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The IUP Journal of Bank Management
Credit Risk Management of Loan Portfolios by Indian Banks: Some Empirical Evidence
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The basic functions of most of the banks are the acceptance of deposits from public and lending funds to public, corporate, etc. This business of lending has brought trouble to individual banks as well as to the entire banking system, thus giving rise to credit risk, which is the risk of default. The present paper is designed to develop an internal credit rating model for banks which improves their current predictive power of financial risk factors. It also studies how banks assess the creditworthiness of their borrowers and how can they identify the potential defaulters so as to improve their credit evaluation. To achieve the above-mentioned objective, a research has been conducted considering the data for the last six years. Altman Z-Score model is used to arrive at an equation of the Z-Score, which helps the banks to predict future defaulters and take necessary action accordingly. The model, which has been developed, is an application of multivariate discriminant analysis in credit risk modeling.

 
 
 

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.

 
 
 

Bank Management Journal, Credit Risk Management, Indian Banks, Economic Reforms, Non-Performing Assets, Risk Management, Corporate Distress, Industrial Sectors, Scheduled Commercial Banks, Statistical Package for Social Studies, Indian Banking Industry, Risk Modeling Techniques, Credit Risk Modeling.