Institute of Chartered Financial Analysts of India (ICFAI) University 2006 Certification Finance Management of Financial Institutions - II - Question Paper

(7 marks) < ans >

10. explain the impediments for the growth of credit derivatives market in India.

(6 marks) < ans >

Deregulation and globalization have introduced new kinds of risks in banking system. The term, risk may be described as an exposure to a transaction with loss, which occurs with a few probability and which can be expected, measured and minimized. 1 such important risk is the Credit Risk which arises from the lending activity performed by a bank.

a few experts opine, “granting credit for economic activities is the prime duty of the banking sector. Lending is generally encouraged because it has the effect of funds being transferred from the system to productive purposes, which in turn outcomes in economic growth.”

Lending carries credit risk, which happens to be 1 of the most common risks that banks often face and which arises due to the default payments. Thus, these loans, which become non-recoverable, affect the banks’ profitability on a large-scale basis. The best example being the Non Performing Assets (NPAs), which are derived from nonpayment of loan borrowed by the party.

The magnitude of NPAs in Indian banking system is very high and the situation is alarming. Though, NPAs as a percentage of total advances have been declining, but true numbers are increasing and there seems to be no reduction in absolute quantity of NPAs.

The gross NPAs still hover around Rs.83,000 cr. The government and Reserve Bank of India (RBI) have taken several initiatives towards managing Non Performing Assets. In this regard, a new ordinance on Securitization and Financial Assets Reconstruction and Enforcement of Security Interest has been created in the year 2002, which would help in speedy recovery of bad loans.

However, complete elimination of this issue may not be possible, but banks can aim to keep this issue at a low level by exploring and having a prudent credit risk management system at place.

Credit Risk, which is otherwise also known as default risk, may be described as:

The potential that a bank borrower/counterparty will fail to meet his/her/its obligations in accordance with the agreed terms.

There is an immense pressure on banks in India to manage credit risk. There are both external as well as internal factors which are posing a challenge to a bank in managing credit risk .

There are also certain internal factors or deficiencies within the banks in managing credit risk, like: Inappropriate lending policies, Heavy exposure to a certain industry/sector/company, No frequent customer contact, No proper loan review mechanism, Wrong selection of borrower etc.

Earning:   Approval pending.