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submitted in partial fulfillment of the requirements for the Diploma of Post Graduate Diploma in Management (Financial Services) at Jaipuria Institute of Management, Lucknow By Raju Kumar Sharma JIML 11 FS 042

MBA is a stepping-stone to the management carrier and to develop goodmanager. It is necessary that the theoretical must be supplemented with exposure to the real environment.Theoretical knowledge just provides the base and its not sufficient to produce a good manager thats why practical knowledge is needed.Therefore the research product is an essential requirement for the student of MBA. This research project not only helps the student to utilize his skills properly learn field realities but also provides a chance to the organization tofind out talent among the budding managers in the very beginning. Working on a relevant and particular project is a part of parcel of any specialized courses of MBA to fulfill this requirement as a student of M.B.A.. I have chosen the project of the study as Risk management and factors of credit defaults by analyzing the results of logistic regression model using SPSS in Canara bank Banks have long stood as the repository of the funds to be made available to the needy. Of late, retail lending process has helped the mass in distress, support and venture out their dreams. Hence, the banks and other financial institutions have assumed the role of a money lender over the years. However this blessing has also its shortfalls. The multitudes of retail lending schemes have also ushered in the pitfalls of defaults. Many a times, banks do not carefully evaluate the borrowers credit worthiness before granting loans. This has often resulted in the creation of NPAs or Non-Performing Assets which are a major liability and set back to the banks. The occurrence of NPA harms the capital adequacy of banks and hence affects the further lending processes I hope my effort to shape this project work will yield best possible result and will go a long way in this direction.

It was indeed a pleasure for me to work in a prestigious organisation like Canara Bank. It was a golden chance to have a summer internship in a bank like Canara and Im thoroughly grateful to Jaipuria Institute of Management for giving me such an opportunity. I would also like to express my profound gratitude to Mr.A.K Sachdeva (Senior Manager.) and the Mr.Y.K Gupta(Manager) Canara Bank Mahanagar Branch, for providing me with their expert guidance and help wherever needed and for clarifying the doubts however small it maybe. Also, I am highly grateful & indebted to staff members of the Canara Bank. I would like to extent my deep gratitude for their constant supervision, expert guidance, enthusiasm, continuous encouragement, sharp observation and suggestions. Their keen interest and support was the driving element in this project report.

I would also like to thank my mentor Dr.Masood Siddiqui for his constant support and valuable suggestions throughout internship period and in the completion of the project report. Also, Im thankful to our Dean, Prof. Dheeraj Mishra and all the other faculty members at JIM,Lucknow who corrected and provided help and assistance at every step. Lastly, I am highly indebted to my family, without their moral support this project could not have been possible.

EXECUTIVE SUMMARY The Summer Internship Project (SIP) undertaken concerns the Study of Risk Management with special focus on credit risk management followed with the prediction of the potential factors of credit default. Risk Management has taken a prominent role in the lending activities of banks, as the availability of credit and the number of products offered for lending has grown. The amounts loaned through retail lending are usually smaller than those loaned to businesses and in these loans most of the times are not attached with any security which increases the risk of default so it become very necessary to identify the factors of defaults and try to minimize them. . Also, during the SIP I observed that the number of Non-Performing Assets (NPAs) has grown in Canara bank. This was due to the failure in monitoring the accounts and predicting the potential NPAs because of two major reasons: lack of available skilled staff and obsolete methods used which are not capable of handling complex and large data. Also adoption of any new technology will not only add to the cost but will also require training of the staff and one has to keep in mind that most of them are old which makes it difficult for them to adopt to new technologies. Thus the bank requires a method which is not only cost effective but is also simple and easy to implement. Therefore I suggest a method to predict the potential NPAs with the help of SPSS which can be used as a tool for risk management. This method is not only cost effective and

easy to implement but also does not require additional staff. There are various limitation of the method suggested because of various constraints I had, like data availability, as an intern but if implemented will reduce the work load of a manager and henceforth, promote creation of further standard assets. The aim of this study is to develop an understanding of the Risk management with special focus on Credit Risk management and gather knowledge about the various risks that stand afore the banks in the lending process and the evaluation and possible reasons for the occurrences of non-performance assets. This is being critically analyzed through SPSS.

Chapter I
Introduction 1 Banking System in India2 About Canara Bank10 Scope & Importance of study....17 Objectives. ..18

Chapter II
Evolution, Origin & Development of Risk management...19

Risk Management...19 Pillars of basel II........24 Risk Management In Banks... 25 Credit Risk..35 Non Performing Assets...41 Credit Risk Management47 Risk Rating.52

Chapter III
Research Methodology..56 Chapter IV Analysis .60 Chapter V Conclusion and Recommendations ...66 Chapter VII Bibliography & References70

Risk Management:-

Risk management underscores the fact that the survival of an organization depends heavily on its capabilities to anticipate and prepare for the change rather than just waiting for the change and react to it. The objective of risk management is not to prohibit or prevent risk taking activity, but to ensure that the risks are consciously taken with full knowledge, clear purpose and understanding so that it can be measured and mitigated. It also prevents an institution from suffering unacceptable loss causing an institution to fail or materially damage its competitive position. Functions of risk management is bank specific dictated by the size and quality of balance sheet, complexity of functions, technical/ professional manpower and the status of MIS in place in that bank. Therefore, banking practices, which continue to be deep routed in the philosophy of securities, based lending and investment policies, need to change the approach and mind-set, rather radically, to manage and mitigate the perceived risks, so as to ultimately improve the quality of the asset portfolio. To the extent the bank can take risk more consciously, anticipates adverse changes and hedges accordingly, it becomes a source of competitive advantage, as it can offer its products at a better price than its competitors. Although Banks and FIs have the freedom to design and implement their own policies for recovery and write-off incorporating compromise and negotiated settlements, still it becomes extremely essential for a bank to avoid giving credit to potential defaulters. Occurrence of NPA can lead to problems like restriction on flow of cash done by bank due to the provisions of fund made against NPA, draining of profit, bad effect on goodwill and on equity value etc.

Non-performing loans epitomize bad investment. They misallocate credit from good projects, which do not receive funding, to failed projects. Bad investment ends up in misallocation of capital, and by extension, labour and natural resources. Banks redistribute losses to other borrowers by charging higher interest rates, lower deposit rates and higher lending rates repress saving and financial market, which hamper economic growth.

The recovery of loan has always been problem for banks and financial institution. To come out of these first we need to think is it possible to avoid NPA. There may not be one-size-fits-all risk management module for all the banks to be made applicable uniformly. Balancing risk and return is not an easy task as risk is subjective and not quantifiable whereas return is objective and measurable. If there exist a way of converting the subjectivity of the risk into a number then the balancing exercise would be meaningful and much easier. Hence, the predictive analysis regarding the default has a huge scope and is of utmost relevance and importance to the banks.

Banking in India:Banking in India originated in the last decades of the 18th century. The first banks were The General Bank of India, which started in 1786, and Bank of Hindustan, which started in 1790; both are now defunct. The oldest bank in existence in India is the State Bank of India, which originated in the Bank of Calcutta in June 1806, which almost immediately became the Bank of Bengal. This was one of the three presidency banks, the other two being the Bank of Bombay and the Bank of Madras, all three of which were established under charters from the British East India Company. For many years the Presidency banks acted as quasi-central banks, as did their successors. The three banks merged in 1921 to form the Imperial Bank of India, which, upon India's independence, became the State Bank of India in 1955.


Indian merchants in Calcutta established the Union Bank in 1839, but it failed in 1848 as a consequence of the economic crisis of 1848-49. The Allahabad Bank, established in 1865 and still functioning today, is the oldest Joint Stock bank in India.( Joint Stock Bank: A company that issues stock and requires shareholders to be held liable for the company's debt) It was not the first though. That honor belongs to the Bank of Upper India, which was established in 1863, and which survived until 1913, when it failed, with some of its assets and liabilities being transferred to the Alliance Bank of Simla. Foreign banks too started to app, particularly in Calcutta, in the 1860s. The Comptoire d'Escompte de Paris opened a branch in Calcutta in 1860, and another in Bombay in 1862; branches in Madras and Pondicherry, then a French colony, followed. HSBC established itself in Bengal in 1869. Calcutta was the most active trading port in India, mainly due to the trade of the British Empire, and so became a banking center. The first entirely Indian joint stock bank was the Oudh Commercial Bank, established in 1881 in Faizabad. It failed in 1958. The next was the Punjab National Bank, established in Lahore in 1895, which has survived to the present and is now one of the largest banks in India. Around the turn of the 20th Century, the Indian economy was passing through a relative period of stability. Around five decades had elapsed since the Indian Mutiny, and the social, industrial and other infrastructure had improved. Indians had established small banks, most of which served particular ethnic and religious communities. The presidency banks dominated banking in India but there were also some exchange banks and a number of Indian joint stock banks. All these banks operated in different segments of the economy. The exchange banks, mostly owned by Europeans, concentrated on financing foreign trade. Indian joint stock banks were generally undercapitalized and lacked the experience and maturity to compete with the presidency and exchange banks. This segmentation let Lord Curzon to observe, "In respect of banking it seems we are behind the times. We are like some old fashioned sailing ship, divided by solid wooden bulkheads into separate and cumbersome compartments."

The period between 1906 and 1911, saw the establishment of banks inspired by the Swadeshi movement. The Swadeshi movement inspired local businessmen and political figures to found banks of and for the Indian community. A number of banks established then have survived to the present such as Bank of India, Corporation Bank, Indian Bank, Bank of Baroda, Canara Bank and Central Bank of India. The fervour of Swadeshi movement lead to establishing of many private banks in Dakshina Kannada and Udupi district which were unified earlier and known by the name South Canara ( South Kanara ) district. Four nationalised banks started in this district and also a leading private sector bank. Hence undivided Dakshina Kannada district is known as "Cradle of Indian Banking". During the First World War (19141918) through the end of the Second World War (19391945), and two years thereafter until the independence of India were challenging for Indian banking. The years of the First World War were turbulent, and it took its toll with banks simply collapsing despite the Indian economy gaining indirect boost due to war-related economic activities. At least 94 banks in India failed between 1913 and 1918 as indicated in the following table: Paid-up Capital (Rs. Lakhs) 35 109 5 4 25 1

Years 1913 1914 1915 1916 1917 1918

Number of banks Authorised capital that failed 12 42 11 13 9 7 (Rs. Lakhs) 274 710 56 231 76 209

Post-Independence The partition of India in 1947 adversely impacted the economies of Punjab and West Bengal, paralyzing banking activities for months. India's independence marked the end 10

of a regime of the Laissez-faire for the Indian banking. The Government of India initiated measures to play an active role in the economic life of the nation, and the Industrial Policy Resolution adopted by the government in 1948 envisaged a mixed economy. This resulted into greater involvement of the state in different segments of the economy including banking and finance. The major steps to regulate banking included:

The Reserve Bank of India, India's central banking authority, was established in April 1934, but was nationalized on January 1, 1949 under the terms of the Reserve Bank of India (Transfer to Public Ownership) Act, 1948 (RBI, 2005b).[1]

In 1949, the Banking Regulation Act was enacted which empowered the Reserve Bank of India (RBI) "to regulate, control, and inspect the banks in India". The Banking Regulation Act also provided that no new bank or branch of an existing bank could be opened without a license from the RBI, and no two banks could have common directors.

