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Credit Risk

Credit Risk is defined as "The inability or


unwillingness of the customer or counter party
to meet commitments in relation to lending,
hedging, settlement and other financial
transactions.
o Credit risk emanates when the counter party is
unwilling or unable to meet or fulfill the
contractual obligations/commitments thereby
leading to defaults.
Variants
Credit Risk
Transaction
Risk
Default Risk
Down Grade
Risk
Port Folio Risk
Concentration
Risk
Systemic Risk
Default Risk
Credit Default Risk Is the probability that the
counter party will fail to meet his payment
obligations as per agreement.
Credit Risk of a bank depends upon several
External and internal factors.
These external or internal factors are related
both to the borrower & the bank.
Default Risk
Internal factors Applicable to Banks:
Deficient loan policies
Inadequately defined powers for sanction of loans
Absence of prudential credit concentration limits
Absence of credit committees
Deficiency in credit appraisal systems
Excessive dependence on collaterals
Inadequate/lack of risk pricing
Absence of loan review mechanism
Post sanction surveillance
Default Risk
External factors-Applicable to Borrowers:
Inadequate technical know-how
Locational disadvantages
Outdated production process
High input costs
Break even point being very high
Uneconomic size of plant
Large investment in Fixed assets
Over estimation of demand
Wide swings in commodity or equity prices







Default Risk
External Factors-Applicable both to the borrower
and Banks:
Credit worthiness of the counter party
Interest rate risk
Forex risk
Country risk
Economic scenario
Government policies
Trade restrictions.

Down Grade Risk
Rating down grade risk
This is the probability that the credit risk measure of the counter party as
measured by a credit rating system ,worsens during the loan period and
market value of the asset falls due to rating down grade.
Status of the credit exposure may not remain the same.
Quality of the credit exposure may improve on account of various
factors.
Quality of the credit exposure may deteriorate .
Improvement in the credit quality indicated by the upward movement
of the rating of the party is called upward migration.
Deterioration in the quality of the credit exposure as indicated by the
down ward movement of the credit rating is called down ward
migration.
Down Grade Risk
When the quality of the exposure deteriorates
as indicated by the down ward migration of
the rating, the exposure needs more
provision.
Down grade risk also calls for more capital
allocation
Portfolio Risk
At the portfolio level, the risk may be concentration risk or systemic
risk. The concentration risk may be by way of:
Industry/Activity
Loan size
Distribution in a region
Security
Loan Ratio
Repayment period
Interest rate
Purpose
Income level
It would be prudent to set overall as also individual sub limits for each
of the concentration classes
Systemic Risk
The portfolio quality may deteriorate in spite of
proper diversification. This may be due to
various factors beyond the control of the
Borrower and the causes may be many and
varied such as-
Interest rate
Exchange rate
Government policy
Inflation Etc

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