Credit Risk

Risk organization and governance covers designs and structures that allocate the final responsibility for the different elements of risk management, both horizontally and vertically in the organization. Our approach to identification of gaps and strengthening of the existing risk organisation and governance structure will keep the important aspects such as Risk Identification, Risk Strategy, Risk Culture in mind.

Our approach review and modification (if required) of risk governance and organization structure is as follows:

• Understanding of existing structure, which includes Reviewing the existing portfolio, understanding the risk appetite and material risks faced by the company
• Studying and understanding the existing roles and responsibilities of risk personnel and reviewing strength of existing units within risk management department.
• Developing the risk organization structure based on the industry best practices taking into consideration the complexity of operation of the company
• Finalizing the risk organization and governance structure, documenting the roles and responsibilities for the proposed risk organization and recommending appropriate FTE (Full Time Equivalent) for different risk units.

Our approach uses Basel to benchmark the existing risk organization of the firm. It includes setting up some principles for Board of Directors, Senior Management, Risk Management, Internal Audit etc. To meet the principles risk organization, structure the firm in analysed. Our focus is on ensuring that the firm is various functions as per the best practices in the risk management.

Setting Credit risk strategy/appetite for the bank is one of the most important part in credit risk management. Risk Appetite needs to be agreed upon by the senior management and board of directors before going forward with maintaining credit risk. Risk appetite is important because it sets risk tolerance limit, concentration limit and it also tells what could be the profit after accepting the mentioned risk.

Once the risk appetite has been finalized and signed by the board of directors, senior management can move to the part of creating a governance structure (Who should take responsibility in case of failure) and credit risk policy, which is a document depicting the approval authorities, collateral management, default definition etc. On the basis of policy document further risk measurement and mitigation process are devised. Policy document clearly establishes the process for approving new credit, renewing credit etc. Risks inherent to all the products and activities of bank should be identified and the products or activities that are new to the bank should undergo stringent risk management procedures and controls before being undertaken.

Policies are made to set the objectives before any actions can be taken in any area or business function. Credit policy sets objectives, procedures, roles and responsibilities, guidelines and a variety of solutions which help credit executives and other stakeholders in exercising judgement in the process of decision making.

We help our clients in the development of credit related policies for credit portfolio and credit administration. Credit policy covers all aspects with respect to extension of credits such as:

• Approval Authorities
• Defining the roles of lending personnel, purpose of loans and loan application procedures
• All types of concentration limits
• Objectives and guidelines while extending credit to specific sectors
• Collateral management
• Default definition etc.

Credit administration policy covers aspects such as limit setting, documentation, security etc.

With the expertise of our professionals we develop credit policy keeping in mind the profile and business of clients while taking into account supervisory regulations and industry best practices.

Banks must have information systems and analytical techniques to measure credit risk inherent in all on and off-balance sheet instruments.

To measure credit risk Probability of Default (PD) models are used which on the basis of an individual or corporate’s financial and subjective factors, calculate PD. PD couples with Loss Given Default (LGD) and Exposure at Default (EAD) provides the bank with the Expected Loss measure. Expected Loss provides an estimate of the credit risk the bank is expected to encounter. PDs related to the retail products such as credit card, personal finance, Mortgages are calculated based on the statistical model probably probabilistic or logistic models, since the data related to retail products is sufficient to use purely statistical models. (Read more about Retail Models).

Whereas in case of corporate and specially in case of specialized lending models such as High Net Worth Individuals (HNWI) or Project Finance, more judgement and experience of the people developing the model is used rather than pure statistics. (Read more about Corporate Models)

All the above-mentioned models calculate capital charge for Basel Pillar I, credit concentration risk capital charge is covered in Basel Pillar II. (Read more about Basel Pillar 2 & ICAAP)

Once the models are made, it is necessary to create a Model Maintenance Policy. It provides a guideline of the process adopted to make the models, the frequency of periodic validation required to keep the models in a healthy state. (Read more about Model Maintenance Policy here and Model Validation and Modification here)

The last part in credit risk management is that of reporting the numbers to senior management who in turn report to the Board of Directors. Various types of regulatory report such as concentration reports, Model documentation reports, Economic Capital results, stress testing reports etc. and internal reports for the information of the management are produced. These reports combined gives the management and senior managers the holistic view of credit risk in the bank and on the basis of these reports further actions are decided if needed.

It is the capital available to the banks to absorb losses to stay solvent. According to Bank for International Settlements - Economic capital can be defined as the methods or practices that allow banks to attribute capital to cover the economic effects of risk-taking activities.

Effective capital allocation suffers a major setback due to the management complexities in banks due to use of both Regulatory capital and Economic capital. One of the most challenging part while using Economic capital is to use it to glean insights from it like right size of capital buffer, concentration risk etc.

We help our clients in increasing their capital efficiency by aligning Economic Capital and Regulatory Capital for decision making. Our Capital Allocation model not only takes care of defaults, but also takes care of the more likely and relevant events such as the risk of failing to maintain regulatory ratios. Our model goes into more granularity to decide the capital needs of the firm, so that it not only captures risk indicators but also risk mitigating factors.

One of the major obstacle in performing Credit Risk Management successfully is the problem of getting right data accurately and in timely manner. Origination, rating process, reporting process all receive data from different systems at most of the banks and this creates problem as the data is delayed and there are too many errors most of the time. Too much manual process from the point of data origination to the point the data is used in PD models till the data is reported to senior managers makes the process extremely challenging. Also there is a problem of different taxonomies followed by different business units for the same data which again creates a problem. To remove all the hassle and to make the process smooth and with low number of errors Risk Data Aggregation (with reference to BCBS 239) has been made mandatory by Basel for G-SIB and D-SIBs.