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“RISK MANAGEMENT IN COMMERCIAL BANKS”(A CASE STUDY OF PUBLIC AND PRIVATE SECTOR BANKS) - ABSTRACT ONLY

Prof. Rekha Arunkumar Faculty (Finance), MBA Programme

ABSTRACT:

“Banks are in the business of managing risk, not avoiding it……………………..”

Risk is the fundamental element that drives financial behaviour. Without risk, the financialsystem would be vastly simplified. However, risk is omnipresent in the real world.Financial Institutions, therefore, should manage the risk efficiently to survive in this highlyuncertain world. The future of banking will undoubtedly rest on risk management dynamics.Only those banks that have efficient risk management system will survive in the market inthe long run. The effective management of credit risk is a critical component ofcomprehensive risk management essential for long-term success of a banking institution.

Credit risk is the oldest and biggest risk that bank, by virtue of its very nature of business,inherits. This has however, acquired a greater significance in the recent past for variousreasons. Foremost among them is the wind of economic liberalization that is blowingacross the globe. India is no exception to this swing towards market driven economy.Better credit portfolio diversification enhances the prospects of the reduced concentrationcredit risk as empirically evidenced by direct relationship between concentration credit riskprofile and NPAs of public sector banks.

“……………………A bank’s success lies in its ability to assume andaggregate risk within tolerable and manageable limits”.

First Author;

Prof. Rekha Arunkumar Ph.D., from University of Mysore (awaiting result by September ’ 05), PGDCA, M.Com.,B.B.M.,Faculty in Finance (10 years of experience),MBA Programme,Bapuji Institute of Engineering & Technology (affiliated to Visveswaraya Technical University)Davangere – 4. Karnataka

Second Author;

Dr. G. Kotreshwar Ph.D., M.Com., ICWAI.,Professor of Commerce (25 years of experience)University of Mysore, ManasagangotriMysore – 6.

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COMPLETE PAPER

RISK MANAGEMENT IN COMMERCIAL BANKS(A CASE STUDY OF PUBLIC AND PRIVATE SECTOR BANKS)

“Banks are in the business of managing risk, not avoiding it…………….……..”

1. PREAMBLE:

1.1 Risk Management:

The future of banking will undoubtedly rest on risk management dynamics. Onlythose banks that have efficient risk management system will survive in the market in the longrun. The effective management of credit risk is a critical component of comprehensive riskmanagement essential for long-term success of a banking institution. Credit risk is the oldestand biggest risk that bank, by virtue of its very nature of business, inherits. This has however,acquired a greater significance in the recent past for various reasons. Foremost among themis the wind of economic liberalization that is blowing across the globe. India is no exceptionto this swing towards market driven economy. Competition from within and outside thecountry has intensified. This has resulted in multiplicity of risks both in number and volumeresulting in volatile markets. A precursor to successful management of credit risk is a clearunderstanding about risks involved in lending, quantifications of risks within each item of theportfolio and reaching a conclusion as to the likely composite credit risk profile of a bank.

The corner stone of credit risk management is the establishment of a framework thatdefines corporate priorities, loan approval process, credit risk rating system, risk-adjustedpricing system, loan-review mechanism and comprehensive reporting system.

1.2 Significance of the study:

The fundamental business of lending has brought trouble to individual banks andentire banking system. It is, therefore, imperative that the banks are adequate systems forcredit assessment of individual projects and evaluating risk associated therewith as well as theindustry as a whole. Generally, Banks in India evaluate a proposal through the traditionaltools of project financing, computing maximum permissible limits, assessing managementcapabilities and prescribing a ceiling for an industry exposure. As banks move in to a newhigh powered world of financial operations and trading, with new risks, the need is felt formore sophisticated and versatile instruments for risk assessment, monitoring and controllingrisk exposures. It is, therefore, time that banks managements equip themselves fully tograpple with the demands of creating tools and systems capable of assessing, monitoring andcontrolling risk exposures in a more scientific manner.

Credit Risk, that is, default by the borrower to repay lent money, remains the mostimportant risk to manage till date. The predominance of credit risk is even reflected in thecomposition of economic capital, which banks are required to keep a side for protectionagainst various risks. According to one estimate, Credit Risk takes about 70% and 30%remaining is shared between the other two primary risks, namely Market risk (change in themarket price and operational risk i.e., failure of internal controls, etc.). Quality borrowers(Tier-I borrowers) were able to access the capital market directly without going through thedebt route. Hence, the credit route is now more open to lesser mortals (Tier-II borrowers).With margin levels going down, banks are unable to absorb the level of loan losses. Therehas been very little effort to develop a method where risks could be identified and measured.Most of the banks have developed internal rating systems for their borrowers, but there has

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been very little study to compare such ratings with the final asset classification and also tofine-tune the rating system. Also risks peculiar to each industry are not identified andevaluated openly. Data collection is regular driven. Data on industry-wise, region-wiselending, industry-wise rehabilitated loan, can provide an insight into the future course to beadopted.

Better and effective strategic credit risk management process is a better way tomanage portfolio credit risk. The process provides a framework to ensure consistencybetween strategy and implementation that reduces potential volatility in earnings andmaximize shareholders wealth. Beyond and over riding the specifics of risk modeling issues,the challenge is moving towards improved credit risk management lies in addressing banks’readiness and openness to accept change to a more transparent system, to rapidlymetamorphosing markets, to more effective and efficient ways of operating and to meetmarket requirements and increased answerability to stake holders.

There is a need for Strategic approach to Credit Risk Management (CRM) in IndianCommercial Banks, particularly in view of;

(1) Higher NPAs level in comparison with global benchmark(2) RBI’ s stipulation about dividend distribution by the banks(3) Revised NPAs level and CAR norms(4) New Basel Capital Accord (Basel –II) revolution

According to the study conducted by ICRA Limited, the gross NPAs as a proportionof total advances for Indian Banks was 9.40 percent for financial year 2003 and 10.60 percentfor financial year 20021. The value of the gross NPAs as ratio for financial year 2003 for theglobal benchmark banks was as low as 2.26 percent. Net NPAs as a proportion of netadvances of Indian banks was 4.33 percent for financial year 2003 and 5.39 percent forfinancial year 2002. As against this, the value of net NPAs ratio for financial year 2003 forthe global benchmark banks was 0.37 percent. Further, it was found that, the total advances ofthe banking sector to the commercial and agricultural sectors stood at Rs.8,00,000 crore. Ofthis, Rs.75,000 crore, or 9.40 percent of the total advances is bad and doubtful debt. The sizeof the NPAs portfolio in the Indian banking industry is close to Rs.1,00,000 crore which isaround 6 percent of India’ s GDP2.

The RBI has recently announced that the banks should not pay dividends at morethan 33.33 percent of their net profit. It has further provided that the banks having NPAlevels less than 3 percent and having Capital Adequacy Reserve Ratio (CARR) of more than11 percent for the last two years will only be eligible to declare dividends without thepermission from RBI3. This step is for strengthening the balance sheet of all the banks in thecountry. The banks should provide sufficient provisions from their profits so as to bringdown the net NPAs level to 3 percent of their advances.

