK MGT DIVISION (HEADED BY THE CHIEF MANAGER)

MARKET RISK MGT DIVISION (HEADED BY THE SENIOR MANAGER)

OPERATIONS RISK MGT DIVISION (HEADED BY THE SENIOR MANAGER)

CREDIT RISK MANAGEMENT COMMITTEE

MARKET RISK MANAGEMENT COMMITTEE

OPERATIONS RISK MANAGEMENT COMMITTEE

Chapter 3. Review Of Literature

y y

Objectives of Risk Management (www.helplinelaw.com)

There are two main areas of focus for risk management: y Internal x To measure management that the business is aware of and in control of current and future business prospects. x To safeguard business assets and reputation of business x To help in improving banks¶ operating performance and shareholder value x To support the achievement of strategic goals. External
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To ensure fulfillment with regulatory requirements To deliver competitive advantage

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To reassure stakeholders and internal groups that the business is actively managing risk. Benefits of Risk Management (www.federalbank.co.in) Increased Risk awareness Prioritization of Business risks Fewer unexpected and unwelcome surprise A better focus internally Reduced losses through process improvement developed by bank Providing a better basis for making key strategic decisions

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Chapter 4. Methodology

4.1 Data Collection
Data collection from secondary sources y Annual Reports y Company Records y Data published on websites y Journals y Websites y Manual book of Bank y Brochures y RBI website

4.2 Sample Selection Method Choice
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Data of past 6 years (2004-2010) have been used for calculations.

4.3 Tools Used For Data Collection
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Capital Adequacy Ratio Asset Quality ENPA Correlation Bar diagram Pie-chart

4.4 Limitations of the study
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Lack of reliability. Study conducted on present conditions. Couldn¶t meet all relevant personnel. Time constraint Limited data

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Chapter 5. Data Analysis & Presentation

5.1 Analysis of Data CAPITAL ADEQUACY RATIO

CAPITAL ADEQUACY RATIO Capital Adequacy Ratio = Capital Risk Weighted Assets
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Year 2004-05 2005-06 2006-07 2007-08 2008-09 2009-10 CRAR 11.27 13.75 13.43 22.46 20.14 21.23

The CRAR has rose to 21.23 in 2009-10 which was 11.27 in 200920042004-05. Thus, showing efficient management of credit risk as per Basel norms.

CAPITAL ADEQUACY RATIO
CRAR
25 20 15 10 5 0 2004-05 2005-06 2006-07 2007-08 2008-09 2009-10 CRAR

Capital Adequacy Ratio comparison with Kerala based Banks
Bank South Gramin Bank Dhanalakshmi Bank Catholic Syrian Bank South Indian Bank Federal Bank 9.77 9.58 11.08 22.46 9.21 9.56 13.80 20.14 Malabar 2007 ± 08 9.10 2008 ± 09 9.19

Among Kerala based banks, Federal bank has the best CRAR of 20.14 compared to least CRAR at South Malabar Gramin bank.

Capital Adequacy Ratio comparison with Kerala based Banks
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20

15 2007 ± 08 2008 ± 09

10

5

0 South Malabar Dhanalakshmi Catholic Syrian South Indian Gramin Bank Bank Bank Bank Federal Bank

Total Advances to Total Assets
Year 2004-05 2005-06 2006-07 2007-08 2008-09 2009-10 Advances (Rs.) 8823 11736 14899 18904 22392 26950 Assets (Rs.) 16820 20642 25089 32506 38850 43605 Ratio .52 .56 .59 .58 .57 .62

The ratio is showing an increasing trend at 0.62 in 2009-10 which implies proper balancing of advances & assets.

Total Advance to Total Assets
Ratio
0.64 0.62 0.6 0.58 0.56 0.54 0.52 0.5 0.48 0.46 2004-05 2005-06 2006-07 2007-08 2008-09 2009-10 Ratio

Total Investment to Assets
Year Investment (Rs.) 2004-05 2005-06 2006-07 2007-08 2008-09 2009-10 5799 6272 7032 10026 12118 12982 Assets (Rs.) 16820 20642 25089 32506 38850 43605 .34 .30 .28 .30 .31 .30 Ratio

The ratio is constant at 0.30 during 2009-10 and shows good maintenance of investments & assets.

Total Investment to Total Assets
Ratio
0.4 0.35 0.3 0.25 0.2 0.15 0.1 0.05 0 2004-05 2005-06 2006-07 2007-08 2008-09 2009-10 Ratio

ASSET QUALITY

Net NPA¶s to Total Assets
Year Net NPA (Rs.) Total Assets (Rs.) 2004-05 2005-06 2006-07 2007-08 2008-09 2009-10 194.51 111.60 65.05 43.20 68.12 128.79 16820 20642 25089 32506 38850 43605 1.15 % .54 % .26 % .13 % .18 % .29% Percentage

The percentage of Net NPA to Total assets has increased to 0.29% during 2009-10. This indicates an unsound asset quality.

