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Chapter 2 Introduction
2.0 Overview

2.1 Factor affecting credit risk in conventional bank
First of all, the risk management in Turkish banks is to monitor, assess, and measure risk. According to this research, the bank have risk management control is not enough for the banks. Today’s risk management technologies and systems have all begun by implementing legal requirements. The risk management process of the Turkish banking system has started to tried to meet the requirements of the legal requirements that to avoid the credit risk in the bank. Other than that, the banking industry has dealt with several bank risks for the bank. According to Goyal (2010), the risks faced by the banking industry include credit risk, market risk, operational risk, interest rate risk, liquidity risk and exchange rate risk. The credit risk is because the borrower or the signatory cannot fulfill their obligation to sign the contract so that the will make the banks facing the risk because of the deterioration in credit quality.

Furthermore, banks have spent a lot of energy and time to developing the credit risk metrics so that they investigate the credit risk in the bank. The credit collapse is not only due to the tight supply of credit but it also the problems caused by supply (Bernanke, 1993). However, foreign exchange risk will also be affected and the bank’s credit demand will be reduced. One of the factors affecting bank credit risk is the increase in credit returns. Other than that, the techniques that the banks use to measure risk include retro analysis, scenario analysis, stress testing, integrated risk management, internal rating methods, standard methods, legal barriers, company ratings, credit policies and credit needs assessments (Yariz, 2011).
Besides that, credit risk is defined as the risk that the cash flow promised by banks and financial institutions may not be able to pay for the cash flow (Saunders & Cornet, 2008). So that the credit risk is the main reason for bank failures and the most obvious risk faced by bank managers (Gup et al., 2007). (Rose and Hudgins 2008) argues that credit risk refers to the possibility that the assets of certain financial institutions especially the loans that will continue to decline and may become worthless. In GDP inflation and market interest rates have been identified as having a significant impact on credit risk. At the micro level, previous non-performing loans, loan growth, loan concentration and bank size are important determinants.
2.1.1 Bank Size
First of all, in the previous experimental studies that according to the Salas and Saurina(2002) hay Hu et al.,(2004) the opposite relationship between bank size and credit risk that the large bank size and the stocks can help commercial banks to achieve profitability without bank failures and to accept high interest rate risks and it’s also can give customer loans. Other than that, in this case it will increase the future credit risk in the bank. Besides that, the bank size will affect the bank performance. Besides that, to control this cases that the bank followed Stiroh (2004) as a reserve for non-interest income in the bank’s total revenue that is because large banks may also fail because they are too big so that the banks may be exposed to more risks. Therefore, we also investigate whether the bank’s earnings volatility is directly and indirectly affected by market concentration by the possible adjustment effect of the size of the bank on volatility. According to the research (Wanzenried and Dietrich 2011) saying that the research shows that bank size should be positively correlated with its performance.

Furthermore, but in another researcher saying that the larger bank can give the bank more credit activities that can reduce the bank facing risk. According to the (Louzis, 2012) saying that the relationship between bank size and credit risk showed unclear results. Larger commercial bank investments can improve credit procedures but the quality of risk management and high-quality human resources provide favorable conditions to help banks. Large-scale operations allow the bank to diversify its credit activities, which can contribute to reducing the risk of credit concentration.
In the nut shell, based on this researches saying that the bank size will affecting to the bank facing risk especially in the small bank it is because the bank can’t hander the bank risk so that will make the bank facing bank run or bankrupt. Other than that, the larger bank will also facing the bank risk but is half of chance will facing the bank risk it is because it of the some of the larger bank can hander the bank risk as well.

Author Years Findings
Saurina, Hay Hu et al., 2002, 2004 Large bank size and the stocks can help commercial banks to achieve profitability without bank failures.

Stiroh 2004 Reserve for non-interest income in the bank’s total revenue to avoid bank bankrupt.

Wanzenried and Dietrich 2011 Bank size should be positively correlated with its performance.

Louzis2012 Larger commercial bank investments can improve credit procedures.

2.1.2 Rate of Return
First of all, a study that conducted by Macaulay (1988) in the United States found that credit risk management is the best choice for banks to investigate and that more than 90% of banks use this method to investigate the credit risk in the bank. The main role of the credit risk management policy must be to maintain the credit risk within the acceptable range of the bank to adjust the return rate of the bank’s risk. Other than that, according to the Naser et al. (2011) that conducting a research that using asymmetric and symmetric GARCH models, however they determined the impact of credit risk and exchange rate risk on the volatility of Australian bank rate of return so that according to this research they found there is fluctuation in rate of returns. The study also shows that financial risk helps predict rate of returns and that can help investors and regulators.

