Entrepreneurship is always accompanied by certain risks. This applies to all forms and types of ownership. Banking institutions are not an exception to the general rule - these are the financial arteries of the modern state. They can suffer a large number of problems, like other commercial structures. But due to the nature of their activities, they have to work with a certain shift in priorities. The bank’s credit risks come first. What are they? What is their management process? These questions will be answered in the framework of the article.
general information
Begin with terminology. What is credit risk? This is a complex concept, which includes possible problems when working with a borrower. But most often it is used in the sense of the risk of delay or non-payment of payments on a bank loan. The main reasons for this development include:
- Loss (decrease) of the borrower's solvency.
- Deterioration of his business reputation.
Bank credit risks can be realized both in separate loans provided by a financial institution, and in the entire portfolio. Therefore, it is important to develop an adequate policy - a documented organization chart, as well as a system for monitoring activities. After all, if a single incident can still be survived, the aggregate credit risk can be a significant danger.
To teach you how to deal with emerging problems, a specialized course has been developed. It is called credit risk management. It solves the problem of reducing the likelihood that counterparties will not fulfill their obligations to return the principal amount of the debt, as well as interest on it, within the agreed time frame. This area deals with:
- Legislative and regulatory bodies that establish liquidity standards, minimum statutory capital and other influencing indicators.
- Supervisory authorities (Central Banks play their role), which monitor compliance with standards.
- Shareholders who appoint a board of directors, senior management and auditors;
- Rating agencies involved in informing the public about hidden risks.
- Board of Directors. He is responsible for the commercial structure, determines the current credit policy, as well as procedures and measures aimed at management.
- External and internal auditors who assess compliance with the identified performance parameters, as well as provide an opinion on effectiveness.
How does credit risk management work?
This process is carried out in several stages. Initially, it is necessary to determine a credit policy, which will consider the main guidelines on which portfolio formation directly depends. Then, attention switches to solvency analysis, monitoring of borrowing customers, and conducting work to restore bad debts. The third stage is the assessment and audit of the effectiveness of the implemented credit policy. There are several methods that help you cope with calls:
- Setting limits on the volume of loans issued. The goal can be one or a group of borrowers, an entire industry and even a region.
- Portfolio diversification. In this case, a whole group of criteria is created. Attention is paid to degrees of risk, categories of borrowers, types of loans, loan terms, and collateral provided.
- Reservation. It involves the creation of special funds from which money will be taken to cover the losses, according to possible problems. In this case, credit risk assessment plays a large role.
- Insurance and hedging.
It should be noted that credit risk management is carried out not only in the formation of portfolios. Financial organizations constantly monitor its condition and are engaged in optimization. This can be done by concluding assignment agreements, which are called cession. Thanks to this, a secondary loan market arises. It allows you to even more actively engage in credit risk management.
About performance
Credit risk and management performance is a key factor on which the success of a financial institution depends. But in times of crisis, the importance of an effective system increases further, because it allows you to survive in fierce competition from many other banking organizations and the products offered.
It also helps minimize negative impact due to imperfections and instability of financial legislation. Banks must constantly monitor their loan portfolio and its quality composition. It is necessary to mention here the dilemma "profitability - risk". Due to its inexorable influence, it is necessary to limit the rate of profit. This is done for the purpose of insurance against excessive risks. A dispersion policy must be pursued.
No need to allow concentration of loans from several large borrowers. After all, this is fraught with significant consequences if one of them cannot repay the loan. Also, the bank should not risk the money of its investors, providing financing for speculative (albeit highly profitable) projects. This is closely monitored by regulatory authorities during periodic audits. In order for the bank to carry out efficient activities, the loan portfolio must be presented according to factors influencing it:
- Profitability and risk of individual loans.
- Demand from borrowers for certain types of loans.
- Risk standards established by the Central Bank.
- The structure of credit resources by maturity.
It is necessary to try to have a balanced loan portfolio, when the increased risk in one case is offset by reliability and profitability in another.
A small digression about activity and evaluation
It should be noted that credit operations themselves are risky. Therefore, it is necessary to achieve a reduction in the level of problems. For this, the following methods are mainly used:
- Assessing the solvency of the borrower and assigning him a credit rating.
- Using a policy of diversification of loans. Their division is made according to groups of borrowers, types, sizes.
- Deposit and loan insurance.
- Formation of an effective organizational structure of a financial institution.
- Creating reserves to cover possible losses on existing loans.
Most importantly, an adequate assessment of credit risk is needed. If you take this lightly - in a not very difficult situation it may turn out that an important point was missed and there is not enough money for further work. If you create a very large number of reserves, then the profitability decreases and the bank can end the reporting period with losses. All this must be taken into account. In Russian realities, external sources of information, corporate risk management, and also the assessment of solvency of potential customers are widely used for this.
What factors need to be considered
Credit risk analysis suggests that potential weaknesses are known. The following factors can affect them:
- The political and economic situation in the country, as well as in the region, when the effect of macro- and microeconomic factors is well manifested. An example of potential sources of problems is the incomplete formation of the banking system, as well as the crisis state of the transition economy.
- Solvency, reputation and types of borrowers.
- The degree of concentration of lending activity in certain sectors, as well as sensitivity to possible changes in the economy.
- The probability of bankruptcy of the borrower.
- The proportion of loans, as well as other banking contracts, that fall on customers who are experiencing financial difficulties.
- The level of abuse (fraud) by borrowers.
- The proportion of new and recently attracted customers about whom the bank does not have enough information.