Net NPA to Total Assets
Percentage
1.40% 1.20% 1.00% 0.80% 0.60% 0.40% 0.20% 0.00% 2004-05 2005-06 2006-07 2007-08 2008-09 2009-10 Percentage

Net NPA¶s to Total Advances
Year Net NPA (Rs.) 2004-05 2005-06 2006-07 2007-08 2008-09 2009-10 194.51 111.60 65.05 43.20 68.12 128.79 Advances (Rs.) 8823 11736 14899 18904 22392 26950 2.2 % .96 % .43 % .23 % .30 % .48% Percentage

During 2009-10 the percentage rose to 0.48% showing an increasing trend due to poor management. Recession also plays a role in this increase from 2008.

Net NPA¶s to Total Advances
Percentage
2.50%

2.00%

1.50% Percentage 1.00%

0.50%

0.00% 2004-05 2005-06 2006-07 2007-08 2008-09 2009-10

ENPA

EXPOSURE TO CREDIT RISK
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The bank can quantify the credit risk on the basis of the level of NPA¶s. The following expression quantifies the credit risk of the bank.

ENPA = (EBT/TA) / (NPA¶s/ TA) ENPA- Earning per Non Performing Assets NPA ± Non Performning Assets TA - Total Assets EBT± Earnings before tax

Credit risk ratio of Federal Bank
Year EBT (Rs.) 2004-05 2005-06 2006-07 2007-08 2008-09 2009-10 90.0859 225.2057 292.7328 368.0538 500.4936 464.5451 TA (Rs.) 16820 20642 25089 32506 38850 43676 NPA (Rs.) 194.51 111.60 65.05 43.20 68.12 128.79 0.46 2.02 4.5 8.6 7.4 3.7 ENPA

The ENPA during 2009-10 has come down to 3.7

Earning per Non Performing Assets
ENPA
10 9 8 7 6 5 4 3 2 1 0 2004-05 2005-06 2006-07 2007-08 2008-09 2009-10 ENPA

CORRELATION

Correlation between Deposits and Advances
Year 2004-05 2005-06 2006-07 2007-08 2008-09 2009-10 Deposits (Rs.) 15192 17878 21584 25913 32,198 36,058 Advances (Rs.) 8823 11736 14899 18905 22392 26,950

The deposits has increased over the years thus leading to an increase in the advances.

Correlation between Deposits & Advances
40000 35000 30000 25000 20000 15000 10000 5000 0 2004-05 2005-06 2006-07 2007-08 2008-09 2009-10 Deposits Advances

Correlation between Deposits and Net Profit
Deposits Year 2004-05 2005-06 2006-07 2007-08 2008-09 2009-10 (Rs.) 15192 17878 21584 25913 32198 36058 Net Profit (Rs.) 90.01 225.20 292.73 368.05 472.01 502.29

Increase in deposits have also lead to an increase in the Net profit during 2009-10.

Correlation Between deposits and Net profit
40000 35000 30000 25000 20000 15000 10000 5000 0 2004-05 2005-06 2006-07 2007-08 2008-092009-10 Deposits Net Profit

Correlation between Advances and Net Profit
Year Advances (Rs.) 8823 11736 14899 18905 22392 26950 Net Profit (Rs.) 90.01 225.20 292.73 368.05 472.01 502.29

2004-05 2005-06 2006-07 2007-08 2008-09 2009-10

The The Net profit has increased to 502.29 in 2009-10 while it was 2009only 90.01 in 2004-05. 2004-

Correlation between Advances and Net Profit
30000 25000 20000 15000 10000 5000 0 2004-05 2005-06 2006-07 2007-08 2008-09 2009-10 Advances Net Profit

Analysis of Deposit Mix

Analysis of Deposit Mix
Year Demand Deposits (Rs.) 861 938 1216 1464 1442 1831 Savings Deposits (Rs.) 2864 3534 4229 5036 6445 7611 Term Deposits (Rs.) 11467 13406 16138 19412 24210 26615 Total Deposits (Rs.) 15192 17878 21583 25912 32097 36057

2004-05 2005-06 2006-07 2007-08 2008-09 2009-10

40000 35000 30000 25000 20000 15000 10000 5000 0 2004-05 2005-06 2006-07 2007-08 2008-09 2009-10 Demand Deposits Savings Deposits Term Deposits Total Deposits