Nationalisation Despite the provisions, control and regulations of Reserve Bank of India, banks in India except the State Bank of India or SBI, continued to be owned and operated by private persons. By the 1960s, the Indian banking industry had become an important tool to facilitate the development of the Indian economy. At the same time, it had emerged as a large employer, and a debate had ensued about the nationalization of the banking industry. Indira Gandhi, then Prime Minister of India, expressed the intention of the Government of India in the annual conference of the All India Congress Meeting in a paper entitled "Stray thoughts on Bank Nationalisation." The meeting received the paper with enthusiasm. Thereafter, her move was swift and sudden. The Government of India issued an ordinance ('Banking Companies (Acquisition and Transfer of Undertakings) Ordinance, 1969')) and nationalised the 14 largest commercial banks with effect from the midnight of July 19, 1969. These banks contained 85 percent of bank deposits in the country [2]. 11

Jayaprakash Narayan, a national leader of India, described the step as a "masterstroke of political sagacity." Within two weeks of the issue of the ordinance, the Parliament passed the Banking Companies (Acquisition and Transfer of Undertaking) Bill, and it received the presidential approval on 9 August 1969. A second dose of nationalization of 6 more commercial banks followed in 1980. The stated reason for the nationalization was to give the government more control of credit delivery. With the second dose of nationalization, the Government of India controlled around 91% of the banking business of India. Later on, in the year 1993, the government merged New Bank of India with Punjab National Bank. It was the only merger between nationalized banks and resulted in the reduction of the number of nationalised banks from 20 to 19. After this, until the 1990s, the nationalised banks grew at a pace of around 4%, closer to the average growth rate of the Indian economy.

Liberalisation In the early 1990s, the then Narasimha Rao government embarked on a policy of liberalization, licensing a small number of private banks. These came to be known as New Generation tech-savvy banks, and included Global Trust Bank (the first of such new generation banks to be set up), which later amalgamated with Oriental Bank of Commerce, Axis Bank(earlier as UTI Bank), ICICI Bank and HDFC Bank. This move, along with the rapid growth in the economy of India, revitalized the banking sector in India, which has seen rapid growth with strong contribution from all the three sectors of banks, namely, government banks, private banks and foreign banks. The next stage for the Indian banking has been set up with the proposed relaxation in the norms for Foreign Direct Investment, where all Foreign Investors in banks may be given voting rights which could exceed the present cap of 10%, at present it has gone up to 74% with some restrictions.


The new policy shook the Banking sector in India completely. Bankers, till this time, were used to the 4-6-4 method (Borrow at 4%; Lend at 6%; Go home at 4) of functioning. The new wave ushered in a modern outlook and tech-savvy methods of working for traditional banks. All this led to the retail boom in India. People not just demanded more from their banks but also received more. In 2010, banking in India is generally fairly mature in terms of supply, product range and reach-even though reach in rural India still remains a challenge for the private sector and foreign banks. In terms of quality of assets and capital adequacy, Indian banks are considered to have clean, strong and transparent balance sheets relative to other banks in comparable economies in its region. The Reserve Bank of India is an autonomous body, with minimal pressure from the government. The stated policy of the Bank on the Indian Rupee is to manage volatility but without any fixed exchange rate-and this has mostly been true. With the growth in the Indian economy expected to be strong for quite some timeespecially in its services sector-the demand for banking services, especially retail banking, mortgages and investment services are expected to be strong. One may also expect M&As, takeovers, and asset sales. In March 2006, the Reserve Bank of India allowed Warburg Pincus to increase its stake in Kotak Mahindra Bank (a private sector bank) to 10%. This is the first time an investor has been allowed to hold more than 5% in a private sector bank since the RBI announced norms in 2005 that any stake exceeding 5% in the private sector banks would need to be vetted by them. In recent years critics have charged that the non-government owned banks are too aggressive in their loan recovery efforts in connection with housing, vehicle and personal loans. There are press reports that the banks' loan recovery efforts have driven defaulting borrowers to suicide. Adoption of banking technology


The IT revolution had a great impact in the Indian banking system. The use of computers had led to introduction of online banking in India. The use of the modern innovation and computerisation of the banking sector of India has increased many folds after the economic liberalisation of 1991 as the country's banking sector has been exposed to the world's market. The Indian banks were finding it difficult to compete with the international banks in terms of the customer service without the use of the information technology and computers. The RBI in 1984 formed Committee on Mechanisation in the Banking Industry (1984) whose chairman was Dr C Rangarajan, Deputy Governor, Reserve Bank of India. The major recommendations of this committee was introducing MICR Technology in all the banks in the metropolis in India. This provided use of standardized cheque forms and encoders. In 1988, the RBI set up Committee on Computerisation in Banks (1988) headed by Dr. C.R. Rangarajan which emphasized that settlement operation must be computerized in the clearing houses of RBI in Bhubaneshwar, Guwahati, Jaipur, Patna and Thiruvananthapuram.It further stated that there should be National Clearing of inter-city cheques at Kolkata,Mumbai,Delhi,Chennai and MICR should be made Operational.It also focused on computerisation of branches and increasing connectivity among branches through computers.It also suggested modalities for implementing on-line banking.The committee submitted its reports in 1989 and computerisation began form 1993 with the settlement between IBA and bank employees' association. In 1994, Committee on Technology Issues relating to Payments System, Cheque Clearing and Securities Settlement in the Banking Industry (1994) was set up with chairman Shri WS Saraf, Executive Director, Reserve Bank of India. It emphasized on Electronic Funds Transfer (EFT) system, with the BANKNET communications network as its carrier. It also said that MICR clearing should be set up in all branches of all banks with more than 100 branches. Committee for proposing Legislation On Electronic Funds Transfer and other Electronic Payments (1995)[11] emphasized on EFT system. Electronic banking refers to DOING BANKING by using technologies like computers, internet and networking, MICR,EFT


so as to increase efficiency, quick service, productivity and transparency in the transaction.

Apart from the above mentioned innovations the banks have been selling the third party products like Mutual Funds, insurances to its clients. Total numbers of ATMs installed in India by various banks as on end March 2005 is 17,642.The New Private Sector Banks in India is having the largest numbers of ATMs which is fol off site ATM is highest for the SBI and its subsidiaries and then it is followed by New Private Banks, Nationalised banks and Foreign banks. While on site is highest for the Nationalised banks of India. OFF SITE ATM 1567 3672 441 3729 579



OF ON ATM 3205 1548 800 1883 218


TOTAL ATM 4772 5220 1241 5612 797


HISTORY Canara Bank (Canara), one of the biggest commercial banks in India, was established in 1906 atMangalore, Karnataka by Mr.AmmembalSubbaRaoPai. He had envisioned the bank to not only offer financial services but also fulfill social causes such as removal of


superstitions and ignorance, promotion of habit of saving, providing assistance to the people in need and develop a sense of humanity among the people. The Bank has gone through the various phases of its growth trajectory over hundred years of its existence. Growth of Canara Bank was phenomenal, especially after nationalization in the year 1969, attaining the status of a national level player in terms of geographical reach and clientele segments. Eighties was characterized by business diversification for the Bank. In June 2006, the Bank completed a century of operation in the Indian banking industry. The eventful journey of the Bank has been characterized by several memorable milestones. Canara has a panIndia presence with a network of 3,046 branches as on March 31, 2010. Thebanks branches are wellspread across metropolitan, urban, semi urban and rural areas.

The bank boasts of having the maximum number of ATM installations among all the nationalized banks summing up to more than 2000 of them at 698 centres. Also, 1351 branches of the bank provide Internet and Mobile Banking (IMB) services, while Anywhere Banking services are being provided at 2027 of its branches. All the branches of Canara Bank are enabled with Real Time Gross Settlement (RTGS) and National Electronic Fund Transfer (NEFT) transaction facilities, insuring smooth and swift money transfer from any corner of the nation to another corner. Apart from setting other benchmarks in the field of providing comprehensive banking services to the consumers, Canara Bank has a number of achievements to its credit, which include being the first bank in India to have launched Inter-City ATM network, being the first bank to have been awarded ISO Certification for one of its branches, providing credit card for farmers for the first time in India along with offering Agricultural Consultancy Services

Significant milestones 1st July 1906 Canara Hindu Permanent Fund Ltd. formally registered with a capital of 2000 shares of 50/- each, with 4 employees. 1910 Canara Hindu Permanent Fund renamed as Canara Bank Limited


1969 1976 1983 1984 1985 1987 1989

14 major banks in the country, including Canara Bank, nationalized on July 19 1000th branch inaugurated Overseas branch at London inaugurated

Cancard (the Banks credit card) launched Merger with the Laksmi Commercial Bank Limited Commissioning of Indo Hong Kong International Finance Limited Canbank Mutual Fund &Canfin Homes launched Canbank Venture Capital Fund started

1989-90 Canbank Factors Limited, the factoring subsidiary launched 1992-93 Became the first Bank to articulate and adopt the directive principles of Good Banking. 1995-96 Became the first Bank to be conferred with ISO 9002 certification for one of its branches in Bangalore 2001-02 Opened a 'Mahila Banking Branch', first of its kind at Bangalore, for catering exclusively to the financial requirements of women clientele. 2002-03 Maiden IPO of the Bank 2003-04 Launched Internet Banking Services 2004-05 100% Branch computerization 2005-06 Entered 100th Year in Banking Service. Launched Core Banking Solution in select branches. Number One Position in Aggregate Business among Nationalized Banks. 2006-07 Retained Number One Position in Aggregate Business among Nationalized Banks. Signed MoUs for Commissioning Two JVs in Insurance and Asset Management with international majors viz., HSBC (Asia Pacific) Holding and RobecoGroep N.V respectively. 2007-08 Launching of New Brand Identity.Incorporation of Insurance and Asset Management JVs. Launching of 'Online Trading' portal. Launching of a Call Centre. Switchover to Basel II New Capital Adequacy Framework. 2008-09 The Bank crossed the coveted 3 lakh crore in aggregate business. The Banks 3rd foreign branch at Shanghai commissioned.


