Managing credit risk in a volatile financial market with Early Warning Systems

Collaborating, brainstorming, improvising and iterating without boundaries. It’s every innovator’s dream. For the Indian banking industry, this dream has finally arrived – heralding an era of extraordinary change and progress

Dr.Jaya Vaidhyanathan
CEO, BCT Digital

Shankar Ravichandran
Senior Manager at BCT Digital

The financial world is not without risks. As part of their fiduciary duties, banks operate with intense systemic risks every day, while empowering small firms to large multinationals begin new ventures, innovate and incubate, and ultimately act as the custodians of trust. If not carefully monitored, these systemic risks can easily snowball, and this can impact not only the banking network, but also the financial health of the country at a macroeconomic level.

A real-world scenario

When a corporate takes a loan has taken loan from a bank for building a plant. Normally, the bank will disburse the loan amount in tranches, using which the borrower will continue to pay suppliers for plant construction. Now, let us assume that the borrower attempts to defraud the bank by diverting the loan funds. In the guise of making vendor payment, the borrower sends the money to a “distributor” – a shell corporation that exists only on paper. Can the bank be defrauded?
Let us examine the whole gamut of information to which the bank is already privy:

  • The list of approved parties with whom the borrower is expected to transact for the project. Source: Project documentation
  • The fact that the sum transferred to the “distributor”, is very similar to the amount disbursed by the bank for the project. Source: core banking and transaction systems
  • The purpose of availing each loan installment. Source: the CA certificate to be mandatorily submitted to the bank
  • Whether the distributor is a blacklisted company or in the news for the wrong reasons, subject to frequent tax raids or audits. Source: Big data

If all of the above information (available at the different branches and locations of the same bank) can be shared with the authorities on time, the bank can proactively prevent fraud and save itself from an unsavory and litigious situation involving painful asset quality deterioration.

Credit risk management in perspective of the RBI mandate

The premise for Early Warning Systems is set here It all begins with credit risk. Broadly speaking, there are two aspects to defaults – ‘inability to repay’ and ‘no willingness to repay’. Both could potentially result in NPAs or Non-Performing Assets.

Following the Asset Quality Review of 2015, the RBI rolled out a string of regulations mandating the adoption of EWS as a best practice in identifying and mitigating the risks posed by Red Flagged Accounts (RFAs). The guideline issued mandated systems that would consider 45 indicators of stress in borrower accounts, measure the accounts with respect to each indicator, and flag incidents to authorities. Indeed, a laudable effort from the RBI.

Technology service providers were able to unearth much more data on borrowers from big data sources in addition to traditional data sources and this has aided with insightful decision-making:

  • Massive data ingestion and analysis of loan portfolios of banks across the country, products, and industries/customer segments, to take management calls on pulling back or expanding credit to specific sets of customers
  • Detect the stress of borrowers from what is reported in semi-public sources, including legal cases, share pledging, dubious business dealings, and so on.
  • Listen to rating agencies on what they are saying about their borrowers, industries or the economy
  • Listen to online and social media chatter on the promoters of a borrower

Now is the opportunity to leapfrog from just analyzing the transactional data of borrowers’ accounts to looking at them strategically.

To begin with, the sanity of data itself is a big factor. The key is in knowing where to look for data and when, and this is no easy task. If we examine industry-leading banking risk management systems, like rt360 built by BCT Digital, which are custom-built for the Indian banking sector, they have some of the most extensive sources and credible touchpoints, making data compilation all the more effective. The advanced algorithms and rules engine are extremely effective in mitigating false positives and unwarranted alerts – an area that is particularly hard to manage. The rules as such are far more exhaustive; for instance, rt360 is configured to flag 200 warning scenarios – well more than the 45 proposed by regulators.

How Artificial Intelligence is transforming Early Warning Systems

Early Warning Systems rely on tens of thousands of data points to measure and monitor risks, which is almost impossible for humans to replicate. Artificial Intelligence can transform Early Warning Systems, enabling them to make instantaneous predictions and extract actionable insights from disparate data sources, using these four distinct transformative components:

  • Collating data from multiple touch points
  • Cleansing, validating and restructuring data into valuable information
  • Algorithmic processing using next-generation technologies and data modeling to generate insightful early warning signals/alerts
  • Case management by channeling alerts to decision-making authorities

The future will reveal to us the role of EWS in strengthening asset quality. Furthermore, for the system to achieve its full potential, there needs to be open collaboration between the bank and its technology partner, and this is where partnering with a service provider that has specialized risk management expertise is bound to show results.

Authors

Dr.Jaya Vaidhyanathan

CEO, BCT Digital

Dr. Jaya Vaidhyanathan is an independent Director on several Boards and is focused on bringing in the best global corporate governance principles to India. Her work has found coverage in top news websites like The Hindu and The Times of India. Recently, she pioneered award-winning Early Warning Systems for Indian banks, which have found acclaim in the industry and among counterparts.

