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Credit Risk

Credit risk is the possibility of a loss being incurred as a result of the failure of a borrower or a counterparty of the Bank to honour their contractual obligations (both on and off-Balance Sheet). The Bank’s business model entails assumption of multitude of credit risks ranging from Lending, International Trade, Treasury Functions, Leasing and Creation of Off-Balance Sheet Exposures such as Letters of Credit and Guarantees. The Bank considers the Credit Risk as the most material risk in the overall risk management process in view of the fact that Lending is the main line of business of the Bank at present which accounts for over 63% its total assets.

Credit Risk Management Structure

The Bank strives to optimise a well-structured credit risk management process through assessing, quantifying, pricing, monitoring and managing credit risk on a consistent basis. The credit risk management structure of the IRMD comprises of the following two key functions:

Country Risk

Country Risk arises when the Bank engages in cross border transactions denominated in foreign currencies. Country Risk generally comprises of the potential losses arising from sovereign transfer restrictions imposed in the counterparty’s country for transferring of money in foreign currency. Country Risk could also arise due to other factors such as political instability or economic downturn of a country on which the Bank has credit exposures.

Credit Risk Appetite

The credit risk appetite of the Bank is set by the Board of Directors and contains a set of credit portfolio monitoring measures which include policies, sector caps, products and country limits to manage the risk within the approved parameters. The ‘Credit Risk Appetite’ including the ‘Risk Acceptance Criteria’ are clearly defined in the ‘Lending Guidelines’ of the Bank and all the Lending Officers are expected to follow these guidelines in evaluating credit proposals/managing credit portfolios.

All the credit risk exposures in the Bank are first evaluated by the business line managers who are considered to be the primary risk owners of the organisation. The Bank is managing the credit risk exposures of the borrowers through establishment of individual credit limits which are approved by various layers of Lending Officers/Credit Committees depending on the size of the credit exposure. Presently, all the high valued credit proposals and new lending products are referred to the Credit Risk Management Unit (CRMU) of the IRMD for independent evaluation and comments prior to the approval.

The Credit Policy Committee (CPC), the Executive Integrated Risk Management Committee (EIRMC) and the Board Integrated Risk Management Committee (BIRMC) supervise and set various concentration limits under different criteria to support prudent portfolio management (i.e. single borrower, industrial/service sectors, product and collateral). These limits are continuously monitored and periodically reviewed to reflect factors such as the current market conditions, future trends, Bank’s risk appetite, portfolio considerations etc. The Bank has devised a System to manage the credit risks on local/foreign counterparty banks and the cross border exposures through a comprehensive set of limits which are reviewed on a continuous basis depending on the financial/economic performance of these counterparties/countries. The concentration levels on the said limits are closely monitored by the CRMU and the exposures are reported to the Executive/Board Committees on a regular basis.

The Credit Risk Review (CRR) function of the CRMU independently identifies lending that is well managed and likely to perform well in adverse circumstances and separately identifies performing lending where emerging risks have not been identified and/or reflected in Rating Reviews. The CRR function focuses on monitoring the credit management processes, quality of portfolios and risk grading system, with the aim of ensuring the maintenance of high credit standards by the Lending Officers at all times.

Type of Credit Risk Exposures

The credit risk of the Bank can be broadly categorised into three types, i.e., (a) Loan Default Risk (b) Counterparty Risk and (c) Country Risk.

Loan Default Risk

This arises from the potential losses on lending operations mainly involving corporate/retail borrowers. The credit exposures on account of corporate and retail borrowers are mainly created from conventional on Balance Sheet lending products such as Overdrafts, Term Loans, Short-Term Loans, Import Loans, Pre-Shipment Loans, Export Bill Purchasing etc., and off-Balance Sheet exposures such as Letters of Guarantee, Letters of Credit, Usance Import Bills etc.

Counterparty Risk

This risk arises from the potential losses on account of Forex Transactions, Money Market Placements, Nostro Transactions and Counter Guarantees involving the local and foreign counterparty banks. The Counterparty Risk is further segregated into three sub risk types: Settlement Risk (the uncertainty that the counterparty will make the corresponding payment to match our advance payment), Replacement Risk (the risk that the Bank will have to replace a transaction at a less favourable market condition following a default by the counterparty) and Cash Risk (the risk that the counterparty not paying the debt obligations).

The Bank has classified the sectors which are of no/limited credit appetite into two main categories; i.e., ‘Prohibited Appetite’ and ‘High Risk’. The sectors which will not be entertained for lending under any circumstances, either due to the very high risks involved or because of negative social/ethical considerations are listed under ‘Prohibited Appetite’ whereas the sectors which are perceived to be exceptionally risky have been listed under the ‘High Risk’ category. The Lending Officers need to ensure that adequate risk mitigants and proper pricing are in place when entertaining proposals from such 'High Risk’ sectors in exceptional circumstances.

Credit Risk Indicators and Monitoring

The Bank’s credit portfolio is subject to continuous close monitoring against predefined key benchmarks and thresholds. This encompasses production and analysis of regular reports on significant risk exposures for review by various management committees. The Bank monitors the advances portfolio at the highest possible granularity to effectively counter the potential adverse impact of over concentration on single parties, industry sectors and loan products etc. This process enables the Bank to identify any emerging risks in the individual credit portfolios and to take suitable corrective action in a proactive manner. Another main focus of portfolio management process is to derive the maximum benefit associated with the diversification of the Bank’s advances portfolio into multitude of thriving economic segments which are perceived to be acceptable risk in the Bank’s lending strategy.

Further, the Bank tracks the quality of the loan book on a regular basis by analysing risk migration and trends in the Non-Performing ratios of different lending portfolios. Such indicators prompt the relevant Risk Management Committees to take timely decisions in preserving the quality of loans and advances.

With the automation of the credit evaluation process during the 1st half of the year 2012, the Bank will improve its risk grading system with the capability of predicting the Probability of Default (PD), Loss Given Default (LGD) and the Exposure at Default (EAD) of a borrower. These indicators would help the Lending Officers to measure the risk profile of the credit portfolios in a more objective manner and will further strengthen the Bank’s credit risk management capabilities.

The provision cover of the Bank improved from 34.05% as at December 31, 2010 to 39.53% as at December 31, 2011. Further, the Bank has made provisions over and above the guide lines stipulated by the regulator.

The open credit exposure too strengthened from 18.6% in 2010 to 14.26% during the period under review signifying the Bank's resilience to absorb any credit losses even without considering the collateral values.