Credit Exposure is the maximum potential amount that will be a loss to the bank if the borrower defaults on payments. Credit Exposure is a calculated risk by the bank to do business and earn a profit. Suppose the bank has landed Rs.100.00 crores to the company M/s. ABC then the bank’s credit exposure to the company M/s. ABC is Rs.100.00 crores.
While assessing credit exposure, banks need to consider the current credit exposure contract and the potential changes credit exposure contract in the contract due to some uncertain event that occurred during the time frame of the agreement. Banks shall also consider indirect lending risk at exposure, which means exposure to a local commercial borrower with a sizeable economic dependence on another industry may be regarded as subject to indirect lending risk. At present, a bank’s lending exposures are 2% or more of the bank’s total asset to any borrower, then the bank must consider the indirect lending risk for measuring, monitoring, and controlling.
Credit Exposure is mainly given to a specific sector by the bank. If that one sector is collapsed, the whole bank will become financially unstable in the future. Hence, to control such avoidable circumstances, banks are limiting credit exposure to each sector, which means that boards of banks set lending exposure sub-limits concerning the bank’s regulatory Tier 1 and Tier 2 capital for each sector, which is reviewed periodically. Banks also set up regional exposure targets for lending. Even RBI can frame rules to set bank lending limits for exposure to higher-risk categories.
Risk Category Wise Exposure
In Public and Private Sector Banks, The Credit exposures are classified as mentioned below based on risk category by banks,
Credit Exposure classification based on Risk with Provisioning
Risk Category | Sub Classification | Provisioning Requirement |
---|---|---|
Insignificant | Insignificant Risk | 0.25% |
Low | Very Low Risk | 0.25% |
Low Risk | ||
Moderate | Moderately Low Risk | 5% |
Moderate Risk | ||
Moderately High Risk | ||
High | High Risk | 20% |
Very High | Very High Risk | 25% |
Restricted | Restricted | 100% |
Off-Credit | Off-Credit | 100% |
Non Rated Risk |
The main focus of Public and Private Sector Banks is on advances that involve insignificant or very low or low risk than risky advances. However, due to the market scenario and competition, Public and Private Sector Banks have been lending advances to very moderate or low or high risk or off credit or non-rated risk, etc., in fewer amounts amongst various risk categories advances. The exposure limit should not exceed its regulatory capital, except in the insignificant risk category as in the insignificant risk category, default chances are significantly less.
Provisioning for Risk Category Wise Exposure
Provision has been made based on risk category wise exposures in Public and Private Sector Banks as mentioned above other than provision required as per IRAC norms, but banks mainly do for insignificant risk category and low-risk category in which mostly Public and Private Sector Banks are dealing.