Financial institutions have faced numerous issues for numerous reasons but the major cause of serious banking problems is due to laxes in credit standards for borrowers & counter parties, poor portfolio risk management and lack of attention to changes in economic and other circumstantial situations leading to deterioration of credit standing of a bank.
Credit risk is most simply defined as the potential of risk to which both the borrower & counter party could sustain in event of the failure of the obligations according to agreed terms. The main goal of credit risk is to maintain the bank’s risk adjusted rate of return by maintaining credit risk exposure within the acceptable parameters. It is the duty of the bank to manage the credit risk inherent in the entire portfolio as well as individual credits or transaction. They should also have a lasting difference mentioned between credit risk & other risk.
For banks, loans are the largest & most obvious source of credit risk, but other sources of credit risk exist throughout the banking activity which includes banking book & trading book both on & off the balance sheet. Banks are increasingly facing credit risk from various other financial instruments other than loans namely, acceptances, interbank transactions etc.
Since exposure to credit risk continues to be the leading source of problems in banks world-wide, banks and their supervisors should be able to draw useful lessons from past experiences. Banks should now have a keen awareness of the need to identify, measure, monitor and control credit risk as well as to determine that they hold adequate capital against these risks and that they are adequately compensated for risks incurred.
So the Best Industry Practices Set Out for Addressing Credit Risk Management Properly Are:
- Establishing Appropriate credit risk environment
- Operating under sound credit granting process
- Maintaining appropriate credit admin, measurement & monitoring
- Ensuring adequate controls over credit risk
Although specific credit risk management practices may differ among banks depending upon the nature and complexity of their credit activities, a comprehensive credit risk management program will address these four areas. These practices should also be applied in conjunction with sound practices related to the assessment of asset quality, the adequacy of provisions and reserves, and the disclosure of credit risk