NPAs are the primary indicators of credit risk. Capital Adequacy Ratio (CAR) isanother measure of credit risk. CAR is supposed to act as a buffer against credit loss, which is

1 ICRA Limited, (2004), “Report 1 : Global Benchmarking”, IBA Bulletin, special issue, January2004, pp. 30

2 ICRA Limited, (2004), Op.cit. pp.363 Parasmal Jain, (2004), “Basel II Accord : Issues and Suggestions”, IBA Bulletin, June 2004,

pp.9-10.

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set at 9 percent under the RBI stipulation4. With a view to moving towards International bestpractices and to ensure greater transparency, it has been decided to adopt the ’ 90 days’ ‘ overdue’ norm for identification of NPAs from the year ending March 31, 2004.

The New Basel Capital Accord is scheduled to be implemented by the end of 2006.All the banking supervisors may have to join the Accord. Even thedomestic banks in addition to internationally active banks may have toconform to the Accord principles in the coming decades. The RBI as theregulator of the Indian banking industry has shown keen interest instrengthening the system, and the individual banks have responded in goodmeasure in orienting themselves towards global best practices.

1.3 Credit Risk Management(CRM) dynamics:

The world over, credit risk has proved to be the most critical of all risks faced by abanking institution. A study of bank failures in New England found that, of the 62 banks inexistence before 1984, which failed from 1989 to 1992, in 58 cases it was observed that loansand advances were not being repaid in time 5 . This signifies the role of credit riskmanagement and therefore it forms the basis of present research analysis.

Researchers and risk management practitioners have constantly tried to improve oncurrent techniques and in recent years, enormous strides have been made in the art andscience of credit risk measurement and management6. Much of the progress in this field hasresulted form the limitations of traditional approaches to credit risk management and with thecurrent Bank for International Settlement’ (BIS) regulatory model. Even in banks whichregularly fine-tune credit policies and streamline credit processes, it is a real challenge forcredit risk managers to correctly identify pockets of risk concentration, quantify extent of riskcarried, identify opportunities for diversification and balance the risk-return trade-off in theircredit portfolio.

The two distinct dimensions of credit risk management can readily be identified aspreventive measures and curative measures. Preventive measures include risk assessment,risk measurement and risk pricing, early warning system to pick early signals of futuredefaults and better credit portfolio diversification. The curative measures, on the other hand,aim at minimizing post-sanction loan losses through such steps as securitization, derivativetrading, risk sharing, legal enforcement etc. It is widely believed that an ounce of preventionis worth a pound of cure. Therefore, the focus of the study is on preventive measures in tunewith the norms prescribed by New Basel Capital Accord.

The study also intends to throw some light on the two most significant developmentsimpacting the fundamentals of credit risk management practices of banking industry – NewBasel Capital Accord and Risk Based Supervision. Apart from highlighting the salientfeatures of credit risk management prescriptions under New Basel Accord, attempts are madeto codify the response of Indian banking professionals to various proposals under the accord.Similarly, RBI proposed Risk Based Supervision (RBS) is examined to capture its directionand implementation problems.

4 Information Bureau, (2004), The Economic Times, 4th August 2004, pp.7

5 Prahlad Sabrani, “ Risk Management by Banks in India”, IBA Bulletin, July 2002.6 Ravi Mohan R., “Credit Risk Management in Bank”, The Chartered Accountant, March 2001.

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1.4 Objectives of the research:

The present study attempts to achieve the following objectives:

1. Analysis of trends in Non-Performing Assets of commercial banks in India.

2. Analysis of trends in credit portfolio diversification during the post-liberalization period.

3. Studying relationship between diversified portfolio and non-performing assets of publicsector banks vis-à-vis private sector banks.

4. Profiling and analysis of concentration risk in public sector banks vis-à-vis private sectorbanks.

5. Evaluating the credit risk management practices in public sector banks vis-à-vis privatesector banks.

6. Reviewing the New Basel Capital Accord norms and their likely impact on credit riskmanagement practices of Indian commercial banks.

7. Examining the role of Risk Based Supervision in strengthening credit risk managementpractices of Indian commercials banks.

8. Suggesting a broad outline of measures for improving credit risk management practicesof Indian commercial banks.

2. THE PROBLEM OF NON-PERFORMING ASSETS

2.1 Introduction:

Liberlization and Globalization ushered in by the government in the early 90s havethrown open many challenges to the Indian financial sector. Banks, amongst other things,were set on a path to align their accounting standards with the International standards and byglobal players. They had to have a fresh look into their balance sheet and analyze themcritically in the light of the prudential norms of income recognition and provisioning thatwere stipulated by the regulator, based on Narasimhan Committee recommendations.

Loans and Advances as assets of the bank play an important part in gross earningsand net profits of banks. The share of advances in the total assets of the banks forms morethan 60 percent7 and as such it is the backbone of banking structure. Bank lending is verycrucial for it make possible the financing of agricultural, industrial and commercial activitiesof the country. The strength and soundness of the banking system primarily depends uponhealth of the advances. In other words, improvement in assets quality is fundamental tostrengthening working of banks and improving their financial viability. Most domestic publicsector banks in the country are expected to completely wipeout their outstanding NPAsbetween 2006 and 20088.

NPAs are an inevitable burden on the banking industry. Hence the success of abank depends upon methods of managing NPAs and keeping them within tolerance level, oflate, several institutional mechanisms have been developed in India to deal with NPAs and

7 Kashinath B.G., (1998) “Reduction of NPAs – legal bottlenecks and amendments suggested”,Conference paper, BECON 98, pp.137-140

8 Dalbir Singh, (2003), Seminar on “Risk Management in Indian banks’ , Business Line, December4, 2003, pp. 10

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there has also been tightening of legal provisions. Perhaps more importantly, effectivemanagement of NPAs requires an appropriate internal checks and balances system in a bank9.

In this background, this chapter is designed to give an outline of trends in NPAs inIndian banking industry vis-à-vis other countries and highlight the importance of NPAsmanagement. NPA is an advance where payment of interest or repayment of installment ofprincipal (in case of Term loans) or both remains unpaid for a period of 90 days10 (new normswith effect from 31st March, 2004) or more.

2.2 Trends in NPA levels:The study has been carried out using the RBI reports on banks (Annual Financial

Reports), information / data obtained from the banks and discussion with bank officials. Forassessing comparative position on CARR, NPAs and their recoveries in all scheduled banksviz., Public sector Banks, Private sector banks were perused to identify the level of NPAs.

The Table 2.1 lists the level of non-performing assets as percentage of advances ofpubic sector banks and private sector banks. An analysis of NPAs of different banks groupsindicates, the public sector banks hold larger share of NPAs during the year 1993-94 andgradually decreased to 9.36 percent in the year 2003. On the contrary, the private sectorbanks show fluctuating trend with starting at 6.23 percent in the year 1994-95 rising upto10.44 percent in year 1998 and decreased to 8.08 percent in the year 2002-03.

