CREDIT RISK MANAGEMENT IN PUBLIC AND PRIVATE SECTOR BANKS

ABSTRACT

Risk is inherent part of bank’s business. Effective risk management is critical to any bank for
achieving financial soundness. In view of this, aligning risk management to bank’s
organisational structure and business strategy has become integral in banking business. Credit
risk is the bank’s risk of loss arising from a borrower who does not make payments as promised.
Such as event is called as default.

The primary cause of credit risk is poor credit risk management. When banks manage their risk
better, they will get advantage to increase their performance (return).

https://ideas.repec.org/a/hur/ijarbs/v5y2015i1p97-106.html

Like other corporations, banks want to create value and seek ways to control risk while aiming to
enhance productivity and performance. This is achieved by granting credits to customers from
the money deposited by the depositor, thus placing them at risk in the case of defaulting. Despite
this risk, banks must continually issue credit since it is the key source of its profitability.

Oino, I. (2016). A Comparison of Credit Risk Management in Private and Public Banks in
India.

"Banks are in the business of managing risk, not avoiding it . . . ."

Risk is the fundamental element that drives financial behavior. Without risk, the financial system
would be vastly simplified. However, risk is omnipresent in the real world. Financial Institutions,
therefore, should manage the risk efficiently to survive in this highly uncertain 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 in the long run. The effective
management of credit risk is a critical component of comprehensive risk management essential
for long-term success of a banking institution.

https://papers.ssrn.com/sol3/papers.cfm?abstract_id=877812

INTRODUCTION

The banking has become the foundation of modern economic development. According to the
dictionary, the term bank means the side of the sea, a little hill, a shoal in the sea or a repository
for money. In economics, a bank means a repository for money of the whole economy (Kapoor,
2004).
Singh, A. (2015). Effect of Credit Risk Management on Private and Public Sector Banks in
India. International Journal of Academic Research in Business and Social Sciences, 5(1), 97.

The banking sector is the principal constituent of the financial system. Banking sector is directly
linked to the country‟s economy; each compliments the other for growth, strength and status. A
strong and resilient banking system is the foundation for sustainable economic growth. The basis
for efficient banking is simplicity in operations based on effective risk management,
transparency and accountability. Trust and confidence are the bedrock of banking.

IOSR Journal of Economics and Finance (IOSR-JEF) e-ISSN: 2321-5933, p-ISSN: 2321-5925
PP 48-59 www.iosrjournals.org 7th International Business Research Conference 48 | Page Indian
Education Society's Management College and Research Centre
Risk Analysis of Select Public and Private Sector Banks Operating in India Dr.SmitaShukla

The banking industry in the world over has undergone a profound transformation since the early 1990s. The
changed operating environment for the banking sector, under pinned by liberalization, privatization and
globalization, coupled with the reforms of information technology, has resulted in intense competitive
pressures. Banks have responded to this challenge by diversifying through organic growth of existing businesses as
well as through creative marketing of its services but the risk factor of banks are increasing. Risk is
inherent in any walk of life in general and in financial sectors in particular.

Vidyashree, D. V., & Rathod, P. (2015). Credit Risk Management-A study on Public sector,
Private Sector and Foreign Banks in India. International Journal of Research in Finance
and Marketing, 5(7), 23-28.

Risk is the element of uncertainty or possibility of loss that prevail in any business transaction in
any place, in any mode and at any time. Credit risk is the possibility that a borrower or counter
party will fail to meet agreed obligations. Globally, more than 50% of total risk elements in
Banks and Financial Institution (FI) s are credit risk alone. Thus managing credit risk for
efficient management of a FI has gradually become the most crucial task. Credit risk
management encompasses identification, measurement, matching mitigations, monitoring and
control of the credit risk exposures.
Lalon, R. M. Credit Risk Management (CRM) Practices in Commercial Banks of
Bangladesh:“A Study on Basic Bank Ltd.”.

As monetary authority of the country, the Reserve Bank of India (RBI) regulates the banking
industry and lays down guidelines for day-to-day functioning of banks within the overall
framework of the Banking Regulation Act, 1949.