Shankar Ravichandran

Senior Manager at BCT Digital

His profound expertise in the field of corporate and retail banking spanning across Credit Risk, Transaction Banking, Service Delivery and Product Management is close to decade. He is an MBA graduate from Indian Institute of Management, Bangalore.

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Innovation Sandbox and Indian Banks – A close look at one of RBI’s most visionary initiatives of our time

Collaborating, brainstorming, improvising and iterating without boundaries. It’s every innovator’s dream. For the Indian banking industry, this dream has finally arrived – heralding an era of extraordinary change and progress

Dr.Jaya Vaidhyanathan
CEO, BCT Digital

Shankar Ravichandran
Senior Manager at BCT Digital

Collaborating, brainstorming, improvising and iterating without boundaries. It’s every innovator’s dream. For the Indian banking industry, this dream has finally arrived – heralding an era of extraordinary change and progress

“Innovation sandbox” – the phrase itself is so liberating. A place where thinking out of the box is the norm; the only rule is that there are no rules (or maybe just the bare minimum) and where mistakes are not only pardoned; they are encouraged. But how applicable is it in an institutionalized and conformist set-up, like banking, where rules and regulations are hardwired into the system and straying far from the rulebook can have serious, often fatal, repercussions on the economy of a nation?

In 2019, the RBI formally announced a draft “Enabling Framework for Regulatory Sandbox”, or the innovation sandbox. The framework seeks to enable technology-led companies to build (subject to limitations) and test financial products or services that facilitate innovation and positive change within the Indian banking industry, in return for possible regulatory relaxations, prior to actual launch. In this manner, it will attempt to bridge the gap between innovation, technology and the banking sector.

The RBI framework and the “amazonification” of banks

It is easy to see why the innovation sandbox is extolled by the industry as a welcome initiative by RBI. For one, similar initiatives have seen widespread success in other countries, UK being the first1, and later in Singapore and Estonia, which are shining examples of innovation in the digital realm. However, will the sandbox meet with unequivocal success in the Indian banking context?

The topic is certainly debatable, but if previous instances have taught us anything, it is that change is good, but disruption, even better.

If we take UPIs as an example – there was a time when the technology was still in the nascent stage and adoption rates were low. Before we go into the triggers that launched UPI to the fore, there are two factors we need to consider, in the context of UPIs.

  • 1. Indian Banks by nature are reluctant to share internal and user data, which they consider sacrosanct.
  • The back-end technology is not immune to risks, given that data changes hands several times – between the telecom service provider, the bank and a third-party gateway integrator.

The NPCI, who developed the system2, was quick to identify the need for a framework to manage the risks and bottlenecks associated with UPIs. They released an experimental set-up – a controlled interface for all parties to collaborate on, learn and improve. This was perhaps one of the early triggers to the launch of the innovation sandbox in India. As of today, with close to 800 million transactions in March’193, UPIs are a highly effective industry-specific innovation, and a game-changer for the Indian banking industry.

At a glance: multiple benefits

In effect, the innovation sandbox interfaces a “black hole”, which is constituted by previously inaccessible core banking data, with technology innovations. In the above manner, working within a controlled environment, it will drive across-the-board innovations that can simplify banking related processes – for example, speed-up payments, lower risks, reduce transactional costs and so on.

Another aspect working in favour of the sandbox is the current “amazonification” of the banking industry aimed to connect bankers to new-age customers. The millennial population in particular need indian banks to become more contextual in their understanding of user needs. So, we have simple algorithms tracking usage patterns and collecting data to dispatch relevant and targeted information (e.g., promotional offers) to users. There has also been an exponential increase in the number of channels by which indian banks can interact with customers. Beyond the regular kiosks and bank branches, there are the mobile devices, credit/cards, UPIs, doorstep banking, ATMs and so on.

With this explosion in touchpoints and technologies come more vulnerabilities and more risks.

The airline industry was one of the most recent victims; a reputed airline was defrauded of millions in a scam. These sorts of occurrences call for an ecosystem where innovations are not only nurtured, but risks are identified and averted in the nick of time. The controlled yet real-life environment hosted by the innovation sandbox not only places confidence on technology service providers, but also provides them access to customer feedback right from day-1. This in turn reduces iterations, fast-tracks time to market and lowers costs. A calibrated launch model helps to limit risks and control losses for stakeholders, which empowers them to think and act freely, and work cohesively with indian banks towards mutually beneficial goals.

The flip side: Manifold risks

The absence of a strict policy on customer data privacy is one of the primary hindrances to the guaranteed success of the innovation sandbox. All said and done, the success of the innovation sandbox is directly related to the extent at which private user data, transactional records and confidential information are made available for experimentation. And as with all experiments, things can seriously go wrong. To ensure this is not the case, beyond the present Information Technology Act, India needs a strong policy restriction, as in the case of Europe with its GDPR regulations.