Table 2.1 Gross and Net Non-Performing Assets (NPAs) as percentage of Advances of PublicSector Banks and Private Sector Banks : 1994 – 2003

Year / Banks Public Sector Banks Private Sector Banks

Gross NPAs Net NPAs Gross NPAs Net NPAs

1993-94 24.80 14.5 6.23 3.36

1994-95 19.50 10.7 6.47 4.10

1995-96 18.00 8.9 7.45 4.34

1996-97 17.84 9.18 8.49 5.37

1997-98 16.02 8.15 8.67 5.26

1998-99 15.89 8.13 10.44 6.92

1999-00 13.98 7.42 8.17 5.14

2000-01 12.37 6.74 8.37 5.44

2001-02 11.09 5.82 9.64 5.73

2002-03 9.36 4.54 8.08 4.95

9 Pricewaterhouse Coopers, (2004), “Management of Non Performing Assets by Indian Banks”,IBA Bulletin, Special Issue, January, 2004, pp.61.

10 Tamal Bandyopadhya, (2002), “Debt Wish for ARCs?”, Business Standard, July 4, 2002.

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Source : Report on Trend and Progress of Banking in India from 1994-2003. Reserve Bank ofIndia.

Graph 2.1 : Gross NPAs as percentage of advances ofPublic and Private Sector Banks : 1994-2003

0.00

5.00

10.00

15.00

20.00

25.00

30.00

1994 1995 1996 1997 1998 1999 2000 2001 2002 2003

Year

(in %

)

Public Sector Banks Private Sector Banks

2.3 International comparison of NPA levles:

Comparison of the problem loan levels in the Indian banking system vis-à-vis thosein other countries, particularly those in developed economies, is often made, more so in thecontext of the opening up of our financial sector. The data in respect of NPAs level ofbanking system available for countries like USA, Japan, Hong Kong, Korea, Taiwan &Malaysia reveal that it ranged from 1 percent to 8.1 percent during 1993-94, 0.9 percent to 5.5percent during 1994-95, 0.6 to 3.0 percent during 2000 as against 23.6 percent, 19.5 percentand 14 percent respectively for Indian banks during this year11.

The NPAs level in Japan, for example is at 3.3 percent of total loans, it is 3.1 percentin Hong Kong, 7.6 percent in Thailand, 11.2 percent in Indonesia, and 8.2 percent in Malaysiaduring 94-95, whereas the corresponding figure for India is very high at 19.5 percent12.

According to Ernst & Young13, the actual level of NPAs of banks in India is around$40 billion, much higher than the government own estimates of $16.7 billion 14 . Thisdifference is largely due to the discrepancy in the accounting of NPAs followed by India andrest of the world. According to Ernst & Young, the accounting norms in India are lessstringent than those of the developed economies. Further more, Indian banks also have thetendency to extend past due loans. Considering India’ s GDP of around $ 470 billion, NPAswere around 8 percent of the GDP which was better than many Asian economic power houses.In China, NPAs were around 45 percent of GDP, while equilent figure for Japan was around

11 www.SomeAspectandIssuesRelatingToNPAsInCommercialBanks.htm, (2001), pp.212 Katuri Nageswar Rao, (2000), “NPAs Ground realities”, Chartered Financial Analysts, April

2000, pp. 46.13 Banking Bureau, (2003), “India and Non-Performing Assets”, IBA Bulletin, January 2003,pp.3614 Banking Bureau, (2003), Op. cit. pp.36

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28 percent and the level of NPAs for Malaysia was around 42 percent. On an aggregate level.Asia’ s NPAs have increased from $ 1.5 trillion in 2000 to $ 2 trillion in 2002- an increase of33 percent. This accounts for 29 percent of the Asian’ s countries total GDP. As per the E &Y’ s Asian NPL report for 2002, the global slowdown, government heisting and inconsistencyin dealing with the NPAs problem and lender complacency have caused the region’ s NPAsproblem to increase. However looking from a positive angle, India’ s ordinance, onSecuritization and Reconstruction of Financial Assets and Enforcements of Security Interestis a step in the right direction. This ordinance will help banks to concentrate on goodbusiness by eliminating the business of bad loans15.

2.4 Reasons for NPAs in India:

An internal study conducted by RBI16 shows that in the order of prominence, thefollowing factors contribute to NPAs.Internal Factors:* diversion of funds for

- expansion / diversification / modernization- taking up new projects- helping promoting associate concerns

* time / cost overrun during the project implementation stage* business (product, marketing etc) failure* inefficiency in management* slackness in Credit Management and monitoring* inappropriate technology / technical problems* lack of co-ordination among lenders.External Factors:* recession* input / power shortage* price escalation* exchange rate fluctuation* accident and natural calamities etc.* changes in government policies in excise / import duties, pollution control orders etc.

2.5 Conclusion:Asset quality is one of the important parameters based on which the performance of a

bank is assessed by the regulation and the public. Some of the areas where the Indianbanks identified to for better NPA management like credit risk management, specialinvestigative audit, negotiated settlement, internal checks & systems for early indication ofNPAs etc.,

3. MANAGEMENT OF CREDIT RISK - A PROACTIVE APPROACH

3.1 Introduction:Risk is the potentiality that both the expected and unexpected events may have an

adverse impact on the bank’ s capital or earnings. The expected loss is to be borne by theborrower and hence is taken care by adequately pricing the products through risk premium

15 Banking Bureau, (2003), Op. cit. pp.3616 Pricewaterhouse Coopers, (2004), Op.cit. pp. 67-68

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and reserves created out of the earnings. It is the amount expected to be lost due to changesin credit quality resulting in default. Whereas, the unexpected loss on account of individualexposure and the whole portfolio is entirely is to be borne by the bank itself and hence is tobe taken care by the capital.

Banks are confronted with various kinds of financial and non-financial risks viz.,credit, market, interest rate, foreign exchange, liquidity, equity price, legal, regulatory,reputation, operational etc. These risks are highly interdependent and events that affect onearea of risk can have ramifications for a range of other risk categories. Thus, top managementof banks should attach considerable importance to improve the ability to identify measure,monitor and control the overall level of risks undertaken.

3.2 Credit Risk:The major risk banks face is credit risk. It follows that the major risk banks must

measure, manage and accept is credit or default risk. It is the uncertainty associated withborrower’ s loan repayment. For most people in commercial banking, lending represents theheart of the Industry. Loans dominate asset holding at most banks and generate the largestshare of operating income. Loans are the dominant asset in most banks’ portfolios,comprising from 50 to 70 percent of total assets17.

Credit Analysis assigns some probability to the likelihood of default based onquantitative and qualitative factors. Some risks can be measured with historical and projectedfinancial data. Other risks, such as those associated with the borrower’ s character &willingness to repay a loan, are not directly measurable. The bank ultimately compares theserisks with the potential benefits when deciding whether or not to approve a loan.

3.3 Components of credit risk:The credit risk in a bank’ s loan portfolio consists of three components18;

(1) Transaction Risk(2) Intrinsic Risk(3) Concentration Risk

(1) Transaction Risk: Transaction risk focuses on the volatility in credit quality andearnings resulting from how the bank underwrites individual loan transactions.Transaction risk has three dimensions: selection, underwriting and operations.

