Credit risk management in volatile markets

2 mins read

Credit risk is an integral part of the financial world. 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, systemic credit risk can easily snowball, and this can impact not only the banking network, but also the financial health of the country at a macroeconomic level.

Mitigate credit risk through effective credit risk management using the rt360 Credit Risk suite. Learn more.

A real-world scenario

A corporate takes a 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.
The fact that the sum transferred to the “distributor”, is very similar to the amount disbursed by the bank for the project.
The purpose of availing each loan installment.
Whether the distributor is a blacklisted company or in the news for the wrong reasons, subject to frequent tax raids or audits.

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 credit risk 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.

Learn more about credit risk and how efficient credit monitoring in banks using rt360 can help mitigate these risks.

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.

Banking analytics plays a big role in mitigating credit risk and ensuring healthy credit monitoring in banks. Learn how rt360 can help.

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 and credit 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 banking analytics – 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 the Early Warning System in Banks

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 detect and flag early warning signals in credit monitoring, 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, i.e. the early warning signals in credit monitoring
Case management by channeling alerts to decision-making authorities

The future will reveal to us the role of the Early Warning System in banks 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.

To know more about using emerging technologies like AI to identify and alert users of the early warning signals in credit monitoring, click here.

Author

Jaya Vaidhyanathan

CEO, BCT Digital

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.

Author

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.