Risk Management in Banks (Sec- B)

A Project Report on Credit Risk Management in Axis Bank

Submitted To: Submitted By:

Dr. Vighneswar Swamy Abhishek Kumar Sinha 09BSHYD0023

Pratik Kamat 09BSHYD0349

Rajni Kant Rajhans 09BSHYD1105

Sumit Jain 09BSHYD 0879

T. Rahul 09BSHYD1108

TABLE OF CONTENTS:

Contents Page No.

1. About Axis Bank 3

a. Business Overview 3

b. Retail Banking 3

c. Corporate Banking 4

2. Credit Risk Management at Axis Bank 6

a. Credit Risk Management Policy 7

b. Credit rating System 7

c. Credit Sanction & related Processes 8

d. Portfolio Management 9

e. Concentration Risk 10

f. Policy for Hedging & Mitigating Credit Risk 10

3. Quantifying Credit Risk Using 13

a. ENPA approach 13

b. CAR model 14

c. Z- Score Model 15

4. Conclusion 17

5. References 18

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ABOUT AXIS BANK

Axis Bank was the first of the new private banks to have begun operations in 1994, after the Government of

India allowed new private banks to be established. The Bank was promoted jointly by the Administrator of the

specified undertaking of the Unit Trust of India (UTI-I), Life Insurance Corporation of India (LIC) and

General Insurance Corporation of India (GIC) and other four PSU insurance companies, i.e. National Insurance

Company Ltd., The New India Assurance Company Ltd., The Oriental Insurance Company Ltd. and United

India Insurance Company Ltd.

The Bank today is capitalized to the extent of Rs. 408.84 Crores with the public holding (other than promoters

and GDRs) at 53.81%. The Bank has a very wide network of more than 1095 branches. The Bank has a

network of over 4846 ATMs. This is one of the largest ATM networks in the country.

The Bank has strengths in both retail and corporate banking and is committed to adopting the best industry

practices internationally in order to achieve excellence.

Business Overview:

RETAILBANKING:

In order to achieve the objective of becoming more customer-centric, rather than product-centric, the Bank has

restructured Retail Banking into two groups namely Mass and Mass Affluent, and Affluent segments. The

Mass and Mass Affluent Segment owns, as the name indicates, mass-market customers, while the Affluent

Segment owns clientele defined as affluent, comprising customers in the wealth and private banking space.

Source: Axis Bank’s Annual Report 2009-10

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From the table shown above we can easily infer that bank is providing constant attention in absorbing more

and more retail clients both in terms of assets and liabilities which provides bank a low cost of fund as well as

good brand visibility. Moreover, more retail liabilities provide bank low risk in comparison to bulk loan as

the bargaining power of creditors distributed over a large population.

The cross-sell strategy is also an important strategic goal for the company by providing more emphasis on

Retail segment. The retail base of 12.5 million is being leveraged more effectively to increase cross-sell

penetration.

The Bank also focuses on distribution of third party products, with a special thrust on mutual funds .The bank

is a leading distributor of Mutual Fund. During the year 2009-2010, the Bank set a milestone with a collection

of Rs. 714 crores in the NFO of Axis Equity launched by the Axis Mutual Fund. Of the 92,000 applications

collected in the NFO of Axis Equity, 77% was from retail investors investing less than Rs. 50,000 each, which

reflects the Bank's ability to generate interest among small retail investors in investment opportunities.

The Bank offers Demat services from more than 750 branches across the country and presently has more than

2 lac accounts. Axis Bank offers 'Online Trading Services' in alliance with Geojit BNP Paribas, facilitating

seamless stock-trading through electronic linkages of trading, bank and Demat accounts with high-security

online features. During the year, ~ 47,000 customers have subscribed to the Bank's online trading account, the

total traded volume in which was more than Rs. 8,000 crores.

In September 2009, Axis Bank launched the private banking business in the domestic market, christened

'Privée' to cater to highly affluent individuals and families offering them unique investment opportunities. Axis

Bank Privée offers sophisticated investment and advisory services to clients who entrust the Bank with Assets

under Management (AUM) of more than Rs. 5 crores. It has been rolled out across six cities in India in 2009-

10 and follows a team-based approach for managing client relationships.

Corporate Banking:

The Bank's Corporate Banking franchise aims to provide a wide array of products across several customer

segments, including credit, trade finance, structured finance and syndication services for debt and equity. Since

each corporate engagement also offers opportunities on the retail side of the business, products anchored in the

Retail SBUs also form a part of the corporate marketing effort. New customer acquisition and relationship-

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deepening constitute the two-pronged strategy for growth. In order to leverage growth opportunities offered by

India's infrastructure sector, a separate infrastructure business group has been established within the corporate

banking group.