- Use as collateral is difficult to realize or subject to rapid depreciation of value.
- The degree of diversification of collateral.
- Failure to obtain collateral for a loan or loss of collateral.
- The accuracy of the feasibility study for a commercial / investment project and a loan transaction.
- The presence / absence of private changes in the policy of a financial organization for the provision of loans and the formation of their portfolio.
- Types, forms and sizes of loans granted, as well as the security used for them.
It should be noted that these factors can influence in opposite directions, for example, positive aspects can offset negative results. If all of them cause problems, then their influence may increase due to joint action.
About internal and external factors
The credit risk of a commercial bank can only be stabilized by employees in a limited range. After all, the bank alone cannot, for example, correct the political or economic situation in the country. Therefore, the division into external and internal factors is carried out. The first include:
- Status, as well as prospects for the development of the country as a whole.
- Conducted in the state monetary, foreign and domestic policy.
- Existing regulatory mechanisms, as well as their possible changes.
In addition, it is necessary to recall such external credit risks: political, social, industry, legislative, macroeconomic, regional, inflationary, interest rate changes. All this cannot be accurately predicted. These factors affect the conditions of the bank. What about the inside? These factors include those related to the activities of a financial institution, as well as borrowers. They are under control. Here you need to remember:
- The leading factor at all levels.
- Selected type of market strategy.
- Adequacy of credit policy.
- Ability to develop, offer and promote new banking products.
- Temporary risk factors (for example, when lending in foreign currency, interest margin, income from securities).
- Early withdrawal of agreements due to non-compliance with the terms of the contract.
- Qualification of staff.
- The level of technology used.
If we talk about the borrower, then they play a role:
- Terms of his business.
- Reputation.
- Risk factors.
- Management level.
Based on all these factors, external and internal risks are identified.
Needs and Opportunities
What causes problems? Risks of a credit institution, depending on their scale, are divided into:
- Fundamental. This includes possible problems that are associated with decision-making by managers who are involved in passive and active operations. That is, it is a decision to issue a loan to a borrower who does not fully meet the requirements put forward, collateral margin, interest rate and currency risks from a banking institution.
- Commercial. This is all related to the activities of units. Commercial credit risk is an ongoing policy of the bank in relation to individuals, small, medium and large businesses.
- Individual and cumulative. This includes the risk of a loan portfolio. In other words, this is the likelihood of problems due to deficiencies in the loan product, services, operations, as well as possible stoppage of the borrower's activity through reasons beyond his control.
Therefore, considering any product and portfolio, you need to make sure that it meets the needs and capabilities. It is about the term and the amount. In addition, it is necessary to carefully consider which activity is being credited, whether the source of loan repayment is reliable. It will not be amiss to verify the sufficiency and quality of collateral.
If we talk about aggregate credit risk, it should be noted that it has its own characteristics. To designate his objects of influence, they use such a concept as a “portfolio of assets and liabilities”, as well as its qualitative aspect. What should I pay attention to? On the qualitative aspect, on the structures and methods of assessment.
About regulation
Here you can work at the macro and micro levels. In the first case, it implies regulation by the Bank of Russia (in the Russian Federation), in the second - independent actions of a separate commercial financial institution. The first option includes establishing the maximum level of risk and the formation of a reserve at the legislative and regulatory level. But for us, what is done directly by the commercial structures themselves is more interesting:
- Diversification of the loan portfolio. By increasing diversity, the likelihood of risks is reduced.
- Preliminary customer analysis.
- Credit risk insurance, attracting sufficient security.
Based on the available data on the possibility of problems, banks decide how to protect themselves. For this, the following credit risk methods are used:
- Development of regulations for decision-making procedures on granting loans.
- Creation of additional reserves in case of outstanding loans.
- Making decisions on acceptable risks, using floating interest rates, checking economic and financial activities, and continuing to work after a loan is issued.
In order for all this to be properly implemented in practice, it is necessary to take care of the quality organization of affairs. For example, create analytical, credit, research departments. The main thing is to reduce credit risk. But exorbitantly inflating the state is not worth it.
On the ongoing credit policy, goals and mechanisms
It is necessary to determine the objectives, as well as priorities for the activities of the financial institution. Credit policy should include strategy and tactics in the field of operations. Its main task is to create the best conditions for the efficient allocation of funds received in order to ensure stable profit growth. The most important principles here are adequacy, optimality, scientific validity and unity of all elements. Thanks to this, credit risk can be minimized. Specific principles (profitability, profitability, safety and reliability) are also highlighted.
In general, the strategy includes priorities and goals. Whereas at the tactical level, issues are resolved about the use of financial and other tools that are necessary for transactions, as well as the rules for their completion and the organization of the transfer process. If everything is done correctly and adequately, then bank credit risks fall almost to zero. The goals pursued in this case are to determine priority areas for development, as well as improving banking activities when investing available resources and developing the investment process while minimizing all negative processes. What mechanisms are used to achieve them? It:
- Creation and organization of work of the apparatus for managing credit operations with clear powers of employees.
- Control and management of processes. A sound analysis of all cases of loans, accepted approval processes, systematic monitoring of all issued loans and their condition.
- Organization of the credit process at different stages of conclusion and implementation of the contract.
Conclusion
In general terms, it was considered what constitutes credit risk. The article also addresses questions about internal and external risk factors, about what policies credit organizations should pursue when working with clients with different statuses (permanent, primary, taking large loans and small ones). The material provided explains quite clearly what financial and credit risks are, as well as what policies should be provided by organizations providing such services.