(2) Intrinsic Risk: It focuses on the risk inherent in certain lines of business and loans tocertain industries. Commercial real estate construction loans are inherently more riskythan consumer loans. Intrinsic risk addresses the susceptibility to historic, predictive, andlending risk factors that characterize an industry or line of business. Historic elementsaddress prior performance and stability of the industry or line of business. Predictiveelements focus on characteristics that are subject to change and could positively ornegatively affect future performance. Lending elements focus on how the collateral andterms offered in the industry or line of business affect the intrinsic risk.

(3) Concentration Risk: Concentration risk is the aggregation of transaction and intrinsicrisk within the portfolio and may result from loans to one borrower or one industry,geographic area, or lines of business. Bank must define acceptable portfolioconcentrations for each of these aggregations. Portfolio diversify achieves an important

17 Timothy W. Koch, (1998), “Overview of credit policy and loan characterstics”, BankManagement, 3rd Edition, The Dryden Press, Harcourt Brace College Publishers, pp. 629-630.

18 John E. Mckinley & John R. Barrickman, (1994), “Strategic Credit Risk Management-Introduction”, Robert Morris Associates, , pp. 4-5.

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objective. It allows a bank to avoid disaster. Concentrations within a portfolio willdetermine the magnitude of problems a bank will experience under adverse conditions.

3.4 Strategic credit risk management:The post liberalization years have seen significant pressure on banks in India, some

of them repeatedly showing signs of distress. One of the primary reasons for this has beenthe lack of effective and strategic credit risk management system. Risk selection, as part of acomprehensive risk strategy that grows and supports from corporate priorities, is thefoundation for future risk management. This is the underlying premise of an integrated pro-active approach to risk management and entails a four step process19 :

Step 1. Establishing corporate prioritiesStep 2. Choosing the credit culture.Step 3. Determining credit risk strategyStep 4. Implementing risk controls

These steps (strategies) focus on reducing the volatility in portfolio credit quality andbank earning’ s performance. Strategic CRM will provide all bank personnel a clearunderstanding of the bank’ s credit culture and of the risk acceptable in the loan portfolio.Senior management then manages the process and the portfolio to align them with corporatepriorities.

3.5 Conclusion:Credit Risk Management in today’ s deregulated market is a big challenge. Increased

market volatility has brought with it the need for smart analysis and specialized applicationsin managing credit risk. A well defined policy framework is needed to help the operating staffidentify the risk-event, assign a probability to each, quantify the likely loss, assess theacceptability of the exposure, price the risk and monitor them right to the point where theyare paid off.

The management of banks should strive to embrace the notion of ‘ uncertainty andrisk’ in their balance sheet and instill the need for approaching credit administration from a‘risk-perspective’ across the system by placing well drafted strategies in the hands of theoperating staff with due material support for its successful implementation.

The principal difficulties with CRM models are obtaining sufficient hard data forestimating the model parameters such as ratings, default probabilities and loss given defaultand identifying the risk factors that influence the parameter, as well as the correlationbetween risk factors. Because of these difficulties one should be aware that credit systemsare only as good as the quality of the data behind them.

4. CONCENTRATION RISK PROFILE OF INDIAN COMMERCIAL BANKS4.1 Introduction:

“Risk selection is more important than risk managementin determining a bank’s credit performance”20.

Credit risk strategy results from a bank’ s tolerance for risk as evidenced by how itselects, manages, and diversifies risk. Banks are moving away from a buy-and-hold strategywith respect to their loans. They are now syndicating risk, distributing the risk to enhance thevalue of their portfolio. When originating a loan, banks need evaluate how much incrementalrisk they are adding, how much they need to be compensated for taking that risk. Many banks

19 John E. Mckinley & John R. Barrickman, (1994), Op. cit. pp. 3-8.20 John E. Mckinley & John R. Barrickman, (1994)“Strategic Credit Risk Management”, Robert

Morris Associates, pp. 36

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look at each credit inside than across the enterprise to understand the incremental risk that thenew loan is adding the loans.

Portfolio theory applies equally to collections of credit risks as to equity and otherinvestments. The purpose of having a portfolio of assets, instead of a single asset, is toreduce risk through diversification without sacrificing the rate of return 21 . An efficientportfolio achieves a specified rate of return with the minimum possible risk for specified levelof risk of for the maximum possible rate of return. The principle, which underlines portfoliomanagement, is ‘ diversification of risk22’ .

The objective of this chapter is to present a general framework for quantification ofconcentration risk followed by concentration risk profiling of public sector banks vis-à-visprivate sector banks; and to explore the relationship between concentration risk profile andNPAs level.

4.2 Concentration risk:

A new methodology adopted to evaluate the volatility in portfolio performancepredicated on the risk profile of the institution. The banking industry has relied heavily onprior experience as a predictor of future credit performance. Concentration risk 23 is theaggregation of transaction and intrinsic risk within the portfolio and may result from loans toone borrower or one industry, geographic area, or line of business. Senior management mustdefine acceptable portfolio concentrations for each of these aggregations.

The most conservative banks manage borrower exposure through restrictive houselimits and maximum exposure to industries and lines of business. Many banks also havewisely sought to mitigate risk through geographic diversification. Aggressive banks havetraditionally accepted hogs ‘ shares’ of individual borrower, lines of business, and industryexposures. Managing concentration limits will become a high priority for these lenders in thefuture because of the lingering pain from lessons leaned in commercial real estate, energy etc.

4.3 Concentration risk strategy:

The bank does have an opportunity to reduce their concentration in one line ofbusiness or industry. Outstanding would have to be replaced with more lending focused onlower risk lines of business and borrowers. Banks must constantly monitor the risk profile todetermine it future lending practices are consistent with the desired risk profile24.

Selecting a Risk Strategy:

Using the risk profile as a frame of reference, management should select a riskstrategy that will be consistent with long-term objectives for portfolio quality andperformance. The three variable risk strategies in order of riskiness are: Conservative,Managed and Aggressive. The selection of the appropriate strategy depends on a bank’ spriorities and risk appetite. Most often, the choice is not made as part of a formal process butevolves as the bank seeks its desired risk posture through its lending practices. Consequently,

21 Ravimohan R, (2001), “A New Perspective – CRM in Banks”, The Chartered Accountant,March 2001.

22 Joseph F. Sinkey, Jr., (1998), “Commercial Bank Financial Management – In the FinancialServices Industry”, Fifth Edition, Prentice-Hall International Inc. New Jersey. pp. 403.

23 John E. Mckinley & John R. Barrickman, (1994) Op.cit. pp.4124 John E. Mckinley & John R. Barrickman, (1994), Op.cit. pp50

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few banks have a clear picture of the risk profile that will emerge. A selection of risk strategywith specific implementation plans provides a much better idea of the future risk profile.

