Risk Management - growing challenge for Indian banks

INDIAN banks operate in an increasingly deregulated and competitive environment. Against this backdrop, the Credit Rating Information Services of India (Crisil) expects a greater differentiation in creditworthiness of banks based on their risk management strategies.

At present, systems for measuring and controlling risk vary considerably across the banking system, and are relatively unsophisticated when compared with international best practices. The efforts involved in upgrading skills and revamping operating procedures are expected to be considerable, and banks which adopt a proactive approach would be better placed to survive and prosper in the future.

Increased deregulation is reflected in several key developments over the last decade including a market-determined interest rate environment, dismantling of the consortium lending system, freedom to fix both lending and deposit rates and increased competition from new private sector banks which have an aggressive business posture.

The consequence has been an increase in competition and greater volatility in the interest rate environment. Longer term, increased competition will lead to squeeze on banks' profit margins that will reduce the capability to absorb risk related charges for market and credit risks. Concomitantly, greater volatility implies that the loss potential from market risks will increase in the absence of strong risk management tools.

Moreover, the restructuring of the Indian industry in response to the increased globalisation of the economy can be expected to have a fallout on banks' asset quality as uncompetitive players are weeded out. In recognition of these trends, the Reserve Bank of India has highlighted the importance of improved risk management practices and in particular, has issued guidelines for managing ALM risks, to ensure that the international best practices are adopted by the banking system.

Despite an increasing focus on asset quality over the last decade, weaknesses in the underwriting culture persist, with the slow pace of evolution of credit evaluation and monitoring systems. With credit evaluation systems tuned to emphasising ``borrower account behaviour'' rather than the cash flow based credit analysis, the internal credit scoring systems often do not reveal the potential problem loans in the asset book. This impedes their ability to assess the potential loss charges from the asset book and plan capital raising programmes effectively.

The increased competition for good quality credit and greater polarisation of the overall corporate credit profile underscores the need for robust credit risk management systems that provide accurate inputs to top management for making lending and pricing decisions as well as formulating strategies for management of problem loans, the rating agency observed.

Severe mismatches in the structure of Indian banks' balance sheets have traditionally existed, with their long tenor government securities holdings and the de-facto perpetual cash- credit lending facilities being funded out of relatively short tenor deposits. The increasing volatility in interest rates coupled with increasing proportion of SLR securities being marked to market heightens the potential for interest rate risk arising from the mismatch to impact the bottomline. These concerns are aggravated by the high information risk relating to ALM issues. The large branch networks and poor information reporting systems cause significant impediments to gathering timely information to enable the ALM to be reported and analysed effectively. In such an event, the ALM process that is being implemented by the banking system is likely to be on less than perfect information.

In general, the new private sector banks and foreign banks (which benefit from the systems employed in their global operations) are better placed than the Indian public sector banks in risk management. Nevertheless, within each of these categories of banks, there are significant differences in the sophistication of risk management systems.

There is a growing recognition, however, of the importance of the risk management and many banks have taken steps to appoint consultants to aid them. An overriding impediment in the risk management initiatives of the banking sector, and in particular, the case of state owned banks, is the low level of technology in the sector with low level of branch and back office computerisation. The union related issues with the state owned banks often hinder the advance of technological capabilities and the process of computerisation of the operations. Given the large branch networks of these banks, the speed of upgradation of technological capabilities would continue to be the critical path for the smooth implementation of risk management initiatives.

VIP Industries

The `A' (single A) rating assigned to the Rs. 25 crore non- convertible debenture programme of VIP Industries has been reaffirmed. The `P1' (P one) rating assigned to the company's Rs. 25 crore commercial paper programme has also been reaffirmed.

The ratings reflect moderate financial risk profile of the company characterised by high level of investments in group companies, relatively higher gearing and moderate interest coverage indicators, average cashflow generation in relation to its liability profile and marginal improvement in working capital management.

The ratings also reflect the company's favourable market position in the premium and mid-price luggage segments, partly offset by the strong competition from the unorganised sector in the low- priced luggage segment and the moulded furniture businesses, stable nature of sales to the canteen stores department (CSD) and the economies of scale arising out of large scale of operations.

Whirlpool of India

`P1 plus' (P one plus) rating has been assigned to the Rs. 60 crore commercial paper programme of Whirlpool of India Limited (WOIL). The rating reflects the company's strong market position in the refrigerators and washing machines market and demonstrated financial and operational support from its parent, Whirlpool Corporation of the U.S. (rated BBB plus by Standard and Poor's).

The improvement in the financial risk profile of the company, due to strong turnover growth, as well as steps taken by the company to improve its working capital management and the equity infusion to correct the capital structure have also been factored in favourably. The rating also factors in the highly competitive nature of the white goods industry and continuing high gearing levels.

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