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Credit risk management is playing anindispensable role towards the relationship between credit risk performance and its components in Indian banks. In addition by emphasizing the importance of credit risk management in an emerging economy contextcharacterized by increasing global competition, and rising forces of globalization, liberalization, consolidation and deregulation the growth of non-performing assets can be controlled and managed efficiently.

The purpose of the study of literature review is to focus on theoretical foundation that is relevant to the study.

Examination aimed at determining implications on quality of credit and risk and draw up suitable strategies at the corporate level to attain the prescribed levels/quality of exposure. They noted that Credit Risk Management policies spelled out the target markets, risk acceptance/avoidance levels, risk tolerance limits, prefer levels of diversification and concentration, credit risk measurement, and monitoring and controlling mechanisms.[Naresh, C., & Rao, B. R. (2015)][1].

The study aimed at the implementation of the Credit Risk Management Framework by Commercial Banks in India.  The study is undertaken primarily to examine the credit risk management framework of schedule commercial banks in India, which is followed in pursuance to Basel Accords and RBI guidelines. An attempt is also made to examine the size and ownership effect on the credit risk management practices in banks [Bodla, B. S., & Verma, R. (2009)][2].

The author attempted to find the impact of credit risk management on banking performance. This study showed that there was a direct but inverse relationship between return on asset (ROA) and the ratio of non-performing assets (NPA). He concluded that banks with higher interest income had lower non-performing assets.  [Singh, A. (2015)][3].

The researcher laid the context of Basel III and then incorporates the views of senior executives of Indian banks and risk management experts on addressing the challenges of implementing the Basel III framework, especially in areas such as augmentation of capital resources, growth versus financial stability, challenges for enhanced profitability, deposit pricing, cost of credit, maintenance of liquidity standards, and strengthening of risk architecture. The capital cushion buffer that has been suggested in Basel III indicated that if a bank’s risk is increasing, the regulator has to determine the inflection point and introduce additional capital requirements. [Jayadev, M. (2013)][4].

Concept and Meaning of Credit Risk Management

Credit risk is most simply defined as the potential that a bank borrower or counterparty will fail to meet its obligations in accordance with agreed terms. The goal of credit risk management is to maximize a bank’s risk-adjusted rate of return by maintaining credit risk exposure within acceptable parameters. Banks need to manage the credit risk inherent in the entire portfolio as well as the risk in individual credits or transactions. Banks should also consider the relationships between credit risk and other risks. The productive management of credit risk is a vital component of a comprehensive approach to risk management and essential to the long-term success of any banking organization (BCBS-125 Principles for the Management of Credit Risk)[5].

Need for Credit Risk Management

Credit Risk Management encompasses identification, measurement, monitoring and control of the credit risk management. The successful management of credit risk is a necessary component of comprehensive risk management and essential for the long term success of a banking organization[IIBF (2023)][6]. Hence credit risk management plays an important role in protecting its assets and resources and ensuring that risks are reduced to an acceptable level. The essence of credit risk management is to minimize the risks to a reasonable and manageable level, on an ongoing basis. The effective management of credit risk is an important component of a comprehensive approach to risk management and required to the prolonged success of any banking business. [RBI Publication (2000)][7].
Credit risk management enables Indian Banking Sectors to identify, assess, manage proactively and optimize their credit risks at an individual level or at an entity level or at the level of a country on different sectors. Given the fast changing dynamic world scenario experiencing the pressures of globalization, liberalization, consolidation and disintermediation, it is important that all banks have a robust credit risk management practice which is sensitive and responsive to these changes [RBI(Sep 2021)][8].

Research Methodology

Data have been collected visiting web sites of bcbs, rbi, iba, banks and also annual reports.