The following guidance should help in understanding, which strategy best servesmanagements intent;

(i) Conservative : Accepts relatively low levels of transaction, intrinsic and concentrationrisk. The strategy normally supports a values-driven culture.

(ii) Managed: Accepts relatively low levels of risk in two categories but high levels in onecategory. For example: a bank that takes conservative levels of concentration and transactionrisk but is more aggressive with intrinsic risk. The strategy normally promotes the immediateperformance culture.

(iii) Aggressive: Accepts relatively low levels of risk in one category, more aggressive risk intwo categories. An example would be a bank that closely manages transaction risk butaccepts higher levels of intrinsic and concentration risk. This strategy is normally employedin a production driven culture.

Obviously, credit volatility rises as the levels and categories of risk are increased.The aggressive strategy requires more careful management because it operates closer to thedanger zone. If risk in all three categories reaches high levels, the bank’ s credit volatilitybecomes so great in a downturn that capital adequacy and survival could become real issues.

4.4 Impact of concentration risk on NPAs level:

The concentration risk is an important component of the credit risk and is promptedby the concentration of the credit portfolio in one or two occupations or industries. It isdesirable to achieve a diversified credit portfolio in order to minimize the occupation-wiseconcentration risk as well as industry-wise concentration risk. It has been the experience ofthe commercial banks that higher NPAs level is generally associated with high degree ofconcentration risk-both occupation-wise and industry-wise. In order to analyse the observedrelationship between NPAs level and concentration risk, the relevant data is presented in thissection.

The highest level of NPAs, i.e., 24.8 percent in the year 1994 corresponds to themaximum index value in the same year. Similarly, the minimum level of NPAs, i.e., 9.36percent in the year 2003 corresponds to the lowest index value in the same year. Overall, thedecrease in occupation-wise concentration risk is matched by the corresponding decrease inNPAs level.

An attempt was made to quantify the relationship between concentration-index andNPAs level by way of coefficient of correlation and the results found to be satisfactory inreinforcing our earlier observations. Table 4.1 lists the results.

Table 4.1 : Coefficient of correlation between Concentration-Index and NPAs for theperiod 1994 – 2003

Public Sector Banks Private SectorBanks

(a) Occupation-wise concentration risk

Coefficient of correlation = r 0.80 0.67

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Coefficient of determination = r2 0.64 0.45

(b) Industry-wise concentration risk

Coefficient of correlation = r

Coefficient of determination = r2

0.89

0.78

-0.52

0.27

As observed earlier, there exists a strong positive relationship between occupation-wise concentration-index and NPAs level in case of both the public sector banks and privatesector banks with the coefficient of correlation value being 0.80 and 0.67 respectively. Thisis confirmed by the higher values of coefficient of determination of 0.64 and 0.45 for publicsector banks and private sector banks respectively. Similarly, there exists a strong positiverelationship between industry-wise concentration-index and NPAs level in case of publicsector banks as confirmed by a very high value of r2 = 0.78. But this is not clearlypronounced in the case of private sector banks as indicated by lower value of r2 = 0.27.

4.5 Conclusion:

Concentration risk is a very significant component of overall credit risk profile of abanking institution. A prudent credit risk management is based on the principle of diversifiedportfolio to avoid concentrations in any one or couple of occupations or industry. Trends inconcentration risk profile of public sector banks during the post-liberalization period clearlyindicate a paradigm shift in the portfolio approach to credit risk management. Theoccupation-wise and industry-wise concentrations reduced significantly during the studyperiod. On the contrary, the trends in concentration risk profile of private sector bankssignify an opposite direction. The occupation-wise concentration risk increased substantiallyfrom 37 percent in 1999 to 59 percent in 2003.

Both the approaches suggested for quantification of concentration risk yieldedsatisfactory results. Under the profile-score method, with a score of less than 10 for publicsector banks, and more than 10 for private sector banks, it is concluded that public sectorbank’ s risk profile is low while that of private sector bank’ s risk is moderate. Similarly,under the concentration-index method it was found that there exists strong relationshipbetween occupation-wise concentration risk profile and NPAs level with higher values ofcoefficient of determination of 0.64 and 0.45 for public sector banks and private sector banksrespectively. Similarly, strong positive relationship between industry-wise concentration riskand NPAs level in case of public sector banks, as confirmed by high value of r2=0.78. Butsame is not pronounced in case of private sector banks.

Based on these results it can be concluded that

1. “The declining trends in Non-Performing Assets (NPAs) in public sector banksduring the post-liberalization period is an outcome mainly caused by theimproved credit portfolio diversification”.

2. “The concentration risk profile of credit portfolio of private sector banks ishigher than that of public sector banks impacting adversely the NPAs level ofprivate sector banks vis-à-vis public sector banks”.

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5. CREDIT RISK MANAGEMENT PRACTICES IN COMMERCIAL BANKS - ANEVALUATION

5.1 Introduction:

The objective of this chapter is to evaluate the credit risk management practices inpublic sector banks vis-à-vis private sector banks based on primary data. Primary datahave been collected from the credit department executives serving in public and private sectorbanks at head office level and regional office level in Karnataka with the help of predesignedquestionnaires. In this case, direct interview method has been followed for data accuracy andto get first-hand information from respondents about credit risk management practices.

5.2 Sample data:

The study has analyzed the credit portfolio risk management policies and practices of21 Banks of which 12 are public sector banks and 9 private sector banks. Though it wasoriginally aimed to cover 20 percent of over 800 credit department executives in the selectedbanks, it was possible to get the response of only about 10 percent of the number. Creditdepartment executives were not easily accessible. They were found either closeted in ameeting or busy otherwise. Therefore, the generalizations formulated here are based on theopinions of this small number.

5.3 Analysis of CRM practices:

This section is devoted for analysis of CRM practices in public sector banks vis-à-visprivate sector banks. For this purpose, various issues covered include scope for NPAsreduction, credit risk measurement, credit evaluation processes, credit rating system andtraining in credit risk assessment.

CRM perform index – Public and Private sector banks:

The questionnaire was designed with a focus on standards of CRM practices envisagedunder the New Basel Capital Accord. The important parameters of performance standardsconsidered for analysis included the following table.

Table 5.1 CRM Performance IndexPublic and Private sector banks

Performance Index ( % )Sl.No.

Performance Evaluation Public SectorBanks

Private SectorBanks

1 Project appraisal procedures 58 492 Availability of comprehensive data 46 393 Risk based loan pricing 48 404 Deployment of information technology 46 575 Efficacy of Internal credit rating system 54 506 Sharing experience with other lenders over

problem loans40 36

7 Practice of fine-tuning loan policies 55 468 Internal audit of CRM procedures 42 499 Bank credit standards 51 4810 Credit decision: merit v/s extraneous

considerations60 46

11 Frequency of credit portfolio reviews 61 58

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12 Renewal of borrowers limits 34 4213 Periodical review of customer credit ratings 33 57

Total 632 617Performance Index 49 47

Overall CRM performance is at below the satisfactory level for both the public andprivate sector banks. Furthermore, with performance index score of 49 percent and 47percent for public sector banks and private sector banks respectively, there is no significantdifference between public sector banks and private sector banks as regards CRM performance.