The Bank has continued to retain its leadership position in the infrastructure debt market and syndicated an

aggregate amount of Rs. 27,000 crores by way of Rupee and Foreign currency loans during 2009-10.

Euromoney Project Finance (Deals of the Year 2009) has conferred several awards in the area of infrastructure

financing to the Bank. These include categories such as 'Road Deal of the Year', 'Indian Rail Deal of the Year'

and 'Indian PPP Deal of the Year'.

CORPORATE CREDIT

During the year2009-2010, corporate credit, including lending to large and mid-corporate and to infrastructure,

grew to Rs. 52,503.53 crores, increasing by Rs. 11,292.63 crores, or 27.40% over last year. This includes the

lending out of the Bank's overseas branches at Rs. 12,285.40 crores (equivalent to USD 2.74 billion).

The credit policy of the Bank has put in place a matrix of industry exposure limits with a view to de-risking of

the portfolio through diversification. In keeping with this strategy, the highest exposure to any sector was

17.50% of the Bank's total lending (10.65% previous year). The practice of internal and external rating

continues to be undertaken on an ongoing basis. The entire corporate credit portfolio is internally rated with

74.42% of the ratings accorded being A and above. 74.13% of the portfolio has been externally rated till the

end of the year 2009-2010.

BUSINESS BANKING

Business Banking initiatives have consistently focused on procuring low-cost funds by offering a range of

current account products and cash management solutions across all business segments covering corporates,

institutions, central and state government ministries and undertakings, as well as small and retail business

customers. The cross-selling of transactional banking products have also succeeded in enlarging the customer

base and growing current account balances. Thus, sourcing of current accounts is one of the key enablers for

the growth of the balance sheet. As on 31 March 2010, current account balances for the Bank stood at Rs.

32,167.74 crores, against Rs. 24,821.61 crores on 31 March 2009, rising 29.60% over the year. On a daily

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average basis, current account balances grew from Rs. 14,658.35 crores on 31 March 2009 to Rs. 18,321.75

crores on 31 March 2010, thus increasing 24.99% over the year.

With the intent of providing business clients greater flexibility in meeting their transactional banking

requirements, the Bank has made significant improvements in its alternate banking channel using mobile and

internet banking. Cash Management Services (CMS) also leveraged the network and reach to provide a wide

range of customized collection and payments solutions.

Source: Axis Bank’s Annual Report 2009-10

CREDIT RISK MANAGEMENT IN AXIS BANK:

The wide variety of businesses undertaken by the Axis Bank requires it to identify, measure, control, monitor

and report risks effectively.

The Bank's risk management processes are guided by well-defined policies appropriate for various risk

categories, independent risk oversight and periodic monitoring through the sub-committees of the Board of

Directors. The Board sets the overall risk appetite and philosophy for the Bank. The Committee of Directors,

the Risk Management Committee and the Audit Committee of the Board, which are sub-committees of the

Board, review various aspects of risk arising from the businesses of the Bank.

Various Senior Management Committees, Credit Risk Management Committee (CRMC), Asset-Liability

Committee (ALCO) and Operational Risk Management Committee (ORMC) operate within the broad policy

framework as illustrated below.

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Source: Axis Bank’s Annual Report 2009-10

The Bank has also formulated a global risk policy for overseas operations and a country specific risk policy for

its Singapore, Hong Kong and Dubai branches. The policies were drawn based on the risk dimensions of

dynamic economies and the Bank's risk appetite.

Credit Risk Management Policy

Credit risk covers the inability of a borrower or counter-party to honor commitments under an agreement and

any such failure has an adverse impact on the financial performance of the Bank. The Bank is exposed to credit

risk through lending and capital market activities.

The Bank's credit risk management process integrates risk management into the business management

processes, while preserving the independence and integrity of risk assessment. The goal of credit risk

management during the year has been to maintain a healthy credit portfolio by managing risk at the portfolio

level as well as at the individual transaction level. The Board of Directors establishes the parameters for risk

appetite, which is defined quantitatively and qualitatively in accordance with the laid-down strategic business

plan. The foundation of credit risk management rests on the internal rating system.

Credit Rating System

Internal reporting and oversight of assets is principally differentiated by the credit ratings applied.

The Bank has developed rating tools specific to market segments such as Large corporate, mid-

corporate, SME, financial companies and microfinance companies to objectively assess underlying risk

associated with such exposures.