Result and Analysis Section

This section has been divided into three parts which are as under:

1. Credit Risk Management and Non-Performing Assets of Banks in India

Credit risk management is playing a crucial role in the relationship between credit risk performance and its components in Indian banks. Further by emphasizing the importance of credit risk management in an emerging economy context, which is characterized by increasing global competition, and rising forces of globalization, liberalization, consolidation and deregulation the growth of non-performing assets can be managed efficiently. As a fall out slippage to NPA can be minimized ensuring quality of assets and performance of banks as well as interest of the stakeholders. Central banks may focus their attention on credit risk identification to bring down the bad and doubtful assets of banks regulated by them. The risk managers will benefit by investing their efforts in critically evaluating the creditworthiness of potential borrowers to mitigate the credit risk by identifying the same at an early stage. The bank executives can benefit by sharing information (data) on credit quality of potential borrowers and their experience in the early identification of risky borrowers. This coordination among banks will help bring down the total NPA in the banking system and may improve the credit flow to different sectors of the economy. Finally, the study has implications for banks, which incur significant losses due to credit failures. It also has implications for the implementation of new Basel Accord (Basel III) norms by Reserve Bank of India (RBI).[Sharifi, S., Haldar, A., & Rao, S. N. (2019)][9].

2. Basel Accord Framework

Banking operations worldwide have undergone phenomenal changes in the last three decadessince 1990s. Financial liberalization and technological innovations have created new andcomplex financial instruments/products with enhanced  role and turnover in financialmarkets and have rendered banking operations vulnerable to a variety of risks. The 2007-2009financial crises revealed that the fragile banking system led to huge costs for the society. Oneof the main reasons the recent crisis became so severe was that banks in many countries builtup excessive on- and off-balance sheet leverage. This was accompanied by a gradual erosion ofthe level and quality of the capital base and by inadequate liquidity buffers (Locarno, IMFWorking Paper (2012)). Basel framework has been drawn by Bank for International Settlements(BIS) in consultation with supervisory authorities of banking sector in fifteen emerging marketcountries with the basic objective of advocating codes of bank supervision and promotingfinancial stability amidst economic crises. Generally, the adoption of Basel standards is to beviewed in the context of regulatory approach to bank supervision by the central bank of thecountry and the incentives system for the banks to improve their risk measurement procedures.

It also takes cognizance of the fact that the new technological innovations in informationtechnology have revolutionized the banking operations and the market practices have alteredsubstantially since the introductory period of Basel standards.Consequently, Basel standardsenvisage a change in the oversight function of the central bank as a regulatory body over thecommercial banks operating in the country and the capital adequacy requirements of the banks.Rapid transformation of financial system around the globe has brought sweeping changes in thebanking sector across the countries. Though new avenues and opportunities have been openedup for augmenting the revenue generation for banks, yet new processes and technologicalprogress has exposed the banks to higher risk. Therefore, the need was felt for strengtheningthe soundness and stability of banks and to protect the depositors and the financial system fromdisastrous developments which could threaten the banks solvency.Basel Committee on Banking Supervision (BCBS) under the auspices of Bank for InternationalSettlements (BIS) took initiative putting in place adequate safeguards against bank failure withcentral banks across the globe. The first initiative from BIS can be identified with Basel IAccord with over 100 central banks in different countries accepting the framework stipulatedby agreement. The accord provided a framework for fair and reasonable degree of consistencyin the capital standards in different countries, on a shared definition of capital. Although thesestandards were not legally binding, they have made substantial and significant impact onbanking supervision in general, and bank capital provisioning and adequacy in particular.However, Basel I comprised of some rigidities, as it did not discriminate between differentlevels of risks. As a result, a loan to an established corporate borrower was considered as riskyas a loan to a new business. So all loans given to corporate borrowers were subject to the samecapital requirements, without taking into account the ability of the counterparties to repay. Italso did not take cognizance of the credit rating, credit history and corporate governancestructure of all corporate borrowers. Moreover, it did not adequately address the risk involvedin increasing the use of financial innovations like securitization of assets and derivatives andcredit risk inherent in these developments. The important category of risk i.e., operational riskalso was not given the attention it deserved. Recognizing the need for a more comprehensive,broad based and flexible framework, Basel III has measures to ensure that the banking systemas a whole does not crumble and its spill-over impact on the real economy is minimized. BaselIII has in effect, some micro –prudential elements so that risk is contained in each individualinstitution and macro prudential overlay that will ‘lean against the wind ‘to take care of issuesrelating to the systemic crisis. The Basel III framework sets out higher and better quality capital,enhanced risk coverage, the introduction of a leverage ratio as a back-stop to the risk-basedrequirement, measures to promote the build-up of capital that can be drawn down in times ofstress and the introduction of compliance to global liquidity standards ( Chintan Arunkumar Vora, Dr. A A Attarwala)[10].