2009-10 The mark.




crossed 4



Net profit of the Bank crossed 3000 crore. The Banks branch network crossed the 3000 2010-11 The Banks aggregate business crossed 5 lakh croremark. Net profit of the Bank crossed 4000 crore. 100% coverage under Core Banking Solution. The Banks 4th foreign branch at Leicester and a Representative office at Sharjah, UAE, opened. The Bank raised 1993 crore under QIP. Govt. holding reduced to 67.72% post QIP. 2011-12 Total number of branches reached 3600. The Banks 5 th foreign branch at Manama, Bahrain opened. . Canara Banks rating reflects its strong market position, adequate capitalization levels, and comfortable liquidity profile. The rating also factors the banks business profile that is supported by a good resources position, as well as its better asset quality as compared to its peers. Crisil also considers the Government of Indias (GoI) majority ownership of Canara Bank to be a positive rating factor. The banks earnings profile is characterized by moderate although improving profitability. Among the Top 5 banks in India Canara is Indias fifth largest bank in terms of asset size; as on March 31, 2010, it had an asset base ofaround Rs 2.6 trillion. It is one of the few national players in the banking industry with a network of more than 3000 branches spread all across the country. Canara Banks strong market position is underpinned by its nationwide presence and its large and diversified balance sheet. This strong market position gives Canara Bank significant advantages in raising resources, besides bringing in diversity of assets. The banks strong market position is underpinned by its market share of over4.8% in deposits and advances, and its panIndia branch network. The banks advances and depositsregistered a compound annual growth rate (CAGR) of 20% and 18%, respectively, over the past threeyears. Deposits and advances grew 25.5% and 22.5%, respectively, yearonyear in FY10. Canara'srevenue profile is diversified across businesses, products, and geographies. As on March 31, 2010,retail advances constituted 15% of the bank's total advances, against an industry average of around20%. Housing


loans (direct) accounted for 42% of the retail portfolio as compared to 37% on March 31,2009. Support from majority owner, Government of India The Government of India (GoI) is the majority owner of Canara, with ~73.2% stake as on March 31,2010. This gives the bank stability both on an ongoing basis and in the event of distress. The flexibility provided by GoIs additional stake over the minimum required holding of 51% and the banks strong TierI base provides it with sufficient ability to absorb asset side risks. Canara's stated posture is tomaintain a capital adequacy ratio (CAR) of above 12%. Further, GoI has reiterated that it will takemeasures to maintain public sector banks' (PSBs) overall CAR at around 12%, so that these banks cangrow their balance sheets and remain competitive. Strategic tieups with international players In 2007, Canara formed a joint venture with M/s RobecoGroep NV, for managing assets of CanbankMutual Fund (since renamed as Canara Robeco Mutual Fund). The joint venture gets sales support fromthe vast network of the bank. Canara also floated an insurance JV along with HSBC Insurance (AsiaPacific) Holding Ltd and Oriental Bank of Commerce, another nationalised bank. The company wasincorporated in September 2007. Canara holds 51% stake in the insurance JV. Adequate capitalisation levels Canara Banks capital position is characterised by a moderate Tier I capital ratio, reasonably large capital base, and comfortable networth coverage of net non-performing assets (NPAs). At 7.85 per cent as at March 31, 2003, Canara Banks Tier I capital adequacy ratio is moderate and is comparable with that of the better public sector banks. Canara Banks reasonably large capital base of Rs 41.49 billion as at March 31, 2003 provides comfort against large asset-related shocks. The net worth coverage for net NPAs at 2.85 times provides substantial comfort to its existing capital position. Good resource and liquidity profile


Canara Banks good resource profile accrues from its large and geographically welldiversified deposit base (which emanates from its national presence), healthy resource mix, and steady growth in deposits. Further, a significant proportion of the banks branches (42 per cent) are in the semi-urban and rural areas, which provides it with a relatively stable source of funds, given the limited presence of the new private sector banks in these areas. Canara provides various banking products and services, primarily in India and the overseas market. In FY10, treasury operations contributed ~25% of total revenue, retailbanking ~26%, corporate/ wholesale banking ~46% and others ~3%. Apart from banking operations, Canara also offers factoring, insurance asset management, and retail institutional broking services through subsidiaries and associates. In addition to overseas branches in London, Leicester, Shangai and Hong Kong, the bank has operations inRussia in partnership with State Bank of India. Further, the bank offers NRI services such as deposits, loans and advances, remittance facilities, and consultancy services, aswell as safe custody, nomination facility, attorney ship services, facilities for returning Indians, safe deposit lockers, and investment products. The bank provides a range of alternative delivery channels, which includes over 2,000 automated teller machines (ATMs) covering 728 centres, 1,959 branches providingInternet and mobile banking (IMB) services and 2,091 branches offering anywhere banking services. Canara was the first Indian bank to launch an inter city ATM network. As onMarch 31, 2010, the bank had 3,046 branches well spread across metropolitan, urban, semiurban and rural areas. The bank's international operations are supported by 395correspondent banks spread across 80 countries. As of March 31, 2010, Canara had 43,380 employees. Canara Banks liquidity position continues to be comfortable, and is supported by a steady growth in deposits, access to the inter-bank call money market, and investments above regulatory requirements in highly liquid Government Securities. Canara Bank made a net profit of Rs.3,283crore in 2011-12, a decline of 23 per cent over the previous year. The growth of deposits and advances during the past year was in low double-


digits.Total provisions amounted to Rs.2,660crore, of which NPAs accounted for Rs.1,294 crore. The bank had a net interest margin of 2.50 per cent in 2012, as compared to 3.12 per cent, a year earlier. The board has maintained the dividend at Rs.11 per share for 201112. Today, Canara Bank occupies a premier position in the comity of Indian banks. With an unbroken record of profits since its inception, Canara Bank has several firsts to its credit. These include:

Launching of Inter-City ATM Network Obtaining ISO Certification for a Branch Articulation of Good Banking Banks Citizen Charter Commissioning of Exclusive Mahila Banking Branch Launching of Exclusive Subsidiary for IT Consultancy Issuing credit card for farmers Providing Agricultural Consultancy Services

Over the years, the Bank has been scaling up its market position to emerge as a major 'Financial Conglomerate' with as many as nine subsidiaries/sponsored institutions/joint ventures in India and abroad. As at March 2010, the Bank has further expanded its domestic presence, with 3043 branches spread across all geographical segments. Not just in commercial banking, the Bank has also carved a distinctive mark, in various corporate social responsibilities, namely, serving national priorities, promoting rural development, enhancing rural self-employment through several training institutes and spearheading financial inclusion objective. Promoting an inclusive growth strategy, which has been formed as the basic plank of national policy agenda today, is in fact deeply rooted in the Bank's founding principles. "A good bank is not only the financial heart of the community, but also one with an obligation of helping in every possible


manner to improve the economic conditions of the common people". These insightful words of Canara bank founder continue to resonate even today in serving the society with a purpose. The growth story of Canara Bank in its first century was due, among others, to the continued patronage of its valued customers, stakeholders, committed staff and uncanny leadership ability demonstrated by its leaders at the helm of affairs. The bank strongly believes that the next century is going to be equally rewarding and eventful not only in service of the nation but also in helping the Bank emerge as a "Global Bank with Best Practices". This justifiablebelief is founded on strong fundamentals, customer centricity, enlightened leadership and a family like work culture.


Scope Importance and Objective of Study

During the last decade, importance of risk management in credit has increased for both borrowers and lenders, especially, in the developing countries. For this reason, banks and financial institutions started to revise their lending policies. There are basically six functional responsibilities associated with credit lending activities; (1)Assessment of the customers credit risk, (2) Making the credit granting decision with regard to credit terms and, where relevant, credit limits, (3) Collecting receivables (debts) as the fall due and taking action against defaulters, (4) Monitoring customer behavior and compiling management information, (5) Bearing the risk of default or bad debt, The study focuses on collecting statistical data on consumer behavior, evaluating the collected data and trying to find managerial outcomes. These outcomes enable financial institutions to evaluate alternative lending policies and minimize their credit default risks in credit types such as home loans, car loans, and personal loans. More specifically, this study aims to examine the relationship between the consumer credit payment performance and some demographic variables (such as marital status, sex, residential status, occupation, Education) and some financial variables (such as income, loan size, interest rate, credit category). The present study is important for two reasons. First, many previous studies and financial institutions have focused on the relationship between lenders decision and the characteristics of the consumer credit applicants rather than the relationship between payment performance of the consumer credit and their characteristics. It is, of course, important to get some information about the relationship between characteristics of people apply for consumer credit (applicants) and to whom the credit will be given. However, it is equally beneficial to have an idea about the relationship between the


characteristics of people that are already accepted (clients) and whether they are paying back their loans on time or not i.e. payment performance. To some extent, this kind of testing whether the decision of accepting/rejecting (or the decision criteria) the applicants is the right one or not we dont know correctly. Therefore, investigating the effects of some characteristics of credit clients on clients payment performance becomes crucial. Second, by ranking customers according to predicted default probabilities, a bank will have a chance to minimize the expected default or misclassification. As a reaction to an increasing competition and bankruptcies, banks all over the world are trying hard to improve the process of loan origination in corporate banking. Practitioners estimate that improvements in risk management can decrease credit losses by 20 to 40%.

OBJECTIVES: To formulate a method so as to identify the potential NPAs and the factors responsible loan defaults with the help of logistic regression model To have in-depth understanding of the different type of risks that pose threat to banks. To have profound understanding existing system of risk management prevailing in the bank. Getting a real time exposure of the corporate world and the processes in the company which will help me in relating the classroom teaching with the practical world for the better understanding of things. Having an experience in a Banking company will help me in pursuing a career in this industry which has a very high growth potential and an immense career opportunities in the near future.



The word risk is derived from an Italian word risicare which means, "to dare". This means that risk is more a choice than a fate. Extending this analogy further we can say that risk is not something to be faced but a set of opportunities open to choice. There is no single definition that captures the entire spectra of what constitutes risk. The Bank for International Settlement (BIS) definition, which is widely accepted, reads thus "Risk is the threat that an event or action will adversely affect an organizations ability to achieve its objectives and successfully execute its strategies". A very wider definition of risk is Risk is nothing but the certainty of an exposure to uncertainty.

Risk Management:Managing the risks commences with the task of identifying all the possible risks in our activities. The next task would be to list out the controls in place against each of the identified risks. Making an assessment of the controls in place versus the identified risks for adequacy follows this. The risk identification and assessment is a dynamic exercise and must be carried out at regular intervals aiming at continuous refinement of our procedures in tune with the risks perceived. Risks also need to be measured to not only ascertain their financial impact on


our resources but also to aid in pricing our products. Finally a system should be in place to monitor/review the above processes.

