Sunteți pe pagina 1din 83

38-C, MIDC Industrial Estate, Hingna Road, Nagpur- 440016.



SUBMITTED BY: Navin Kumar Choudhary


38-C, MIDC Industrial Estate, Hingna Road, Nagpur- 440016.

A Report On


Enrolment ID -08bs0004115

A report submitted in Partial Fulfillment of the requirements of MBA Program of ICFAI Business School, Nagpur

Distribution List:

Prof. Vikram Joshi, Faculty Guide, ICFAI Business School, Nagpur Mr. Amit Neole, Company Guide, Area Sales Manager ICICI Bank ACKNOWLEDGEMENT

This is an effort in the direction which fulfills the need of my MBA program. As the efforts cannot be successful single handily this report is also completed under the guidance many supportive hands. The report and analysis details which are being presented here are a tiresome and fruitiest effort of many unseen hands that were continuously being a helping hand in all kind of conditions. At this onset I would like to pay my sincere gratitude and thankfulness to my project guide Mr. Amit Neole who is the Area Sales Manager of ICICI Bank, Nagpur .His stimulating suggestions and encouragement helped me in all the time of my Summer Internship Project. He made me aware about the working environment of the company. He also introduced me to the basic concepts and banking channel of the company. His dedication and hard work was always a source of inspiration for me. I am also thankful to ICICI Bank to give me an opportunity of learning about the working of the company, as well as giving me a chance to complete my project. I want to take this opportunity to extend my sincere thanks to my college mentor Prof. Vikram Joshi for guiding me throughout the tenure of my project and giving me valuable support throughout my project. He provides me many in depth details and enlightened me in the preparation of the study report. I want to acknowledge with great respect to entire Loan department which have been extremely helpful to complete my project. I also thanks to all the staff members of ICICI Bank, at Nagpur, who have always guided me during my training. I take this opportunity to thank ICFAI BUSINESS SCHOOL, NAGPUR for providing me all facilities and helping me to carry out my project successfully.


Serial Number Particulars Page Number

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Introduction Objective Research Methodology Benefit to the organization Limitations About ICICI Bank Indian banking industry Risks in Banking Credit risk management- the process Risk Management in ICICI Bank Risk Rating Sources Of Risks Considered In The Tool Credit Risk Mitigation Various Techniques Of Credit Risk Mitigation Credit Scoring Model At ICICI Bank

1 3 3 4 4 5 8 9 15 16


Model Description: Altmans Z Score Model Discriminant Analysis


17 18 19 20 21 22 23

Data Description Analysis Of The Data Through Discriminant Analysis Classification Verification of the Model Conclusion Recommendations References

36 38 49 51 53 55 56

The basic function of a bank is the acceptance of deposits from public and lending funds to public/corporate and this business of lending has brought trouble to individual banks and entire banking system. It is, therefore, vital that the banks have adequate systems for credit assessment of individual projects and for evaluating risk associated therewith as well as the industry as a whole. As banks move in to a new high powered world of financial operations and trading, with new risks, the need is felt for more sophisticated and versatile instruments for risk assessment, monitoring and controlling risk exposures. With margin levels going down, banks are unable to absorb the level of loan losses. Most of the banks have developed internal rating systems for their borrowers, but there has been very little study to compare such ratings with the final asset classification and also to fine-tune the rating system. Also risks peculiar to each industry are not identified and evaluated openly. Hence, in this paper, I have tried to address how banks assess the creditworthiness of borrowers which forms a vital part in the success and better performance of any bank across the globe. The paper deals with the credit risk management of banks. It explains as to what is the importance of credit risk as compared to many other risks in banks such as liquidity risk, market risk, interest rate risk, etc. This project tries to analyze the reasons of bank failure. In this project I have also dealt with ICICI Bank specific credit risk management techniques also. Special emphasis is given to the ICICI bank. The project also analyses the trends in NPA of banks taking the data of Non-Performing Assets of both commercial banks and private banks of India Only. The data taken for the purpose of evaluation is of past 6 years. The project uses the Altmans Z-Score model. The Altmans Z-Score Model tries to arrive at an equation of the Z-Score, which will enable the banks to predict future defaulters, and hence take the necessary actions accordingly. It will help in improving the current predicting power of financial risk factors of banks thereby helping the banks in reducing its Non-Performing Assets. The model is an application of multivariate Discriminant analysis in credit risk modeling. 3

Banking system in India is one of the most important ingredients in the Indian financial market. Banks are the biggest purveyors of credit, and they also attract most of the savings from the population. Banking industry, dominated by public sector banks, has so far acted as an efficient partner in the growth and development of the Indian economy. Driven by the socialist ideologists and the welfare state concept, public sector banks have long been the supporters of agriculture and other priority sectors. The Indian banking has come from a long way from being a sleepy business institution to a highly proactive and dynamic entity. This transformation has been largely brought about by the large dose of liberalization and economic reforms that allowed banks to explore new business opportunities rather than generating revenues from conventional streams (i.e. borrowing and lending). The world of banking has assumed a new dimension at the dawn of the 21st century with the advent of tech banking, thereby lending the industry a stamp of universality. In general, banking may be classified as retail and corporate banking. Retail banking, which is designed to meet the requirements of individual customers and encourage their savings, includes payment of utility bills, consumer loans, credit cards, checking account balances, ATMs, transferring funds between accounts and the like. Corporate banking, on the other hand, caters to the needs of corporate customers like bills discounting, opening letters of credit and managing cash. Commercial Banking mainly has two functions, which are a) Accepting deposits and b) Granting credit. Out of these two, it is the latter which is a revenue generation activity for the bank. So, it is imperative that banks carry out this function with utmost efficiency and due diligence. It is, therefore, vital that the banks have adequate systems for credit assessment of individual projects and for evaluating risk associated therewith as well as the industry as a whole. Generally, Banks in India evaluate a proposal through the traditional tools of project financing, computing maximum permissible limits, assessing management capabilities and prescribing a ceiling for an industry exposure. As banks move in to a new high powered world of financial operations and trading, with 3

new risks, the need is felt 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 potential losses from the refusal or instability credit customer to pay what is owed in full and on time. Trade credit involves a supplier providing a buyer with goods or services for which payment is deferred. Bank lending involves a bank providing a loan in return for the promise of interest and capital repayment in the future. Hence, in this paper, we try to address how banks assess the creditworthiness of borrowers which forms a vital part in the success and better performance of any bank across the globe. We understand that banks consider, among other factors, the current and prospective profitability, the borrower's history, as well as its industrial sector and how the borrower is positioned in it. The data taken for the purpose of evaluation is of past 6 years. The project uses the Altmans ZScore model. The Altmans Z-Score Model tries to arrive at an equation of the Z-Score, which will enable the banks to predict future defaulters, and hence take the necessary actions accordingly. It will help in improving the current predicting power of financial risk factors of banks thereby helping the banks in reducing its Non-Performing Assets. All the data collected in this project is sourced from various web sites and database sites such as the RBI web site and database. They are secondary databases and no aid of primary data has been taken. In this paper a total of 46 Indian banks have been taken for the purpose of study. All the banks belong to either public sector or the private sector. Out of 46 banks, 40 banks are then divided into two groups of 20 each both having equal number of companies. They are used to develop the coefficient for the discriminant analysis and to test the accuracy of the model. Then various information has been obtained regarding these banks for the purpose of the study. Rest 6 banks have been used to verify the model developed in this paper.


