CREDIT RISK MANAGEMENT IN STATE BANK

OF INDIA

BY
KALSANG LHAMO
IV SEMESTER M.COM
Reg. no. MCM150309

ST.PHILOMENAS COLLEGE
MYSORE-570015
 TABLE OF CONTENTS
Chapters Particulars Page
number Number
INTRODUCTION
1. Need of study
Statement of problem
Objective of study
Methodology
Scope of study
 CHAPTER-1

INTRODUCTION
INTRODUCTION:
Banks are very important in every economy because they provide special
functions or services which if disturbed or interfered with, can lead to
adverse effects on the rest of the economy. They make available financial
resources necessary for economic growth from lenders to borrowers. They
take deposit from those who have to save (lenders) and then lend the
money deposited to those who is in deficit (borrowers) as loans. There
traditional activity of deposit taking and loans making enlarged with
activities like remittance, foreign exchange dealings, trustee services,
securities brokerages, investment advisory dealings, bill paying, leasing
factoring, etc.

Despite all the problems that banks might face, the major one
which is very delicate and can have very negative consequences stem
largely from loans that are not paid even after their due date. This is
termed credit risk. Credit risk is seen as very big problem because it
results to increase debts since the bank will have to borrow more in order
to meet up with its demands especially from its customers who may come
for cash withdrawals. This leads to higher interest payments, reduced
borrowing capacity, reduced profits since less customers will borrow,
increased equity, reduced shareholders value, reduced future capital
investments, limiting the banks long term business performance, or an
increase in the length of trade credit taken from suppliers.

Risk is inherent in all aspects of a commercial operation and covers areas

such as customers services, reputation, technology, security, human
resources, market price, funding, legal and regulatory, fraud and strategy.
However for banks and financial institutions credit risk is the most
important factors to be managed. The term credit risk is defined, as the
potential that a borrower or counter-party will fail to meet its obligations in
accordance with agreed terms. In simple terms, its the probability of loss
from a credit transaction.

State Bank of India (SBI) is the largest bank in India. If one

measures by the no. of branches offices and employees, SBI is the largest
bank in world. Established in 1806 as bank of Bengal it is the oldest
commercial bank in the Indian subcontinent. SBI provides various
domestic, international and NRI products and services, through its vast
network in India and overseas. The government nationalized the bank in
1955, with reserve bank of India taking a 60%ownership stake.
The state bank of India traces its roots to the first decade of 19th century,
when the bank of Calcutta, later renamed the Bank of Bengal, was
established on 2nd June 1806. The government amalgamated bank of
Bengal and two other presidency banks, namely, the bank of Bombay and
the bank of madras and named the reorganized banking entity the
imperial bank of India. The state bank of India act 1955, enacted by the
parliament of India, authorized the reserve bank of India, to acquire a
controlling interest in the imperial bank of India, which was renamed the
state bank of India on 30th April 1955.
In recent years, the bank has sought to expand its overseas operations by
buying foreign banks. It is the only Indian bank to feature in the top 100
world banks in the Fortune Global 500 rating and various other rankings.
According to the Forbes 2000 listing it tops all Indian companies.
 LITERATURE REVIEW
Literature review is most important to identify the problem of the study,
which can be solved by collection of data. Literature review observes the
work being done is not repeated unintentionally. It also helps to avoid the
mistakes, which is already done by another authors. A well created
literature review establishes creditability of the researcher of the study, so
he can get the entire benefit of his work.

INTERNATIONAL PERSPECTIVE
Crouhy, Gala, Marick have summarized the core principles of
enterprise wide risk management. As per the authors risk management
culture should percolate from the board level to the lower level employee.
Firms will be required to make significant investment necessary to comply
with the latest best practices in the new generation of risk regulation and
management. Corporate governance regulation with the advent of
Sarbanes-Oxley Act in US and several other legislations in various
countries also provide the framework for sound Risk management
structures. Hitherto, enterprise wide risk management existed only for
name sake. Generally firms did not institute a truly integrated set of risk
measures, methodologies or risk management tools encompassing all the
activities of a corporation. The integrated risk management infrastructure
would cover areas like corporate compliance, corporate governance,
capital management etc. areas like business risk, reputation risk and
strategic risk also will be incorporated in the overall risk architecture more
formally. As always it will be the banks and the financial services firms
which will lead the way in this evolutionary process, the compliance
requirements of Basel II and III accords will also oblige banks and financial
institutions to put in place robust risk management methodologies.