History of Risk Management in Banks: The origin and development of risk management in Banks in a chronological order. For this purpose the subject is divided into the following periods, 1970s and BCBS, Basel Accord I, Events of 1990s, Basel Accord II 1970s and BCBS:: The first major Bank event that opened the eyes of financial sector was that of Bank Herstatt of Germany, which was forced by German regulators into liquidation. The G-10 countries and Luxembourg formed a committee under the auspices of Bank for International Settlements (BIS), called Basel Committee on Banking Supervision (BCBS) to promote stability in the global banking system. The committee meets regularly four times a year. It has about thirty technical working groups and task forces, which also meet regularly. The two main objectives of the committee at the time of its formation were No foreign Banking system should escape supervision Supervision must be adequate for all Banks operating internationally BCBS engaged itself in formulating standards, guidelines and best practices with the expectation that respective central banks will implement them to best suit their national systems. Basel Accord I:: Pursuing the goal of creating a level competitive field for all Banks, BCBS published a credit risk framework to guide the allocation of capital reserves for all internationally active Banks. This popularly came to be known as Basel I accord. The Basle I framework defined two minimum standards for acceptable Capital adequacy requirements.


Risk based capital ratio & Asset to capital multiple Risk based capital ratio is defined as the ratio of capital to risk weighted assets. Assets means both on balance sheet items(Loans, advances and investments etc) and off balance sheet exposures(Guarantees and Letters of credit etc).As per the accord Banks had to hold a minimum capital of 8% over the risk weighted assets. Out of the minimum capital to be held at least 4% of it should be in the form of Tier I capital. The asset to capital multiple was set at 12.5.Tier II capital is limited to 100% of Tier I capital Capital Adequacy Ratio(CAR) = Capital divided by Credit risk Capital = Tier I Capital + Tier II Capital Credit risk = Sum of Risk Weighted Assets (RWA) Risk Weighted assets = Exposure X Supervisor determined risk weights. Capital ratio Minimum 8% as per Basel. and 9% as per RBI In India Basel I accord, was implemented through the Narasimham Committee

Recommendations introducing Prudential Norms such as Asset Classification, Income Recognition & Capital Adequacy Ratio. CAR of 9 % was stipulated by Reserve Bank of India. Basel I met the following objectives: o Strengthened the capital base of Banks o Created clear and uniform guidelines for all Banks world over o Reduced competitive distortion among banks Capital brought in by the above formula is known as Regulated Capital as risk weights are prescribed by the regulator of the respective countries ( In India RBI) Events of 1990s:: In the 1990s many loss incidents were witnessed in the financial sector. Failure of Barings Bank, BCCI, Sumitomo Bank and Daiwa Bank are some of the


examples. BCBS continued its efforts to suggest measures and remedies to strengthen the Banking system world over. In January 1996 BCBS came out with amendment to the 1988 accord to incorporate Market risks. Accordingly RBI introduced Asset Liability Management for Banks in India to address Liquidity and Interest rate risks with effect from 1.04.1999. Basel New Accord:: Towards the end of 20th century banking operations witnessed significant changes like:: Deregulated environment Liberalization, Privatization and Globalization Technology boost leading to introduction of sophisticated and complex products Expansion and foray into new types of activities Basel I though a revolutionary move of earlier times, it suffered from many shortcomings are: Non-recognition of Operational risk Ignoring of the Risk management advancements Capital reserve inaccuracies which have ignored the above changes. The short comings of Basel I

In 1999 BCBS came out with fresh proposals to align the capital held by banks more closely with the risks faced by them. This is popularly known as Basel New Accord. The proposals had three stages of consultation and have finally found approval on 26.06.2004.The proposals of the new accord have to be implemented by 01 04 2007. These proposals stand on three reinforcing pillars namely


Minimum Capital Requirements Supervisory Review Market Discipline Pillar I Minimum Capital Requirements:: Prescribes the various approaches in the order of risk sensitivity for measuring credit and operational risk, thus enabling banks to move from Regulated Capital to Economic Capital. Pillar II Supervisory Review:: This pillar of the Accord aims at not only ensuring that Banks are capital adequate in terms of risks faced but also encourages them to use better risk management techniques in monitoring and managing their risks. Another important aspect of pillar II is the assessment of compliance with the minimum standards and disclosure requirements for pursuing advanced measurement approaches as mentioned above. National supervisor i.e., Reserve Bank of India will ensure that these requirements are met both as qualifying criteria and on a continuous basis.


Minimum Capital Regulatory Review requirements Encompassing calculated based on a) Assessment of a) Credit Risk Minimum Capital Adequacy b)Operational Risk b) Expected to operate c) Market Risk above Min. CAR c) Timely interventions by Regulator First Pillar Second Pillar QUANTITATIVE QUALITATIVE

Market Discipline Requirements on disclosures. a) Capital Structure b) Risk Exposure c)Capital Adequacy Third Pillar MARKET FORCES


RISK MANAGEMENT IN BANKS Operating in a liberalized & globalized environment banks are exposed to various kinds of risks that can emanate from financial & non-financial factors. Generally risks faced by banks are grouped in clearly identifiable categories which include a) credit risk b) market risk and c) operational risk.

With progressive de-regulation, cross border dealings, globalization, introduction of wide range of products & services, improvement in technology & communications, significant changes have occurred in the balance sheets of banks. Risks faced by banks have now increased manifold posing significant challenges to both banks & supervisors. To respond to these challenges there have been various supervisory initiatives to introduce better operating standards in banks, greater transparency & sensitivity towards risk management by banks. The risks faced by banks can be categorized under two risk groups: 1) Business risks which are inherent in the activities that banks undertake. 2) Control risks that arise out of inadequacy, break down or absence of various controls that are used to mitigate business risks. Inherent business risks include credit risk, market risk, liquidity risk, operational risk, strategy & business environment risk, group risk etc. Control risks include breakdown of internal controls & risk related to organization structure & management. The impact of losses on account of various risks get reflected in a banks earnings & capital. As such, while earnings & capital do not represent risk per se, since they bear the impact of various risks their assessment in relation to risk management is important. Hence capital & earnings have been included under business risks.



CREDIT RISK:: Credit risk represents the major risk faced by banks

on account of nature of their business activity, which includes dealing with or lending to a corporate, another bank, financial institution or a country. Credit risk may be carried in banking book or the trading book or in the off balance sheet items. Credit risk includes: a) COUNTER PARTY RISK- The possibility that a borrower or counter party will fail to meet obligations in accordance with agreed terms. It may also be reflected in the down grading of the standing of the counter party making him more vulnerable to possibility of defaults. b) PORTFOLIO RISK Due to adverse credit distribution, credit Concentration / investment concentration . c) COUNTRY RISK The possibility that a country will be unable to service or repay its debts to foreign lenders in a timely manner. ii) MARKET RISK:: Market risk is the potential of erosion of income or market

value of an asset arising due to changes in market variables such as interest rate, foreign exchange rate, equity prices & commodity prices. a) Interest rate risk The risk in the erosion of earnings due to variation in the interest rate with in a given time zone. Interest rate risk may arise on account of gap or mismatch risk, basis risk, embedded options risk, yield curve risk etc. b) Foreign exchange risk The holdings of foreign exchange assets or liabilities, not been hedged against movement in exchange rates. This position is referred to as open position. Forex risk affects both spot & forward positions of the bank. Forex risk includes settlement risk, time zone risk & translation risk.



Equity price risk- Potential of an institution to suffer losses on its exposure to markets, from adverse movements in the prices of equity.


d) Commodity price risk The potential of adverse movements in prices of physical products, which are or can be traded in the secondary markets like agricultural products, minerals & oils, precious metal. iii). LIQUIDITY RISK Possibility that a bank may be unable to meet its liabilities as they become due for payment or may be able to fund the liabilities at a cost much higher than the normal cost. The risk arises due to mismatch in the timing if inflows & outflows of funds, and from funding of long term assets from short term liabilities. Surplus liquidity could also represent a loss to the bank in terms of earnings missed & hence an earning risk. iv). STRATEGY & BUSINESS ENVIRONMENT RISK May arise due to

inappropriate or non-viable business strategy adopted by the bank/ its absence altogether & the business environment that the bank operates in, including the business cycle that the economy may be passing through. A dynamic & viable medium term strategy formulated on the basis of proper research & planning, identifying target areas, markets, products, customer base etc is necessary for effective risk management. Lack of the same may pose a significant risk to the earnings & viability of the bank. v). OPERATIONAL RISK May arise due to inadequate or failed internal processes, people & systems or from external events. It includes People risk ( incompetence, frauds, work environment, motivation ), Operational control risk ( failure of operational controls, volumes ),Model risk ( model application error, methodology error ). Apart from the above the following are also covered under operational risk. a) Legal risk May arise due to the possibility of actions of a bank not being in

conformity with the laws of a country or being in violation thereof. The bank can also experience legal risk when customers approach court of law for redressal of their


grievances where transactions with its counter parties are not supported by proper documents or the terms of the contract are unclear or even due to lack of well established legal pronouncements in cases where issues involved are nebulous. b) Reputational risk The financial implications of a moral obligation cast on

a bank in the environment it is functioning or by virtue of its association with another organization is called reputational risk. Reputational risk is the potential of suffering loss due to significant negative public opinion, bad or wrong publicity. c) Technological risk Arising out of IT related factors like validity of IT

systems, back up & disaster recovery systems, failure of systems, security of systems, programming errors etc. It can also arise due to obsolescence of technology being used, technology not being in alignment with business needs or adoption of untried & untested technology, inability of the staff to respond to new technology etc. vi). GROUP RISK Arising on account of financial implications being cast on the bank due to its obligations to other entities in the group or due to contagion effect. A bank may have various domestic/over seas subsidiaries dealing in mutual funds, merchant banking services, housing finance, gilt securities, banking services etc. Since there are, as yet, no rigorous capital adequacy norms & prudential regulations governing subsidiaries, the parent bank is exposed to the risk of rescue operations whenever a subsidiary runs in to losses/ needs fresh injection of funds. vii). EARNINGS RISK It can be assessed through assessment of fund cost & return, assessment of earnings & expenses and assessment of earnings quality & stability. viii). CAPITAL INADEQUACY RISK Capital of bank is a cushion against unexpected losses. The volume of capital determines the direction & magnitude of future growth of business of a bank. Though capital does not represent business risk, since it bears the impact of other risks its adequacy or inadequacy is a material in the risk assessment of a bank.


CONTROL RISKS. i) Internal control risk Arising on account of failure of internal control system

of the bank. Weakness in internal controls have been historically recognized as a high risk factor. It requires special attention due to its high potential to inflict heavy losses on a bank on account of failure of various control systems. ii) Organization risk Arising on account of organizational bottlenecks in the form of inadequate or inappropriate structure in relation to its business and the quality of its external & internal relationships. The organization structure needs to be clear and in tune with the legal & business requirements of the bank .The organization should be flexible to meet the challenges. iii) Management risk Arising out of poor quality and lack of integrity of

management. It is reflected in quality of senior management personnel, their leadership, competence, integrity and their effectiveness in strategizing, delivering & dealing with the problems. iv) Compliance risk Arising out of non-compliance with various requirements on

account of authorisation, statutory requirements, prudential operations & supervisory directives/guidance. RISK MANAGEMENT ARCHITECTURE: The effectiveness of risk management systems depends to a large extent on having in place appropriate and effective risk management architecture. It should at the minimum include the following: i) ii) iii) iv) Risk management policies. Board of directors & Senior management commitment. Effective organization structure for risk management. Effective risk management processes & systems.


v) vi)

Human resources & training. In-house monitoring.