To study overview about the banking industry. To study the importance of credit risk in banks and its management. To study the importance of banks Non-Performing Assets in the economy of a country. To facilitate the banks in predicting future defaulters. To improve the current predicting power of financial risk factors of banks and thereby reduces Non-Performing Assets in banks.

For undertaking the project, following research methodology are adopted:

Descriptive Studies, it comes under formal research, where the objectives are clearly established. In Descriptive Studies, a researcher gathers details about all aspects of problem situation. Descriptive research seeks to determine the answers to who, what, when, where, and how questions.

SECONDARY DATA Required data for study will be collected from Secondary data sources. Secondary data include some external sources such as company internal sources, Internet, books and periodicals, published reports and study of research papers for extensive analysis. DATA INTERPRETATION AND ANALYSIS Use of research analysis tools such as SPSS software in order to run the data and develop the model for risk management along with fundamental analysis of banking sector using financial & internet data. 3

Financial sector is of pioneering importance for growing economies and any variation in its performance can affect the economy in either way. Many researchers have disclosed the fact that the financial development of the country contributes to the growth of the economy. Also, researchers have found that the firms in countries which are more financially developed, have active financial market, and large intermediary sector, are able to get more financial debt than the firms in the other countries and that is the reason why they are able to develop much rapidly (Demirguc-Kunt and Maksimovic, 1998). Similarly, Rajagopal (1996) made an attempt to overview the banks risk management and suggests a model for pricing the products based on credit risk assessment of the borrowers. He concluded that good risk management is good banking, which ultimately leads to profitable survival of the institution. A proper approach to risk identification, measurement and control will safeguard the interests of banking institution in long run.The role of banks in the financial sector is a crucial for the economy. Its importance can be seen from the fact that economic downfalls of the countries occur as a result of the banking crisis of that country. We can take the example of the Asian crisis during the second half of the 1990s. There were sufficient events which showed that the weak financial system and inadequate macroeconomic policies (The weakness in one area causing problems in the other) were the reasons in aggravating the crises. Also the problems faced by the Asian banks were only due to the bad lending practices adopted by them which were being carried on for years. Several studies in the banking literature agree to the fact that banks lending policy is a major driver of non-performing loans (McGoven, 1993, Christine 1995, Sergio, 1996, Bloem and Gorters, 2001). Although this caused rapid growth in lending activities but it also increase the risk of the banks (Lindgren et al, 1996; Caprio and Klingebiel, 2003). Gourinchas et. al. (2001) emphasizes that, while most banking crisis may be preceded by a lending boom, most lending booms are not followed by a banking crisis.

The problem of NPAs is related to several internal and external factors dealing with the borrowers (Muniappan, 2002). Sometimes when the managers obtain a reasonable return on their equity shareholdings, they involve in activities that is against the firm's value maximization. Since they have limited liability, they can adopt high risk-return strategies (i.e., over expansion of credit) in order to increase the social presence of the bank managers in an organization (Williamson, 1963). Strong competition among the banks also decreases their profits margins and forces them to take risky measures. To expand their profits bank sometimes indulge in increasing loan growth without taking much into consideration the credit evaluation standards. It focuses too much on its shortterm objectives. Hence the bank managers finance negative NPV projects during expansions (Rajan, 1994) that, later on, could become non-performing loans. The increased time period since the last loan default can lead to an increase in the problem loans of banks. This could be due to two reasons: First, the percentage of loan officers that experienced the last default declines as the bank hires new officers, and the ones retire, leading to an overall loss of experience. Second, some of the experienced officers might not be able to recollect properly the previous default; due to these reasons there is an overall decrease in institutional memory also leading to formation of groups that are less skillful at evaluating risk, resulting in the increase of problem loans (Berger and Udell, 2004). Sometimes the collaterals offered at the time of taking loans also play a major role in the creating bad loans. What generally happens is during the upturn period of the economy the prices of the assets generally increase forcing the banks to accept those properties as collaterals since it has a much worthier asset to back the loans. Now as the upturn recedes and recession creeps in, there is a decline in the assets values thereby leading to decline in the collateral values. This leads to bad loans and increasing NPAs of banks (Gabriel et al, 2006). Santanu das (2002) focuses on the increasing rate system to examine the reason of NPAs. He says that in an increasing rate system, quality Borrowers more often than not switch over to other avenues such as capital markets, internal accruals for their requirement of funds. Under such

circumstances, banks have no option but to dilute the quality of borrowers thereby increasing the probability of generation of NPAs. In India, Dilip K. Das (2000) has examined the aspect of the non-performing loan problem. He says that problem loans are caused due to both macroeconomic and microeconomic factors. In a downturn, borrowings generally decrease, thereby causing greater problem loans. At the same time, factors, such as low operating efficiency and uncontrolled branch expansion, might also lead to an increase in problem loans. This would mean that not only macroeconomic conditions, but also microeconomic variables are important in explaining problem loans in banks. The problems that troubled the Indian banking sector were also due to decades of directed credit policies of successive Indian governments. During much of the second half of the twentieth century, the Indian banking sector had characteristics of social control. The supposed role that banking sector played in the economy was that of providing financial support for preferred sectors which would lead to development of the country. However, because of inefficient lending practices, combined with poor monitoring, corruption, and a host of other factors, the Indian banking sector became saddled with huge folios of non-performing loans. In order to clean up its banking system, the Indian government has embarked upon major regulatory reform in the last decade. Most recently, the Indian government has allowed Banks and Financial Institutions to securitize non-performing assets. (Anshu S K Pasricha, 2007) Hence, Credit Risk, that is, default by the borrower to repay lent money, still remains the most important risk to manage till date. The power of credit risk is even reflected in the composition of economic capital, which banks are required to keep aside in order to protection themselves from various risks. It takes about 70% and 30% remaining is shared between the other two primary risks, namely Market risk (change in the market price) and operational risk i.e., failure of internal controls (Prof. Rekha Arunkumar). NPAs are an inevitable burden on the banking industry. Hence the success of a bank depends upon methods of managing NPAs and keeping them within tolerance level, of late, several institutional mechanisms have been developed in India to deal with NPAs.

The future of banking will therefore undoubtedly rest on risk management dynamics. Only those banks that have efficient risk management system will survive in the market in the long run. The effective management of credit risk is a critical component of comprehensive risk management essential for long-term success of a banking institution (Prof. Rekha Arunkumar, 2005). Since credit risk includes the possibility of social, economic and financial harms, some control setting and some credit risk management policies have to be determined in order to minimize the harmful effects of disastrous risky events such as failures. Such a process requires defining and measuring the combinations of events that are likely to cause a bankruptcy (Hayette Gatfaoui, 2008). Edward I Altman in his paper Predicting Financial Distress of Companies: Revisiting the Z score and Zeta model has used this model to examine the unique characteristics of business failure in order to specify and quantify the variables which are effective indicators and predictors of corporate distress. He has explored not only the quantifiable characteristics of potential bankrupts but also the utility of a much-maligned technique of financial analysis: ratio analysis through the help of this technique. In this paper we have tested Altmans Z-score model approach in Indian context. Janet Mitchell and Patrick Van Roy in their working paper research Failure prediction models: performance, disagreements, and internal rating systems has used Altmans Z Score model to in the ranking of firms, and the design of internal rating systems. She also analyzes the design of bank internal rating systems by looking at the performance of systems with differing numbers of classes and distributions of borrowers across classes with the help of this model. Since exposure to credit risk continues to be the leading source of problems in banks world-wide, banks and their supervisors should be able to draw useful lessons from past experiences. Hence, in this paper, we try to address how banks assess the creditworthiness of borrowers. We understand that banks consider, among other factors, the current and prospective profitability, the borrower's history, as well as its industrial sector and how the borrower is positioned in it. For this purpose we are using Altmans Z score model in this paper.


