Credit Risk

Bank assets comprise loans and investments.  Investment is usually made in treasury bills and gilt edge securities. Treasury bills are free from risk as these are backed by state organs or even issued with State guarantees i.e. federal govt. provincial govt. local govt. and municipality. Guilt edge securities are those issued by corporations of stable and wealthy book sizes. Observable prices of level 1 fair value are available and there is an active market for trading the gilt edge securities.  Therefore these are comparatively less risky. On the other hand, central bank guidelines and directives limit the trading and investment of banks in trading on stock exchanges.

 Credit risk is mainly associated with nonpayment on the due date of the due amount. Since the credit portfolio is the major asset among the total assets on the balance sheet of a bank and the major source of income and revenue on the income statement, it is a comparatively high-risk area of the bank in its overall business operations. Diversification of loans means lending to multiple sectors of the economy for multiple purposes of the borrowers. The financial service industry is available with techniques to identify, assess, measure, control, and monitor risks. But some risks are measurable and quantifiable and can be controlled whereas some are uncertain non-quantifiable and inherent in the economic activity undertaken e.g. seasonal loans are allowed for the purchase of material for manufacturing or purchase of merchandise inventory for on the expected sale during the seasons are involved the risk of bad weather, calamities, unexpected low demand, change in fashion and taste, the introduction of new technologies, etc.

 Credit risk arises when the bank is complacent with incomplete credit information about the factors of production. Men, money, methods, and market are crucial not only for the business but also for a credit officer to know and understand the behavior, worth, credibility, and sustainability of these factors while considering a loan application. Analysts and credit officers as representatives of the bank are responsible for Bad loans and cause credit risk when they;

•  Are technically incompetent
• Are unable to identify, assess, and quantify the risks
• Incomplete credit information
• Incorrect selection of borrower
• Improper loan structuring
• Inadequate loan management
• Over lending
• Short Termism approach
• Lack of understanding of the changing economic conditions

Assets Backing

Basel III has introduced a fresh rule for banks to keep a ratio of 100% of Net Stable Funds (NSF) used for the creation of Assets. The Net Stable Funds shall be the capital and liabilities of the bank with maturities of more than 12 months.  Banks have been warned of raising short-term cheap funds. The purpose of this rule is to fund the assets with stable liabilities.