EVALUATION OF CREDIT RISK MANAGEMENT PRACTICES: AN EMPIRICAL STUDY OF INDIAN PUBLIC SECTOR COMMERCIAL BANKS

Abstract

At present, the biggest problem before Indian public sector banks is to improve their asset quality and control their mounting non- performing loans. RBI reports (2011-15) repeatedly impressed these banks to tighten their credit assessments and monitoring mechanisms especially for loans to business and industry. Thus, this study evaluates the credit risk management practices of Indian public sector banks (PSBs) in the grant of commercial loans to find the grey areas which need review and restructuring to improve banks’ asset quality. The research objectives are to identify and examine the characteristics and causes of credit risk, compare credit risk management practices of large and small public sector banks, analyse the extent to which these banks have implemented the Basel norms on credit risk management and evaluate their credit risk rating framework. The study also aims to design a credit risk assessment model for banks based on a comparison of existing and theoretical credit-scoring or rating models. The study is limited to commercial loans to SMEs and mid-corporates. A conceptual framework of credit risk management (CRM) systems has been developed to delineate the strengths, problems and obstacles in public sector banks’ CRM practices through a structured questionnaire. Survey based perception studies have been undertaken on a sample of 337 credit and risk managers working in 12 sample public sector banks. The study also uses secondary data to define the characteristics of credit risk in public sector banks and to design a credit risk assessment model for these banks. vi The study concludes that size of the bank is a critical credit risk variable as small public sector banks have higher credit risk in terms of stressed assets ratio (gross non performing and restructured loans/Total Advances). Credit managers or analysts of large banks are found to be more satisfied with their credit risk management practices. Credit analysts in all public sector banks (PSBs) have found that liquidity and solvency risk factors of the corporate borrower are the most potent causes of default on bank loans followed by his management, business and industry risk factors. Presently the credit and risk managers in these banks are finding the industry risk of their corporate borrowers, the most challenging risk to manage. The study has observed high subjectivity in credit risk assessments in these banks because of a large number of qualitative or experiential risk factors in their credit risk rating framework and because of statistically significant disagreement between different categories of credit and risk managers on these risk factors. The study also develops a three group multivariate discriminant model (MDA) to predict credit risk in new loan proposals, based on 40 performing and seven non performing or restructured loans of a sample public sector bank, under High Safety, Moderate Safety, and Inadequate Safety categories. The study found that the combination of quantitative and qualitative risk factors under multi-discriminant analysis improved credit risk assessment. This research has thus, provided deep insight into the credit risk management practices of the Indian public sector banks. It will serve as a standard research on the subject, and its limitations will provide scope for further research on the subject.