Following are the benefits that will accrue to the ICICI Bank: It will be very easy for the banks to identify their future defaulters. The discriminant model through the use of Altmans Z Score model arrives at an equation which makes it very easy for the banks to find out the defaulters and non defaulters. The paper through the help of entire calculations and analysis has helped a lot in improving the current predicting power of financial risk factors of banks and thereby reduce NonPerforming Assets in banks, Non-Performing Assets which is a major concern in todays hi-tech competitive world of real business. Project helps the banks in increasing its efficiency.


The study has the following limitations: Period of study under consideration is 6 years. The primary drawback of the project is the lack of the primary data. The project is totally based on the secondary data collected from various source such as books, journals, research papers, articles, web sites etc.

As we have considered all the banks on the same platform but in reality Nationalised banks have pressure from govt in giving loans to Priority sector which can increase their NPA.

All the data has been taken from reliable sources such as company website and sites such as India infoline & kotak securities but still their can be some Manipulation that can change our results.


ICICI Bank, formerly Industrial Credit and Investment Corporation of India, is India's largest private sector bank in market capitalization and second largest overall in terms of assets. Bank has total assets of about USD 100 billion (at the end of March 2008), a network of over 1,399 branches, 22 regional offices and 49 regional processing centres, about 4,485 ATMs and 24 million customers. ICICI Bank offers a wide range of banking products and financial services to corporate and retail customers through a variety of delivery channels and specialized subsidiaries and affiliates in the areas of investment banking, life and non-life insurance, venture capital and asset management. ICICI Bank is also the largest issuer of credit cards in India. ICICI Bank has got its equity shares listed on the stock exchanges at Kolkata and Vadodara, Mumbai and the National Stock Exchange of India Limited, and its ADRs on the New York Stock Exchange (NYSE).


The Bank is expanding in overseas markets and has the largest international balance sheet among Indian banks. ICICI Bank now has wholly-owned subsidiaries, branches and representatives offices in 18 countries, including an offshore unit in Mumbai. This includes wholly owned subsidiaries in Canada, Russia and the offshore banking units in Bahrain and Singapore, an advisory branch in Dubai, branches in Belgium, Hong Kong and Sri Lanka, and representative offices in Bangladesh, China, Malaysia, Indonesia, South Africa, Thailand, the United Arab Emirates and USA. Overseas, the Bank is targeting the NRI (Non-Resident Indian) population in particular. ICICI reported a 1.15% rise in net profit to Rs. 1,014.21 crore on a 1.29% increase in total income to Rs. 9,712.31 crore in Q2 September 2008 over Q2 September 2007. The bank's current and savings account (CASA) ratio increased to 30% in 2008 from 25% in 2007.

Source: Diversified Portfolio of ICICI Bank The asset composition change on account of statutory requirements and increase in retail assets is contributing to de-risking the portfolio




The Banking sector in India is all set to witness path breaking changes. While the decade of 90s has witnessed a sea change in the way banking is done in India, Technology has made tremendous impact in banking then provisioning norms for NPAs have considerably reduced banks net NPAs and also made them strong financially. The future trends in Indian banking can be captured through following points.

Basel II and risk management

To strengthen the capital base of the banks the Bank of International Standards (BIS) has come up with Basel Accords. As per the recommendations of these accords every bank having an international presence has to set aside capital as a percentage of its Risk Weighted Assets (RWAs) Banks capital adequacy ratio = Total Capital

-------------------------------------------------------RWAs of Credit Risk+ Market Risk+ Op. Risk

With the opening up of the banking sector in 2009 week/ small banks will find it tough to compete with the large banks. Hence, it is likely that consolidation will soon catch up with the banks. A recent example in this context is the merger of Centurion bank of Punjab with HDFC bank. Though there is no confirmation yet, speculative signals arising from the market point to the prospect of consolidation involving banks such as Union Bank of India, Bank of India, Bank of Baroda, Dena Bank, State Bank of Patiala, and Punjab and Sind Bank. Further, the case for merger between stronger banks has also gained ground a clear deviation from the past when only weak banks were thrust on stronger banks.

Indian Banking sector is all set to open up for foreign players with effect from April09 which will allow them to operate in India through wholly owned subsidiaries. Also Indian banks are increasingly going Global.


Banks face the following main risks Credit Risks Operational Risks Market Risks o Liquidity Risk 3

o Interest rate Risk o Foreign exchange Risk o Commodities and Equity Risk Keeping in view the scope of the project, I will be discussing only Credit risk and its management in detail

Credit risk is defined as the possibility of losses associated with diminution in the credit quality of borrowers or counter-parties. In a banks portfolio, losses stem from outright default due to inability or unwillingness of a customer or counter-party to meet commitments in relation to lending, trading, settlement and other financial transactions. Alternatively, losses result from reduction in portfolio value arising from actual or perceived deterioration in credit quality. The credit risk of a bank's portfolio depends on both external and internal factors. The external factors can be economy wide as well as company specific. Some of the economy wide factors are: State of the economy Wide swings in commodity prices Fluctuations in foreign exchange rates and interest rates Trade restrictions Economic sanctions. Government policies, etc. Some company specific factors are: Management expertise Company policies Labour relations The internal factors within the bank, influencing credit risk for a bank is: Deficiencies in loan policies/administration 3

Absence of prudential credit concentration limits Inadequately defined lending limits for Loan Officers/Credit Committees Deficiencies in appraisal of borrowers' financial position Excessive dependence on collateral without ascertaining its quality/reliability Lack of risk pricing mechanisms Absence of loan review mechanism Ineffective system of monitoring of accounts The goal of credit risk management is to maximize a banks risk-adjusted rate of return by maintaining credit risk exposure within acceptable parameters. Banks need to manage the credit risk inherent in the entire portfolio as well as the risk in individual credits or transactions. Banks should also consider the relationships between credit risk and other risks.


The liberalization of the Indian economy has brought about sweeping changes in the economic environment. Changes in economic environment have induced new anticipated and unforeseen risks in lending. The assessment of these risks is essential to facilitate prudent credit decisions. The terms and conditions of loans & advances sanctioned to borrowers (i.e. the price, the maturity, the form of credit etc.) determine the profit that accrues to the bank from that loan. If the terms are decided without proper assessment of the credit risk, the bank might be charging low interest rates from poor quality customers thereby sustaining losses due to default, and charging high rates from good quality customers thereby driving them away to other banks. The increasing pressure on spreads in the banking industry as well as competition on both sides of the balance sheet makes an efficient credit risk management system essential for banks. In this increasingly competitive situation a sound credit risk management system can be a source of competitive advantage for the bank.