The authors felt that risk management concerns largely with activities
within the firm, however, during the next decade government in different
countries would desire to have innovatively drawn risk management
system for the whole country. The authors draw reference to the
suggestions of Nobel laureate Robert Merton who suggested that a
country with exposure to a few concentrated industries should be obliged
to diversify its excessive exposures by arranging appropriates swaps with
other countries with similar problems. Risk management offers many
other potential Marco applications to improve the management of their
social security measures etc. they draw references to the spread of risk
management education worldwide.
Daniele Nouy (29) elaborates the Basel core principles for effectives
banking supervision, its innovativeness, content and the challenges of
quality implementation. Core principles are a set of supervisory guidelines
aimed at providing a general framework for effectives banking supervision
in all countries. They are innovative in the way comprehensive in
coverage, providing a checklist of the principal features of a well-designed
supervisory system.

The core principles specify preconditions for effective banking

supervision characteristics of an effective supervisory body, need for
credit risk management and elaborates on principle 22 dealing with
supervisory powers. Dearth of skilled human resources, poor financial
strength of supervisor and consequent inability to retain talented staff,
inadequate autonomy and the need for greater understanding of modern
risk management techniques are identified as the main difficulties in
quality implementation. The critical elements of infrastructure, legal
framework that supports sound banking supervision and a credit culture
that supports lending practices are the essence of a strong banking
system. Widespread failures have occurred during a period of increased
vulnerability that can be traced back to some regime change induced by
policy or by external conditions.
Jacques De Larosiere, former managing director of the international
monetary fund discusses the implications of the new prudential
framework. He explains at length how the new regulatory code could have
some dangerous side effects. The increased capital requirements as
decided by the Basel Committee on banking supervision in September
2010 will affect the amount of own funds would affect the profitability of
the banks. The consequences of such increased capital requirements
would incentivize the banks to transfer certain operations that are heavily
taxed in terms of capital requirement to shadow banking to avoid the
scope of regulation. The risks of such a practices might affect the financial
stability. While the central banking authorities might contemplate
registration and supervision of such shadow banking entities like the
hedge funds and other pools, such a course might be more cumbersome
than expected. The new regulation would result in the banks to reduce
activities with rather poor margins. For example they may reduce
exposure to small and medium enterprises or increase credit costs or
concentrate on more profitable but higher risk activities. He is also critical
of the proposal of Basel to introduce an absolute leverage ratio that might
push banks to concentrate their assets in riskier operations. The authors
feels that the banking model which favours financial stability and
economies growth might become the victim of the new prudential
framework, and force banks to search for assets with maximum returns
despite the attendant risks.

As per G.Rutherbeg, M.Sarnat and B.Z.Schreiber (36) risk is intrinsic to

banking. However the management of risk has gained prominence in view
of the growing sophistication of banking operations, derivatives trading,
securities underwriting and corporate advisory business etc. risk have also
increased on account of the on-line electronic banking, provision of all bill
presentation and payment services etc. the major risks faced by financial
institutions are of course credit risk, interest rate risk, foreign exchange
risk and liquidity risk.
Credit risk management requires that banks develop loan assessment
policies and administration of loan portfolio, fixing prudential per
borrower, per group limits etc. the tendency for excessive dependence on
collateral should also be looked into. The other weaknesses in credit risk
management are inadequate risk pricing, absence of loan review
mechanism and post sanction surveillance.
Interest rate risk arises due to changes in interest rates significantly
impacting the net interest income, mismatches between the time when
interest rates on asset and liability are reset etc. management of interest
rate risk involves employing methods like value-at-risk (VAR), a standard
approaches to assess potential loss that could crystallize on trading
portfolio due to variations in market interest rates and prices. Foreign
exchange risk is due to running open positions. The risk of open positions
of late has increased due to wide variations in exchange risks. The board
of directors should law down strict intraday and overnight position to
ensure that the foreign exchange risk is under control.
Chief risk officer, Alden Toevs of commonwealth bank of Australia 37
states that a major failure of risk management highlighted by the global
financial crisis was the liability of financial institution to view risk on a
holistic basis. The global financial crisis exposed, with chilling clarity the
dangers of thinking in silos, particularly where risk management is
concerned says the author. The malady is due to the banks focusing on
individual risk exposures without taking into consideration the borders
picture, as per the author the root of the problem is the failures of the
banks to consider risks on an enterprise-wide basis. The new relevance
and urgency for implementing the enterprise risk management (ERM) is
due to the regulatory insistence with a number of proposals to ensure that
institution stay focused on the big picture. In a way the three pillar
approach frame work of the Basel II accord is an effort to fulfil this
requirement. The risk weighted approaches to credit risk on the basis of
the asset quality, allocation of capital to operational risk and market risks
attendant to a banks functioning.

