Sunday, August 2, 2015

Rs 70000 cr..to go for NPA..Cost Accountants can only save.

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 banks 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.

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