Basel II is the second of the Basel Accords, which are recommendations on banking laws and regulations issued by the Basel Committee on Banking Supervision. The purpose of Basel II is to create an international standard that banking regulators can use when creating regulations about how much capital banks need to put aside to guard against the types of financial and operational risks banks face. Basel II accords are based on three pillars: The First Pillar The first pillar deals with maintenance of regulatory capital calculated for three major components of risk that a bank faces: credit risk, operational risk and market risk. Other risks are not considered fully quantifiable at this stage. The credit risk component can be calculated in three different ways of varying degree of sophistication, namely standardized approach, Foundation IRB and Advanced IRB. IRB stands for "Internal Rating- Based Approach".2


The Second Pillar The second pillar deals with the regulatory response to the first pillar, giving regulators much improved 'tools' over those available to them under Basel I. It also provides a framework for 3

dealing with all the other risks a bank may face, such as systemic risk, pension risk, concentration risk, strategic risk, reputation risk, liquidity risk and legal risk, which the accord combines under the title of residual risk. The Third Pillar The third pillar greatly increases the disclosures that the bank must make. This is designed to allow the market to have a better picture of the overall risk position of the bank and to allow the counterparties of the bank to price and deal appropriately.

CAPITAL ADEQUACY RATIO RECOMMENDED BY BASEL II The Basel II accord has recommended the following method of calculating the capital adequacy ratio of the banks.

Total Capital Banks CAR = ---------------------------------------------------RWAs of Credit Risk+ MR+ OR Here, CAR= Capital Adequacy Ratio MR= Market Risk RWA= Risk Weighted Assets OR = Operational Risk

The Minimum Capital Adequacy as prescribed by the Basel II Accord is 9% of Risk weighted Asset. Banks find out their capital requirement by putting the values of their RWAs and minimum CAR in the above formula With respect to capital, the Basel II accord permits banks to adopt one of two methods for risk weighting of assets: the standardized approach and the internal ratings based (IRB) model. The IRB model provides for two alternatives: Foundation and Advanced.

Standardized Approach towards Credit Risk Management

Under this approach the banks are required to use ratings from External Credit Rating Agencies to quantify required capital for credit risk. The standardized approach is the simplest of the three broad approaches to credit risk. The other two approaches are based on banks internal rating systems, i.e foundation IRB and Advanced IRB

Internal Ratings Based (IRB) Approach towards Credit Risk Management

A characteristic of the IRB approach is that the institution itself shall be able to determine, in a reliable manner, the values for certain risk parameters for its exposures. Permission to use such an approach is conditional on the institution demonstrating that it possesses such capability. Under IRB approach the bank has to calculate the following for the purpose of capital requirements i. Probability of Default (PD) It measures the likelihood that the borrower will default over a given time-horizon. ii. Loss given Default (LGD) It measures the proportion of the exposure that will be lost if a default occurs. iii. Exposure at Default (EAD) It measures the amount of the facility that is likely to be drawn if a default occurs. iv. Maturity (M) It measures the remaining economic maturity of the exposure. ICICI Bank has adopted both the Standardized as well as the IRB approach wherein it sources the credit ratings country wise and industry wise from the ECAIs and also has an in house mechanism for assigning the credit risk ratings to the individual borrowers based upon various risk rating models.



The Bank has taken major initiatives in putting in place the Risk Management Systems in order to adopt advanced approaches prescribed in Basel II and detailed operational guidelines for these initiatives have been issued through various circulars from time to time. Some of such initiatives are:

Separate Risk Management Division has been established. The division looks after management of all the three risks namely Credit Risk, Market Risk and Operational Risk. Various policies like entry level benchmark, Delegation of loaning powers according to risk, Pricing (for all accounts availing total limits above Rs. 20 lakhs) are linked to the credit risk ratings.

The approval process of the credit risk rating is independent of the credit approval process. A committee approach has been adopted for all accounts falling under the powers of DGM and above.

The credit risk rating tool has been developed with a view to provide a system for assigning a credit risk rating to the borrowers of the bank according to their risk profile. This rating tool is applicable to all large corporate borrowal accounts availing total limits (fund based and non-fund based) of more than Rs. 12 crore or having total sales/ income of more than Rs. 100 crore. Inputs to the tool are the financial data of the borrower, industry information and the evaluation of the borrower on various objective and subjective parameters. There are broadly seven types of rating which are assigned to the borrower ranging from AAA to D.


Signals for credit risks can be picked up from a number of sources. The credit risk-rating tool considers the following broad areas in evaluating the default risk of a borrower Financial Strength 3

Business Performance Industry Outlook Quality of Management Conduct of account These parameters are further evaluated under various sub-parameters. They are discussed in brief as following:

Financial Strength
These parameters are taken normally from the annual financial statements of the company i.e. Balance Sheet, Profit & Loss Statement and the Cash Flow statement. Past performance is taken as a guide to realistically assess future performance. The financials are evaluated under four broad areas as under: Past financial performance Turnover Growth OPBDIT/Sales Short term bank borrowings / Net sales Operating Cash Flow/Total Debt Debt Equity Ratio TOL/TNW Interest Coverage Return on Capital Employed

Business Performance
This section measures operational efficiency and core competence of a company vis--vis its competitors. The performance of a company is influenced both by its own set up as well as its competitive position within the industry. Thus the two broad sub-areas used to assess the business performance of a company are: 3

Operating Efficiency Market Position Operating efficiency can be gauged from the following parameters Operating leverage Inventory Turnover Credit Period allowed/ availed . Net Sales/Operating Assets Net Sales/ Current Assets Market Position Can be gauged through following parameters Competitive Position Input Related Risk Product Related Risk Price Competitiveness Marketing

Industry Outlook
Industry performance very often has a direct bearing on the performance of a company. Two companies in different industries would have different credit worthiness depending on the outlook for their industries. The outlook and performance of an industry depend on a number of parameters. 1. Expected industry growth rate 2. Capital market perception. The industry P/E ratio is an useful indicator in this regard. 3. Regulatory framework Tax Concessions Tariff Protection 4. Industry cyclicality 5. Demand-supply mismatch 6. Financial performance of industry 3

7. Technology used in the industry and its rate of obsolescence 8. Threat from environmental factors 9. Threat from globalization 10. Structural attractiveness Supplier power Buyer power Threat of product substitution Threat of new entrants and entry barriers Competition within the industry

Management Evaluation
Evaluation of management is important not only due to its impact on the companys performance, which determines its capability to repay, but also from the point of view of its integrity. This is because the intentions of the management determine the willingness of the company to repay its debts. The management quality thus influences both aspects of default risk, the ability as well as the willingness of the borrower to repay its debts. Evaluation of management is done to determine both their competence as well as their integrity. The two sub-areas considered for this purpose are: Achievement of past targets by the company Subjective assessment of management quality

Conduct of Account
The conduct of account refers to as to how the borrowers existing accounts with our Bank as also with other banks are being conducted and whether any problems are being faced. The following areas and factors are taken into consideration: Status of Documentation/Security Creation/Terms of Sanction Delay in creation of primary security Delay in creation of personal/corporate guarantees Delay in creation of collateral security 3

Non-compliance of terms & conditions of sanction Status of Financial Discipline Credit summations in Cash Credit account being less than the sales realisations Returning of cheques Devolvement of LCs Invocation of LGs Requests for adhoc limits Status of Feedback by the Borrower Delay in submission of stock/book debt statements Delay in submission of QMS forms Delay in submission of audited balance sheet Delay in submission of CMA data and other papers necessary for renewal of credit limits Delay in renewal of credit limits


Credit Risk Mitigation (CRM) refers to the process through which credit risk is reduced or is transferred to counterparty. Strategies for risk reduction at the transaction level differ from that at the portfolio level. At transaction level, the most common technique used by the bank is the collateralization of the exposures, by first priority claims or obtaining a third party guarantee. Other techniques include buying a credit derivative to offset credit risk at transaction level. At portfolio level, asset securitization, credit derivatives etc. are used to mitigate risks in the portfolio. Basel II Accord allows a wider range of credit risk mitigants to be recognized for regulatory capital purposes.


