Banking Technique: LECTURE 11. Credit Risk Management

BANKING TECHNIQUE
LECTURE 11. Credit risk

management
Objectives
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 Policiesfor Managing Credit Risk

 Regulatory Policies to Limit Exposures
 Management Policies to Reduce Credit
 Analyzing Credit Risk
 Asset Classification and Loan Loss Provisioning
 Assessing Credit Risk Management Capacity

11.1. Policies for Managing Credit Risk
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There are typically three kinds of policies related to credit risk

management:
 One set aims to limit or reduce credit risk

 These include policies on concentration and large exposures,
diversification, lending to connected parties, and overexposure.
 The second set aims to classify assets
 These mandate periodic evaluation of the collectability of the portfolio
of credit instruments.
 The third set aims to provision loss or make allowances at a
level adequate to absorb anticipated loss.
11.2. Regulatory Policies to Limit Exposures
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To reduce or limit credit risk, regulators pay close attention to

three issues:
 exposure to a single customer
 the maximum permitted exposure to a single client, connected group, or
sector of economic activity (for example, agriculture, steel, or textiles).
This is especially important for small, regionally oriented or specialized
banks.
 related party financing
 typically include a bank’s parent, major shareholders, subsidiaries,
affiliate companies, directors, and executive officers. Such parties are in
a position to exert control over or influence a bank’s policies and
decision making, especially concerning credit decisions.
 overexposure to a geographic area or economic sector
11.3. Management Policies to Reduce Credit
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 Lending Authority
 Lending authority is often determined by the size of a bank. In smaller banks, it is
typically centralized. To avoid delays in the lending process, larger banks tend to
decentralize according to geographical area, lending products, and types of customers.
 Type of Loans and Distribution by Category
 Decisions about types of credit instruments should be based on the expertise of lending
officers, the deposit structure of a bank, and anticipated credit demand.
 Loan Pricing
 Rates on various loan types must be sufficient to cover the costs of funds, loan
supervision, administration (including general overhead), and probable losses. Rates
should provide a reasonable margin of profit.
 Maturities
 A lending policy should establish the maximum maturity for each type of credit, and
loans should be granted with a realistic repayment schedule.
11.4. Analyzing Credit Risk
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Contents of a Loan Review File

11.5. Asset Classification and Loan Loss
Provisioning
7
Asset Classification Categories

 Standard, or pass. When debt service capacity is considered to be beyond
any doubt.
 Specially mentioned, or watch. Assets with potential weaknesses that may,
if not checked or corrected, weaken the asset as a whole or potentially
jeopardize a borrower’s repayment capacity in the future.
 Substandard. This classification indicates credit weaknesses that jeopardize
debt service capacity, in particular when the primary sources of repayment are
insufficient and the bank must look to secondary sources for repayment, such
as collateral, the sale of a fixed asset, refinancing, or fresh capital.
 Doubtful. Such assets have the same weaknesses as substandard assets, but
their collection in full is questionable on the basis of existing facts.
 Loss. Certain assets are considered uncollectible and of such little value that
the continued definition as bankable assets is not warranted.
Provisioning
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Nonperforming Loans
 Nonperforming assets are those not generating income.
 As a first step, loans are often considered to be nonperforming

when principal or interest on them is due and left un paid for 90
days or more.
Loan Loss Provisioning

 Asset classification provides a basis for determining an adequate
level of provisions for possible loan losses.
 It forms the basis for establishing a bank’s capacity to absorb
losses.
Provisioning
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Recommended Loan Loss Provisions

11.6. Assessing Credit Risk Management
Capacity
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Lending Processes
 A detailed credit analysis and approval process, including samples of
loan application forms, internal credit summary forms, internal credit
manuals, and loan files
 Criteria for approving loans, determining loan pricing policy and
lending limits at various levels of the bank’s management, and for
making arrangements for lending through the branch network
 Collateral policy for all types of loans, including the actual methods
and practices concerning revaluation of collateral and files related to
collateral
 Administration and monitoring procedures, including
responsibilities, compliance, and controls
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BANKING TECHNIQUE

LECTURE 11. Credit risk

 Policiesfor Managing Credit Risk

 Management Policies to Reduce Credit

 Analyzing Credit Risk

 Asset Classification and Loan Loss Provisioning

 Assessing Credit Risk Management Capacity

There are typically three kinds of policies related to credit risk

 One set aims to limit or reduce credit risk

To reduce or limit credit risk, regulators pay close attention to

Contents of a Loan Review File

Asset Classification Categories

 As a first step, loans are often considered to be nonperforming

Loan Loss Provisioning

Recommended Loan Loss Provisions

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