Credit Risk

Introduction

Risk is inherent in all aspects of a commercial operation, however for financial institutions, credit risk is an essential factor that needs to be managed. Credit risk is the possibility that a borrower or counter party will fail to meet its obligations in accordance with agreed terms. Credit risk, therefore, arises from the company's dealings with clients who may carry out transactions and not pay the losses suffered.

Central to this is a comprehensive IT system, which should have the ability to capture all key customer data, risk management and transaction information including trade. Given the fast changing, dynamic global economy and the increasing pressure of globalization, liberalization, consolidation and dis- intermediation, it is essential that the company has robust credit risk management policies and procedures that are sensitive and responsive to these changes.

The purpose of this document is to provide directional guidelines to improve the risk management culture, establish minimum standards for segregation of duties and responsibilities, and assist in the ongoing improvement of the company. Credit risk management is of utmost importance to the company, and as such, policies and procedures should be endorsed and strictly enforced by the MD/CEO and the board of the company.

Credit Assessment

A thorough credit and risk assessment should be conducted prior to the opening of client accounts, and at least annually thereafter. The RM should be the owner of the customer relationship, and must be held responsible to ensure the accuracy of the entire credit application submitted for approval. RMs must be familiar with the company's margining policies and should conduct due diligence on new clients.

It is essential that RMs know their customers and conduct due diligence on new Clients to ensure such parties are in fact who they represent themselves to be. KYCs should be completely filled up in all respects along with documentary evidences and Anti-Money Laundering guidelines which should be adhered to at all times.

In addition, the following risk areas should be addressed:

• Financial capacity: KYCs should ask for nature of income of the prospective client and the quantum of such income. An insight is absolutely necessary to draw in mind the financial capacity of the client.
• Trading Pattern: Ongoing analysis of trading pattern of clients must be done by concerned RMs to notice any divergence from normal pattern, and to early detect over-indulgence in the trading.
• Segment Analysis: The derivatives segment offers very high credit risk for the reason of leverage effect. The margin requirements are very less compared to the exposure and may lull investors to overindulge in the market in the hope of quick profits.
• Payment History: The delay between incidence of payment and the time when the payment becomes due needs monitoring. A deteriorating situation is alarming and may require reduction of exposure by the concerned party.
• Name Lending: Account opening should not be unduly influenced by an over reliance on the introducing constituent's reputation.

Segregation of Duties

The company should aim to segregate the following functions:

• Credit Approval/Risk Management
• Credit Administration

The purpose of the segregation is to improve the knowledge levels and expertise in each department and obtain an objective and independent judgment of creditworthiness.

Internal Audit

The company should have a segregated internal audit/control department charged with conducting audits of all departments. Audits should be carried out annually, and should ensure compliance with regulatory guidelines, internal procedures and anti-money laundering guidelines.

Key Responsibilities

• Credit Administration
• To monitor dues from/ to clients
• To require payments for pay-in, margin
• To make payments for pay-out, margin release
• To monitor adequacy of margins and funds with us
• To make Ageing Schdule of customers and identify clients with tendency to lag payments

Relationship Management/Marketing (RM)

• To act as the primary point of contact with borrowers
• To maintain thorough knowledge of borrower's business and industry through regular contact, friendly visits. RMs should proactively monitor the financial performance and account conduct of clients
• To be responsible for the timely and accurate submission of KYCs and annual reviews
• To highlight any deterioration in client's financial standing and amend the client's Risk Grade in a timely manner

Internal Audit/Control

• Conducts independent inspections annually to ensure compliance with Exchange Guidelines, operating procedures, company policies and necessary directives. Reports directly to MD/CEO.

Early Alert process:

An Early Alert Account is one that has risks or potential weaknesses of a material nature requiring monitoring, supervision, or close attention by management.

If these weaknesses are left uncorrected, they may result in deterioration of client's credit position at some future date with a likely prospect of being downgraded to Impaired status within the next twelve months.

Early identification, prompt reporting and proactive management of Early Alert Accounts are prime credit responsibilities of all Relationship Managers and must be undertaken on a continuous basis.

Despite a prudent credit approval process, loans may still become troubled. Therefore, it is essential that early identification and prompt reporting of deteriorating credit signs be done to ensure swift action to protect the company's interest. Moreover, regular contact with customers will enhance the likelihood of developing strategies mutually acceptable to both the customer and the company. Representation from the company in such discussions should include the local legal adviser when appropriate.

Credit Recovery

No need for separate Recovery Unit has so far been felt. Credit Administration Department will directly manage accounts with sustained deterioration.

The primary functions are:

• Determine Account Action Plan/Recovery Strategy
• Pursue all options to maximize recovery, including placing customers into receivership or liquidation as appropriate.
• Ensure adequate and timely loan loss provisions are made based on actual and expected losses.