Indian banking has come a long way from being a slow and lazy business institution to a
highly proactive, energetic and dynamic entity. This transformation is due to liberalization and
economic reforms that have facilitated banks to explore new business opportunities. As banks move
into a new high powered world of financial operations and trading, with new risks, there is a
need for more sophisticated and versatile instruments for risk assessment, monitoring and
controlling risk exposures.
Credit risk exists because an expected payment might not occur. Credit risk can
be defined as the probability of losses associated with diminution in the credit quality of
borrowers/counterparties or potential losses resulting from the refusal or inability of
a customer to pay what is owed in full and on time. It remains the most important risk
to manage till date (Bodla and Verma, 2009). In other words, it can be said that credit risk
is the potential that a bank borrower or counterparty will not succeed to meet up its
obligations in harmony with agreed upon terms and
conditions. Credit risk arises when the borrower
is unable to repay the loan or when the credit rating
deteriorates. The power of credit risk is even reflected in the composition of economic capital, which the banks are required
to keep aside (70%) in order to protect themselves from various risks. The remaining is
shared between the other two primary risks, viz., market risk and operational risk. So, it
has become essential for banks to check the credit risk and keep the risk under control
which would otherwise lead to an increase in Non-Performing Assets (NPAs) which
ultimately lead to bankruptcy. Non-performing asset is a loan or a lease which does not meet
its stated principal and interest payments. Normally, any commercial loan, which is
more than 90 days in arrears, and any consumer loan, which is more than 180 days in
arrears, is considered as an NPA. In other words, NPA is a debt obligation where the borrower
has not paid any formerly agreed upon interest and principal repayments to the chosen
lender for an extended period of time. Differently, the asset which is not generating any income
to the bank is called an NPA. |