This is being made available for Risk Management Practice Group on Linkedin. RMPG Learning Series CRM Workshop Handouts: File 3 of 9

1. Agenda for Day 1
Introduction of Participants
Introduction to Credit Risk
Overview of Basel Guidelines
Lunch Break
Framework for Credit Risk Management
Open Session/ Q&A
IM aCS 2010
Printed 11-M ay-11
For Classroom discussion only Page 1

2. A loan creation planning process in a bank
Credit Credit Lending
Strategy Policy Policy
Focus Volume / Risk-Return / Client-base Norms/ Ratios
• Business targets • Characteristics of
• Basis
preferred borrowers
• Risk-return relationship
• Corporate objectives
• Customer base
• Thrust areas • Concentration Norms
The above aspects are captured in Business Plan,
Credit Policy, Manual of Instructions, Circulars
IM aCS 2010
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For Classroom discussion only Page 2

3. Credit Risk defined
Manifestation of Credit Risk Likely Causes
Credit risk is the possibility that Inability to pay
payments would not happen as Short term cash flow or
per agreed terms – uncertainty in liquidity problems
amount and timeliness of Longer term solvency issues
repayments Delays in payment due to
Inadequate repayments operational issues with the
Untimely repayments treasury function
Default risk is the risk that the Unwillingness to pay
repayments stop all together
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4. Sources of Credit Risk
• Repayment inability due to bad financial performance,
Asset Based point in the business cycle, poor management quality
lending • Unwillingness on part of obligor to make repayments on
time
• Delays in completion
• Uncertain cash flows during operation due to lower PLFs,
Cash flow price risk, offtaker credit risk
based lending • Sponsor and Technology risks
• Force Majeure
• Political risks
IM aCS 2010
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5. Assessing and Managing Credit Risk
Effects of credit Measurement of Management of
risk credit risk credit risk
• Potential inability of the • Appraisal and assessment. • Identification potential
organization to meet the • Use of internal and venerable credit
liabilities as they become external rating • Assessment of potential
due risk
• Borrowing under • Monitoring and follow up
unfavorable terms and • Control and mitigation
conditions like collaterals.
• Distress asset sale
• Reputational risk
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6. Credit Risk Management Process has to be installed
Identification Identification of products (e.g. loan product, derivative, forex, guarantees),
geographical locations (e.g. country risk), industry sectors (e.g. real estate,
NBFCs) from where the credit risk is originating
Analyse past credit trends, macro-economic factors and expected trends
Measurement Measuring credit risk using validating scoring / rating models
Estimating historical probability of default and recovery rates and loan loss
rates to bank
Linking risk scoring with quantification of risk
Control Limits on individual / group exposure, specific sectors like real estate,
unsecured exposure etc.
Eligible collaterals and their frequent valuations
Loan Review Mechanism
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7. Credit risk management function at Bank
Credit Risk
Management
Function
Quantification Management
Management Monitoring
Quantification
Tools
Policy Organization Tools Processes
Processes and Control
The Board of Directors has the overall responsibility for the credit risk management and shall approve the
credit risk management policy, procedures and set prudential and other limits.
IM aCS 2010
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8. Policy Guidelines of Bank
Structure of Credit guidelines of banks
1. Credit objectives 6. Credit appraisal
2A. Quality of asset base (Industry 7. Assessment of limits
Exposure)
8. Pricing
2B. Quality of asset base (Selection
9. Credit monitoring
of Borrower)
10. Delegation of authority
3. Exposure norms
11. Recovery and exit policy
4. Tenure of credit
5. Credit acquisition 12. Internal Audit
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9. Prudential limits for Individual and Group exposure
Prudential limits Exposure ceiling
Individual Exposure Exposure of its owned fund
Lending ≤ 35 %
Group exposure
Lending ≤ 35 %
IM aCS 2010
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10. Credit risk management function at Bank
Credit Risk
Management
Function
Quantification Management
Management Monitoring
Quantification
Tools
Policy Organization Tools Processes
Processes and Control
The Board of Directors has the overall responsibility for the credit risk management and shall approve the
credit risk management policy, procedures and set prudential and other limits.
IM aCS 2010
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For Classroom discussion only Page 10