For retail and schematic SME exposures, scorecards and borrower-scoring templates are used for

application screening. Hence, for these exposures, the credit risk is measured and managed at the

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portfolio level. The Bank is also trying to use internal database of retail loans for building up statistical

behavioral scorecards as well as for refining credit assessment at the application sourcing level.

The credit rating tool uses a combination of quantitative inputs and qualitative inputs to arrive at a 'point-in-

time' view of the rating of counterparty. The monitoring tool developed by the Bank helps in objectively

assessing the credit quality of the borrower taking into cognizance the actual behavior post-disbursement.

The output of the rating model is primarily to assess the chances of delinquency over a one-year time horizon.

Each internal rating grade corresponds to a distinct probability of default. Model validation is carried out

periodically by objectively assessing its calibration accuracy and stability of ratings.

Credit Sanction and related processes followed at Axis bank:

The Bank has put in place the following hierarchical committee structure for credit sanction and review:

• Zonal Office Credit Committee (ZOCC)

• Central Office Credit Committee (COCC)

• Committee of Executives (COE)

• Senior Management Committee (SMC)

• Committee of Directors (COD)

The guiding principles behind the credit sanction process are as under:

1. Know your Customer' is a leading principle for all activities.

2. Sound credit approval process with well laid credit-granting criteria.

3. The acceptability of credit exposure is primarily based on the sustainability and adequacy of borrower's

normal business operations and not based solely on the availability of security.

4. Portfolio level risk analytics and reporting to ensure optimal spread of risk across various rating classes

prevent undue risk concentration across any particular industry segments and monitor credit risk quality

migration.Page | 8

5. Sector specific studies are periodically undertaken to highlight risk and opportunities in those sectors.

6. Rating linked exposure norms have been adopted by the Bank.

7. Industry-wise exposure ceilings are based on the industry performance, prospects and the

competitiveness of the sector.

8. Separate risk limits are set up for credit portfolios like advances to NBFC and unsecured loans that

require special monitoring.

9. With heightened activity in the real estate sector, the Bank has strengthened its risk management

systems to ensure that its advances are to borrowers having a good track record and satisfying the

criterion of minimum acceptable credit rating.

10. Appropriate covenants are stipulated for risk containment and monitoring.

Portfolio Management

The Bank continues to track the quality of all portfolios through appropriate risk metrics. Periodic delinquency

reporting, vintage analysis of the portfolio and rating-wise distribution of its borrowers provides insight for

future course of action.

In the backdrop of the economic slowdown, the Bank has pursued a strategy of growth with consolidation of

asset quality. The exposure to sectors that had been most affected by the downturn were kept under control and

there was an increased focus on borrowers having good and stable rating.

During the year the Bank has been selective in choosing a growth path for retail assets. The focus has been on

increasing lending to secured portfolios (mortgage, auto), while maintaining a cautious approach to unsecured

lending (personal loans and credit card business). Move has been to improve the quality of incremental

origination through tighter credit underwriting standards, increased use of bureau level data and

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leveraging on internal customer base of the Bank for cross sell. Account management and focus on

collection are a priority to control delinquencies at the portfolio level.

Concentration Risk

The Bank controls and limits concentration risk by means of appropriate structural limits and borrower

limits based on creditworthiness. These include:

Large Exposures to Individual Clients or Group

The Bank has individual borrower-wise exposure ceilings based on the internal rating of the borrower as well

as group-wise borrowing limits. The Bank monitors the level of credit risk (Low/Moderate/High/Very High)

and direction of change in credit risk (increasing /decreasing/stable) at the portfolio level based on the

following six parameters that capture concentration risk.

While determining level and direction of credit risk, parameters like percentage of low-risk credit (investment

grade and above) to credit risk exposure and migration from investment to non-investment grade (quantum as

percentage of credit risk exposure) are also considered.

Industries

Industry analysis plays an important part in assessing the concentration risk within the loan portfolio. Particular

attention is given to industry sectors where the Bank believes there is a high degree of risk or potential for

volatility in the future.

The Bank has fixed internal limits for aggregate commitments to different sectors so that the exposures are

evenly spread over various sectors.

Policies for Hedging and Mitigating Credit Risk

Credit Risk Mitigants (CRM) like financial collateral, non-financial collateral and guarantees are used to

mitigate credit risk exposure. Availability of CRM either reduces effective exposure on the borrower (in case

of collaterals) or transfers the risk to the more creditworthy party (in case of guarantees). A major part of the

eligible financial collaterals is in the form of cash, the most liquid of assets and thus free from any market and

liquidity risks. The Bank has formulated a Collateral Management Policy as required under Basel II guidelines.

