The Basel Committee on Banking Supervision in September 2000 has given guidelines regarding the principles of Credit Risk Management. This induces the banking sector to promote sound practices in credit risk management globally. Such guideline covers five major areas1, as given below:
- i. Establishing an appropriate credit risk environment;
- ii. Operating under a sound credit granting process;
- iii. Maintaining an appropriate credit administration, measurement, and monitoring process; and
- iv. Ensuring adequate controls over credit risk.
- v. Role of Supervisors
i) Establishing an appropriate credit risk environment: For establishing an appropriate credit risk management, three principles are pronounced by the BIS.
- Principle 1: The Board of directors has the responsibility of approving and periodically reviewing the credit risk strategy and significant credit risk policies of the bank. The strategy reflects the bank‘s tolerance for risk and the level of profitability the bank expects to achieve for incurring various credit risks.
- Principle 2: Senior management has the responsibility for implementing the credit risk strategy approved by the Board of directors and for developing policies and procedures for identifying, measuring, monitoring, and controlling the credit risk of the Bank. Such policies and procedures address credit risk in all its activities and at both the individual and portfolio levels.
- Principle 3: Banks have to identify and manage the credit risk inherent in all products and activities. They have to ensure that the risks of products and activities new to them, before being introduced or undertaken, and approved in advance by the Board of directors or its appropriate committee, are subject to adequate procedures and controls.
ii) Operating under a sound credit granting process: Four guidelines, as listed below, are given by the BIS to ensure sound credit-granting process.
- Principle 4: Banks have to operate under sound, well-defined credit-granting criteria. The criteria include a thorough understanding of the borrower or counterparty, as well as the purpose and structure of the credit, and its source of repayment.
- Principle 5: Banks have to establish overall credit limits at the level of individual borrowers and counterparties, and groups of connected counterparties that aggregate in a comparable and meaningful manner is different types of exposures, both in the banking and trading book and on and off the balance sheet items.
- Principle 6: Banks have to ensure a clearly-established process in place for approving new credits as well as the extension of existing credits.
- Principle 7: All extensions of credit are to be made on an arms-length basis. In particular, credits to related companies and individuals need to be monitored with special care, and appropriate steps need to be taken to control or mitigate the risks of connected lending.
iii) Maintaining an appropriate credit administration, measurement, and monitoring process: To facilitate banks to have an appropriate credit administration, measurement and monitoring, six guidelines as given below are furnished by BIS:
- Principle 8: Banks have to ensure a system for the ongoing administration of their various credit risk-bearing portfolios.
- Principle 9: Banks need to have a system for monitoring the condition of individual credits, including determining the adequacy of provisions and reserves.
- Principle 10: Banks need to develop and utilize internal risk rating systems in managing credit risks. The rating system has to be consistent with the nature, size, and complexity of a bank‘s activities.
- Principle 11: Banks need to have information systems and analytical techniques that enable management to measure the credit risk inherent in all on- and off-balance sheet activities. The management information system should provide adequate information on the composition of the credit portfolio, including the identification of any concentration of risk.
- Principle 12: Banks need to have in place a system for monitoring the overall composition and quality of the credit portfolio.
- Principle 13: Banks have to take into consideration potential future changes in economic conditions when assessing individual credits and their credit portfolios, and they should assess their credit risk exposures under stressful conditions.
v) Role of Supervisors The role of supervisors of the Bank with regard to the role of supervisors is accorded in principle 17.
- Principle 17: Supervisors require that banks have an effective system in place to identify, measure, monitor, and control credit risk as a part of an overall approach to risk management. Supervisors conduct an independent evaluation of a bank‘s strategies, policies, practices, and procedures related to the granting of credit and the ongoing management of the portfolio. Supervisors need to consider setting prudential limits to restrict bank exposures to single borrower or groups of connected counterparties.
For citing this article use:
- Prem Kumar, S. (2019). A study on credit risk management of new generation private sector banks in india.