Credit Quality and Credit Risk: A Rigorous Walkthrough

Abstract

This article provides an insight into the quality of credit portfolio of banks for the period from 2007–2008 to 2020–2021. The objective is to study the transition of public sector and private sector banks in India from standardised approach (SA) to internal rating-based (IRB) approach of credit risk. The overall structure of the article gives clear insight into why it is important for the banks to improve credit portfolio quality, considering default and recovery risk estimates, which in turn affect the returns of the bank. The study concludes that there is a need to improve credit quality of banks in India with a focus on small banks in public sector and large banks in private sector, as these banks are saddled with high defaults. Low rate of recovery in small banks in public sector and private sector adds to credit loss severity and high risk weights for the banks in IRB regime. However, the recent merger of the public sector banks, considering asset quality concerns, is still an unanswered question. JEL Codes: G010, G210, G320, G330