5.4 Conclusion:

The analysis of the primary data revealed some interesting aspects about the creditrisk management practices of commercial banks in India. The important among them arelisted below:

(1) More popular credit evaluation techniques like Altman’ s Z score model, J.P.Morgan credit matrix, Zeta analysis do not find a place in the credit evaluation toolkit of the commercial banks in India.

(2) Employees are not given enough training to enhance their conceptual understandingof credit risk and improving their skills in handling it.

(3) The leverage provided by information technology for efficient credit riskadministration is not satisfactorily harnessed by commercial banks in India,particularly in public sector banks.

(4) The availability of comprehensive data for credit evaluation is far from satisfactoryin commercial banks in India.

(5) Overall CRM performance of commercial banks in India as against the standard setout under New Basel Capital Accord is not satisfactory.

(6) With CRM performance Index of 49 percent in public sector banks and 47 percent inprivate sector banks respectively, the performance of public sector banks is at parwith the performance of private sector banks.

Based on these findings it can be concluded that;

1. “Credit risk management practices of commercial banks in India do not meetthe standards set out under the New Basel Capital Accord”.

2. “There exists no marked difference between public sector banks and privatesector banks as regards their credit risk management performance”.

6. RISK BASED SUPERVISION PROBLEMS AND PROSPECTS

Changes over the past ten years in the banking system have been dramatic.Advances in technology, closer interrelations among economies, liberalization andderegulation etc. have made the world of banking a far more complex place. The system ofannual inspection of banks by RBI may soon be a thing of the past. The central bank isexpected to follow a system of random and more frequent inspections based on the riskprofile of individual banks. RBI insisted that all commercial banks move towards the system

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of Risk- Based Supervision (RBS) by January 1st 200325, its inspections would be morefocused on areas of potential risk such as credit risk, market risk and operational risk. Basedon the guidelines to be drafted by the RBI all banks have to submit information to the centralbank periodically. With this information, bankers believe that the RBI will always be in theknow as how particular bank is operating and can monitor its performance almost on a day-to-day basis.

RBI inspections, both on-site and off-site can be conducted as and when the centralbank deems necessary and could be as often as possible based on RBI’ s risk perception of abank. “After the recent scams, the RBI wants to tighten norms so that the central bank isinformed well in advance about any irregularity 26 ”. The Basel Committee on BankingSupervision had advocated Risk- Based Supervision of banks and this has been put to practicein various countries. Now RBI has come with a discussion paper on “Move towards RiskBased Supervision of Banks” in Aug 2001 and RBI roll out the process and implementedfrom the financial year April 200427. This chapter describes the main features of proposedRBS and analyses the responses of executives to the modalities of implementing it.

In moving towards a Risk Based Supervision of banks the goal of Reserve Bank ofIndia and the concern of banks converge in a common point: we want strong, healthyinstitutions that offer loans to worthy borrowers who in turn repay the loan interest, so thatthe bank can build its capital base and provide a reasonable return to its shareholders. If thegoal can be achieved, the public, including both borrowers and depositors, will be betterserved through a network of safe and sound financial institutions that properly identify,measure, monitor and control their risks. The risk based supervision project would lead toprioritization of selection and determining frequency and length of supervisory cycle, targetedappraisals, and allocation of supervisory resources in accordance with the risk perception ofthe supervised institutions. The RBS will also facilitate the implementation of thesupervisory review pillar of the New Basel Capital Accord, which requires that nationalsupervisors set capital ratios for banks based on their risk profile.

Private sector banks executives are not in-favour for implementation of RBS asvindicated by the sample data according to which 94 percent (an average) of them are against thevarious proposals of RBS. This negative response reflect the reservations hosted by the privatesector banks in general about the various proposals coming from a Central Bank leading to moreinterfere in their internal affairs. On the other hand, the public sector banks show a differentscenario as they have almost balanced opinion in favour of RBS.

7. NEW BASEL CAPITAL ACCORD - IMPLICATIONS FOR CRM PRACTICESOF COMMERCIAL BANKS IN INDIA

7.1 Introduction:

One of the most crucial methods of risk control in banks and financial institutionsaround the world is regulatory capital requirement, which is vital in reducing the risk of bankinsolvency and the potential cost of a bank’ s failure for its customers.

25 Rajalakshmi Menon, (2002), “RBI may shift to risk-based supervision of banks”, Business Line,July 3, 2002, pp.10.

26 Rajalakshmi Menon, (2002), Op.cit. pp.1027 Pathrose P.P. (2002), Op.cit pp.21

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The Basel Committee of the Bank for International Settlements (The Committee) thatsets the capital adequacy requirements for banks and other financial institutions drew upBasel Accord-I in 1988 28 . This Accord recommends a method of relating the capitalrequirement of banks to their assets, using a simple system of risk weights and minimumcapital ratio of 8 percent. This Accord provides a standard approach to measuring credit,market risk of the banks to arrive at the minimum capital requirement.

Basel-I have served the banking world for over 10 years. The business of banking,risk management practices, supervisory approaches and financial markets have seen a seachange over the years. In 1996, the initial Accord was extended to include market risk thatbanks incur in their trading account. The BCBS (Basel Committee on Banking Supervision)brought out a consultative paper on New Capital Adequacy framework in June 1999, followedby second and third consultative package in January 2001 and April 200329. Implementationis expected to take effect in member countries by 2006. Banks in India will not meet a 2006deadline for implementing the revised Basel Capital Accord and will need at least twoadditional years to comply with the new international banking rules30. The Basel II Accordwill put further pressure on banks requiring them to also hold capital to offset operational riskthat the Committee expects on an average to constitute approximately 20 percent of theoverall capital requirement.

Recognising the importance of Basel-II and the need for a reasonable timeframe toswitch over, the RBI has already initiated discussions in several areas well in time. Theadoption and implementation of the new capital accord by all banks in India may furtherresult in the improvement in our country rating which, in turn, will increase our competencyto adopt the new accord.

7.2 The New Basel Capital Accord(Basel -II):

The New Accord is being proposed to introduce greater risk sensitivity. The NewAccord provides a spectrum of approaches from simple to advance methodologies for theadvancement of both credit and operational risks in determining capital levels.