Rajeswari, M. (2014). A Study on Credit Risk Management In Scheduled

Banks. International Journal of Management (IJM), 5(12), 79-89.
Credit risk management is the practice of mitigating losses by understanding the adequacy of a
bank’s capital and loan loss reserves at any given time – a process that has long been a
challenge for financial institutions. To comply with the more stringent regulatory requirements
and absorb the higher capital costs for credit risk, many banks are overhauling their approaches
to credit risk. But banks who view this as strictly a compliance exercise are being short-sighted.
Better credit risk management also presents an opportunity to greatly improve overall
performance and secure a competitive advantage.

https://www.sas.com/en_us/insights/risk-management/credit-risk-management.html

The goal of credit risk management is to maximise a bank’s risk-adjusted rate of return by maintaining
credit risk exposure within acceptable parameters. Banks need to manage the credit risk inherent in the
entire portfolio as well as the risk in individual credits or transactions. Banks should also consider the
relationships between credit risk and other risks. The effective management of credit risk is a critical
component of a comprehensive approach to risk management and essential to the long-term success of
any banking organisation.

https://www.bis.org/publ/bcbsc125.pdf

The global financial crisis – and the credit crunch that followed – put credit risk management
into the regulatory spotlight. As a result, regulators began to demand more transparency. They
wanted to know that a bank has thorough knowledge of customers and their associated credit
risk. And new Basel III regulations will create an even bigger regulatory burden for banks.

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REVIEW OF LITERATURE

Study by Mitrica, Moga and Stanculescu (2010) has presented a risk analysis for the Romanian
Banking system. The analysis was conducted from the point of prudential rules and also from the
point of view of Romanian Banking system‟s exposure to foreign funds. The study concluded
that foreign funds were important source of risk for the banking system in Romania.

Mitrica Eugen, Moga Liliana, Stanculescu Andrei, 2010, “Risk Analysis of Romanian
Banking System – An Aggregated Balance Sheet Approach”, Economics and Applied
Informatics, Years XVI, No. 2, Page 177-184

(Singh, 2013) Effective credit risk management should be a critical component of a bank‘s
overall risk management strategy and is essential to the long-term success of any banking
organization. It becomes more and more significant in order to ensure sustainable profits in
banks.

Singh Asha, (2013), “Credit Risk Management in Indian Commercial Banks” in

International Journal of Marketing, Financial Services and Management Research, Vol.
No.2, Issue No.7, Page No.47-51, July.
Hassan, (2009), made a study “Risk Management Practices of Islamic Banks of Brunei
Darussalam” to assess the degree to which the Islamic banks in Brunei Darussalam implemented
risk management practices and carried them out thoroughly by using different techniques to deal
with various kinds of risks. The results of the study showed that, like the conventional banking
system, Islamic banking was also subjected to a variety of risks due to the unique range of
offered products in addition to conventional products. The results showed that there was a
remarkable understanding of risk and risk management by the staff working in the Islamic Banks
of Brunei Darussalam, which showed their ability to pave their way towards successful risk
management. The major risks that were faced by these banks were Foreign exchange risk, credit
risk and operating risk. A regression model was used to elaborate the results which showed that
Risk Identification, and Risk Assessment and Analysis were the most influencing variables and
the Islamic banks in Brunei needed to give more attention to those variables to make their Risk
Management Practices more effective by understanding the true International Journal of
Academic Research in Business and Social Sciences January 2015, Vol. 5, No. 1 ISSN: 2222-
6990 99 www.hrmars.com application of Basel-II Accord to improve the efficiency of Islamic
Bank’s risk management systems.

Hassan, M.K., (2009), “Risk Management Practices of Islamic Banks of Brunei

Darussalam”, The Journal of Risk Finance, Vol. 10, No.1, pp. 23-37.