Collateral Management On- Balance Sheet Netting Guarantees 3

Collateral Management
The collateralized transaction are the one in which banks have a credit exposure and that credit exposure is hedged in whole or in part by collateral posted by a counter party or by a third party on behalf of the counter party. Banks may opt for either the simple approach, which, substitutes the risk weighting of the collateral for the risk weighting of the counterparty for the collateralized portion of the exposure (generally subject to a 20% floor), or for the comprehensive approach, which allows fuller offset of collateral against exposures, by effectively reducing the exposure amount by the value ascribed to the collateral. Banks may operate under either, but not both, approaches in the banking book, but only under the comprehensive approach in the trading book. Partial collateralization is recognized in both approaches. Mismatches in the maturity of the underlying exposure and the collateral will only be allowed under the comprehensive approach. Before capital relief will be granted to any form of collateral, the standards set out in this section must be met. Supervisors will monitor the extent to which banks satisfy these conditions, both at the outset of a collateralized transaction and on an on-going basis.

Process of Collateral Management: Collateral Management process covers the entire gamut of activities comprising interalia the following aspects; Defining the criteria on acceptability of various forms of collaterals Level/extent of collateralization, Guidelines for valuation & periodical inspection of collateral Measures for security and protection of collateral value Legal aspects to ensure enforceability and reliasability of collateral in a timely and efficient manner.

On Balance Sheet Netting

On balance sheet netting is another technique of credit risk mitigation. This technique is applicable in cases where a borrower has a deposit with the bank. In such a case it is possible that the bank treats the deposit as collateral. The advantage to the bank under this technique is that the capital requirement for that loan will be calculated after offsetting the value of the deposit. Moreover there is NO HAIRCUT APPLICABLE to the deposit. Conditions The bank should have a proper legal basis for affecting such an offsetting and such right should be enforceable. There is no time mismatch There is no Currency Mismatch The Credit balances (Deposit) and Debit Balances (Advance) should relate to the same customer or the customer in the same company group. At the present juncture, the Basle Committee is inclined to restrict the scope for on-balance-sheet netting to loans and deposits only. However, recognizing that netting can be a beneficial part of the risk management process, the Committee may be prepared to consider other circumstances under which banks might be allowed to net on-balance-sheet claims in calculating capital adequacy.

For the protected portion of an exposure, a bank may substitute the risk weight of the protection provider for that of the obligor. However, in the case of a guarantee from a sovereign, central bank or bank, there will be no additional capital requirement (i.e. w is zero); this equates to .pure substitution.


Details of parameters respective weightage FINANCIAL RISK Coverage Manufacturing Nonmfgrs. Range >= 5 times 4 to 5 times 3 to 4 times 2 to 3 times 1.5 to 2 times < 1.5 times <= 4 4 to 6 6 to 7 7 to 8 8 to 10 > 10 <= 30 days 30 to 45 45 to 60 60 to 90 90 to 120 Scale and 30% 8% Total Weight Weight s 4%



Interest coverage ratio

>=5 times 4 to 5 times 3 to 4 times 2 to 3 times 1.5 to 2 times <1.5 times

5 4 3 2 1 0 5 4 3 2 1 0

Total debt to net cash accruals

<=4 4 to 6 6 to 7 7 to 8 8 to 10 >10


Ratio Analysis Debtors & Inventory turnover period <=90 days 90 to 120 120 to 150 150 to 210 210 to 270 5 4 3 2 1

22% 4%

>270 days TOL/TNW <= 1 1 to 1.5 1.5 to 2 2 to 2.5 2.5 to 3 >3 Current ratio >=1.75 times 1.33 to 1.75 1.25 to 1.33 1.15 to 1.25 1 to 1.15 <1 Sales Trend* Increase in sales /gross receipts over last two available audited years Up to 25% Up to 20% Up to 15% Up to 10% 10-0% EBIDTA Trend* Increase in EBIDTA over last two available audited years Up to 25% Up to 20% Up to 15% Up to 10% 10% - 0% TNW Trend* Increase in TNW over last two available audited years Up to 25%

>120 days <= 1 1 to 1.5 1.5 to 2 2 to 3 3 to 4 >4 >= 1.75 times 1.33 to 1.75 1.25 to 1.33 1.15 to 1.25 1 to 1.15 <1

0 5 4 3 2 1 0 5 4 3 2 1 0 4% 4%

Up to 25% Up to 20% Up to 15% Up to 10% 10% - 0%

5 4 3 2 1


Up to 25% Up to 20% Up to 15% Up to 10% 10% - 0%

5 4 3 2 1


Up to 25%


Up to 20% Up to 15% Up to 10% 10-0% *In case the trends are not available, the score would be allocated to other Financial Performance norms in proportion to the present respective assigned scores MANAGEMENT RISK Parameter Business vintage (years) Range > =10 years Above 5 years but up to 10 yrs Above 2 years but up to 5 years Below 2 years Personal net worth of promoters More than 50 mn providing PG (Rs. in mn) Between 25 mn to Rs 50 mn Between 25 mn and Rs 10 mn Below Rs 10 mn Constitution of the entity Public limited company Private limited company Registered partnership firm Sole proprietorship concern HUF

Up to 20% Up to 15% Up to 10% 10% -0%

4 3 2 1

25% Scale 5 4 3 1 5 4 3 2 5 4 3 5% 5% Weight 5%

2 1

Business Commitment & Fund Diversion Risk

Sole business interest of promoter Promoter has other firm/companies , but negligible business compared to main entity More than one firm/ company but not in exactly same line of business, all entities have comparable business volume More than one firm/company in exactly same line of business & all entities have comparable business volume Promoters legal descendent(s) is/are adult and is/also also Partner/Director in the business Promoters legal descendents is/are adult and is/are involved in business only in executive capacity Promoters legal descendent(s) is/


Succession Risk


are adult but not involved in the business (borrowing entity) in any way Promoters legal descendents have lot reached 18 years of age Promoters dont have any legal descendent TRANSACTION HISTORY


Parameter Inward Cheque Returns

Range Up to 1 Up to 2 Up to 3 Up to 4 Up to 5

Scale 4 3 2 1 0

Weight 5%

Average Balance in 6 month period (For Current Account Customers Only) In case of Cash Credit and Overdraft Accounts - Refer next point. 200,000 High 150,000 200,000 100,000 150,000 75,000 100,000 50,000 75,000 < 50000 Overdrawings in the last six 5 10%

4 3 2 1 0

months in case of Cash Credit and Overdraft Account Customers Up to 1 event Up to 2 events Up to 3 events Up to 4 events Up to 5 events Up to 6 events Credit summation in 6 month period As a percentage of latest audited turnover (As 6 months is compared with One year, percentages reduced by 50%) Up to 40% 5 5% 5 4 3 2 1 0 10%

