12 - 18, 2010

Banks' core business - acceptance of deposits and lending of money - entails a variety of risks broadly categorized as Liquidity Risk, Market Risk, Operational Risk, and Credit Risk. Credit risk refers to the prudent use of depositors' money in profitable financial transactions that may take shape of loans and investments. While SBP oversees commercial banks' operations on a macro level and controls them through various tools, it is not possible for it to oversee bank operations on a micro level. It is surely the job of commercial banks themselves to formulate policies to develop an internal control system that minimizes various types of risks associated with the banking business. An efficient credit risk management system of a bank attempts to deal in minute details of all types of risks that may arise at different stages, from credit origination to final settlement by the borrower.

State Bank of Pakistan has provided all commercial banks and DFIs with certain guidelines that represent a structural design on which the banks and DFIs could base their detailed risk management system. Guideline 2.2.1 states:

"A typical credit risk management framework in a financial institution may be broadly categorized into following main components,

a) Board and Senior Management's Oversight

b) Organizational structure

c) Systems and procedures for identification, acceptance, measurement, monitoring and control of risks."

Since we are concerned here with the systems and procedures a corporate banker must design and follow to minimize credit risk, we will move forward to Guideline 2.4.1 pertaining to credit origination. The Guideline is reproduced below:

"Banks must operate within a sound and well-defined criteria for new credits as well as the expansion of existing credits. Credits should be extended within the target markets and lending strategy of the institution. Before allowing a credit facility, the bank must make an assessment of risk profile of the customer/transaction. This may include:

a) Credit assessment of the borrower's industry and macro economic factors;

b) The purpose of credit and source of repayment;

c) The track record / the history of borrower;

d) Assess/evaluate the repayment capacity of borrower;

e) The proposed terms and conditions and covenants;

f) Adequacy and enforceability of collaterals;

g) Approval from appropriate authority."

The keywords in the above cited Guidelines are: a sound and well-defined criteria, target market and lending strategy. A sound and well-defined criteria should be set keeping in view the country's economy, SBP monetary policy stance and government's short term and long term economic goals and objectives. Target market for a corporate banker is essentially the corporate clients with varied financial requirements ranging from short-term working capital finance to medium-term foreign currency loans to long-term finance for new projects or for modernization and expansion of existing operations. For stricter risk management, the target market may be narrowed down to good corporate borrowers who have an unblemished track record. The sector-wise risk exposure limits set by SBP or certain other SBP directives in line with the government policy objectives - for example special credit quota for small and medium enterprises, or liberal/controlled lending to certain industries- may also help to evolve a clear picture of target market. Lending strategy of a bank may well be guided by its liquidity position, its risk appetite, the existing size of its NPL portfolio, SBP monetary policy stance, and some other factors. SBP monetary policy stance (including the policy rate management) can influence the demand for credit. Tightened money supply and a high policy rate discourage demand for credit.

Assessment of the risk profile of customers at the time of credit origination is very important for a corporate banker. Any undetected negative aspect concerning the prospective borrower or disregard of any unusual trend or development in the market or the industry concerned may well magnify the normal credit risk to an unmanageable extent. The basic fact sheet should be designed in such a manner that ensures extraction of all relevant information about the borrower company, its directors and sponsors.

A critical study of company's past and latest financial accounts should be undertaken to ascertain its operational, liquidity and profitability status. The comparative study of financials will tell a lot about company's track record with reference to its capacity to repay its existing loans, if any, as well as the new ones it plans to acquire. There are several important documents the controlling authorities - SBP, SECP etc - arrange to make available to commercial banks, for example borrower's credit report, statement of lenders' existing charge on company assets. These documents are of great importance in ascertaining company's current debt position. Updated market information about the industry the company is in, for example the demand and supply position, any recent domestic economic developments that could negatively affect company operations, any material change in international market trends that may have direct or indirect bearing on company's product or its cost composition, should be collected from relevant sources and objectively analyzed.

The terms and conditions of the credit, for example mark-up rate, maturity period, repayment schedule, nature and value of collaterals etc. are basically determined by the market standing of the company or the group the company belongs to. A triple-A corporate borrower would go to the extremes while negotiating on the price and collateral issues of a credit. It might well ask the bank to lend at a rate that is just equal to the KIBOR against a ranking charge on its assets. On the contrary, in case of a weaker borrower company, the bank may set the credit price at KIBOR plus three percent with first exclusive charge on company's assets.