The new accord is built around the THREE Pillars as shown in Figure 7.131:(1) Pillar-I : Minimum Capital Requirement(2) Pillar-II : Supervisory Review(3) Pillar-III : Market Discipline

7.3 New Basel Accord – Issues in the Indian context:The Accord, aims at boosting the safety of the world banking system. Regulators in

both India and China are anxious to nudge their banks on to the proposed risk-based capitalregime, to ensure that they are competitive and managed to the highest standards32. True,

28 Geetha Bellu, (2003), “Discloures in the forefront”, Decan Herald, Monday, October 6, 2003,pp.1 .

29 Geetha Bellu, (2003), Op.cit. pp.130 Gautam Chakravorthy, (2003), “Indian banks not ready for capital rule deadline”, International

Herald Tribune, Wednesday, Septermber 24, 2003.31 BIS, (2003), “An overview of the New Basel Capital Accord”, IBA Bulletin, September 2003,

pp.33-34

32 Melvyn Westlake, (2003), “India, China still undecided on adopting new accord”, Gulf News,September, 2003, pp. 1.

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banks in these two Asian giants may not all be ready to adopt the full rigorous of the accorddubbed Basel II from the outset, at the end of 2006. The RBI agrees with committee’ s viewthat the focus of the New Accord may be primarily on Internationally Active Banks, that is,those with 20% of the business from foreign operations. SBI’ s Chairman Mr. A.K. Purwarsays that SBI’ s International operations (India’ s largest bank) contribute about 6% of itsbusiness33. So the new accord feared by many central banks, including the RBI. In this regard,RBI is of the view that all banks with cross border business exceeding 20% of the totalbusiness may be defined as ‘ Internationally Active’ banks and ‘ Significant’ banks may bedefined as those banks with complex structures and whose market share in the total assets ofthe domestic banking system exceed 1 percent34.

The Basel II accord is a challenge to Indian banks. Indian Banks are conceptually andacademically ready to adopt the new norms. It would involve shift in direct supervisory focusaway to the implementation issue and also there are lot of difficulties and issues in itsimplementation in the Indian Context35. These difficulties like availability of historical data,higher risk wrights for sovereign, cost factor, technological up-gradation, diversified products,legal and regulatory guidelines, higher risk weight to small and medium enterprises, creditrating etc.

7.4 Conclusion:

The response to Basel Accord II reforms world over is not uniform and spontaneous.Basel-II is known for complicated risk management models and complex data requirements.Big international banks, as those in the US, prefer this new version, as they perceive that theirsuperior technology and systems would make them Basel compliant and provide an edge inthe competitive environment, in the form of lower regulatory capital.

Indian banks do not perceive any immediate value in the new norms as they areglobally insignificant players with simple and straight forward balance-sheet structures. Thisis clearly vindicated by the sample study according to which 57 per cent of the executives ofpublic sector banks are sceptical about Basel Accord II norms, particularly in respect ofinvestment cost and the complexity of proposed internal rating system. As against this, theprivate sector banks with supposedly more investment in technology related infrastructure arein favour of the proposals under New Basel Capital Accord as vindicated by the sample studyaccording to which 67 percent of executives of private sector banks are in-favour for NewBasel Capital Accord.

However, putting Basel II in place is going to be far more challenging than Basel I.The adoption of Basel II will boost good Risk Management practices and good corporategovernance in banks. However, the cost of putting in place robust system today is viewed inan increasingly number of countries as a price worth paying to prevent such crisis. Assumingthat the banks can get over the technological and operational hurdles, switching over to BaselII norms can no doubt turn the Indian banks, mainly the public sector banks, more efficientand competitive globally. This, in turn, will help strengthen the financial sector to undertakefurther reforms including capital account convertibility more confidently.

33 Information Bureau, (2003), “SBI to be Basel-II compliant: Purwar”, The Hindu Business Line,September 2003.

34 Information Bureau, (2003), “Testing waters: RBI to meet bank CEOs on Basel II soon”, TheEconomic Times, September 19, 2003.

35 Parasmal Jain, (2004), Op.cit. pp.8-10

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8. FINDINGS, SUGGESTIONS & CONCLUSION:

8.1 SUMMARY OF FINDINGS:

The trends in NPAs level, CRM practices of commercial banks and the response toreforms under Basel Accord II and Risk Based Supervision were examined and comparedbetween public sector banks and private sector banks in this study. The analysis of secondaryand primary data resulted in satisfactory results, a summary of which is presented in thefollowing paragraphs.

(1) While NPAs level of public sector banks did register a clear decreasing trend duringthe post-liberalization period, NPAs level of private sector banks remained constantduring this period.

(2) The concentration risk profile of private sector banks is found to be higher than that ofpublic sector banks.

(3) In case of public sector banks, there exists a strong relationship between NPAs level andcredit portfolio diversification as vindicated by higher co-efficient of correlation values.The decrease in NPAs level is caused by reduction in concentration risk. Thisrelationship is however, not clearly pronounced in case of private sector banks.

(4) Credit risk management performance of commercial banks in India is not satisfactory. (5) There exists no marked difference between public sector banks and private sector banks

as regards their credit risk management performance: (6) Though the private sector banks executives are not in-favour of implementation of Risk

Based Supervision, yet they are receptive to the proposals under New Basel CapitalAccord. This is vindicated by sample data according to which only 6 percent ofrespondents have expressed their concurrence with RBS and the remaining 94 percent ofthem opposing it. In contrast, 67 percent of the respondents expressed their concurrenceto the proposals under NBCA and remaining 33 percent of respondents opposing it.

(7) The executives of public sector banks have almost balanced their opinions in-favour ofRBS and New Accord. While 54 percent of them expressed their concurrence to theproposals under RBS, 43 percent of them agree with the proposed reforms under NBCA.

8.2 SUGGESTIONS:(1) Achieving a better portfolio equilibrium:

Commercial banks need to diversify further to achieve a better credit portfolioequilibrium. The share of transport operations and finance occupations in case of publicsector banks was very minimal i.e., 1.21 percent and 6.53 percent respectively as on March 31,2003. Similarly, in case of private sector banks, the share of occupations like transport andfinance was very minimal at 1.52 percent and 6.46 percent respectively as on March 31, 2003.

(a) In India now the services sector (including transportation, financial services etc.,) isplaying an important role and in fact it accounts for about one half of India’ s GDPand this sector is also generating more income and more employment opportunities.Banks will, therefore, have to sharpen their credit assessment skills by providingbetter training to enhance their conceptual understanding of credit risk and improvingtheir skills in handling it which lay more emphasis in providing finance to the widerange of activities in the services sector.

(b) Retail loans are also a relatively small fraction of the Indian banking system’ s totalloans and advances. In India retail loans constitute about 5 percent of aggregateGDP compared to an average of around 30 percent for other Asian economies. Theimplication of all this data is that the retail market is relatively ‘ under-penetrated’and has significant potential for growth both for public and private sector banks.

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(c) Retail products help banks in diversifying their risk by spreading credit to widelydispersed set of individual customers. Retail loans offers banks the opportunity tocross sell various other value added services and retail products like insurance andmutual fund to the depositors.

(2) Establishing Risk Management Information System (RMIS):

The effectiveness of risk management depends on efficient information system,computerization and networking of the branch activities. An objective andreliable database has to be built up for which bank has to analyse its own pastperformance data relating to loan defaults, operational losses etc.

(a) Added to IT expenditure is the cost and effort of training and redeployment ofmanpower. Besides training in the ‘hard’ aspects of understanding risk and usingsoftware, it is also need for building in a risk orientation in individual officers at theoperating level, to create awareness about credit assessment skills and risk mitigationprocesses is needed.

(b) Public sector banks need to set up modern IT infrastructure in place within one totwo years in line with foreign and new generation private banks. There is a need ofcentralized database so that core banking solution can be implemented.