Up to 35% Up to 30% Up to 25% Up to 20% Up to 15%

4 3 2 1 0

No. of Credits in 6 month period 101 High 26 100 11 25 3 10 02 5 4 3 1 0 30 **In case, where customer does not has the respective Current Account, Cash Credit account or Overdraft account with ICICI Bank, the respective score would be proportionately allocated in the scoring model. 5%



Altmans Z-score model is an application of multivariate Discriminant analysis in credit risk modeling. Financial ratios measuring probability, liquidity and solvency appeared to have significant discriminating power to separate the firm that fails to service its debt from the firms that do not. These ratios are weighted to produce a measure (credit risk score) that can be used as a metric to differentiate the bad firms from the set of good ones. Variable Selection After the initial groups are defined and firms selected, balance sheet and income statement data are collected. The variables are classified into five standard ratio categories, including liquidity, profitability, leverage, solvency, and activity. The ratios are chosen on the basis of their popularity in the literatures and their potential relevancy to the study. The final discriminant function is as follows: Z = a1 + b1x1 + b2x2 + b3x3 + b4x4 + b5x5 Z = 1.2X1 + 1.4X2 + 3.3X3 + .6X4 +0.999X5 X1 = working capital/total assets, X2 = retained earnings/total assets, X3 = earnings before interest and taxes/total assets, X4 = market capitalization/book value of total liabilities, X5 = sales/total assets, and Z = overall index. X1, Working Capital/Total Assets (WC/TA). The working capital/total assets ratio is a measure of the net liquid assets of the firm relative to the total capitalization. Working capital is defined as the difference between current assets and current

liabilities. Liquidity and size characteristics are explicitly considered. Ordinarily, a firm experiencing consistent operating losses will have shrinking current assets in relation to total assets. X2, Retained Earnings/Total Assets (RE/TA). Retained earnings are the account which reports the total amount of reinvested earnings and/or losses of a firm over its entire life. The account is also referred to as earned surplus. The RE/TA ratio measures the leverage of a firm. Those firms with high RE, relative to TA, have financed their assets through retention of profits and have not utilized as much debt. X3, Earnings Before Interest and Taxes/Total Assets (EBIT/TA). This ratio is a measure of the true productivity of the firms assets, independent of any tax or leverage factors. It determines the earning power of the assets. Since a firms ultimate existence is based on the earning power of its assets, this ratio appears to be particularly appropriate for studies dealing with NPAs and credit risks. X4, Market Value of Equity/Book Value of Total Liabilities (MVE/TL).

Equity is measured by the combined market value of all shares of stock, preferred and common, while liabilities include both current and long term. The measure shows how much the firms assets can decline in value (measured by market value of equity plus debt). X5, Sales/Total Assets (S/TA). The capital-turnover ratio is a standard financial ratio illustrating the sales generating ability of the firms assets. It is one measure of managements capacity in dealing with competitive conditions. This final ratio is quite important because it is the least significant ratio on an individual basis. In fact, based on the univariate statistical significance test, it would not have appeared at all. However, because of its unique relationship to other variables in the model, the sales/total assets ratio ranks second in its contribution to the overall discriminating ability of the model.

Multiple discriminant analysis (MDA) is used in this project as the appropriate statistical technique. Although not as popular as regression analysis, MDA has been utilized in a variety of disciplines since its first application in the 1930s. In recent years, this technique has become increasingly popular in the practical business world as well as in academia. Altman, (1981) discusses discriminant analysis in-depth and reviews several financial application areas. MDA is a statistical technique used to classify an observation into one of several groupings dependent upon the observations individual characteristics. It is used primarily to classify and/or make predictions in problems where the dependent variable appears in qualitative form, for example, male or female, bankrupt or non-bankrupt. Therefore, the first step is to establish explicit group classifications. The number of original groups can be two or more. We prefer that the multiple concepts refer to the multivariate nature of the analysis. After the groups are established, data are collected for the objects in the groups; MDA in its most simple form attempts to derive a linear combination of these characteristics which best discriminates between the groups. If a particular object, for instance, a corporation, has (financial ratios) which can be quantified for all of the companies in the analysis, the MDA determines a set of discriminant coefficients. When these coefficients are applied to the actual ratios, a basis for classification into one of the mutually exclusive groupings exists. The MDA technique has the advantage of considering an entire profile of characteristics common to the relevant firms, as well as the interaction of these properties. A univariate study, on the other hand, can only consider the measurements used for group assignments one at a time. Another advantage of MDA is the reduction of the analysts space dimensionally, that is, from the number of different independent variables to G-1 dimension(s), where G equals the number of original groups. Perhaps the primary advantage of MDA in dealing with classification problems is the potential of analyzing the entire variable profile of the object simultaneously rather than sequentially examining its individual characteristics. Just as linear and integer programming have improved upon traditional techniques in capital budgeting, the MDA approach to traditional ratio analysis has the potential to reformulate the problem correctly. Specifically, combinations of ratios can be analyzed together in order to remove possible ambiguities and misclassifications observed in earlier traditional ratio studies. As we will see, the Z-Score model is a linear analysis in that five measures are objectively weighted and summed up to arrive at an overall score that then becomes the basis for classification of firms into one of the groupings. The discriminant model has the following assumptions:

The predictors are not highly correlated with each other. The mean and variance of a given predictor are not correlated. The correlation between two predictors is constant across groups. The values of each predictor have a normal distribution.

All the data collected in this project is sourced from various web sites and database sites such as the

RBI database web site and various database. They are secondary databases and no aid of primary data has been taken. In this paper a total of 40 Indian banks have been taken for the purpose of study. All the banks belong to either public sector or the private sector. The total group of 40 banks is then divided into two groups of 20 each both having equal number of companies. The first group is used to develop the co-efficient for the discriminant analysis. The other group is used to test the accuracy of the model. Then various information have been obtained regarding these banks for the purpose of the study. This information includes: Working Capital to Total Assets Retained Earnings to Total Assets Earnings before Interest and Tax to Total Assets Market Capitalization3 to Book Value of Debt Sales to Total Assets


We use discriminant analysis now to get the critical value or range for predicting group membership for an observation in future. The factor scores here are used as the independent variables and the group behavior as the dependent variable. The groups we are dividing the firms into are sound financial health and bad financial health. The groups are pre-determined here and so is their membership. But the discriminant function we will so get will help us in predicting the group membership of other companies in future. The groups have been named as 1. Good financial health 1
2. Bad financial health 0

The discriminant function so developed has incorporated all the 5 factors in it. The Eigen value (1.023) is also greater than 1. Eigen value shows the ratio of between group sum of squares and within group sum of squares. The higher the value, the better it is. The Wilks lambda shows that proportion of variation in discriminant scores which is not explained by the differences among groups. So the lower it is, the better it is. Generally it should be less than .5. In our model, it comes out to be 0.494. The canonical correlation explains the correlation between the groups and the discriminant scores. This also seems to be pretty reasonable at .711. The hit ratio which shows the efficiency of the model in correctly predicting the groups is also fairly high at 92.5%. So the model or the discriminant function is finally accepted.

