Risk culture – Why transformation is essential
The objective of Credit Risk Management is to reduce the degree of impairment by arriving at certain mitigating measures after extrapolating the past data and using statistical analysis to decide the prospects of default. The process is continuous which require regular evaluation of portfolio, audit of sample accounts , analysis of data. The major instrument for implementation of control measures is through the policy, which is approved at the highest level of the bank. The data manifests the degree of concentration of business in segments/ geographies etc and the potential for risk in each segments / locations. Control of exposure is an essential prerequisite in risk management system. There has to be a balance between most secured top rated advances and other categories of advances , so that the revenue is also not sacrificed, keeping risk management principles in view. As transpired, Credit management policy as well as Credit monitoring policy are key instruments in inculcation of risk management culture across all the centers of the bank. There are surveillance mechanisms in place, but these are instrumental after the incident. What essentially required is a mechanism to insulate the system from aberrations on an ongoing manner. During last two decades, most of the banks developed their risk management mechanisms, still the growing degree of defaults indicate inadequacy of risk management , the true reason for which should still remains to be identified.
Most of the banks segregated centers based on credit exposure, i.e Retail. Mid corporate. Large corporate etc. Credit Administration is differentiated based on exposure and accordingly qualified and experienced officials are engaged in such sensitive centers. The delegation of credit sanction powers are also conferred based on the exposure. These centers are expected to play their role judiciously within the framework of the policy guidelines stipulated by the bank. Any departures from the prescribed norms require approval of higher authority. Sanction process involves various tiers. Any new business, including new lines of business of existing obligors, require approval of new business committee , which is generally different from the sanctioning authority. Acceptance of any new business requires fulfillment of certain minimum criteria, e.g BB+ (or as prescribed) rating of external rating agencies, since that is the floor for 100% capital adequacy. Beyond the stipulated minimum the capital adequacy requirement is higher. New business committee examines acceptability of the new business line as well as the new entrepreneur. Bank maintains data base of exposure in various industry segments. The objective is to restrict over exposure in certain sectors or certain borrowers. It is necessary to keep track of exposure of banking sector in various sectors. In case default rate is more in certain sectors, further exposure in such sectors are restricted.
Risk management guidelines are more explicit about liquid securities and credit rating. Other collateral securities are generally not recognized for capital adequacy purposes. On the other hand Indian banks prioritize proposals with non project collateral. This is because of the past experience, which shows that value of the collateral was high at the time of sanction, but reduced drastically, since value of project assets are dependent upon the status of the industry. In case business is sluggish the assets only fetch real estate value., since there are no takers of the assets. Further, in connivance with valuation professional , the value of the asset is inflated at the time of sanction. There are also local problems, such as blockage of entrance partially by installing make shift shops etc, which influences the value of project assets. Value of stock ,against which facilities are sanctioned, also escape the attention of banks and deplete fast whenever there is default. Banks engage officials for periodic evaluation by way of credit audit, inspection etc and also quarterly audits to ensure that the quality of the portfolio is maintained. Despite of all those surveillance mechanisms, the degree of default continues to grow, with some exception of retail credit. It is imperative that the matter is evaluated properly to identify the reasons of the aberration.
Lot of thinking went in to the creation of an infrastructure for corporate governance of risk management , but the compatibility with the operational mechanism of credit dispensation did not receive required attention. In compliance with the corporate guidelines of risk management, centers were advised to ensure adherence of the terms of sanction , but the systems and procedures at the operational level did not undergo significant transformation. Reliance on the external rating was an one time requirement, for sanction of the facilities or enhancement at the end of the sanction process and is examined at the time of review/renewal.
Basle committee considered its recommendations based on study of banking operation in countries where legal system is adequate and time bound. While recommending policies the committee advised central banks of the respective countries to implement based on the state of the economy. Owing to the heterogeneous demography etc, and despite of repeated government interventions, the legal system is not fast enough to address the delay in settlement of financial disputes of small and medium business units. The legal system is far from satisfactory. The entrepreneurs are also hesitant to take legal recourse in apprehension of losing the business. Any further tightening of NPA norms will only affect these units where the owners intend to run the business honestly but do not have control on the realization of dues. It happens both with government as well as large corporate. The sanctions imposed by US on Iran affected the realization of export proceeds and also sealed further prospect of export to Iran, which used to be a major source of export.
The role played by RBI is the past decade was more of a guide and supporter. In support of ailing exporters , who were affected by International political volatility, RBI advised the banks to allow handholding operations. Many units were saved from closure in this process. At this stage , when the banking sector is facing stiff increase in impairment, instead of enforcing strict norms of NPA, they should be more supportive . In early 2000, Japan faced similar situation, but their pragmatic approach helped them to come out of the crisis. The willful defaulters are aberrations and should be taken to task, but entrepreneurs require support from lenders at the time of volatility. Cessation of operation of an unit result in unemployment in its own unit as well as in associated units supplying materials and services to the unit. Even government owned aviation company is managing working capital requirement with the support of vendors. The resultant effect is in the balance sheet of the banks.
Credit administration at the dispensation centers plays a vital role. The policy prescriptions of risk management, such as segregation of credit sanction and credit administration is difficult to achieve unless similar segregation is attempted at the operational level. It is generally found that the same official is empowered to process sanction proposals as well as administration of the unit by making inspection as well as allowing drawing power. Job design is literally nonexistent in large corporate /flagship corporate branches, in absence of which it is impossible to assess staff accountability. As a result there are cases of wrongful assessment of accountability. The result is slow down in lending decisions.
At this stage it is an essential requirement that banks are permitted to engage in handholding operation of ailing units and extend period of default for identification of impairment. The task before the regulator is to ensure continuation of operation in industrial units and support genuine entrepreneurs by examining possible avenues. The banks should be encouraged to support ailing units. Japan has shown the way of how to come out of a crisis situation, it is also possible for us to evaluate and develop strategy to overcome the crisis.