RISK MANAGEMENT POLICIES: Bank should have appropriate risk management policies in place. The risk management policy document should broadly cover the followings: a) Identify the risks that are to be measured & monitored. b) Define risk tolerance level for the bank. c) Specify the methodology for measuring the various risks and specifically approve the methodology or models to be used. d) Provide for exception reporting to top management when the allocated limits are breached. e) Indicate the process to be adopted for immediate corrective action. f) Set up an organizational structure for risk management including delegation of powers & responsibilities for risk monitoring & control. g) Provide detailed guidelines for proper data collection, collation & updating. h) Specify a separate organizational unit for validation & review of the risk monitoring techniques used. i) Specify system for comprehensive review of risk management & risk control & report to the board.


BOARD OF DIRECTORS AND SENIOR MANAGEMENT COMMITMENT: The Board should set various risk limits by assessing the banks risk appetite, skills available & risk bearing capacity represented by capital. It should also set up appropriate procedures for management of the risks. This calls for clear lines of responsibility for managing risk, adequate systems for measuring risk, appropriately structured limits on risk taking, effective internal controls & a comprehensive risk reporting process. The Board should ensure that senior management attends to its responsibilities concerning risk management & internal control and frequently reviews the effectiveness of the system. It also needs to make a periodical review of risk management policies, control systems in place, clarity of various reporting lines, adequacy of monitoring mechanisms, adherence to policies, procedures & limits by operational departments and adequacy of management responses on identified weaknesses. RISK MANAGEMENT ORGANIZATION : At the apex of the risk management organization of a bank should be the Risk Management Committee, which generally comprises the Managing Director, Heads of business units of the bank and Head of Risk Management. It can also include some members of the Board. The RMC is responsible for supervising the activities & operations of all committees entrusted with risk management functions with in the bank. These committees include Credit Risk Management Committee, Asset Liability Management Committee and the Operational Risk Control Function. The Risk Management Department supports the activities of Risk Management Committee through research on & analysis of risks, reporting risk positions & making recommendations as to the level & degree of risk to be assumed. RMD has the responsibility to identify, measure & monitor the risks faced by the bank, develop & issue policies and procedures, verify the models that are to be used for risk measurement & pricing complex products and identify new risks as a result of emerging markets & new products.


Under RMD, there may be independent groups/departments for supporting the committees for specific risks ie. Credit risk, Market risk and Operational risk. The Credit Risk Management Department may be supported by Risk Planning Cell, Risk Assessment & Monitoring Cell, Risk Analytic Cell & Credit Risk Systems Cell. RISK MANAGEMENT PROCESSES & SYSTEMS: a) Risk Identification: The first step for risk management process is to identify all risks to which the bank is exposed. The activities undertaken by the bank as well as the new activities that the bank proposes to enter in to as observed from the balance sheet & other records should be systematically examined to identify all kinds of risks faced by the bank. The bank will have to proceed in systematic manner across all its activities both on assets and liabilities, including off balance-sheet items to ensure that there is no activity of the bank omitted from risk management. b) Risk measurement: Banks should have proper systems in place to measure the risks identified as arising from various activities. For this, banks may develop risk management techniques that are appropriate to the size & complexities of their portfolios, resources & data availability. The methodologies of risk measurement may range from a simple assessment on the basis of certain qualitative & quantitative criteria compared with certain pre-set standards/bench marks to sophisticated statistical/mathematical models. c) For measuring credit risk traditional methods involve financial analysis in

conjunction with credit rating framework to arrive at risk aggregation, pricing & other decisions. On the other hand there are several other new techniques in the nature of quantitative models using econometric, mathematical programming or simulation methodologies for decision making.


d) For interest rate/forex/market risk measurement, some of the standard techniques used are maturity gap analysis, duration gap analysis, value-at-risk approach etc. e) Risk monitoring & control: Controlling the risk with in the parameters & limits set by the Competent Authority is the ultimate objective of the risk management exercise. Risk monitoring & control involves i) Limit setting each bank should determine for itself what is the maximum level of risk it can face given the level of its capital. Fixation of risk level has a great significance since capital is subject to erosion if risks actually materialise. The limits could be fixed in terms portfolio standards for credit risk or setting limit for value at risk in respect of credit risk, earning risk & market risk.

ii).Monitoring once limits are fixed, the actual performance/utilization needs to be compared against the limits for risk monitoring. The results of such comparisons will reveal the exceptions, which may be investigated for reasons of material deviations and reported to the proper authority for remedial action. Tracking of risk migrations upward or downward is another aspect of risk mitigation. iii).Reporting & MIS the existence of strong MIS that captures relevant information and data is an important pre-requisite for effective risk control. However, the accuracy of data, the frequency of revision of data/information and its timely availability are important factors that determine the efficacy of the risk monitoring & control process. iv). Risk mitigation the essential aspect of risk monitoring & control is to take corrective action for bringing down risk to manageable levels if it is considered high. The various ways of risk mitigation are reduction in exposure to a particular industry, stepping up of recoveries to bring down NPAs, acceptance of collaterals, reducing open positions in foreign currencies .etc.


HUMAN RESOURCES & TRAINING:: with banks gradually refining their risk management systems & the impending introduction of risk based supervision of banks by RBI, the need of understanding the risks m the process of their management & control and the increasing use of sophisticated tools for measuring & managing the risks, bank should have specialised staff adequately trained to discharged various risk management functions. Since specialization develops over time, identification and positioning core staff for risk management as well as availability of second line of support are crucial for effective risk management. IN-HOUSE MONITORING:: The risk management process needs to be reviewed periodically by an independent group of executives to ensure that all important elements of risk management process are functioning effectively/efficiently and the risk as measure through the process is the actual risk/close to the actual risks faced by Bank.


The banks and financial institution have faced difficulties over the years for several reasons. The major causes continue to be directly related to the low quality of credit, poor portfolio risk management besides insensitivity to changes in economic and other circumstances. Loans and Advances are the most obvious source of Credit Risk. Focused attention on credit delivery, recovery and review are pre requisite for effective Credit Management. Therefore Credit Risk is the critical component of Integrated Risk Management. The success of integrated Risk Management largely depends on effective handling of Credit Risk. Definition of Credit Risk: Credit Risk is defined as The inability or unwilling ness of the customer or counter party to meet commitments in relation to lending, hedging, settlement and other financial transactions. Hence credit risk emanates when the counter party is unwilling or unable to meet or fulfill the contractual obligations/ commitments thereby leading to defaults. Credit Risk of a Bank depends upon several External and Internal factors. These External or Internal factors are related both to the borrower & the bank. Internal factors (Applicable to Banks):: Deficient loan policies, Inadequately defined powers for sanction of loans, Absence of prudential credit concentration limits, Absence of credit committees, Deficiency in credit appraisal systems, Excessive dependence on collaterals, Inadequate/lack of risk pricing, Absence of loan review mechanism and post sanction surveillance External factors (Applicable to Borrowers) :: Inadequate technical know-how,

Locational disadvantages, Outdated production process, High input costs, Break Even Point being very high, Uneconomic size of plant, Large investment in Fixed Assets, Over estimation of demand, wide swings in commodity or equity prices.


External Factors (Applicable both to the Borrower and Banks): Credit worthiness of the counter party, default risk, interest rate risk, forex risk, country risk, concentration risk, portfolio risk, transaction risk, Economic scenario, Government policies and Trade restrictions etc. Effects of External factors on Credit Risk: 1. Creditworthiness of the counter party: Failure of the counter party to meet the

commitments agreed upon either on account of unwillingness to pay despite adequate cash generation or incapacitated to pay for reasons beyond the control of the country party leads to default there by leading to Credit Risk. Failure to meet the commitments agreed upon can occur on account of either intentional default or bona-fide reasons. However at the same time situations can not be ruled out where despite low or no cash generation the counter parties may still honor their commitments. assessment of credit worthiness of the counter party is crucial. 2. i. Default risk: This kind risk can arise on account of failure of the counter party who is our borrower to meet Hence proper

the commitments agreed upon. ii. the counter party. 3. Interest Rate Risk: Lending rates that are stipulated for any activity should be Also on account of defaults committed by other parties connected to

reasonable, acceptable besides being affordable to the borrower based on his cash generation as well as repaying capacity. Fixation of unreasonable interest rates which are not matched by adequate cash generation may lead to defaults in meeting the commitments. Hence interest rates shall be linked to creditworthiness & default risk of the borrower.



Forex Risk: Volatility in foreign exchange rates may also impair the repaying

ability of the counter party. When rupee depreciates, the counter may have to bring more Indian currency to meet the obligations/ commitments denominated in foreign currency (import bills). However when the Rupee appreciates against the foreign currency, the counter partys foreign currency earnings gets reduced resulting in erosion of profits & there by making him unable to meet his commitments. Therefore counter parties importers are likely to suffer when the Rupee value depreciates and Counter parties Exporters are likely to suffer when the Rupee appreciates. 5. Country Risk: Prevailing economic conditions in different countries determine

the risk which the bank is exposed to. If the importers country has imposed an embargo on repatriation, our exporter will not be in a position to receive the exports proceeds which may lead to defaults. 6. Concentration Risk: This is the single largest cause for major credit problems.

This includes concentration in a single borrower, a group of connected counter parties, sectors or industries and the concentration based on common or correlated risk factors. 7. Portfolio Risk: This is similar to Concentration risk. When the Bank takes Textile

credit or investment exposure on certain sectoral activities like, Housing,

Industry etc, the success or failure of these sectors has direct bearing on the performance of the credit or investment. In the event of all or some of them not performing well may cause hardships to parties engaged in these business which in turn may result in default of payments agreed upon.



Transaction Risk: The very nature of transaction some times has an intrinsic

risk like: Granting of clean or unsecured loan Discounting of a supply bill Book debt finance to individuals & proprietary concerns Economic Scenario /Government Policies/ Trade Restrictions: The changes in


economic scenario or the Government policies or the trade restrictions imposed by different countries which are beyond the control of either the Bank or the Borrower may adversely affect the business or activity which might cause default leading to Credit Risk. Credit risk is having two components. The first is the solvency aspect of credit risk, which relates to the risk that the borrower is unable to repay in full the sum outstanding. The second is the liquidity aspect of credit risk that arises when the payment due from the borrower are delayed leading to cash flow problems for the lender. The liquidity and solvency risks are closely related. In order to meet the short liquidity needs, a firm may have to undertake fire-sale of assets which might fetch a lower amount for the assets sold as compared to the sale of assets under normal circumstances. This could lead to a situation of technical insolvency where the realizable value of assets may be less than the value of liabilities. This problem is more pronounced in case of banks as their balance sheet contains assets ( like loans and investment etc ) which fluctuate in value where as the value of deposits remains constant and in fact might grow on account of interest element. Thus what may appear to be liquidity risk in the beginning may turn in to solvency risk over a period of time. 44

Capital Charge for Credit Risk: In the earlier chapters we have seen how the equation for capital adequacy ratio has changed after the advent of Basel II. But capital charge for credit risk is totally different from provisioning for NPAs. In the environment of risk management, NPA is defined as a situation in which the default has already occurred and the credit risk thereof has crystallized. But Credit Risk is more concerned with quality of credit portfolio before default. Therefore adequate cover by appropriate allocation of Capital for unexpected losses in future is the objective Credit risk Management. As per RBI requirement, the CAR remains at 9 %, but the risk weights assigned to various credit assets depends upon the credit quality, area of operation, consistency of operation etc of that credit asset.