Pooled Within-Groups Matrices(a) liquidity .001 -9.92E-005 .000 -.002 -2.30E-006 1.000 -.416 -.404 -.513 leverage -9.92E-005 5.84E-005 4.50E-005 3.65E-005 -3.81E-007 -.416 1.000 .566 .041 profitability .000 4.50E-005 .000 6.59E-005 -2.91E-007 -.404 .566 1.000 .054 -.044 solvency -.002 3.65E-005 6.59E-005 .014 9.39E-008 -.513 .041 .054 1.000 .001 activity -2.30E-006 -3.81E-007 -2.91E-007 9.39E-008 3.96E-007 -.117 -.079 -.044 .001 1.000


liquidity leverage profitability solvency activity


liquidity leverage profitability solvency activity

-.117 -.079 a The covariance matrix has 38 degrees of freedom.

The within-groups correlation matrix shows the correlations between the predictors. The largest correlations occur between profitability and leverage, but it is difficult to tell if they are large enough to be a concern

Group Statistics Valid N (listwise) Unweighted Weighted 20 20.000 20 20.000 20 20.000 20 20.000 20 20.000 20 20.000 20 20.000 20 20.000 20 20.000 20 20.000 40 40.000 40 40.000 40 40.000 40 40.000 40 40.000

Fin_health Bad Fin_Health

Good Fin_Health


liquidity leverage profitability solvency activity liquidity leverage profitability solvency activity liquidity leverage profitability solvency activity

Mean .0746 .0047 .0792 .0432 .0002 .0965 .0063 .0855 .1327 .0000 .0856 .0055 .0823 .0879 .0001

Std. Deviation .01860 .00728 .00956 .02627 .00086 .04007 .00798 .01118 .16347 .00022 .03277 .00758 .01075 .12414 .00063

This table provides the mean and standard deviation for the variables for two groups. From the group statistics table it is clear that the mean and standard deviation of the variables is not very high.
Log Determinants Fin_health Bad Fin_Health Good Fin_Health Pooled within-groups Rank 5 5 5 Log Determinant -49.812 -47.514 -45.885

The ranks and natural logarithms of determinants printed are those of the group covariance matrices.

Log determinants are a measure of the variability of the groups. Larger log determinants correspond to more variable groups. Large differences in log determinants indicate groups that have different covariance matrices.
Tests of Equality of Group Means Wilks' Lambda .886 .989 .913 .867 .987 F 4.907 .430 3.637 5.847 .515 df1 1 1 1 1 1 df2 38 38 38 38 38 Sig. .033 .516 .064 .021 .477

liquidity leverage profitability solvency activity

The tests of equality of group means measure each independent variable's potential before the model is created. Each test displays the results of a one-way ANOVA for the independent variable using the grouping variable as the factor. If the significance value is greater than 0.10, the variable probably does not contribute to the model. According to the results in this table, only liquidity, profitability and solvency variable in the discriminant model is significant. Wilks' lambda is another measure of a variable's potential. Smaller values indicate the variable is better at discriminating between groups. The table suggests that solvency is best.

Standardized Canonical Discriminant Function Coefficients Function liquidity leverage profitability solvency activity 1 1.195 .220 .615 .959 .068

The standardized coefficients allow you to compare variables measured on different scales. Coefficients with large absolute values correspond to variables with greater discriminating ability. It indicates the importance of the independent variables in predicting the dependent variables. This table downgrades the importance of leverage ratio, but the order is otherwise the same.
Canonical Discriminant Function Coefficients Function liquidity leverage profitability solvency activity (Constant) 1 38.258 28.835 59.104 8.190 108.495

-9.033 Unstandardized coefficients

The co-efficients given in this table is used to develop the actual equation used for predicting and help to classify new variables. Structure Matrix
Function 1 solvency liquidity profitability activity leverage .388 .355 .306 -.115 .105

Pooled within-groups correlations between discriminating variables and standardized canonical discriminant functions Variables ordered by absolute size of correlation within function.

The structure matrix shows the correlation of each predictor variable with the discriminant function. The ordering in the structure matrix is the same as that suggested by the tests of equality of group means and is different from that in the standardized coefficients table. In our case we can see that the correlation in highest in case of solvency ratio which is 0.799. Eigen values
Eigen value % of Variance Cumulative % Canonical Correlation 1.023(a) 100.0 100.0 .711 a First 1 canonical discriminant functions were used in the analysis. Function 1

The eigenvalues table provides information about the relative efficacy of each discriminant function
Wilks' Lambda Test of Function(s) 1 Wilks' Lambda .494 Chi-square 25.006 df 5 Sig. .000

Wilks' lambda is a measure of how well each function separates cases into groups. It is equal to the proportion of the total variance in the discriminant scores not explained by differences among the groups. Smaller values of Wilks' lambda indicate greater discriminatory ability of the function. This value is between 0 and 1. In this case there is one function that is significant. The associated chi-square statistic tests the hypothesis that the means of the functions listed are equal across groups. The small significance value indicates that the discriminant function does better than chance at separating the groups.

Classification Results a Predicted Group Membership Bad Fin_ Good Fin_ Health Health 20 0 3 17 100.0 .0 15.0 85.0


Count %

Fin_health Bad Fin_Health Good Fin_Health Bad Fin_Health Good Fin_Health

Total 20 20 100.0 100.0

a. 92.5% of original grouped cases correctly classified.

This output popularly known as classification matrix is also known as confusion matrix. It indicates that the discriminant function we have obtained is able to classify 78.8%of the objects correctly. The classification table shows the practical results of using the discriminant model. Of the cases used to create the model, 22 of the 26 cases are classified correctly. 4 of the 7 cases are classified correctly.
Prior Probabilities for Groups Cases Used in Analysis Unweighted Weighted 20 20.000 20 20.000 40 40.000

Fin_health Bad Fin_Health Good Fin_Health Total

Prior .500 .500 1.000

A prior probability is an estimate of the likelihood that a case belongs to a particular group when no other information about it is available. The probabilities shown in the table are used to classify groups with alternative of specifying equal group size as well as different group size. Unless specified otherwise, it is assumed that a case is equally likely to be a defaulter and non-defaulter. Prior probabilities are used along with the data to determine the classification functions. Adjusting the prior probabilities according to the group sizes can improve the overall classification rate. A priori, 50% of the cases are performers, so the classification functions will now be weighted equally among defaulters and non defaulters in banks.

Functions at Group Centroids Functio n 1 Bad Fin Health -.986 Good Fin Health .986 Unstandardized canonical discriminant functions evaluated at group means Fin health

The group centroid helps to determine the cut-off points for classification. This is used to group the variables in two groups, defaulters and non defaulters in banks.

A nalysis Case Processing Sum ary m U nweighted Cases Valid Excluded M issing or out-of-range group codes At least one m issing discrim inating variable Both m issing or out-of-range group codes and at least one m issing discrim inating variable Total Total N 40 0 0 Percent 100.0 .0 .0

0 0 40

.0 .0 100.0

It indicates the number of missing variables and those processed.