LITERATURE REVIEW: INDIAN PERSPECTIVE

Rekha Arunkumar and Koteshwar (38) feel that the credit risk is the oldest
and highest risk that banks, by virtue of their very nature of business
inherit, the predominance of credit risk takes the major part of the risk,
management apparatus accounting for over 70 percent of all risks. As per
them the market risk and operational risk are important, but more
attention needs to be paid to the credit risk management in banks.
Reserve banks of India, volume 3, 1967-81. (39) Gives very valuable
account of the evolution of central banking in India. This third volume
describes vividly the background against which the reserve bank of India
came into being on April 1, 1935. Before the establishment of the reserve
bank, the central banking functions were handled by the imperial bank of
India. The royal commission on Indian currency and finance (Hilton young
commission) 1926 recommended that there is conflict of interest in the
imperial bank of India functioning as the controller of currency while also
functioning as a commercial bank. After detailed analysis on the
ownership, constitution and composition of the ownership, RBI was
established by a bill in the legislative assembly. It was in 1948 that the
reserve bank of India was nationalized under the RBI (transfer to public
ownership) Act 1948. The earlier volumes viz., volume I and volume II
covered the developments in central banking up to 1967. Volume III cover
the period 1967 to 1981. This is the most dynamic period in the history of
commercial banking. The government was very critical of the attitudes of
the private banks for their failure to be socially responsible, which led the
govt. to impose social control on banks. Mrs. Indira Gandhi nationalized 14
banks during July 1969. Reserve bank was given newer responsible in
terms of the developmental role.
The RBI was assigned not only the role of maintaining monetary and fiscal
stability but also the development role of establishing institutional
framework to complement commercial banking to help agriculture, SSI
and export sectors. RBI, despite the criticism of not enjoying adequate
autonomy due to the interference of the finance ministry (with govt.
ownership of most banking companies) has been able to commendably
discharge the regulatory functions.
True it was during this period that the performance of the Indian
banks deteriorated with most nationalized banks wiping out their capital
and their balance sheets showing huge negatives in terms of quality of
assert etc.
The period covered by the volume III is the pre-liberalization and
pre-reform period and the reserve bank had to compromise on its
regulatory and supervisory role in view of the Govt. control over banks.
Banking law and regulation 2005(40) published by Aspen Publisher
looks at the regulatory practices relating to banks and financial
institutions. The book analysis the various provision of the Gramm-Leach
Bialy Act 1999, the Financial Institutions recovery and Enforcement Act
2002, the Federal Deposit Insurance Corporation Improvement Act, and
the Fair and Accurate Credit Transaction Act 2003.
S.K Bagchi (41) observed that in the world of financial more specifically in
banking, credit risk is the most predominant risk in banking and occupies
roughly 90-95% of risk segment, the remaining fraction is on account of
market risk, operations risk etc. he feels that so much of concern on
operational risk is misplaced. As per him, it may be just one to two
percent of banks risk. For this small fraction, instituting an elaborate
mechanism may be unwarranted. A well laid out Risk Management system
should give its best attention to credit risk and market risk. In instituting
the risk management apparatus, banks seem to be giving equal priority to
these three risks viz., credit risk, operational risk and market risk. This
may prove counter-productive.
Securitization and reconstruction of financial assets enactment of
security interest act 2002. (SARFAESI ACT) (42) govt. of India has taken
the initiative of making the legislation to help banks to provide better risk
management for their asset portfolio. Risk management of the loan book
has been posing a challenge to the banks and financial institutions which
are helpless in view of the protracted legal processes. The act enables
banks to realize their dues without intervention of courts and tribunals. As
a part of the consideration in the form of debentures, bonds etc. this
relieves the bank transferring the asset to concentrate on their loan book
to secure that the quality of the portfolio does not deteriorate. The act
contains severe penalties on the debtors. The AMC is vested with the
power of issuing notices to the borrowers calling for repayment within 60
days. If the borrower fails to meet the commitment, the AMC can take
possession of the secured asset to concentrate in the form of debentures,
bonds etc. this relieves the bank transferring the assets to concentrate on