Measurement of Credit Risk:

Basel II proposes two methods for measurement of Credit Risk. They are 1. Standardized Approach 2. Internal Ratings Based (IRB) Approach. Standardized Approach:: Under this approach, the Basel II accord proposes

differential capital requirements depending upon the credit quality of the borrower. The differential risk weights range from 0 %, 20%, 50%, 100 % and 150% would be assigned on the basis of ratings of the borrower. Therefore to adopt this approach Risk Rating of the borrowers is pre requisite. Internal Ratings Based Approach: A further option of 2 methods exist in this. They are Foundations Approach & Advanced Approach. This approach is based calculation


of Expected Losses and Unexpected Losses. In turn these are calculated by Probability of Default (PD), Loss Given Default(LGD) and Exposure at Default (EAD) Banks which comply with certain minimum requirements like Comprehensive Credit rating system shall be permitted to adopt the Foundation Approach. Under this approach, the rating system adopted by the banks shall be capable of quantifying the Probability of Default, whereas the LGD and EAD are provided by RBI. Under Advanced Measurement Approach, banks will be allowed to use the internal for calculation of PD, EAD, LGD for assigning the risk weights and they will be validated by RBI. However for adopting the IRB Approach, banks should build up historical data base on the Portfolio quality/Provisioning/Write offs etc.


All the risk management activities are done in order to avoid the occurrence of potential default or occurrence of Non-performing Assets. A Non-performing asset (NPA) is defined as a credit facility in respect of which the interest and/or instalment of principal has remained past due for a specified period of time. For the identification of NPA and with a view to moving towards international best practices and to ensure greater transparency, it has been decided to adopt the 90 days overdue norm for identification, from the year ending March 31, 2004. Accordingly, with effect from March 31, 2004, a non-performing asset (NPA) shall be a loan or an advance where;

Interest and/or installment of principal remain overdue for a period of more than 90 days in respect of a term loan, The account remains out of order for a period of more than 90 days, in respect of an Overdraft/Cash Credit (OD/CC), The bill remains overdue for a period of more than 90 days in the case of bills purchased and discounted, Interest and/or installment of principal remains overdue for two harvest seasons but for a period not exceeding two half years in the case of an advance granted for agricultural purposes, and Any amount to be received remains overdue for a period of more than 90 days in respect of other accounts.

The banking industry has undergone a sea change after the first phase of economic liberalization in 1991 and hence credit management. While the primary function of banks is to lend funds as loans to various sectors such as agriculture, industry, personal loans, housing loans etc., in recent times the banks have become very cautious in extending loans. An NPA is defined as a loan asset, which has ceased to generate any income for a bank whether in the form of interest or principal repayment. As per the 47

prudential norms suggested by the Reserve Bank of India (RBI), a bank cannot book interest on an NPA on accrual basis. In other words, such interests can be booked only when it has been actually received. Therefore, this has become what is called as a critical performance area of the banking sector as the level of NPAs affects theprofitability of a bank. Therefore, an NPA account not only reduces profitability of banks by provisioning in the profit and loss account, but their carrying cost is also increased which results in excess &avoidable management attention. Apart from this, a high level of NPA also puts strain on the banks net worth because banks are under pressure to maintain a desired level of Capital Adequacy and in the absence of comfortable profit level; banks eventually look towards their internal financial strength to fulfill the norms thereby slowly eroding the net worth. Today the Net NPAs of Indian PSBs (which account for around three-fourths of the total assets of Indian banking industry) are as low as 0.72 per cent and gross NPAs are at 2.5 per cent. However, NITSURE (2007) contends that once there is a slowdown in private expenditure and corporate earnings growth, companies on these banks books will not be in a position to service their debts on time and there is a strong likelihood of generation of new NPAs. Moreover, he also suggests that with rising interest rates in the government bond market, the banks treasury incomes have declined considerably. So banks will not have enough profits to make provisions for NPAs. Under these circumstances, management of NPAs is a difficult task. Classification Banks are required to classify non-performing assets further into the following three categories based on the period for which the asset has remained non-performing and the realisability of the dues:

Sub-standard Assets Doubtful Assets Loss Assets


Sub-standard : The account holder comes in this category when they dont pay three installment continuously after 90 days and upto 1year. for this category bank has made 10% provision of funds from their profit(10% of its reserves.) to meet the losses generated from NPA.In the case of term loan, if installments of principal are overdue for more than one year but not exceeding two years, it is to be treated as sub-standard asset. An asset where the terms of the loan agreement regarding interest and principal have been re-negotiated or re-scheduled should be classified as substandard and should remain in such category for at least two years of satisfactory performance under the re-negotiated or rescheduled terms. In other words, the classification of assets should not be upgraded merely as a result of re-scheduling unless there is satisfactory compliance of the above condition. Doubtful NPA: An asset, which remains NPA for more than two years. Here too, rescheduling does not entitle a bank to upgrade the quality of an advance automatically.In the case of a term loan, if installments of principal are overdue for more than two years, it is to be treated as doubtful.Under doubtful NPA there are three sub categories : Loss Assets: Under this 100% provision is made. When account holder comes in this category their account can be written off by the banks. After this the assets are handed over to recovery agents for sale. An asset where loss has been identified by the bank or internal/external auditors or by RBI inspection but the amount has not been written-off, wholly or partly. In other words, such an asset is considered unrealizable and of such little value that its continuance as a bankable asset is not warranted although there may be some salvage or recovery value. D1 i.e. up to 1 year : 20% provision is made by the banks D2 i.e. up to 2 year: 30% provision is made by the bank D3 i.e. up to 3 year : 100% provision is made by the bank.



An internal study conducted by RBI shows that in the order of prominence, the following factors contribute to NPAs. Internal Factors Diversion of funds for

Expansion/diversification/modernization Taking up new projects Helping/promoting associate concerns time/cost overrun during the project implementation stage

Business (product, marketing, etc.) failure Inefficiency in management Slackness in credit management and monitoring Inappropriate technology/technical problems Lack of co-ordination among lenders

External Factors Recession Input/power shortage Price escalation Exchange rate fluctuation Accidents and natural calamities, etc. Changes in Government policies in excise/ import duties, pollution control orders, etc. Apart from this following are also quite few reasons: 50

Liberalization of economy/removal of restrictions/reduction of tariffs A large number of NPA borrowers were unable to compete in a competitive market in which lower prices and greater choices were available to consumers. Further, borrowers operating in specific industries have suffered due to political, fiscal and social compulsions, compounding pressures from liberalization (e.g., sugar and fertilizer industries) Lax monitoring of credits and failure to recognize Early Warning Signals It has been stated that approval of loan proposals is generally thorough and each proposal passes through many levels before approval is granted. However, the monitoring of sometimes-complex credit files has not received the attention it needed, which meant that early warning signals were not recognised and standard assets slipped to NPA category without banks being able to take proactive measures to prevent this. Partly due to this reason, adverse trends in borrowers' performance were not noted and the positionfurther deteriorated before action was taken. Over optimistic promoters Promoters were often optimistic in setting up large projects and in some cases were not fully above board in their intentions. Screening procedures did not always highlight these issues. Often projects were set up with the expectation that part of the funding would be arranged from the capital markets, which were booming at the time of the project appraisal. When the capital markets subsequently crashed, the requisite funds could never be raised, promoters often lost interest and lenders were left stranded with incomplete/unviable projects.

Directed lending Loans to some segments were dictated by Government's policies rather than commercial imperatives.


Highly leveraged borrowers Some borrowers were under capitalized and over burdened with debt to absorb the changing economic situation in the country. Operating within a protected market resulted in low appreciation of commercial/market risk. Funding mismatch There are said to be many cases where loans granted for short terms were used to fund long term transactions. High Cost of Funds Interest rates as high as 20% were not uncommon. Coupled with high leveraging and falling demand, borrowers could not continue to service high cost debt. Wilful Defaulters There are a number of borrowers who have strategically defaulted on their debt service obligations realizing that the legal recourse available to creditors is slow in achieving results


Credit Risk Management

Introduction : The main risk associated with lending is that the various parties (borrower/coobligant/Guarantor) who have to repay interest and or installments may fail to meet their commitments on the due dates. This is called as default risk. The default may occur either due to decline in the credit worthiness of the borrower or due to external factors like the exposure to adverse interest rate and foreign exchange rate movements. Trade restrictions imposed by the country where exposures are taken may also have adverse impact on the borrowers and consequently the banks, which have lent them. The credit risk of Banks loan portfolio depends both on external and internal factors External factors State of economy

Internal factors Deficient loan policies

Wide swings in commodity Inadequately defined powers for sanction of /equity prices loans

Interest rates Foreign exchange rates Trade restrictions Economic sanctions

Absence of prudential credit concentration limits Deficiency in credit appraisal systems

Excessive dependence on collaterals

Inadequate/lack of risk pricing


Government policies

Absence of loan review mechanism and post sanction surveillance

Credit management as is conventionally understood is confined to selection, limitation and diversification and overall management of credit. At time of selection, the obligors or borrowers financial condition, profitability and cash flows etc. are assessed with a view to decide whether or not the borrower has a repaying capacity. The nature of the industry in which the borrower is operating, the quality of management, the presence of collaterals etc. is an essential part of the appraisal process as all these can affect the prospect of recovery. In short , the six Cs viz., Character, Capacity, Cash, Collateral, Conditions and Control relating to borrower are examined. Credit Risk Management is not merely Credit Management. Credit Management focuses on probability of repayment, whereas Credit Risk Management focuses on probability of default. Limitation is based on the premise that the borrower concentrations should not be too large. There are regulatory norms on individual or group exposure limits but bank may prescribe a lower per borrower/group of borrower exposure limits in its loan policies. Diversification is related to limitation and is based on the age-old principle, which says that does not put all your eggs in one basket. The banks credit policy normally indicates the exposure limits to various sectors of the


Credit Management Credit Risk Management It is based on Asset-by-Asset or Stand alone It is based on portfolio approach to risk. approach to credit management. The risk in the portfolio as a whole are not captured Expected loss and unexpected loss are not Measurement of EL and UL is carried out measured. Losses are recognised in the as an integral credit risk management accounting sense or as per the regulatory process. guidelines The concentration risks are identified on the The concentration risks are measured in basis of owned funds/ industry/ terms of additional portfolio risk arising on account of increased exposure to a borrower/group of correlated borrowers. The correlation among constituent assets are captured to arrive at a measure of portfolio risk. The strategy under this approach is to Credit risk management techniques allow originate the loan and hold the loan till active management of the credit portfolio maturity. by trading credit risk through securitization/ Credit derivatives. Credit risk management is not NPA management. It is much more than that. NPA management is largely recovery management. A NPA account represents a situation when credit risk has crystallized i.e, the situation when default has already taken place. Credit risk management is concerned more with the quality of credit portfolio before default rather than in the post default situation when the recovery proceedings begin. The credit risk approach gives indications of worsening credit quality of portfolio by tracking credit migration of constituent assets in the credit/investment portfolio much before the actual defaults occur so that management action can be initiated in to stem the deterioration in the credit portfolio quality. geographical area etc.