11. Organization structure
•Overall risk management
•Decide the risk management Policy
Board •Loan Sanction
•Setting up internal limit for portfolio management
•Implementation of policy
•Adherence to limits set by the Board
• Recommendation of ceiling for various types of internal limits to the Board
for effective portfolio management.
RMC •Monitoring and reporting of risk levels
•Review the risk based pricing
• Review the appraisal note , results and trends
•Preparation and presentation of appraisal note
• Objective assessment of the credit risks involved
Credit Officer • Ensuring the validity and accuracy of the data used for Credit decision
IM aCS 2010
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12. Comprehensive risk management structure
Organisation Structure
Internal Documents
Board of Directors
Risk Management Policy
Risk Management Committee of Board
Asset Liability
Policies for Credit Risk Management Operational Risk
Management Committee Management
Committee (CRMC) Committee (ORMC)
Risk (ALCO)
Management Business Unit
•Business units
unit
RM
Policies for Policies Policies for
Department
management Different Different
of different business operations
risks units procedures
RM interacts and functions with
business units IM aCS 2010
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13. A Board level Risk Management Committee should be put in place to
implement risk management across the bank
Desirable • Managing Director / Chief Executive Officer, Executive Directors ,
Composition Heads of Credit and Head of Risk.
Reporting • Board of Directors
Supported By • Credit
Risk Management Committee, Asset Liability Management
Committee and Operational Risk Management Committee
Frequency • At minimum quarterly intervals
Roles • Devisingpolicy and strategy for integrated risk management
containing various risk exposures
• Providing guidance to various risk management committees operating
under it
• Oversee the identification, measuring and monitoring the risk profile
of the Bank IM aCS 2010
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14. Bank should set up multiple risk management committees to create
focus and handle different constituents of risk
CRMC ALCO ORMC
Should be headed by Should be headed by Should be headed by
Desirable Chairman/Executive Chairman/ED/CEO Chairman/ED/CEO
Composition Director/Chief Executive and comprises of and comprises of
Officer (CEO) and heads of Credit, heads of Credit,
comprises of heads of Investment, Treasury, Information
Credit and Risk Resource and Technology, Human
Management Dept & International Banking Resource and Risk
Chief Economist Management
Reporting Risk Management Committee of Board
Supported By Credit Risk ALCO Cell / Middle Operational Risk
Management Office Management
Department Department
IM aCS 2010
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15. The committees should meet at frequent intervals to discuss to
monitor various aspects of risk
CRMC ALCO ORMC
Frequency of
Meeting At Frequent Intervals (Minimum Monthly)
Supported By Risk Management Department
Roles Measure, Control and Measure, Control and Formulation of Bank
Manage Bank wide Manage Bank wide risk wide Operational
Credit Risk on liquidity, interest Risk Policy
Compliance with rates and foreign Act as agency for
lending and credit risk exchange creating awareness on
management policy Product Pricing for operational risk in the
Enforce compliance Deposits & Advances Bank
with prudential limits Strategy for Resources Development of
Mobilisation Operational Risk
Management tools
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16. Bank should install an independent risk management
department housed in the Head Office
Location At Head Office / Corporate Office
Headed By An officer with a minimum rank of General Manager, having expert
knowledge of banking business and credit, market and operational risk
management
Supported By Minimum of 3/4 persons on current scale of operations and shall be
increased with the enlargement of operations
Desired Chartered Accountants, MBA, Cost Accountant, CFA, M. Sc. –
Qualifications Statistics and any other equivalent degree
IM aCS 2010
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17. Credit risk management function at Bank
Credit Risk
Management
Function
Quantification
Quantification Management
Management Monitoring
Policy Organization Tools Processes and Control
Tools Processes
The Board of Directors has the overall responsibility for the credit risk management and shall approve the
credit risk management policy, procedures and set prudential and other limits.
IM aCS 2010
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For Classroom discussion only Page 17