Basel I is a set of international banking regulations established by the Basel Committee on Banking Supervision (BCBS). It prescribes minimum capital requirements for financial institutions, with the goal of minimizing credit risk. Under Basel I, banks that operate internationally were required to maintain at least a minimum amount of capital (8%) based on their risk-weighted assets and nationally it is 9%. Basel I is the first of three sets of regulations known individually as Basel I, II, and III, and collectively as the Basel Accords. Basel I, the committee's first accord, was issued in 1988 and focused mainly on credit risk by creating a classification system for bank assets. The Basel I classification system groups a bank's assets into five risk categories, labeled with the percentages 0%, 10%, 20%, 50%, and 100%. A bank's assets are assigned to these categories based on the nature of the debtor. The bank must maintain capital (referred to as Tier 1 and Tier 2 capital) equal to at least 8% of its risk-weighted assets. This is meant to ensure that banks hold an adequate amount of capital to meet their obligations.

Basel I primarily focuses on credit risk and risk-weighted assets (RWA). It classifies an asset according to the level of risk associated with it. Classifications range from risk-free assets at 0% to risk assessed assets at 100%.Tier 1 capital refers to capital of more permanent nature. It should make up at least 50% of the bank’s total capital base. Tier 2 capital is temporary or fluctuating in nature.

The main features of Basel Capital Accord known informally as Basel I was to prevent banks from building business volumes without adequate capital backing, the cornerstone of risk management. Other features are:

1. The focus was on credit risk

2. Set minimum capital standards for banks

3. Became effective at the end of 1992

4. By amendment in 1996 to capital accord to incorporate market risk effective at the end of 1997

The purpose of Basel I was to establish an international standard for how much capital banks must keep in reserve in order to meet their obligations. Its regulations were intended to enhance the safety and stability of the banking system worldwide [IIBF (2010)][11].

Basel I introduced guidelines for how much capital banks must keep in reserve based on the risk level of their assets. Basel II refined those guidelines and added new requirements. Basel III further refined the rules based in part on the lessons learned from the worldwide financial crisis of 2007 to 2009.

Basel II is a comprehensive framework for improving bank safety and soundness by more closely linking regulatory capital requirements with bank risk, by improving the ability of supervisors and financial markets to assess capital adequacy, and by giving banking organizations stronger incentives to improve risk measurement and management. The Committee believed that the revised Framework would promote the adoption of stronger risk management practices by the banking industry. The challenge before the Committee was recognition of Operational Risk as an additional element for determining capital allocation in addition to Credit Risk and Market Risk. The Revised Framework encompasses three elements:

1. Risk focused regulatory capital requirements

2. Supervisory review

3. Market discipline

These are so-called three pillars of Basel II.

Pillar I: Minimum Capital Requirement

Pillar II: Supervisory Review Process

Pillar III: Market Discipline

Pillar I: Minimum Capital Requirement

The Revised Framework provides a range of options for determining the capital requirements for credit risk and operational risk to allow banks and supervisors to select approaches that are most appropriate for their operations and financial markets. Capital requirements for Market Risk continued as per the provisions of Amended Basel I accord.

Pillar II: Supervisory Review Process

This pillar identifies the role of the national supervisors under Basel II. Basel has identified four principles of supervisory review:

Principle 1: Banks should have a process for assessing their overall capital adequacy in relation to their risk profile and strategy for maintaining their capital levels.

