
Management Accounting profession covers
wide range of areas among which we are also credit risk analyst also where we know
the inherent risk and its management. But does the Indian baking system is
ready to accept us. This article is an initiative to raise the eyebrows of the
industry heads to save from massive collapse within the economy. It’s an initiative
to use cost management profession to improve the quality of banking system
through efficient use and implementation of credit risk management and risk management
for the banking industry. Banks are in the business of asset management and we
cost accountants are trained in the field where cost and risk management is an integral
part of the profession. But its unfortunate that Indian banking industry hardly
recognizes us. The Banking industry could not come up above the bank audit
level. Before I being with the initiative
of eye opening I would like to accentuate few key areas where cost accountants
can work to control this devil. Risk Analysis and Risk Management has got much
importance in the Indian Economy after the financial crisis in 2008.Cost accountant’s
profession comprises of extensive risk control since cost control is nothing but
controlling and measuring the risk of loss. Now coming to the banking industry The
management of credit risk hy the profession includes a) Measurement through credit rating/
scoring, b) Quantification through estimate of expected loan losses, c) Pricing
on a scientific basis and d) Controlling through effective Loan Review
Mechanism and Portfolio Management. I will discuss about these thing later on
at the end so that we don’t get diverted from the topic.
The Eye Opener Truth…
How much will go to the end user
and how much it will benefit the earnings growth of the common man is a
trillion dollar question. We get scared
when we hear about any foreign bank going for bailout but when it comes to
India we are bailout each year. The tax payer’s funds are invested under the disguise
of economic growth and hence liquidity of banks is required. One this is clear
the top 20% of the wealth holder’s asset and wealth base is bound to grow by
another 40000 to 50000 cr. Well that’s why certain powers of the RBI governor and
its management are being taken away. I am scared with the recent actions and
plans of the government to control the monetary policy. The way the government wants to control
monetary policy decision making its seems that if Indian Equity markets needs
to kept on a happy mood lower interest rates despite of macro factors going
north or south ways. I have told several times that Equity market and Economy
are two different things. Kits now well clear those bureaucrats are well inside
the game of framing interest rates. I think I better start a company and become
rich within the next 5 years as everyone is making money at the cost of tax
payers. My plan is simple that I start a company take some good board of
directors take loan from banks later on become bankrupt and I raise my hands. The funniest part is that despite of interest
rates coming down our EMI are at the same levels and we are still paying more.
We are paying taxes we are paying more EMI and we are earning less as our incremental
salary is going just by 10 to 12% like FD interest rates. Even if we get
bonuses we have to shed higher taxes on that too.
Banks are not going to lend to
ones who needs capital to grow business but rather it will go to those who are
within that 20% segment. Further their will be another round of scam and
another round of auction of natural resources or Telecom and hence one fine morning
the CAG will come up and will block all deals and all lending would turn out to
be NPA. In India it has become mockery that a common man prays for his home loan
EMI to come down and the interest rates also comes down but hardly any benefit
goes to the prayer.
While disbursing loans priority
sector and all those fancy words goes for a toll when a slow down happens.
Banks get liquidity the same is passed to the 20%, that 20% also raises money
from equity market and one fine day the stock price collapse. We need to a process where assets are sold
rather than going for restricting of debts. Long back I wrote an article that
restructuring of asset base is a killer for the economy as they ruin the tax payer’s
money. Banks and Government needs to come out with solution to sell assets and
that should be a hard lesson. Silently going for restructuring is like slowly
going for a repeating of history of financial crisis in India. But banks are
now changing their rules but I doubt
that how long they can changes as Indian financial system is mixed with politicians
benefit to corporate. We are ready to get NPA form reputed companies but we will
never fund a new startup. Why banks have to shed below their capital norms
while disbursing loans.
Why can’t they maintain a fixed
level and become choosy in their products choice. This reveals that banks are
not properly having credit score validation and credit rating analysis process
and there is significant loop hole which is being used by the industry to
pocket the tax payer’s funds. Just check your EMI and see that despite of loan
rates coming down how much have been benefited to the 130 cr + population. From where consumption will come if the past experience
of taking loan is so horrible. The Indian banking system does not have a
concrete system of controlling the Big giants of the market. We lack credit analyst
and we lack risk measuring talent.
