The gaps with regard to monitoring of credit risk relate to the formulae-based determination of loan loss provisions, a somewhat lenient approach to off-balance sheet activities and inadequate attention to the impact of changes in the economic scenario on banks' credit portfolio under stressful conditions.
Banks need to improve their MIS as well as the credit risk management systems and strategies within as short a timeframe as possible.
Banks must establish a system of independent, ongoing assessment of their credit risk management processes and the results of such reviews should be communicated directly to the Board of Directors and senior management.
Since the activities of the clients and the facilities enjoyed by them are multidimensional, banks must move towards multidimensional credit rating.
Banks should adopt more risk-oriented systems of internal rating so that in the process they can capture elements of risk like probability of default (PD), loss given default (LGD) and exposure at the time of default (EAD) which are hitherto not being captured.
Banks shall have to build historical database on the portfolio quantity and provisioning/charge off to equip themselves for pricing risks properly. The bigger banks must expedite the process of transition from elementary levels of risk management to levels of greater sophistication.
Banks in India would have to formulate a medium term strategy to implement risk aggregation and capital allocation mechanism. RBI may consider guiding the banks to more sophisticated risk management practices in a time bound manner.
Guidelines in respect of dealings with highly leveraged institutions should be put in place.