Principle 2: Supervisors should review and evaluate banks’ internal capital adequacy assessments and strategies as well as their ability to monitor and ensure their compliance with regulatory capital ratios. Supervisors should take appropriate supervisory action if they are not satisfied with the result of this process.

Principle 3: Supervisor should expect banks to operate above the minimum regulatory capital ratios and should have the ability to require banks to hold capital in access of the minimum.

Principle 4: Supervisors should seek to intervene at an early stage to prevent capital from falling below the minimum levels required to support the risk characteristics of a particular bank and should require rapid remedial action if capital is not maintained or restored.

Pillar III: Market Discipline (Transparency and Disclosures)

This sets out the minimum disclosure requirements for external reporting. A bank is expected to be transparent. It should disclose various information relating to its financial aspects including its risks at periodical intervals.

Basel III reforms attempts to strengthen the bank-level i.e. micro prudential regulation, with the intention to raise the resilience of individual banking institutions in periods of stress. Besides, the reforms have a macro prudential dimensional also, addressing system wide risks, which can build up across the banking sector as well the procyclical amplification of these risks over time. These new global regulatory and supervisory standards mainly seek to raise quality and level of capital to ensure banks are better able to absorb losses on both a going concern and a gone concern basis. However, The Basel III regulatory standards continue to be based on three-mutually reinforcing Pillars viz. minimum capital requirements, supervisory review of capital adequacy and market discipline of Basel II capital adequacy framework.

According to the BCBS, the Basel III proposals have two main objectives:

i. To strengthen global capital and liquidity regulations with the goal of promoting a more resilient banking sector.

ii. To improve the banking sector’s ability to absorb shocks arising from financial and economic stress.

3. Challenges before the Banking Sector in India

The requirement that banks must maintain a minimum capital amount in reserve will make banks less profitable. Most banks will try to maintain a higher capital reserve to cushion themselves from financial distress, even as they lower the number of loans issued to borrowers.

In recent years, Indian banks have been making great advancements in terms of technology, quality as well as stability such that they have started to expand and diversify at a rapid rate. As a result of this, the needs for professional skills in the modeling and management ofcredit risk have rapidly increased and credit risk modeling has become an important topic in the field of finance and banking in India.

The introduction of Basel advanced approaches has incentivized many of the best practiced banks in the Indian economy to adopt better risk management framework to evaluate their performance relative to the market expectations.

The IRB advanced approaches under Based regime would entail fundamental changes in their balance sheet management philosophy: From deposit taking to lending, from investments to diverse ancillary business, from pricing to capital allocation and stakeholder wealth maximization. The banks will have to incorporate model outputs in business decisionmaking. This will create a risksensitive framework to align capital more closely with underlying risks. Therefore, banks need to correctly assess the capital cushion that would protect them against various business risks in future.

1. Naresh, C., & Rao, B. R. (2015). Credit risk management practices of Indian Commercial Banks. International Journal in Management & Social Science, 3(1), 89-94. 2. Bodla, B. S., & Verma, R. (2009). Credit risk management framework at banks in India. The IUP Journal of Bank Management, 8(1), 47-72. 3. Singh, A. (2015). Performance of credit risk management in Indian commercial banks. International Journal of Management and Business Research, 5(3), 169-188. 4. Jayadev, M. (2013). Basel III implementation: Issues and challenges for Indian banks. IIMB Management Review, 25(2), 115-130. 5. BCBS-125 Principles for the Management of Credit Risk 6. IIBF (2023). Risk Management by Macmillan Publication, 1st Edition, P.147. 7. RBI Publication (2000). https://rbi.org.in/Scripts/Publications.aspx?publication=Annual 8. RBI Publication (Sept 2021) https://rbi.org.in/Scripts/Publications 9. Sharifi, S., Haldar, A., & Rao, S. N. (2019). The relationship between credit risk management and non-performing assets of commercial banks in India. Managerial Finance. 10. Vora, C. A., & Attarwala, A. A. CREDIT RISK Management with Implementation of Basel Norms In Indian Banks. 11. IIBF (2010). Risk Management – An Overview by Macmillan Publication, 1st Edition, P.158.