Academic journal article The International Journal of Business and Finance Research

A Comparison of Credit Risk Management in Private and Public Banks in India

Academic journal article The International Journal of Business and Finance Research

A Comparison of Credit Risk Management in Private and Public Banks in India

Article excerpt

ABSTRACT

Like other corporations, banks want to create value and seek ways to control risk while aiming to enhance productivity and performance. This is achieved by granting credits to customers from the money deposited by the depositor, thus placing them at risk in the case of defaulting. Despite this risk, banks must continually issue credit since it is the key source of its profitability. This research study assesses the impact of credit risk management on Indian public and private banks during the 2009-2012 period. Using pooled OLS, fixed effects and random effects, the study examines credit risk management in seven private banks and seven public banks. The results show that private banks are more capitalized and more profitable than public banks. In addition, in both cases asset quality measured using non-performing assets with negative coefficients significantly influenced bank profitability. The study extrapolates the importance of regulatory capital and the importance of risk management in ensuring stability in the financial industry.

JEL: G02, G18

KEYWORDS: Capital Adequacy, Non-Performing Assets, Performance, Net Interest Margin

(ProQuest: ... denotes formulae omitted.)

INTRODUCTION

During the last thirty years, the world has experienced a number of financial and banking crises. Most of these crises occurred in developing countries. The dominant crises corresponded to deregulatory processes that forced extension of credit in short timeframes. Continuous rises in asset prices in the long run precipitate bubbles. Ultimately, bankruptcies resulted from non-performing loans, leading to acute banking crises and credit losses. Over the last five years, the banking sector has undergone great metamorphosis as a result of the financial crisis of 2008. There is more emphasis on not only capital adequacy, but also on moral hazard. The global bailout of banks was a major paradigm shift, with taxpayers stepping in to rescue banks as a result of their short-term profits or bonuses. The argument for the bailout is that banks play a significant role of intermediation in the economy.

Significant reforms have been suggested in response to banking crises. For instance, Basel I, and Basel II and Basel III represent the banking supervision accords proposed by the Basel Committee (Felix and Claudine, 2008). The Basel Accord implemented a framework in 1988 by G-10 central banks focusing on credit risk and safe banking. The Reserve Bank of India (RBI) issued a guideline on credit risk management in 2002 per international law. Basel I played a critical role in strengthening the financial system, through several measures like weak incentives and deficiency of risk management. As a result, Basel II sought to reveal banks' fundamental risk exposure and response to financial innovation like securitization. Paradoxically, the incidence of crisis did not decline despite the introduction of succeeding development.

The recent international financial crisis signifies that risk management in banking sectors is significantly inadequate. The drive for globalization, innovation and financial deregulation has not eliminated credit risk even if the off-balance and market risk hold more interest in the wake of the disruption to the global financial markets (Paradi et al. 2012). Thus, credit risk is still the greatest concern to banking authorities and regulators. There is huge economic impact that is linked with bank failure because of the ripple effects that spread from banking to other sectors of the economy. Therefore, credit risk management is an issue of great value given that the core function of every bank is credit granting. The character of the banking sector has been so perceptive since more than 85% of their liability is deposits (Saunders & Cornett, 2005), and banks mobilize these deposits to credit for borrowers, which in fact is an income-generating function of banks. Besides all other services, bank must generate credit for customers to make money, enhance growth and remain competitive in the market. …

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