Credit risk management process :


The credit risk management in any Bank should be addressed both qualitatively and quantitatively. Qualitative credit risk management aims at improving the assets quality while quantitative credit risk management aims at measuring credit risk and providing required capital in tune with the credit risk. Qualitative & Quantitative Risk Management address the following issues respectively Qualitative Credit Risk Management Well drawn Loan Policy Having a proper organizational Making Provisions as per the Expected Loss estimated. Well formulated Delegation of Holding Capital for the Powers for sanction of loans. Prudential Limits to contain the Unexpected Loss. Portfolio Management Loan Review Mechanism Assessing the asset quality Quantitative Credit Risk Management Measuring the extent of risk

in the Banks Credit Portfolio. structure.

Concentration Risk. in term of risks involved and loading the risk premium while pricing the loans so as to realize optimum returns.

For achieving the twin objectives of qualitative & quantitative credit risk management the following tools are used::

Measurement of risk through credit rating/scoring


Estimation of the probable default and loss occurrence and calculation of capital

required for credit risk through assignment of either supervisor determined or internally generated risk weights. Risk pricing of loan products.

Organization structure
Every Bank should have a Credit Policy Committee (CPC) headed by the Chairman and with heads of Credit, Treasury and the chief Economist as its members. They should also set up a Credit Risk Management Department (CRMD)to enforce and ensure compliance of the practices and prudential limits set by CPC through loan policy. The CRMD should be accountable for protecting the quality of the entire loan portfolio. Qualitative Credit Risk Management can be achieved by various parameters like Loan Policy, Delegation of powers, Prudential limits, Loan Review Mechanism (LRM). Some of the Techniques adopted by some banks in Qualitative Credit Risk Management are::

Credit policy duly approved by the Board. Proper Delegation of Powers for sanction of loans.




Separation of relationship function (loan disbursement and follow up) from

appraisal function. This practice will not only enhance the quality of appraisal, but helps the relationship manager to concentrate on disbursement and review of loans.

Fixing of prudential limits to contain the concentration risk Stipulation of benchmark current, debt equity, debt service coverage,

profitability ratios with flexibility for deviations under certain conditions Fixation of single/group borrower limits Fixation of substantial exposure limits Maximum exposure limits to industry/sector. Exposure limits to sensitive sectors like loans against equity shares, real estate

etc which are subject to high degree of asset price volatility. Fixing lower portfolio limit for High-risk industries. Some of the Loan Review mechanisms which are like, Review of sanctions of


each authority by the next higher authority. Midterm review system to review the asset quality at the time of renewals and in between two renewals.

Preventing slippage of accounts NPA through follow up. Close follow up of accounts suffering mortality within 1 year.

Risk Rating
Risk rating helps the banks in understanding the various dimensions of risks in different credit transactions. The aggregation of such ratings borrower-wise, activity-wise and 58

region-wise gives a broad assessment of the quality of the credit portfolio. Rating can be undertaken both at the pre-sanction and the post-sanction stage. At the pre sanction stage, it helps the sanctioning authority to take a decision on whether or not to lend. At the post sanction stage it helps the banks in deciding on the periodicity and depth of review and on the precautions to be taken to maintain the asset quality. Features of risk rating system It should serve as a single point indicator of the diverse risk factors of the

borrower It should incorporate the following risks Industrial risks Financial risks Business risks Management risks Separate rating models may be used for Large corporate, SMEs, Traders and NBFCs. The overall score for risk should be on a numerical scale between 1-6 or 1-8. For each numerical category a quantitative description of the borrower, the loans underlying quality should be presented. Bank has to prescribe in its Risk Management Policy, the minimum rating below which no exposures would be undertaken. Any relaxations in deviating from the minimum standards and the authority vested with permitting such deviations should be clearly spelt out in the loan policy.


Rating Parameters: These are various areas relating to the activity financed that are separately assessed and awarded scores. The four common areas of assessment are Industrial, Management, Business and Financial risks. Depending on the line of business of the borrower the score composition for the above four areas will undergo a change. Financial Parameters:: Under this, the Balance sheet and other financial statements of the borrower are studied and important ratios are worked out. Based on the ratios appropriate risk weights are assigned. Industry related parameters:: This includes comparison of the industry being rated with its peers, studying of aspects such as growth of net sales, operating profit before depreciation, interest and tax, working capital etc. The track record of the industry over the years is also studied. Here again depending on the type of industry the risk weights assigned for various sub-parameters may vary. Management Parameters:: This includes aspects like promoters details, their stake in the business, their experience in running the business, their ability to face challenges and capacity to meet difficult situations. For example the unit may be doing well when the industry in general is not doing that well. Business risks:: This includes aspects like the type of creditors, the availability of infrastructure, marketing arrangements, the debtors and their turnover ratio etc. Apart from the above the partys proposal is studied in depth and the key issues unique to the borrower being rated are listed out and studied before assigning/ approving the final rating.


In a nuts shell the whole of credit risk is as stated below:











Data collection:For the purpose of our study, we gathered the data on the characteristics of the credit clients of one of the biggest banks in India(Canara Bank). The Conceptual Model We constructed a conceptual model to explain the relationship between clients payment performance and income, assets, loan size, maturity, residential status and occupation, purpose of loan, interest rate, age, marital status, Hypotheses The hypothesis for each independent variable to express our expectations about the relationship between each independent variable and the pay back performance i.e. whether the payment is made or not, are explained below respectively: Hypothesis 1: Intuitively, Personal loans are expected to have more credit default risk. For this kind of loans, in case of default, there is no property can be mortgaged except collateral offering by the borrower. For this reason, these kinds of loans are sometimes fallen into arrears by borrowers. Hypothesis 2: Intuitively, probability of credit default increases when interest rate increases due to increases in payback amount. Hypothesis 3: Intuitively, females have less credit default risk due to their precautionary motives.


Hypothesis 4: Intuitively, older people have less credit default risk due to their precautionary motives. Hypothesis 5: According to Carling K., Jacobson T., and Roszbach Ks study, married clients tend to pay back their loans faster. So we expect that married clients pay their installments on time. Hypothesis 6: According to Carling K., Jacobson T., and Roszbach Ks study, probability of credit default increases when the income decreases. So, we expect to find a negative relationship between income and clients payback performance, assuming there is no inflation. Hypothesis 7: According to Carling K., Jacobson T., and Roszbach Ks study, probability of credit default increases when the loan size increases. So, we expect to find a positive relationship between loan size and clients payback performance, assuming there is no inflation. Hypothesis 8: Intuitively, probability of credit default increases when maturity increases because the longer term, the more probability of being missed installment because of forgetfulness and carelessness etc. Hypothesis 9: Intuitively, homeowners have less credit default risk than non home owners do because their houses are considered as a collateral, in case of default. For this reason, homeowners try not to fall their credits into arrears. Data Data used to explain the relationship between credit loan payments and some financial and demographic variables were obtained through consumer credit records of one of the biggest banks in India (Canara Bank). In order to preserve confidentiality, clients Personal information are not given in this research. The dataset consists of more than


100 individuals. Our data contains credits, which are repaid monthly with installments that are constant along the payback period. RESEARCH METHOD OR TYPE OF STUDY The research method used is descriptive research. Descriptive research describes data and characteristics about the population or phenomenon being studied. Descriptive research answers the questions who, what, when, where and how. Descriptive research is also called Statistical Research.The idea behind this type of research is to study frequencies, averages, and other statistical calculations. Although this research is highly accurate, it does not gather the causes behind a situation. Descriptive research is mainly done when a researcher wants to gain a better understanding of a topic. It is quantitative and uses surveys and panels and also the use of probability sampling.Descriptive research is the exploration of the existing certain phenomena. The details of the facts wont be known. The existing phenomenas facts are not known to the persons. In the report, descriptive research has been done as the various demographic characteristics of the borrowers are being taken and a logistic regression is being run to detect and predict certain relationship between the different variables.

SAMPLING PLAN Sampling is concerned with the selection of a subset of individuals from within a population to estimate characteristics of the whole population. Researchers rarely survey the entire population because the cost of a census is too high. The three main advantages of sampling are that the cost is lower, data collection is faster, and since the data set is smaller it is possible to ensure homogeneity and to improve the accuracy and quality of the data.ach observation measures one or more properties (such as weight, location, color) of observable bodies distinguished as independent objects or individuals. A probability sampling scheme is one in which every unit in the population has a chance (greater than zero) of being selected in the sample, and this probability can be


accurately determined. The combination of these traits makes it possible to produce unbiased estimates of population totals, by weighting sampled units according to their probability of selection. Nonprobability sampling is any sampling method where some elements of the population have no chance of selection (these are sometimes referred to as 'out of coverage'/'under covered'), or where the probability of selection can't be accurately determined. It involves the selection of elements based on assumptions regarding the population of interest, which forms the criteria for selection. Hence, because the selection of elements is non-random, nonprobability sampling does not allow the estimation of sampling errors. These conditions give rise to exclusion bias, placing limits on how much information a sample can provide about the population. Information about the relationship between sample and population is limited, making it difficult to extrapolate from the sample to the population. In this report, non probability convenience sampling has been done. Convenience sampling is a non-probability sampling technique where subjects are selected because of their convenient accessibility and proximity to the researcher.The subjects are selected just because they are easiest to recruit for the study and the researcher did not consider selecting subjects that are representative of the entire population. In all forms of research, it would be ideal to test the entire population, but in most cases, the population is just too large that it is impossible to include every individual. This is the reason why most researchers rely on sampling techniques like convenience sampling, the most common of all sampling techniques. Many researchers prefer this sampling technique because it is fast, inexpensive, easy and the subjects are readily available. Sample unit: This is that element or set of elements considered for selection in some stage of sampling (same as the elements, in a simple single-stage sample). In a multistage sample, the sampling unit could be blocks, households, and individuals within the households. In the report, various borrowers are taken as samples.


