In credit risk management, risk management technology (RMT) and information system are also important for the designing and applying of a credit risk evaluation and management system. Bansal, Kauffman, Mark, and Peters (1993) observe that methods for sound RMT are of increasing interest among Wall Street investment banking and brokerage firms in the aftermath of the October 1987 crash of the stock market. As the knowledge of advanced technology applications in risk management increases, commercial banks are finding innovative ways to use them practically, in order to insulate themselves. The recent development in models, the software and hardware, and the market data to track risk are all considered advances in RMT. These advances have affected all three stages of credit risk management: the identification, the measurement, and the formulation of strategies to control credit risk.
Bansal et al. (1993) identify the advances made in five areas of RMT, including communication software, object-oriented programming, parallel processing, neural nets and artificial intelligence. Systems based on any of these areas may be used to add value to the business of a bank/firm with regard to risk control and credit risk management. The authors show the utility of advanced systems can be measured to justify their costs. Cebenoyan and Strahan (2004) test how active management of bank credit risk exposure through the loan sales market affects capital structure, lending, profits, and risk. They find that banks that rebalance their loan portfolio exposures by both buying and selling loans - that is, banks that use the loan sales market for risk management purposes rather than to alter their holdings of loans - hold less capital than other banks; they also make more risky loans (loans to businesses) as
83 a percentage of total assets than other banks. Holding size, leverage and lending activities constant, banks active in the loan sales market have lower risk and higher profits than other banks. Their results suggest that banks that improve their ability to manage credit risk may operate with greater leverage and may lend more of their assets to risky borrowers. Thus, the benefits of advances in risk management in banking may be greater credit availability, rather than reduced risk in the banking system. Following the financial crisis, banks and financial institutions have realised that the conventional methods of managing their credit risk, although important, may not always be sufficient. RMT can have a role to play to overcome the insufficiency. In addition to traditional credit risk methods, they are now looking at more adaptive and innovative approaches through advances of information technology to managing risk.
Moreover, there is a focus on understanding the interdependencies between credit risk and all other types of risk as banks look for an integrated organisation-wide risk management system. No doubt, to manage credit risks requires an effective approach and system. Credit risk management methods and systems are still developing. The pace of development and innovation in credit risk management may be especially high due to the rapid rate of recent change in the discipline of credit risk measurement and management, as well as to current regulatory initiatives like the Basel II
framework. It is vital important for banks to adopt integrated risk management (IRM) to address various aspects of risk management issues. Unfortunately, small banks and RCBs do not have much resource to advance their RMT and IT system. Most of them reply on traditional approaches and people personal experience to evaluate and manage banks’ credit risk. The results of interviews and case study of this study reported in Chapter 6 also reveal the above problem. Therefore, it is important for RCBs to develop a different approach that fits their own needs and characteristics. This study aims to make a contribution by developing a credit risk management framework specifically for RCBs in China.
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3.6 Summary
This chapter has provided a literature review on credit risk management. It presents some general concepts on credit, credit risk and credit risk management approaches, and credit evaluation and assessment models. The review provides a profile of the current literature and debates on the applicability and effectiveness of these
approaches and models. In most cases, the findings of the previous studies are still not inclusive.
This chapter discusses the basic concepts of credit risks and the importance of credit risk management. Among various risks faced by financial institutions, credit risk plays a vital role in the whole portfolio of risks, influencing the survival of financial institutions and the financial markets (Njanike, 2009). However, the causes of credit risks which are subject to a variety of factors and influence can only be identified and explained in a particular context, and through detailed analysis. Credit risk
management methods and systems are still developing. In addition to measuring and controlling it, banks also try mitigating their credit risk. A variety of approaches have been adopted by a financial institution to mitigate its credit risks, including, for example, risk-based pricing, covenants, credit insurance, credit derivatives,
collaterals, engaging in credit guarantee scheme. Some of the popular ways in which banks manage their credit risk include credit portfolio models, credit ratings
(including internal ratings), exposure limit, and stress testing. Most financial institutions have their own internal credit assessing models that they use for risk evaluation and management. The recent development in credit risk management has been rapid mainly due to the advance of IT, the imposition of corporate governance, as well as to current regulatory initiatives like the Basel II Framework. Financial institutions need to adopt integrated risk management to address various aspects of credit risk management.
From the literature reviewed, it shows that most of the existing literatures on credit risk management were based on the cases and data from western developed
economies where financial systems and risk management practices have been well established. China as an emergent economy started its economic reform in 1978 and
85 the Shanghai stock exchange was opened in late 1989. China’s banking system is still in the stage of transformation and internationalisation. Risk management in the banking sector has begun to attract some attentions recently. A number of researches have been carried out with a view to identifying the appropriate technical approach to manage operation and financial risks in general (e.g., Liu and Saleh, 2009), and credit risk in particular. The contemporary credit risk measurement instruments are efficient and explicit while they are bearing the problem of difficult to calculate and apply in real cases, particularly for small financial institutions. These processes are time and labour consuming which requires huge resources to maintain it. For the small and medium sized banks like RCBs, which are largely based on relationship lending and non-economic factors, these measurement instruments are not applicable. The current study attempts to overcome this problem by specifically considering Chinese
characteristics and institutional contexts for managing credit risk and developing a credit risk management framework for RCBs in China. The next chapter will focus on the Chinese characteristics and RCBs’ institutional context.
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