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Credit Risk Asset Quality

Rating scale for large and mid corporates is a 14-point granular scale that ranges from AB-AAA to AB-D. The

rating tool for SME has an 8-point rating scale, ranging from SME 1 to SME 8. There are separate rating tools

for financial companies and schematic SME and retail agricultural exposures.

Definitions of Non-Performing Assets

Advances are classified into performing and non-performing advances (NPAs) as per RBI guidelines. NPAs

are further classified into sub-standard, doubtful and loss assets based on the criteria stipulated by RBI. An

asset, including a leased asset, becomes non-performing when it ceases to generate income for the Bank.

An NPA is a loan or an advance where:

1. Interest and/or installment of principal remains overdue for a period of more than 90 days in respect of a

term loan;

2. The account remains "out-of-order'' in respect of an Overdraft or Cash Credit (OD/CC);

3. The bill remains overdue for a period of more than 90 days in case of bills purchased and discounted;

4. A loan granted for short duration crops will be treated as an NPA if the installments of principal or interest

thereon remain overdue for two crop seasons; and

5. A loan granted for long duration crops will be treated as an NPA if the installments of principal or interest

thereon remain overdue for one crop season.

6. In respect of derivative transactions, the overdue receivables representing positive mark-to-market value of a

derivative contract, if these remain unpaid for a period of 90 days from the specified due date for payment.

Definition of Impairment

At each balance sheet date, the Bank ascertains if there is any impairment in its assets. If such an indication is

detected, the Bank estimates the recoverable amount of the asset. If the recoverable amount of the asset or the

cash-generating unit, which the asset belongs to, is less than its carrying amount, the carrying amount is

reduced to its recoverable amount. The reduction is treated as an impairment loss and is recognized in the

profit and loss account.

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Credit Risk: Use of Rating Agency under the Standardized Approach

The Bank is using issuer ratings and short-term and long-term instrument/bank facilities' ratings which are

assigned by the accredited rating agencies viz. CRISIL, ICRA, Fitch and CARE and published in the public

domain to assign risk-weights in terms of RBI guidelines.

In respect of claims on non-resident corporates and foreign banks, ratings assigned by international rating

agencies i.e. Standard & Poor's, Moody's and Fitch is used. For exposures with contractual maturity of less

than one year, a short-term rating is used. For cash credit facilities and exposures with contractual maturity of

more than one year, long-term rating is used.

Issue ratings would be used if the Bank has an exposure in the rated issue and this would include fund-based

and non-fund based working capital facilities as well as loans and investments. In case the Bank does not have

exposure in a rated issue, the Bank would use the issue rating for its comparable unrated exposures to the same

borrower, provided that the Bank's exposures are senior and of similar or lesser maturity as compared to the

rated issue.

Structured Obligation (SO) ratings are not used unless the Bank has a direct exposure in the 'SO' rated issue.

If an issuer has a long-term or short-term exposure with an external rating that warrants a risk weight of 150%,

all unrated claims on the same counterparty, whether short-term or long-term, also receive 150% risk weight,

unless the Bank uses recognized credit risk mitigation techniques for such claims.

Issuer ratings provide an opinion on the general credit worthiness of the rated entities in relation to their senior

unsecured obligations. Therefore, issuer ratings would be used to assign risk-weight to unrated exposures

provided that the unrated exposures are senior as compared to senior unsecured obligations of the same

borrower.

CREDIT RISK MITIGATION

The Bank uses various collaterals both financial as well as non-financial, guarantees and credit insurance as

credit risk mitigants. The main financial collaterals include bank deposits, NSC/KVP/LIP, and gold, while

main non-financial collaterals include land and building, plant and machinery, residential and commercial

mortgages. The guarantees include guarantees given by corporate, bank and personal guarantees. This also

includes loan and advances guaranteed by Export Credit & Guarantee Corporation Limited (ECGC), Credit

Guarantee Fund Trust for Small Industries (CGTSI), Central Government and State Government.

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The Bank has in place a collateral management policy, which underlines the eligibility requirements for credit

risk mitigants (CRM) for capital computation as per Basel II guidelines. The Bank reduces its credit exposure

to counterparty with the value of eligible financial collateral to take account of the risk mitigating effect of the

collateral. To account for the volatility in the value of collateral, haircut is applied based on the type, issuer,

maturity, rating and re-margining/revaluation frequency of the collateral. The Bank revalues various financial

collaterals at varied frequency depending on the type of collateral. The Bank has a valuation policy that covers

processes for collateral valuation and empanelment of valuers.