their loan book to secure that the quality of the portfolio does not
deteriorate. The act contain severe penalties on the debtors. The AMC is
vested with the power of issuing notices to the borrowers calling for
repayment within 60 days. If the borrower fails to meet the commitment,
the AMC can take possession of the secured assets and appealing to the
debt tribunal, but only after paying 75% of the amount claimed by the
AMC. There are strict provision of penalties for offences or default by the
securitization or reconstruction company. In case of default in registration
of transactions, the company officials would be fined up to rs 5000/- per
days similarly non-compliance of the RBI directions also attract fine up to
rs 5 lakhs and additional fine of rs 10,000/- per day. This has proved to be
a very effective risk management tool in the hand of the banks.
The report of the banking commission 1972-(43) RBI Mumbai. The
commission made several recommendation for making the Indian banking
system healthier. The commission observed that the system of controls
and supervisory oversight were lax and underlined the need for closured
supervision of bans to avoid bank failures. However most of the
recommendation of the commission lost their relevance in view of the
proprieties of the government which is more concerned with its relevance
in view of the priorities of the government which is more concerned with
its political compulsions. The nationalisation of banks and the tight control
on the banks of the govt. left little scope for implementation of the
recommendations of the commission. If only the recommendation which
are meant to restore tighter regulatory measures, strengthening of the
internal control systems and professionalization of the bank boards were
properly appreciated and implementation, Indian banks would not have
ended in the mess of corrosion of capital , mounting burden of non-
performing assets, etc.
A well-known study analysing the performance of commercial banks in
India was conducted by Vashist (1991). Avatar Krishna Vashist: public
sector banks in India H.K.Publishers&distributors, New Delhi 1991.
In order to find out relative performance of different banks, composite
weighted growth index, relative growth index and average growth index of
banks were constructed. The study revealed that commercial banks did
well with respect to branch expansion, deposit mobilization and
deployment of credit to the priority sectors. But they showed poor
performance in terms of profitability. After identifying the causes of the
decline in profitability a number of suggestions were made to improve the
performance of commercial banks in the country.
Dr.Atulmehrotra, Dean, Vishwakarma institute of management
emphasizes the need for promotion of corporate governance in these
uncertain and risky times. This paper discussed at length corporate
government related aspects in banks as also touches upon the principles
for enhancing corporate governance in bank as suggested by BCBS. The
author felt that despite the RBIs initiatives on the recommendations of
the consultative group of directors of banks/ financial institutions under
the chairmanship of Dr.A.S.Ganguly, member of the board for financial
supervision, there is more ground to be covered before Indian banks are in
a position to attain good government standards. As per the author the
publish sector banks with government ownership control almost over 80
percent of banking business in India. This complicates the role of the
reserve bank of India as the regulator of the financial system. The role of
the government performing simultaneously multiple functions such as the
manager, owner, quasi-regulator and sometimes even as super-regulator
presents difficulties I the matter. Unless there is clarity in the role of the
government, and unless boards of the banks are given the desired level of
autonomy, it will be difficult to set up healthy governance standards in the
banks.
As a part of the review of literature, the reports of various committees and
commissions have been perused. Important among them are given below:
The report of the committee on the financial system 1991 chairman Shri
M.Narsimham by far is the most important document while discussing the
reform process in Indian banking. The following recommendations made
by the committee which were largely implemented put the Indian banking
system on an even keel:
Main recommendations:

1. Operational flexibility and functional autonomy.

2. Pre-emption of lendable resources to be stopped by progressively

reducing the SLR and CRR

3. Phasing out of directed credit programmers.

4. Deregulation of interest rates.

5. Capital adequacy requirements to be gradually stepped up.

6. Stricter income recognition norms.

7. Provisioning requirements tighten.

8. Structural organization.

i. Three to four large banks (including state bank of India) which

could become international in character.

