Controlling risk, averting disaster

PATHFINDER

The essential function of a bank is to take deposits and lend money. It lends a large portion of its money to corporates. Hence, a key function within the bank is to ensure that the risk taken by the bank in lending to the corporates is kept under control. This is monitored and controlled by the credit risk division. The credit risk analyst is a person who ensures that the bank is aware of the risks that it is taking and does not take any more risk than is necessary when lending to any company.

Credit risk is simply the risk of the borrower not repaying the loan. There are various stages of the loan, where the bank monitors this risk and tries to minimise it. The first stage is when the loan is sanctioned. For the loan to be sanctioned, the bank makes a compre-hensive proposal regarding both the ability and intent of the corporate house to pay back as well as the terms and conditions of the loan. The bank evaluates its risk through a risk score or rating. The rating is an indication of the credit worthiness of the client.

For example, an AAA rating is usually a sign that the company is very unlikely to default on its loans, while a BBB rating would mean that the company has a relatively higher chance of defaulting on its loans. The rating is also important for pricing the loan. The higher the risk from the loan, the higher will be the interest on the loan. The bank charges a risk premium from the client to account for the higher risk that it is taking.

The credit risk analyst has a key role at the stage of sanction. A relationship manager, who connects the bank to the corporate, will prepare a credit appraisal memorandum (CAM) or a credit appraisal note. This practice might vary from bank to bank, the other common alternative being the credit risk division preparing the note. CAM is a document that will outline in detail the dynamics of the industry in which the borrower company operates, entire business of the company, its financials and any likely future developments. The CAM also covers, in detail, the nature of the loan that is being sanctioned with all terms and conditions clearly outlined.

Skills required

Once the CAM is prepared by the relationship manager, it is sent to the credit risk division for approval. The credit risk analyst will now scrutinise the CAM. He will analyse the financials and the business aspect of the company. The analyst needs to understand business cycles and have a good knowledge of various industries to be able to vet the CAM. He will also need to have a good understanding of financial statements to evaluate the financials of the clients. Typically, the analyst will do a financial ratio analysis to check for the financial soundness, liquidity and profitability of the company. The queries are sent to the relationship manager who then co-ordinates with the company to resolve these queries. He will also look at the structure of the loan and the terms and conditions.

Once he is satisfied that he has understood the loan proposal completely, the risk analyst will take one of three views. The most positive would be to accept the proposal and recommend sanction. The second view could be to reject the loan. The third and most common view would be to accept the loan with a few modifications that mitigate risk for the bank.

An example could be to reduce the amount of the loan or to covenant a condition to the company. The covenant could be to ensure the company does not raise further debt without permission from the bank or that the company keep its debt/equity ratio within levels acceptable to the bank.  After the risk analyst gives a go-ahead on the proposal it is presented to sanctioning authorities within the bank who are authorised to sign and take the sanction forward.

Once the loan has been sanctioned and drawn down upon, the risk analyst has to ensure that the company follows any covenants that the bank has stated while sanctioning the loan. A built-in checkpoint for this is the review of the CAM which has to be done within 12 months even if there is no new sanction of the loan. This has to happen as long as the bank has any exposure on the company.

Moving up the ladder

Senior analysts will also look at the entire credit risk portfolio and look at portfolio analytics regarding the overall exposure of the bank across various industries, sectors and geographies.

The senior analyst has to prevent excess concentration of risk in any industry. This will ensure the bank does not get affected adversely if a particular sector or industry is not doing well or there is a change in government policy that adversely affects the industry. The role of the risk analyst is very analytical in nature and requires a special attention to detail, high comfort with financial statements and a breadth of knowledge that runs across all sectors.

Courses to qualify

Typically, banks recruit MBAs from premier colleges or chartered accountants in the risk analyst role. The career path is fairly steady and well defined, especially as compared to client-facing roles. This is because the risk analyst is always needed; there is a lot of work when the economy is booming and even more when there is a downturn! There are certifications issued by PRMIA and GARP that are useful if you are looking to enter a bank as a risk analyst. These certifications, though, do not give the student an operational view of the role and are more useful for those with some amount of work experience.

If you are aspiring for a role as a credit risk analyst, you would need to have an analytical bent of mind and keep a close watch on risk management practices in the industry.

With Basel 3 norms recently being taken up for implementation by banks, risk management is an area of focus and recruitments for this division are on the rise.