Of lesser magnitude, yet a concern nonetheless, is the fact RBI regulations expressly prohibit testing on cryptocurrencies. Blocking progress in this domain, especially given how Blockchain technologies are gaining traction across the globe, can be very limiting.

Fighting fire with fire

As things stand, it is too early to comment on how and when the concept of the innovation sandbox will finally take flight, and up to what extent. But there is no doubt that the RBI initiative has vast transformative potential. Current risk management systems, which manage and predict credit, liquidity and operational risks, make use of statistical models to make accurate and timely forecasts. The innovation sandbox can open new avenues of assessing, measuring, monitoring, controlling and preventing risks, while improving access to vast repositories of user and banking related data by bypassing regulatory restrictions. Equally noteworthy is how this collaborative ecosystem will accelerate technology adoption, promote out-of-box thinking and increase competitive user offerings.

But perhaps most important is its role in building solutions to issues that have been long plaguing the Indian banking system, including money laundering and NPAs. The current state of the industry, which is in dire need of innovative fintech intervention, dwarfs any apprehensions of data privacy violation, provided the RBI heightens measures to protect the use of valuable and confidential information.

Authors

Dr.Jaya Vaidhyanathan

CEO, BCT Digital

Dr. Jaya Vaidhyanathan is an independent Director on several Boards and is focused on bringing in the best global corporate governance principles to India. Her work has found coverage in top news websites like The Hindu and The Times of India. Recently, she pioneered award-winning Early Warning Systems for Indian banks, which have found acclaim in the industry and among counterparts.

Shankar Ravichandran

Senior Manager at BCT Digital

His profound expertise in the field of corporate and retail banking spanning across Credit Risk, Transaction Banking, Service Delivery and Product Management is close to decade. He is an MBA graduate from Indian Institute of Management, Bangalore.

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Practitioners’ Insights On Credit Monitoring

In an industry-first survey on Credit Monitoring Practices of Indian Banks, Bahwan CyberTek highlights the need to take a holistic approach to credit monitoring with organizational ownership combined with an urgent need for automation as well as data integration.

Bahwan CyberTek, a leading global provider of innovative software products and solutions, has launched a report based on India’s first ever survey on ‘Credit Monitoring Practices of Indian Banks’; the report titled ‘Practitioners’ Insights on Credit Monitoring’.

In an industry-first survey on Credit Monitoring Practices of Indian Banks, Bahwan CyberTek highlights the need to take a holistic approach to credit monitoring with organizational ownership combined with an urgent need for automation as well as data integration.

Bahwan CyberTek, a leading global provider of innovative software products and solutions, has launched a report based on India’s first ever survey on ‘Credit Monitoring Practices of Indian Banks’; the report titled ‘Practitioners’ Insights on Credit Monitoring’. This was part of an event organized by the company where industry leaders and practitioners from private and public sector banks shared their experiences, both from a regulatory and a banker’s viewpoint and the latest regulatory developments in the Indian banking system, for credit monitoring.

The survey was conducted between October 2016 and February 2017, amongst senior bankers spearheading the credit risk monitoring or are part of the management unit, spread across 25+ public and private sector banks in India of varying asset sizes; this included banks whose total asset size comprised 42% of the combined asset size of all Indian scheduled commercial banks, as of March 2016.

Commenting on the launch of the report, Jaya Vaidhyanathan, President – BFSI & Strategic Business Initiatives, Bahwan CyberTek said, “We at Bahwan CyberTek believe in proactive action as opposed to merely reacting to an action. As a key priority for 2017 and years to come, we think it is important for Indian banks to make full use of the technology which will help automate and therefore improve their credit monitoring techniques, given that the health of our country’s economy depends on it.
“This therefore brings about the need for an Early Warning System where bankers can predict and assess the health of a borrower, for instance, and take the necessary measures. Moreover, such a system should help gauge the performance of all critical sectors that contribute towards the growth of the Indian economy”, she added.

Some of the key findings from the survey include:

  • No bank has completely automated the SMA (Special Mention Accounts) monitoring process
  • Banks largely rely on internal data to monitor the borrower health that might cause trouble in the future; the absence/ minimal use of external data (from an availability and quality point of view) doesn’t help in taking sound decisions.
  • Majority of the responding banks (>70%) see a need for a separate Early Warning System rather than making modifications to the existing systems, and have planned for one.
  • With regard to reporting, data collection is fully manual for 40% of the responding bank
    • For over 75% of the banks, report generation, dissemination and follow up actions is either fully manual or just partially automated

Speaking at the launch, T. N. Manoharan, Chairman, Canara Bank, said, “I would like to congratulate Bahwan CyberTek for undertaking this survey. I am sure that the findings will be of immense value to both banking personnel and the BFSI industry as a whole, and I personally hope to be enriched by the insights presented in the report. With regard to the banking industry, the two major challenges faced by the sector in the last one year have been the Asset Quality Review issued by the RBI, and demonetization. However, the banking industry is returning to normalcy, after having faced these hurdles.”

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