Analysis:Block 1: Method = Enter ChiStep 1 square Step 111.917 Block 111.917 Mode 111.917 l df 11 11 11 Sig. .000 .000 .000

The above test shows the correctness of the model, here as the significance level is less than 0.05 is signifies this model is fit and is showing correct results Model Summary -2 Step 1 Log Cox Snell & R Nagelkerke R Square .763


d Square 69.430(a) .570

Hosmer and Lemeshow Test ChiStep 1 square 3.503 Df 8 Sig. .899


Contingency Table for Hosmer and Lemeshow Test Customer_profile = .00 Observe Step 1 1 2 3 4 5 6 7 8 9 10 d 13 13 12 9 7 1 2 1 0 0 Expected 13.000 12.985 12.408 9.034 5.091 2.768 1.585 .759 .293 .076 Customer_profile = 1.00 Observe d 0 0 1 4 6 12 11 12 13 14 Expected .000 .015 .592 3.966 7.909 10.232 11.415 12.241 12.707 13.924 Total 13 13 13 13 13 13 13 13 13 14

Model Summary -2 Step 1 Log Cox Snell & R Nagelkerke R Square .765


d Square 69.586(a) .572

According to above table the strength of model is good as the values of R square is quiet high, R square shows the relatedness between various variables like in this case Income, Family size, employment status salaried or self employed, Assets Residential Status, Education, Purpose, Sanctioned Amt., Rate of Interest. Here by our examination of various loan accounts we can say that all above variables are correlated with each other like Income and employment status is high correlated and Assets and Residential status are highly correlated Classification Table(a)


Predicted ACC_STATUS Step 1 Observed ACC_STATUS .00 1.00 Overall Percentage .00 48 6 1.00 11 67

Percentage Correct 81.4 91.8 87.1

The above table represents the level of correctness in prediction done in the model, here this model is able to predict 87% of observation correctly which is shows the results obtained the model is quiet significant and can be relied upon.

Variables in the Equation B 22.96 S.E. 15413.4 Wald .000 Df 1 Sig. .999 Exp(B) 9363206




1(a) Income Family_Size Employment

0 .000 -.468 21.23 2 .000 1.026 .000 -.522 20.23 3 .000 .389 19.85 5

46 .000 .326 20223.7 88 .000 .633 .000 .641 7862.67 6 .000 .358 25506.6 14

14.128 2.059 .000 .193 2.622 .272 .662 .000 3.005 1.185 .000

1 1 1 1 1 1 1 1 1 1 1

.000 .050 .999 .660 .105 .002 .094 .998 .083 .276 .999

033.197 1.000 .86 .000 1.000 .359 1.000 .594 6121791 04.160 1.000 1.476 .000

Net_Worth Residence Liabilities Education Purpose_of_loan Sanctioned_amt Rate_of_interest Constant

Variable(s) entered on step 1: Marital_Status, Income, Family_Size, Employment, Net_Worth, Residence, Liabilities, Education, Purpose_of_loan, Sanctioned_amt, Rate_of_interest. Income level, however, is significant factor at the 000 levels. Family size is significant factor at the 0.050 level. Sanctioned amount is significant at the 0.083 level. Liabilities stand at a significant level of 0.02. Education is a significant level of 0.094 The income, sanctioned amount, family size, liabilities, education determine the potential of the prospective borrower for turning their accounts to be a standard asset or non-performing asset. Interest rate positively affect the credit default risk, thus, the longer the maturity, the higher the interest, higher the risk for clients not paying their loans on time.


Cox and Snell R Square This R^2 test as well as other logistic regression R^2 tests tries to measure the strength of association of the model. The values of this test are between 0 and 1. Today Nagelkerke R^2 is more common and considered a better indication to strength of association. Nagelkerke R Square A modification of the Cox and Snell R^2 Homsmer-Lemeshow Probability The Homsmer Lemeshow probability test is based on a chi-square test which is done over the Homsmer Lemeshow table (below). This important parameter tests the assumption that the model distinguishes the explained variable better. The actual Null hypothesis is that the model is insignificant and the test tries to break this hypothesis. Values for this test should be higher than 0.5 0.6. Homsmer-Lemeshow table A model classification table which describes both expected model classifications and actual model classifications. The HomsmerLemeshow table divides the data into 10 groups (deciles, one per row) each representing the expected and observed frequency of both 1 and 0 values. The expected frequency of data assigned to each deciles should match the actual frequency outcome and each deciles should contain data. As the Hosmer and Lemeshow goodness-of-fit test examines the null-hypothesis that our proposed binary logistic regression model adequately fits the data. A significance value of 0.899 (> 0.05) reflects that the proposed model adequately fits the data. This result is further substantiated by Omnibus tests of Model Coefficients, (having the null hypothesis that model coefficients are insignificant) indicate that model coefficients are significant at all levels- steps, block and model (sig = 0.000). As seen in model summary, the R Square values (Cox & Snell R Square=0.570 and Nagelkerke R Square=0.763) reflect that a major portion of the variation of the dependent variable (i.e. preference) can be explained by the considered predictors. This shows that our proposed model is good in predicting the occurrence of potential NPAs, based on considered predictors, which is further corroborated by a high Hit Ratio of 87.4%.


Conclusions And Suggestions

A bank that lends money to consumers faces two types of risk: ( i) risk of default; (ii) risk of paying the loan earlier than the agreed time. The present study examines the probability of risk of default in terms of various financial and demographic variables and serves a useful function for creditworthiness. Our study is unique and important in many aspects. First because it examines the relationship between consumer credit clients payment performance and their demographic characteristics. In addition, we included


financial variables additional to the demographic variables, Second, our findings may enable banks and financial institutions to optimize their lending policies without changing their market structure and potential clients. Our results indicate that financial variables rather than the demographic characteristics of clients have a significant influence on customers pay back performance. Thus, the longer the maturity time, the higher the interest rate, and the higher the credit default risks. Higher the income lower is the chances of default. This suggests bankers apply appropriate adjustments to financial variables in order to minimize credit default risk. Through our some experience in bank and also with the help of our study of the retail banking and the risk management we can say that the retail loans schemes of the Canara bank are almost similar to the private sector retail loan schemes and thus Canara bank is well equipped with scheme set which it offers to the customer and thus stands in at par with the private sector banks. Also, prior to the giving of the loans, field credit investigation is being done which includes visit to residence, visit to office/business center, neighbourhood, income related verification like salary slip or income tax returns of various years are determined. This may involve appointment of an external agency. Along with this rating evaluation is done which involves rating of the borrower being done based upon certain criteria on a rating sheet. It is mandatory to score 70% on this rating scale to make a borrower eligible for the loan imbursement. Through the careful monitoring of the various loan schemes, it could be gathered that the Canara bank focuses at the commercial and public banking as major operations. It targets the rural and urban middle group as its major customers. Canara bank has positioned itself as a complete Banking and financial solution being offered to the customer, which is apparent from its tagline Together we can; It's easy to change for those who you love. The USP of the bank is that it has strong founding principles. Also, though occurrence of NPA may be purely unintentional and accidental, but due diligence is very much necessary to avoid default risk, and each loan acceptance on the


managers part calls for the thorough and careful examination of the credit worthiness of the borrower. This needs compliance with the existing risk management norms by the employees and managers. This includes careful and consistent monitoring of the borrowers current status and reminding them of EMIs being due. The Canara bank Mahanagar Branch, Lucknow has a current NPA of Rs.2 crore and 85 lakhs and advances Rs 9 crore in the year ending March 2011. The trend over the years shows that the NPA percentage has been increasing over the years in the bank pan India. Recommendations:Following are some recommendation which can be implemented to minimize existing defaults and to avoid further defaults: Reschedule your debt:- After having analyzed your financial position, if the bank feels that the quantum of EMI is what is troubling you, they may be willing to reschedule your debt by extending the loan tenure. That will bring down the monthly EMI commitment, though it will mean more interest outgo in the long term. When the tide turns and you are facing better times you can try negotiating with your bank and revert to your old or higher EMI or even prepay your loan, closing it early and saving excessive interest outgo if it makes sense post the prepayment penalty. Deferring the payment:- If your financial situation is such that there is likely to be a jump in cash flow going forward because of change in job or any other reason, you may seek temporary relief from the bank for a few months. The bank may permit the same but may charge penalty for not paying within the time frames agreed upon earlier. Restructuring the loan: - In case of housing loans, banks have a provision for restructuring the loan e.g. terms of extending the tenure of the loan. For the same, the bank must perceive the reason of default to be genuine. The Reserve Bank of India (RBI) has issued guidelines on the same. For. e.g. the loan tenure can be


increased by not more than 1 year in most cases. Foreclosure by selling the collaterals with the borrowers co-operation is also advised as the next step. One time settlement: If you express your desire to pay back, and make known to the bank your current financial condition, banks may be willing to enter into a one time settlement on a case to case basis. This is a good way to get rid of your loan if you have some money as usually the settlement will be done at a lesser value i.e. the bank may waive off some amount/charges. If your financial situation is really bad, then you may need to file for bankruptcy to free yourself from the loan commitment. Conversion of loan in case of unsecured loans: Banks tend to be stricter as far as unsecured loans are concerned. The borrower could opt for converting the unsecured loan to a secured one by offering a security. That should bring down the rate of interest and thus the EMI burden.

Banks have to find out the original reasons for the loan. Proper identification of the guarantor should be check by the bank and his/her wealth also, so that he/she cant mislead the bank. Agriculture loan comes in priority sector, so banks are bound to achieve the targets set by government. In this situation government has to relax some norms about the priority sector.

The stocks and receivables are to check randomly by the bank, so that the bank are aware of position of the firms. Banks have to be assure that the collateral security should not be disputed asset and neither any other loan is taken on that security. Banks have to make a separate department, whose duty is only inquire the personnel goodwill in the city apart from the financial asset. In the export related loan, banks have to check the authenticity of the firm with the export house.


Banks should have to consider the market condition of economy before disbursement of loan in case of import, export. Branches should not permit any deviation/relaxation in terms & condition without prior permission from the appropriate authorities. No dilution to be allowed to creep in scheme guidelines notwithstanding competition prevailing. Identity of the borrower to be verified by making a visit to residence/office/business place. The recovery process is very slow, so the governments have to update the process which is fast and effective. The credentials of the builder to be verified through market enquiries. Wherever family/other income is taken into account to determine the loan quantum, documentary evidence should be insisted upon. Periodic inspection of the property as per guidelines to be conducted. The credentials of the builder to be verified through market enquiries. Wherever family/other income is taken into account to determine the loan quantum, documentary evidence should be insisted upon.




Staff members of Canara Bank, Mahanagar Branch

www.investopedia.com www.wikipedia.com

Egonometrics by DamodarGujrati

Books and journals published by Canara bank: Risk Management