(3) Redesigning the Internal Rating System:

In order to ensure a systematic and consistent credit assessment process within thebank, a robust and auditable rating system must be in place. A list of credit drivers or factorsthat influence the creditworthiness of a barrower / company with a weight assigned onmeasurable element data like financial ratios and subjective elements like managementquality, industry prospects etc., The Basel Committee set up by BIS has been urging banks toset up internal systems to measure and manage credit risk. It is important that Indian banksuse credit ratings available from agencies in conjunction with their internal models tomeasure credit risk.

(4) Early Warning Signals:

It is essential to identify signs of distress or early recognition of problem loans. The need forearly identification of problem loans has been established as one of theprinciples of the Basel Committee for the management of credit risk. Problemloans most commonly arise from a cash crisis facing the borrower. As thecrisis develops, internal and external signs emerge, often subtly.

A typical Early Warning Signals process is listed below:a. Continuous Monitoring by Loan Officersb. Scheduled Loan Reviewsc. External Examinationd. Loan Covenantse. Warning Signsf. Asset Classification and Downgrade Report

8.3 CONCLUSION:

Credit risk management in today’ s deregulated market is a challenge. The verycomplexion of credit risk is likely to undergo a structural change in view of migration of Tier-I borrowers and, more particularly, the entry of new segments like retail lending in the creditportfolio. These developments are likely to contribute to the increased potential of credit riskand would range in their effects from inconvenience to disaster. To avoid being blindsided,

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banks must develop a competitive Early Warning System (EWS) which combines strategicplanning, competitive intelligence and management action. EWS reveals how to changestrategy to meet new realities, avoid common practices like benchmarking and tell executiveswhat they need to know – not what they want to hear.

The reputation of a bank is very important for corporate clients. A corporation seeksto develop relationship with a reputable banking entity with a proven track record of highquality service and demonstrated history of safety and sound practices. Therefore, it isimperative to adopt the advanced Basel-II methodology for credit risk. The Basel Committeehas acknowledged that the current uniform capital standards are not sensitive and suggested aRisk Based Capital approach. Reserve Bank of India’ s Risk Based Supervision reforms are afore-runner to the Basel Capital Accord-II. For banks in India with the ‘ emerging markets’tag attached to them going down the Basel-II path could be an effective strategy to compete invery complex global banking environment. Indian banks need to prepare themselves to becompeted among the world’ s largest banks. As our large banks consolidate their balancesheets size and peruse aspirations of large international presence, it is only expected that theyadopt the international best practices in credit risk management.

“…….…………………A bank’s success lies in its ability to assume andaggregate risk within tolerable and manageable limits”.

BIBLIOGRAPHY:

Books:Bidani S.N., (2002), “Managing Non-Performing Assets in Banks”, Vision Books publishers,

Ref:#8-02-06-12, pp.71-74.Eddie Cade, (1997), “Managing Banking Risks”, First Edition, Woodhead Publishing Ltd., In

association with The Chartered Institute of Bankers, England, pp. 104 – 144.James T. Gleason, (2001), “ Risk – The New Management Imperative in Finance”, Jaico

Publishing house, pp. 13-19. & 113-121.Johan E.Mckinley & John. R. Barrickman, (1994), “Strategic Credit Risk Management”,

Robert Morris Association, Philadelphia, pp. 1-12, 20-27, 36-42, 62-68.Joseph F. Sinkey, Jr., (1998), “Commercial Bank Financial Management – In the Financial

Services Industry”, Fifth Edition, Prentice-Hall International Inc., New Jersey. pp. 22-35,/213-220 and 404-408.

Timolthy W.Koch, (1998), “ Bank Management”, Library of Congress Cataloging-in-Publication Data, pp. 431-440.

Timothy W. Koch, (1998), “Bank Management - Overview of credit policy and loancharacterstics”, Third Edition, The Dryden Press, Harcourt Brace College Publishers, pp.431-440 and 629-630.

Articles :Agarwal P. and Srikanth V (2002), “A question of Reliability”, Economic Times, July 24,

2002.Bank for International Settlement (BIS), January, 2000.Banking Bureau, (2002), “RBI Reports finds increase in NPAs of Commercial Banks”, The

Financial Express, November 16, 2000.Banvali O.P. (2001), “ Life line of Banking New RBI formula for NPA recovery”, IBA

Bulletin, January 2001, pp. 23-26.Basel Committee on Banking Supervision, (2003), “Third Quantitative Impact Survey – An

Overview”, IBA Bulletin, February 2003, pp. 6ICICI Bank Ltd., Report (2003), “Banking scene in India”, IBA Bulletin, January, 2003.

pp.36

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ICRA Limited “Global Benchmarking”, IBA Bulletin, January 2004, Vol XXVI. No.1, pp. 26.Murthy E.N., (2002), “Managing Credit Risk”, ICFAI Reader, Vol.2, February 2002, pp. 3Murthy G.R.K., (2001), “Credit-Risk-Management in a market driven economy; The Acid

Test for banks”, IBA Bulletin, March 2001. pp.105-123.Narasimham P.V., (1998), “Risk Management - Towards Sound & Strong Banking”,

presented at BECON’ 98 conference, pp. 54-61Narasimhan N., (2003), “Banking sledge hammers for NPA Files”, Professional Bankers,

March 2003, pp. 25-27.Pricewaterhouse Coopers, (2004), “Management of Non-Performing Assets by Indian Banks”,

IBA Bulletin, January 2004, Vol XXVI. No. 1., pp, 61-97Rajeev A.S. (2004), “Basel II – Issues and Constraints”, IBA Bulletin, June 2004, pp. 11Murthy E.N., (2002), “Managing Credit Risk”, ICFAI Reader, Vol.2, February 2002, pp. 3Murthy G.R.K., (2001), “Credit-Risk-Management in a market driven economy; The Acid

Test for banks”, IBA Bulletin, March 2001. pp.105-123.www.BaselAccord.htm, (2002), “Risk Management systems in Banks”, pp.1-15.www.PortfolioCreditRiskEvaluation-ANewPerspective.htm, (2001), “Portfolio Credit

Risk Evaluation – A new perspective”, The Hindu, May 27.www.rbi.org.in, (2001), “Move towards RBS of banks – discussion paper”, (2001), RBI,

DBS.CO/RBS/58/36.01.002/2001-02., 13th August 2001.pp. 1-10

First Author;

Prof. Rekha Arunkumar Ph.D., from University of Mysore (awaiting result by September ’ 05), PGDCA, M.Com.,B.B.M.,Faculty in Finance (10 years of experience),MBA Programme,Bapuji Institute of Engineering & Technology (affiliated to Visveswaraya Technical University)Davangere – 4. Karnataka

Second Author;

Dr. G. Kotreshwar Ph.D., M.Com., ICWAI.,Professor of Commerce (25 years of experience)University of Mysore, ManasagangotriMysore – 6.

Submitted to

Review CommitteeNinth Capital Market ConferenceIndian Institute of Capital Market (December 19-20, 2005)Mumbai.