18. The Policy would enable a structured assessment of risks,
mitigants enabling credit and pricing decision
Assessment of risks
Financial Parameters Qualitative Parameters
Assessment of mitigants on offer for the proposed transaction
Contractual arrangements in a project Financial collaterals, guarantees etc. for asset
based lending
Credit Decision
Additional collaterals, covenants, higher
Approve / Reject
pricing
Portfolio Risk Management
Monitoring, Oversight and Governance
Exposure Limits IM aCS 2010
For Classroom discussion only Structure Printed 11-M ay-11
Page 18

19. Structure of rating model for balance sheet based lending
Financial
Risk Project evaluation
and status
Business Risk
Final Borrower
Borrower +
Industry Risk Risk Score
Risk Score
Management
Risk Account
conduct
Credit rating model enables to view the borrowers with the risk perspective based on grades.
IM aCS 2010
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For Classroom discussion only Page 19

20. Multiple components of model* and multiple parameters for
each component
* Slide provides an outline of a rating
model for Corporate Customers
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21. Key Risks that need to be assessed for a project
Market /
Construction Technology
Revenue
risk risk
Risk
Sponsor Risk O& M Risk
DSCR, IRR
Financial
Overall Fuel supply
Best Case project
Risk risk
Worst Case risk
Equity
Contribution
IM aCS 2010
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For Classroom discussion only Page 21

22. Bank would need to finalise an approach for
implementing robust risk rating models
Financial
Risk Score W1
Collateral
Basic Structuring
Management W2
Borrower
Risk Score Risk Score
W3 Modified Transaction
PLUS Risk Score
Score
Industry Risk Conduct of
Score account Risk
Score
Calibration and
Validation Robust & Acceptable
Risk Scoring Model
IM aCS 2010
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23. Estimation of Loss Given Default (LGD)
Security Type
Market Value of Present Value
security of Recovery LGD=(1 -RR)
Rate (RR)
Loan Outstanding
at Default
IM aCS 2010
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For Classroom discussion only Page 23

24. Assessment of risks would also enable risk based pricing besides
building a good quality portfolio
Aligns the incentive to balance risk with return
Pricing is a tool to maintain proactive provisioning
Necessary for value creation and preservation
Loan
Price
Credit Overhead &
(Interest
Cost of Funds
Rate and = + Charge + Operating
fee income) Risk
IM aCS 2010
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For Classroom discussion only Page 24

25. Credit risk management function at Bank
Credit Risk
Management
Function
Quantification Management
Management Monitoring
Quantification
Tools
Policy Organization Processes and Control
Tools Processes
The Board of Directors has the overall responsibility for the credit risk management and shall approve the
credit risk management policy, procedures and set prudential and other limits.
IM aCS 2010
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For Classroom discussion only Page 25

26. Bank would need to install a three tier structure for
Lending process loan management
. Front Office Mid Office Back Office
Origination/Renew Credit Risk Analysis Post disbursement
al • Assessment •Monitoring
Regulatory Reporting
Sales/Acquisition •Sanction • Support to front and
• Pre disbursement mid office
Borrower
formalities •NPA Management
Evaluation •Disbursement
Collect and review
data
Risk Management Sanctioning Authority Audit and Control
IM aCS 2010
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27. Lending Process in Banks: Origination
DSA/DMA convert
prospective loan
RM/Branch
seekers into loan
applicant
Front office checks whether all documents are in order
and as per norms
CPU
Check whether file has been Check MIS to know the status of the file and
already logged Yes if declined, reasons for decline
No No
Refer to Credit
File is processed by Yes
CPU as per policy
Initiate Contact point verification (send details of the applicant
containing customer number, residence address, residence
telephone no. , employer name ,office address, telephone no. etc.)
and income document verification
Initiate contact point verification and
income document verification
Prepare CAM (Credit Appraisal Memorandum) by leaving column
blank for remarks about Income document verification
Check for discrepancies and email the IM aCS 2010
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same to RM For Classroom discussion only Page 27