Calculating the discriminant scores

The canonical standardized coefficients are the coefficients of the discriminant function and are used in forming the discriminant equation
THE DISCRIMINANT EQUATION Discriminant score = -9.033+38.258*X1+ 28.835*X2+59.104*X3+8.19*X4+108.495*X5

Classification of companies
Now the next step is deciding the range which will categorize the company as of sound financial health or of bad financial health. This is done by taking out the mean of group Centroids.
Functions at Group Centroids Original Group Function Critical Value Bad Financial Health -.986 Good Financial Health 0.986 Unstandardized canonical discriminant functions evaluated at group means

The range comes out to be 3

Bad financial health company< 0 < good health financial company Thus the new means for group 1 (performing banks) is -0.986 and for group 2(non-performing banks) is 0.986. this means that the midpoint of these two is zero. This is clear when the two means are plotted on a straignt line, and their mid points are located as shown below:

-0.986 Mean of group 1 of group 2 (Defaulters) Defaulters)


+.986 mean (Non -

Therefore any positive (greater than zero) value of the discriminant score will lead to classification as defaulters, and any negative (less than zero) value of the discriminant score will lead to classification as non-defaulters banks So in future when we want to predict whether a company has a bad or good health, we can simply use the discriminant equation to calculate the discriminant scores and predict the group membership. Therefore the model helps us in evaluating the financial health of a company and see if its position is in good or dire state so that we can manage our risk.


Various companies have been classified as being having good or bad financial health based on the Altman Z score calculated and there after 40 out of these 46 companies have been divided into two groups having 20 companies with good financial health and 20 having bad financial health. These are then used as an input for the discriminant analysis and develop the credit risk management model. Thereafter the last 6 companies of this table is used to verify the model.

Company name
ICICI bank Kotak Mahindra bank City union bank ltd State bank of mysore Bank of india Andhra bank Canara bank Corporation bank Indian bank Oriental bank of commerece SBI UCO bank United bank of india ING vysya bank Catholic Syrian bank ltd Federal bank ltd Karur vysya bank Ratnakar bank ltd Axis bank Indusind bank

Altman Z score
3.70 3.75 3.16 2.40 2.80 3.21 2.86 3.39 2.36 3.41 3.01 2.49 2.45 2.82 2.40 3.32 3.50 3.34 4.44 3.61

Financial health
Good Good Good Bad Bad Good Bad Good Bad Good Good Bad Bad Bad Bad Good Good Good Good Good 3

Bank of rajasthan State bank of Patiala South Indian bank Lakshmi vilas bank J&K bank ltd Dhanlakshmi bank ltd Tamilnad merchantile bank ltd Development credit bank Vijya bank Union bank of india Syndicate bank PNB IOB IDBI bank Dena bank Central bank of india Bank of maharastra Bank of baroda Allahabad bank American Express Centurian bank of Punjab ltd Karnataka bank limited State bank of Bikaner & jaipur State bank of Travancore Bharat co-operative bank

3.95 2.11 2.80 3.03 3.33 3.37 2.49 3.32 2.84 2.74 2.71 3.06 3.03 2.25 1.83 2.39 2.68 2.31 2.34 3.30 3.40 2.82 1.86 1.47 3.80

Good Bad Bad Good Good Good Bad Good Bad Bad Bad Good Good Bad Bad Bad Bad Bad Bad Good Good Bad Bad Bad Good


According to the model developed, the health of any company can be ascertained by calculating the discriminant score and then comparing with the critical value that distinguishes between the two groups. For calculating the score we need the data of the 5 ratios of any particular company. In our case the data of the 6 companies that I have used to verify the model is given in the Annexure.
THE DISCRIMINANT EQUATION Discriminant score = -9.033+38.258*X1+ 28.835*X2+59.104*X3+8.19*X4+108.495*X5

Putting the value of X1 to X5 in the above equation we get the following scores.

Company name
American Express Centurian bank of Punjab ltd Karnataka bank limited State bank of Bikaner & jaipur State bank of Travancore Bharat co-operative bank

Altman Z score
3.30 3.40 2.82 1.86 1.47 3.80

Financial health
Good Good Bad Bad Bad Good

Discriminant Financial health score

0.180423 0.223316 -0.95789 -3.43781 -4.6268 1.632715

Good Good Bad Bad Bad Good

So from the above table we can see that the model developed yield the same result as the Altman Zscore hence we can say that the model developed is correct.

In this paper, an attempt has been made to study the Credit Risk Management Framework of scheduled commercial banks operating in India and also to arrive at a model that can help Indian banks to manage their credit risk in a better way. From all the above calculations it is now very easy for the banks to identify their future defaulters. The discriminant model through the use of Altmans Z score model arrives at an equation which makes it very easy for the banks to find out the defaulters and non defaulters. The paper through the help of model and analysis can help a lot in improving the current predicting power of financial risk factors of banks and thereby reduce Non-Performing Assets in banks, which is a major concern in todays hi-tech competitive world of real business. Hence the paper helps the banks in increasing its efficiency. The banks through the help of this paper can identify their defaulters and then can lay down their strategies accordingly. The ratio analysis done in this project gave us some valuable insights regarding the banks, it helped in clearly viewing the solvency, profitability, liquidity, activity and leverage positions of the banks. The paper can be of immense use in the Indian scenario as it takes into consideration the current positions of the Indian banks. It gives some valuable insights to the banks as to how to enhance their performance in the present situation. Presently the financial system of the entire world is passing through a very sensitive phase. There is a global financial turmoil prevalent in the world economy which is affecting the Indian economy as well. The country thus needs to strengthen its financial system. Banks form a major part of the Indian financial system. Hence there is a need to strengthen the Indian banks and this paper can help in doing so.

Following are some of the recommendations based on the study done on credit risk management in banks: The use of derivatives in banks for credit risk management is almost negligible. Its use should be implemented meticulously as it is a very effective method to reduce risk. This paper uses some very logical calculations. If it implemented properly in the banks can lead to increased efficiency of the banks. The Indian banks should use this technique of enhancing its performance as it uses some very strong calculations and interpretations which can prove to be of immense help. While NPAs level of public sector banks did register a clear decreasing trend during the post-liberalization period, NPAs level of private sector banks remained constant during this period. Hence the private banks need to use these techniques of increasing its efficiency and decrease its NPA levels successfully.

Banks should sharpen their credit assessment skills by providing better training to enhance their conceptual understanding of credit risk and improving their skills in handling it which lay more emphasis in providing finance to the wide range of activities in the services sector.

The effectiveness of risk management depends on efficient information system, computerization and networking of the branch activities. An objective and reliable database has to be built up for which bank has to analyze its own past performance data relating to loan defaults, operational losses etc. this can lead to efficient credit risk management in banks.

Regarding frequency of the credit risk assessment exercise, it has been observed that the bankers perform it annually. The most important technique for credit risk management, as suggested by RBI, is Risk adjusted pricing of the portfolio. Future Business Potential should be most important factor considered for pricing credit risk in banks. 3



Dr. Bhattacharya, K.M., 2003. Risk Management in Indian Banks, Mumbai: Himalaya Publishing House Pvt. Ltd., 2nd Edition.

Pandey, I.M., 2008. Financial Management, Noida: Vikash Publishing House Pvt. Ltd., 9th Edition.

Chandra, P., 2008. Financial Management, New Delhi: Tata McGraw-Hill Publishing Company Limited, 7th Edition.

Donald,Cooper R; Pamela, Schindler S., 2006. Business Research Methods, New Delhi: Tata McGraw-Hill Publishing Company Limited, 9th Edition.

Risk Management In Commercial Banks (A Case Study Of Public And Private Sector Banks) (Rekha Arunkumar, G. Kotreshwar)

Marketing Research: Texts and Cases. ( David L Loudon, Robert E Stevens, Bruce

Business Research Methods: Using SPSS in Business Research ICMR Publications.

Websites 3 P47.pdf tag=artBody;col1 : King and Levine, 1993; : Levine and Zervos, 1998 tag=artBody;col1 3