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Part - II

1.2      Building Blocks on Credit Risk
In any bank, the corporate goals and credit culture are closely linked, and an effective credit risk management framework requires the following distinct building blocks: -

1.2.1      Strategy and Policy
This covers issues such as the definition of the credit appetite, the development of credit guidelines and the identification and the assessment of the credit risk.

1.2.2      Organisation
This would entail the establishment of competencies and clear accountabilities for managing the credit risk.

1.2.3      Operations/Systems
MIS requirements of the senior and middle management, and the development of tools and techniques will come under this domain.

1.3      Strategy and Policy

1.3.1      It is essential that each bank develops its own credit risk strategy or enunciates a plan that defines the objectives for the credit-granting function. This strategy should spell out clearly the organisation's credit appetite and the acceptable level of risk - reward trade-off at both the macro and the micro levels.

1.3.2      The strategy would therefore, include a statement of the bank's willingness to grant loans based on the type of economic activity, geographical location, currency, market, maturity and anticipated profitability. This would necessarily translate into the identification of target markets and business sectors, preferred levels of diversification and concentration, the cost of capital in granting credit and the cost of bad debts.

1.3.3      The policy document should cover issues such as organizational responsibilities, risk measurement and aggregation techniques, prudential requirements, risk assessment and review, reporting requirements, risk grading, product guidelines, documentation, legal issues and management of problem loans. Loan policies apart from ensuring consistency in credit practices, should also provide a vital link to the other functions of the bank. It has been empirically proved that organisations with sound and well-articulated loan policies have been able to contain the loan losses arising from poor loan structuring and perfunctory risk assessments.

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Compiled by CoolAvenues Knowledge Management Team