ii. Eight to ten national banks with a network of branches

throughout the country engaged in universal banking

The indian banking system:

Banking in our country is already witnessing the sea changes as the
banking sector seeks new technology and its applications. The best port is
that the benefits are beginning to reach the masses. Earlier this domain
was the preserve of very few organizations. Foreign banks with heavy
investments in technology started giving some out of the world
customer services. But, such services were available only to selected few-
the very large account holders. Then came the liberalization and with it a
multitude of privates banks, a large segment of the urban population now
requires minimal time and space for its banking needs.
Automated teller machines or popularly known as ATM are the three
alphabets that have changed the concepts of banking like nothing before.
Instead of tellers handling your own cash, today there are efficient
machines that dont talk but just dispenses cash. Under the
Reserve bank of India Act 1934, banks are classified as scheduled banks
and non-scheduled banks. The scheduled banks are those, which are
entered in the second schedule of RBO Act 1934. Such banks are those,
which have paid-up capital and reserve of an aggregate value of not less
than Rs 5 lacks and which satisfy RBI that their affairs are carried out in
the interest of their depositors. All commercial banks Indian and foreign,
regional rural banks and state co-operative banks are scheduled banks.
Non-scheduled banks are those, which have not been included in the
second schedule of the RBI Act, 1934.
The organized banking system in India can be broadly classified
into three categories:
i. Commercial banks
ii. Regional rural banks
iii. Co-operative banks.
The Reserve Bank of India is the supreme monetary and banking
authority in the country and has the responsibility to control the
banking system in the country. It keeps the reserve of all
commercial banks and hence us known as the Reserve Bank.
 The structure of Indian baking:
The Indian banking industry has reserve bank of India as its
regulatory authority. This is a mix of the public sectors, co-operative
banks and foreign banks. The privates sectors banks are again split
into old banks and new banks.

Reserve Bank of India

(Central bank)

Scheduled
Banks

Scheduled
Scheduled co-
commercial bank
operative banks

Public Private Foreign Regional

Sector bank Sector Bank banks Rural

Nationaliz SBI & Its Scheduled Scheduled

ed bank associate Urban co- state co-
s operative operative
banks

Old Privates New Private

Sector bank Sector
NEED FOR THE STUDY:
Banking professionals have to maintain a balance between the
risk and the returns. For a large customer base banks need to have a
variety of loan products. Credit risk management is risk assessment that
comes in an investment. Risk often come in investing and in the allocation
of capital. The risk must be assessed so as to derive a sound investment
decision and sound decision should be made by balancing the risks and
returns.

STATEMENT OF THE PROBLEM:

Credit risk encompasses both default risk and market risk. Default risk is
the objectives assessment of the likelihood that counterparty will default.
Market risk measures the financial loss that will be experienced should the
client default.
Non-Performing Assets are getting increased in banks which
are due to unrecovered loans.
Banks are facing the risk of exposure arising from traded
market products.

OBJECTIVES OF THE STUDY:

1. To study the complete structure and history of State Bank of India.
2. To know the different methods available for credit rating and
understanding the credit rating procedure used in State Bank of
India.
3. To gain insights into the credit risk management activities of the
State Bank of India.
4. The compare credit policy adopted in selected public sector and
private sectors bank.
RESEARCH METHODOLOGY:
The methods used to an analytical research where in the researcher
has to use the available facts as information and analyse these to
make critical evaluation of materials facing the industry or in firm.

DATA COLLECTION METHODS:

To fulfil the objective of my study, I would choose into consideration
secondary data.
Secondary data: the data is collected from the annual reports, journals,
internets, text books.
The various sources that were used for the collection of secondary data
are:
Internal files and materials
Websites- various sites like
www.sbi.co.in
www.indiainfoline.com
www.investopedia.com

IMPORTANCE OF THE STUDY:

The project helps in understanding the clear meaning of credit risk
management in State Bank of India. It explains about the credit risk
scoring and rating of the bank. Study is focusing on credit risk
management strategies adopted in State Bank of India from the year 2011
to 2014.

Limitation of study:
The study extensively uses the data provided in the financial reports. If
there is any window dressing the finding could be misleading.
This being academic study it suffers from the time and cost
constraints.
Some of information is of confidential in nature that could not be
divulged for the study.