Hennie (2003) stated that credit risk still remains the most prominent reason for bank failure. For
this reason, “more than 80% of the bank’s balance sheet commonly relates to this aspect of risk
management.” The major reason for serious banking problems directly relate to poor portfolio
risk management, loose credit standards for counterparties and borrowers and lack of awareness
of changes in economics. Collectively, these observations indicate the enormous critical role
played by credit risk management in the entire bank risk management approach. The ultimate
objective of credit risk management is to intensify the risk-adjusted rate of return by controlling
and standardizing credit risk exposure.

Hennie V. G (2003), Analyzing and Managing Banking Risk: A Framework for Assessing
Corporate Governance and Financial Risk, 2nd Edition, Washington DC: World Bank
Publications.

(Jackson and Perraudin, 1999)Credit risk is the largest element of risk in the books of most banks
which if not managed in a wiser way, may break down individual banks or may cause
widespread financial instability by endangering the whole banking system.

https://www.ukessays.com/dissertation/literature-review/literature-review-about-
managing-credit-risk-in-banking.php

(Basel, 1999) Credit risk management processes enforce the banks to establish a clear process in
for approving new credit as well as for the extension to existing credit. These processes also
follow monitoring with particular care, and other appropriate steps are taken to control or
mitigate the risk of connected lending.

Basel. (1999). Principles for the management of credit risk Consultive paper issued by
Basel Committee on Banking Supervision, Basel.

(Atakelt & Veni, 2015).Assessing the determinants of credit risk is the cornerstone for the
effectiveness of risk management system and practice. Optimal portfolio diversifications,
establishing a comprehensive credit limit system and loan pricing, as well as Credit risk
management strategy, policy and procedures without a clear picture of credit risk drivers
considered just like driving a car without having a break and knowing final destination.
Therefore, the success and survival of commercial banks is greatly depending on effective Credit
risk management system and practice.

Atakelt, H. A., & Veni, p. (2015). CREDIT RISK MANAGEMENT TOOLS PRACTICED
IN ETHIOPIAN COMMERCIAL BANKS. International Journal of Social Science &
Interdisciplinary Research , 4 (5).

Greuning& Bratanovic, 2009 Credit risk is a critical risk area in banking business. If not
effectively managed, it causes non-performing loans or bad assets, reduces a bank’s profit
margins, erodes capital and in extreme cases, may lead to bank failure. Credit risk management
thus, has to be a vital banking practice, involving identification, measurement, aggregation,
control and continuous monitoring of credit risk.
Greuning, H.V.; Bratanovic, S.B. (2009) Analysing banking risk: A framework for
assessing corporate governance and financial risk, 3rd Ed. The World Bank,
Washington D.C.

The advantages of implementing better risk management led to better banks performance. Better
bank performance increases their reputation and image from public or market point of view. The
banks also get more opportunities to increase the productive assets, leading to higher bank
profitability, liquidity, and solvency (Eduardus et al., 2007).

Eduardus T., Hermeindito K., Putu A., Mahadwartha and Supriyatna (2007). Corporate
Governance, Risk Management, and Bank Performance: Does Type of Ownership Matter?
University Yogyakarta, Indonesia.

Kolapo, Ayeni & Oke, 2012, p.31 Among other risks faced by banks, credit risk plays an
important role on banks’ financial performance since a large chunk of banks’ revenue accrues
from loans fromwhich interest margin is derived.

Kolapo, T. F., Ayeni, R. K. & Oke, M. O (2012). Credit risk and commercial banks’
performance in Nigeria: A panel model approach. Australian Journal of Business and
Management Research, 2 (2), 31 – 38.
Bagchi (2003) examined the credit risk management in banks. He examined risk identification,
risk measurement, risk monitoring, and risk control and risk audit as basic considerations for
credit risk management.

Muninarayanappa and Nirmala (2004) outlined the concept of credit risk management in banks.
They highlighted the objectives and factors that determine the direction of bank’s policies on
credit risk management. The challenges related to internal and external factors in credit risk
management are also highlighted. They concluded that success of credit risk management require
maintenance of proper credit risk environment, credit strategy and policies. Thus the ultimate
aim should be to protect and improve the loan quality.