Now coming to the TOOLS OF CREDIT RISK MANAGEMENT
The instruments and tools,
through which credit risk management is carried out, are detailed below: a)
Exposure Ceilings: Prudential Limit is linked to Capital Funds – say 15% for
individual borrower entity, 40% for a group with additional 10% for
infrastructure projects undertaken by the group, Threshold limit is fixed at a
level lower than Prudential Exposure; Substantial Exposure, which is the sum
total of the exposures beyond threshold limit should not exceed 600% to 800% of
the Capital Funds of the bank (i.e. six to eight times).
b) Review/Renewal:
Multi-tier Credit Approving Authority, constitution wise delegation of powers,
Higher delegated powers for better-rated customers; discriminatory time
schedule for review/renewal, Hurdle rates and Bench marks for fresh exposures
and periodicity for renewal based on risk rating, etc are formulated
c) Risk Rating Model: Set up comprehensive
risk scoring system on a six to nine point scale. Clearly define rating
thresholds and review the ratings periodically preferably at half yearly
intervals. Rating migration is to be mapped to estimate the expected loss.
d) Risk based scientific pricing:
Link loan pricing to expected loss. High-risk category borrowers are to be
priced high. Build historical data on default losses. Allocate capital to
absorb the unexpected loss. Adopt the RAROC framework.
e) Portfolio Management: The need
for credit portfolio management emanates from the necessity to optimize the
benefits associated with diversification and to reduce the potential adverse
impact of concentration of exposures to a particular borrower, sector or
industry. Stipulate quantitative ceiling on aggregate exposure on specific
rating categories, distribution of borrowers in various industry, business
group and conduct rapid portfolio reviews.
f) Loan Review Mechanism : This one of the key
metrics. This should be done independent of credit operations. It is also
referred as Credit Audit covering review of sanction process, compliance
status, review of risk rating, pickup of warning signals and recommendation of
corrective action with the objective of improving credit quality. It should
target all loans above certain cut-off limit ensuring that at least 30% to 40%
of the portfolio is subjected to LRM in a year so as to ensure that all major
credit risks embedded in the balance sheet have been tracked. ii) Market Risk
Market Risk may be defined as the possibility of loss to bank caused by the
changes in the market variables. It is the risk that the value of
on-/off-balance sheet positions will be adversely affected by movements in
equity and interest rate markets, currency exchange rates and commodity prices.
Market risk is the risk to the bank‟s earnings
and capital due to changes in the market level of interest rates or
prices of securities, foreign exchange and equities, as well as the
volatilities, of those prices.
But many banks will say that we
are already in the same boat of the metrics and we are already having all these
things placed in the system. Well half knowledge is bigger killer. We have
these thing in place does certain tools are being deployed to figure the
analysis process of the tools and its outcomes. This is the key area which is
being hardly covered. Only having process written and drafted in papers and
only followed for due diligence purpose would not be suffice. This is the area
where an expert professional segment needs to come in. Lets figure out the
analysis process.
GAP Analysis It is an interest rate risk management tool based on
the balance sheet which focuses on the potential variability of net-interest
income over specific time intervals. In this method a maturity/ re-pricing
schedule that distributes interest-sensitive assets, liabilities, and
off-balance sheet positions into time bands according to their maturity (if
fixed rate) or time remaining to their next re-pricing (if floating rate), is
prepared. These schedules are then used to generate indicators of interest-rate
sensitivity of both earnings and economic value to changing interest rates.
Value at Risk (VaR) It is one of
the newer risk management tools. The Value at Risk (VaR) indicates how much a
firm can lose or make with a certain probability in a given time horizon. VaR
summarizes financial risk inherent in portfolios into a simple number. Though
VaR is used to measure market risk in general, it incorporates many other risks
like foreign currency, commodities, and equities.
Risk Adjusted Rate of Return on
Capital (RAROC) This is very key tool to analyze. It gives an economic basis to
measure all the relevant risks consistently and gives managers tools to make
the efficient decisions regarding risk/return tradeoff in different assets. As
economic capital protects financial institutions against unexpected losses, it
is vital to allocate capital for various risks that these institutions face Risk
Adjusted Rate of Return on Capital (RAROC) analysis shows how much economic
capital different products and businesses need and determines the total return
on capital of a firm. Though Risk Adjusted Rate of Return can be used to
estimate the capital requirements for market, credit and operational risks, it
is used as an integrated risk management tool.
In conclusion I will only say that we cost accountants/management accountants and their profession have been hardly taken into account by the Banking industry.
Rising NPA is going to be nightmare. Only disbursing of loan and getting liquidity
form government would not solve the problems of the industry. We need applied
cost management and not mere bookish knowledge for the same. Banking industry needs to changes it old
primitive process otherwise a global slowdown would eat up the liquidity of the
Indian banking industry and whole of the capital deployment would become NPA.