28. Lending Process: Assessment , Risk Management and
Sanction
Update the status of Income document verification, on receipt of the same in CAM (Credit
Appraisal Memorandum) and MIS and complete the credit .Valuation and assessment of
guarantor will also be done based on prescribed guidelines
Credit officer adds the remarks on the basis of
deviation observed and credit process checks
Credit and Risk Department assesses the case based on score card /
internal rating model for quantification of Risk
In case Personal discussion felt necessary conduct
the same Note: Please refer to credit process checks
and policy for requirement to conduct the personal
discussion
Approved Hold Declined
Communicate For want of
Subject to
to Br/RM conditions
signinging Communicate to Br/RM
deviation so that the customer can
Br/RM collects PDC Communicate to Communicate to be informed
,loan agreement and Br/RM so that the Br/RM so that the
other documents conditions can be conditions can be
fulfilled fulfilled
Inspection officer Operation for
Verifies Communicate approval Disbursement/Post
disbursal activities
IM aCS 2010
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29. Lending Process: Pre disbursement and disbursal
Creation of
Review of security documents, execution of new set of prescribed mortgage and
loan document as advised by Legal department and entry of details
into document execution register.
charges in
Register of
Charges
Collection of Post Dated cheques (PDC)
Customer has bank
account with cheque
book facility.
No
Customer will have to
Yes open savings account and
PDC will be issued
thereafter
Creation of account into CBS by following extant guidelines issued
with respect to KYC norms and setting up of limits
Update Drawing Power limit, Recovery of margin money and recovery of fees
and charges ,if any . Creation of insurance on financed assets, issue of cheque
book in the case of revolving credit,
Send copy of all executed document to CPU for disbursal clearance
Disbursal IM aCS 2010
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30. Lending Process: Post disbursal
Calculation of DP will be done at
regular interval based on submitted • Closure of Account
stock and debtors statement and the • Returned securities
same will be allowed in CBS. documents and
unused PDC End
Revolving • All loan documents
Credit marked as cancelled
and closed
Credit admin
Foreclosure and
Post officer
loan maturity
disbursal regularly
Loan Servicing
checks monitor Yes
activities in
loan account
Monitoring of
• Repayment
• Penalties & charges Loan account
• Change in interest rate performance as
• Revival of time bared per agreement
documents and pre decided
• Collection of required terms
additional PDC and
No
extension of ECS mandate
period
Triggers and early IM aCS 2010
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For Classroom discussion only warning signals Page 30

31. Credit risk management function at Bank
Credit Risk
Management
Function
Quantification Management
Quantification
Tools Monitoring
Policy Organization Processes
Tools Processes and Control
The Board of Directors has the overall responsibility for the credit risk management and shall approve the
credit risk management policy, procedures and set prudential and other limits.
IM aCS 2010
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For Classroom discussion only Page 31

32. Lending Process: Monitoring ,Follow-up and NPA
Management
No
Escalate to Head
CPU Credit Performance
officer needs to Credit Admin and Credit Credit officer and improved by
be assigned Officer to analyze unit Admin to examine moratorium, Credit sanctioning
prepare unit and prepare deferment of authority will take
recommendations recommendations interest pay, final decision on
re-assessment recommendation s
If any of
Review Yes, Escalate to put forth by Credit
the defined
and decide Head CPU Yes Officer
triggers or
to escalate Escalation of a
weakness
further/ke Execute remedial case to
observed
ep in view solution and Credit Recovery/NPA cell
than CR
Admin to can happen only
Admin
•Monitor to ensure after review and
Officer
Keep in recommendations are final decision by
escalate the Escalate to
view implemented appropriate
matter to it Credit
•Prepare specific check authority
superior's admin
supervisor Credit Admin and its points during
supervisor to review
If sign of
inspections
unit on a monthly basis deteriorati
for next two months on persist
NO
If unit
End complying Yes
NO
with the
condition
End
IM aCS 2010
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33. Risk monitoring and control
Objectives of monitoring :-
• Improvement in the quality of credit portfolio
• Review of sanction process
• Compliance of due diligence process
• Feedback on regulatory compliance
• Picking-up early warning signals and suggesting remedial measures
• Recommending corrective action to improve credit quality, credit administration and
credit skills of staff etc.
Phase wise monitoring :-
• During construction phase
• During operating phase
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34. Risk mitigation
Collateral securities can be broadly classified into two categories viz. Financial and Non-
financial
Financial collaterals :-
• Cash (including deposits),
• Gold,
• Securities issued by Central and State Government etc.
Non-financial collaterals :-
Land and building,
Raw materials, stock in trade, produce, and other goods
Movable assets such as machineries.
Documents of title to goods etc.
•The other forms of credit mitigation includes various form of guarantees and letter of comfort etc. Few
other mitigation arrangement includes escrow mechanism ,TRA and DSRA
IM aCS 2010
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35. Portfolio concentration needs to be minimised to manage Credit
Risk at the portfolio level
Bank shall aim to diversify exposures through:
Prudential limits for individual and group borrowers
Rating-wise distribution of all the borrowers
Exposure to particular sub-sector
Geographical distribution of borrowers
IM aCS 2010
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For Classroom discussion only Page 35