QUANTIFYING CREDIT RISK

USING NPAs:

As we know ENPA= PBT/ NPA

The table shows the ENPA calculation over the years and we plotted the graph of the same to have a trend

understanding of ENPAs over the years.

Year PBT (Cr) NPA (Cr) ENPA (%) =

PBT*100/NPA

2005 503.7 311.1 161.91

2006 731.3 374.28 195.39

2007 996.24 418.67 237.95

2008 1646.3 494.61 332.85

2009 2785.19 897.77 310.23

2010 3851.36 1318 292.21

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2005 2006 2007 2008 2009 20100.00

50.00

100.00

150.00

200.00

250.00

300.00

350.00

ENPA (%) = PBT*100/NPA

ENPA (%) = PBT*100/NPA

For an example ENPA of 292.2 % for the year 2010 means when 292.2 % of NPAs turns into loss assets the

entire profit of the company will get eroded.

As the NPA management of the company shows a good trend (upward slopping from 2005-2008) and hence

company has a very good credit position over the years as the minimum ENPA (%) is 161.9. The downward

slope for the year 2009 & 2010 can be attributed to the global financial crisis but still the percentage ENPA

shows a healthy position.

Using CAR model:

CAR as per BASEL II

Year Capital

(Cr)

Risk Weighted Assets

(Cr)

CAR

(%)

2005 3013.15 23799.52 12.66

2006 4278.26 38598.25 11.08

2007 6554.5 56643.37 11.57

2008

*

11890.89 84990.65 13.99

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2009 15027.64 109787.49 13.69

2010 22307.89 141169.77 15.80

*Shows the year from which BASEL II was followed before it BASEL I was followed by the bank.

The Capital Adequacy Ratio of the Bank over the years is above than the BASEL II requirement and hence the

bank has a sound credit risk management as per the CAR approach.

Z' Score Bankruptcy Model:

Applying Z Score Bankruptcy model on Axis Bank, we tried to find out its “Zone” of operation. We used this

model considering us as a lender and Axis Bank as a borrower and hence we have to take decision whether to

lend to Axis Bank or not i.e. assess the Axis Bank’s credit worthiness using Z-Score Bankruptcy model.

Formula for Z' Score for non-manufacturing company is

Z' = 6.56T1 + 3.26T2 + 6.72T3 + 1.05T4

Where

T1 = (Current Assets-Current Liabilities) / Total Assets

T2 = Retained Earnings / Total Assets

T3 = Earnings Before Interest and Taxes / Total Assets

T4 = Book Value of Equity / Total Liabilities

Source: (http://en.wikipedia.org/wiki/Altman_Z-score)

From Financial statements (Year 2009-2010) of Axis Bank, we calculated Ti where i= {1, 4}.

Current Assets 179425.44

Current

Liabilities

141300.22

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Total Assets 180647.87

Retained

Earnings

5784.69

EBIT 11874.1

Book Value of

Equity

16044.61

T1 0.211

T2 0.032

T3 0.066

T4 0.089

Therefore, Z Score for a non-manufacturing firm can be given as

Z' Score  6.56T1 + 3.26T2 + 6.72T3 + 1.05T4

Hence,

Z' Score 2.024

Zones of Discrimination:

Z > 2.6 -“Safe” Zone

1.1 < Z < 2. 6 -“Grey” Zone

Z < 1.1 -“Distress” Zone

As the Z’ Score for Axis Bank is 2.02 and hence the bank is in Grey Zone. The year 2009-2010 being a year

having a lot of financial stress in the economy, still the bank has managed to be in the Grey Zone. With

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improve in the situation of the financial market and economy as a whole; we can believe that bank will come in

the safe zone.

Conclusion:

The Axis Bank has a well defined Credit Risk Management policies and a well structured organization

hierarchy. It uses both the Internal Rating Based (IRB) as well as External Rating Approach for assessing the

creditworthiness for different categories of its borrowers. The bank has also set exposures ceilings on different

categories of borrowers thereby limiting the concentration risk. The Axis Bank also has a well defined

collateral management policy for the credit risk management and to account for volatility in the collateral an

appropriate hair-cut is applied. From the quantitative findings we can conclude that an ENPA of 292.2 % for

the year 2009-10; the Axis Bank has a sound NPA management. Moreover, from CAR model finding we can

infer that Axis Bank has an adequate Capital as per BASEL II norm which provides sufficient cushion to the

bank.

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References:

1. Annual Reports of Axis Bank from the year 2005 to 2010.

2. http://en.wikipedia.org/wiki/Altman_Z-score

3. http://www.axisbank.com/aboutus/aboutaxisbank/About-Axis-Bank.asp

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