Percentage of Demand Deposits to Total Deposit
Year 2004-05 2005-06 2006-07 2007-08 2008-09 2009-10 Demand Deposits (Rs.) 861 938 1216 1464 1442 1831 Total Deposits (Rs.) 15192 17878 21583 25912 32097 36057 % to Total Deposits 5.66 5.24 5.63 5.64 4.49 5.07

The proportion was 5.66% in 2004-05 & is 5.07% in 2009-10. 20042009-

Percentage of Demand Deposits to Total Deposit
% to Total Deposits
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5

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3 % to Total Deposits 2

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0 2004-05 2005-06 2006-07 2007-08 2008-09 2009-10

Percentage of Savings Deposits to Total Deposits
Year Savings Deposits(Rs.) 2864 3534 4229 5036 6445 7611 Total Deposits(Rs.) 15192 17878 21583 25912 32097 26615 % to Total Deposits 18.9 19.8 19.6 19.4 20.0 28.59

2004-05 2005-06 2006-07 2007-08 2008-09 2009-10

The proportion was 18.9% in 2004-05 & has 2004increased to 28.59 in 2009-10. 2009-

Percentage of Savings Deposits to Total Deposits % to Total Deposits
35 30 25 20 15 10 5 0 % to Total Deposits

Percentages of Term Deposits to Total Deposits
Year Term deposit (Rs.) 11467 13406 16138 19412 24210 26615 Total Deposits (Rs.) 15192 17878 21583 25912 32097 36057 % to Total Deposits 75.3 74.9 74.7 74.9 75.4 73.8

2004-05 2005-06 2006-07 2007-08 2008-09 2009-10

The proportion is showing a consistent relation from 20042004-05 from 75.3 to 2009-10 73.8. 2009-

Percentages of Term Deposits to Total Deposits
% to Total Deposits
76 75.5 75 74.5 74 73.5 73 % to Total Deposits

Credit Exposure of Federal bank in 2010
CREDIT LIMITS 2 Lakhs ± 50 lakhs 50 Lakhs ± 500 lakhs 500 Lakhs and above Retail loans PERCENTAGE FIGURE 30 20 15 35

The bank shows a high percentage of 35% in lending retail loans.

Credit Limits

2 Lakhs ± 50 lakhs 35% 30% 50 Lakhs ± 500 lakhs 500 Lakhs and above Retail loans

15%

20%

Chapter 6. Summary & Conclusions

6.1 Findings of the study
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The CRAR has rose to 21.23 in 2009-10 which was 11.27 in 200405. Thus, showing efficient management of credit risk as per Basel norms. Among Kerala based banks, Federal bank has the best CRAR of 20.14 compared to least CRAR at South Malabar Gramin bank. The ratio of total advances to total assets show an increasing trend at 0.62 in 2009-10 which implies proper balancing of advances & assets. The ratio of total investment to total assets is constant at 0.30 during 2009-10 and shows good maintenance of investments & assets. The percentage of Net NPA to Total assets has increased to 0.29% during 2009-10. This indicates an unsound asset quality. During 2009-10 the percentage of Net NPA advances rose to 0.48% showing an increasing trend due to poor management. Recession also plays a role in this increase from 2008.

Findings of the study
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The ENPA during 2009-10 has come down to 3.7 The deposits has increased over the years thus leading to an increase in the advances. Increase in deposits have also lead to an increase in the Net profit during 2009-10. Increase in advances has also lead to an increase in Net profit to 502.29 in 2009-10 while it was only 90.01 in 2004-05. 20092004The proportion of demand deposits to total deposit was 5.66% in 20042004-05 & is 5.07% in 2009-10. 2009The proportion of savings deposits to total deposit was 18.9% in 20042004-05 & has increased to 28.59 in 2009-10. 2009The proportion of term deposits to total deposit is showing a consistent relation from 2004-05 from 75.3 to 2009-10 73.8. 20042009Federal bank shows a high percentage of 35% in lending retail loans.

6.2 Recommendations
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Bank should establish a system that helps identify problem loan ahead of time when there may be more options available for remedial measures. Banks should disclose to the public, information on the level of risk and policies for risk management. Bank should take measures to improve its asset quality, so that the credit risk can be minimized. The bank must put maximum effort to attract the fixed deposits which contribute significantly towards the enhancement of banks profitability. The bank should maintain a good proportion in their deposits and advances.

6.2 Conclusions
The effectiveness of credit risk management rests where the credit quality is maintained by the bank. y Basel III is likely to improve the risk management systems of banks as the banks aim for adequate capitalization to meet the underlying credit risks and strengthen the overall financial system of the country y Formerly, people were not much bothered about the banking services but now they are comparing banks based on the services offered.
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