36. The need for a more comprehensive risk assessment for cash
flow based lending
Limited recourse to the sponsors Extent of risks differ during different phases of
Limited tangible security from the project
the project till the assets are
Need for specific assessment for each phase
created
Highly capital intensive Commissioning
Due to long gestation period of
Risks
power projects repayment of
principals starts after quite some
time. Steady state
operations
Lack of diversification and there
is a single stream of revenue
Financial
Closure
Time
IM aCS 2010
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For Classroom discussion only Page 36

37. Preliminary analysis would help banks optimise effort spent on
detailed appraisal
Minimum information required for evaluation of credit request
Status of land acquisition and statutory clearances
Availability of construction infrastructure and status of fuel linkage.
Status of all contracts e.g. EPC, Package contract and Shareholders agreement are in
place d) Proposed off take mechanism – through long term PPA or merchant sale.
Cost of the project, Debt Equity ratio proposed.
Proposed Shareholding pattern
Promoters’ background and their capability to bring their share of contribution.
Financial projections and ratios like IRR, DSCR of the project worked out by the
applicant.
Principle business of the promoters and their ability to implement the current project.
IM aCS 2010
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38. Assessment of credit risks in cash flow (SPV) based lending…1
Financial Parameters
• Project IRR
• Average DSCR and Minimum DSCR for the base case.
• Sensitivity of DSCR and IRR to the project cost
o Change in Project Cost
o Change in PLF
o Change in Sale rate
o Change in Interest rate
o Change in fuel Cost
• CDM benefit
• Any other project specific critical risk
IM aCS 2010
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39. Assessment of credit risks in cash flow based (SPV) lending…2
Qualitative parameters
• The promoters and Quality & expertise of management.
• Market size, growth prospects and business environment.
• Global market outlook.
• Govt. policies & economic situation.
Risks could arise during the construction phase:
• Non completion of the project or various milestones.
• Time and cost overrun due to delay in completion.
• Cost overrun even though part of the project completed on time.
Risks could arise during the operating phase:
• Fuel risk, Hydrological risk , Technology risk , Revenue risk , O & M risk ,Sponsor
risk and Supplier risk etc
IM aCS 2010
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For Classroom discussion only Page 39

40. Assessment of credit risks in balance sheet based lending…1
Financial Parameters
• Quantitative factors:
o Financials, ratios e.g. Sales growth , gearing , ROCE ,Quick ratio , Cash interest
coverage ratio and retained earnings to equity etc.
o Sensitivity analysis.
o Industry inter-firm comparison.
• Sensitivity analysis.
• Industry inter-firm comparison.
Qualitative parameters
• The promoters and Quality & expertise of management.
• Market size, growth prospects and business environment.
• Global market outlook.
• Govt. policies & economic situation.
IM aCS 2010
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For Classroom discussion only Page 40

41. Assessment of credit risks in balance sheet based lending…2
Risks could arise during the construction phase:
• Non completion of the project or various milestones.
• Time and cost overrun due to delay in completion.
• Cost overrun even though part of the project completed on time.
Risks could arise during the operating phase:
• Fuel risk, Hydrological risk , Technology risk , Revenue risk , O & M risk
,Sponsor risk and Supplier risk etc
Product fit & pricing.
Credit rating.
Review of account operation.
Collateral offered.
IM aCS 2010
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For Classroom discussion only Page 41

42. DISCUSSIONS
IM aCS 2010
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43. All the contents of the presentation are confidential and
should not be published, reproduced or circulated without the
written consent of IFC, Bangladesh Bank and IMaCS.
IM aCS 2010
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For Classroom discussion only Page 43