Other than that, according to the Janssen (2012) saying that the studied of the impact of credit risk on the rate of returns in the German, French and Dutch in the stock markets during the period 2004-2012. The purpose of this study is to determine whether credit risk will affect the rate of return in the stock returns. However, it was also found that there is no significant relationship between stock excess returns and credit spreads. Besides that, according to the Kang and Kang (2009) saying that the studied of the impact of bank credit risk and rate of return in stock market. Moreover, research shows that only high risks during financial distress will result in a reduction in revenue.

Furthermore, based on this cases the researches saying that the rate of return will not affect the credit risk in the bank. Therefore, from this cases the credit risk will help the rate of return on the stock market. Besides that, if the bank is during the financial distress so will affect the bank rate of return in the stock market.

Author Years Findings
Macaulay 1988 To maintain the credit risk within the acceptable range of the bank to adjust the return rate of the bank’s risk.

Naser et al. 2011 To determine the impact of credit risk and exchange rate risk on the volatility of Australian bank rate of return.

Janssen 2012 The impact of credit risk on the rate of returns.

2.1.3 Bank Performance
First of all, according to the researches Felix and Claudine (2008) saying that they also studied bank performance and credit risk management. They use the ratio of non-performing loans to total loans to measure credit risk. This study shows that the ratio of non-performing loans is the opposite of profitability. According to the researches (Boivin et al., 2010) saying that the bank profitability is strongly related to the country’s economic growth and credit risk is one of the most important risks for the banks. Besides that, the right investment is the banks can get the most out of their investment under the lowest credit risk. However, loans that customers do not repay will result in a decline in the bank’s profits. If the bank cannot control these loans it may lead to bank failures.
Other than that, according to the researches (Bourke, 1989; Molyneux and Thornton, 1992; Demirguc and Huizinga, 1999; Abreu and Mendes, 2002; Goddard et al., 2004; Naceur and Goaied, 2001). 2005; Pasiouras and Kosmidou, 2007; Mileris, 2012; Romanova, 2012) that saying the most studies that they focus on the impact of credit risk on bank performance use time series or panel data. However, banks are also the investigate credit risk at the end of each month. Besides that, bank’s return on assets and return on equity as indicators of bank performance, for the example of stress test, expected default rates, loan loss reserves, default loss ratios and non-performing loans are considered credit risk indicators in banks. The relationship between bank performance and credit risk has become one of the main findings of the study. Furthermore, according to the researches (Boahene, Dasah and Agyei, 2012) studied the relationship between credit risk and bank profitability. They found a positive correlation between credit risk and bank profitability.
Other than that, based on this cases of credit risk affecting the bank performance that is positive correlation to the bank. Furthermore, the bank performance is related to the country economic growth if the country economic growth is not well so that the bank performance will not good that will affect the bank profit of the month or years.

Author Years Findings
Felix and Claudine 2008 The ratio of non-performing loans is the opposite of profitability.

Boivin et al., 2010 Bank profitability is strongly related to the country’s economic growth and credit risk is one of the most important risks for the banks.

Bourke, Molyneux and Thornton, Demirguc and Huizinga, Abreu and Mendes, Goddard et al.,, Naceur and Goaied, Pasiouras and Kosmidou, Mileris, Romanova1989 – 2012 Bank’s return on assets and return on equity as indicators of bank performance.

Boahene, Dasah and Agyei 2012 They found a positive correlation between credit risk and bank profitability.
2.1.4 Personal Loan
First of all, the credit status of a personal loan applicant will be considered as if you have the ability to repay the loan you borrowed because it indicates the possibility of repayment within a reasonable range. Besides that, but the bank officials can’t 100% confirm whether the borrower tells you about his financial situation it is true. In this cases the loan official doesn’t say that all borrowers are not able to pay his loan. However, we cannot confirm whether the borrower has the possibility of breaking the law or even breaching the contract. Therefore, the choice of the loan officials for the borrower must depend on the probability. Loan officials rely on experience to determine which applicants are more likely to default than others.

Other than that, according to the researches (Swaren, 1990) saying that he suggested that a loan to those borrowers that had been over-debt or had an unfavorable credit record to give them a letter about saying that the loan could expose the borrower to unnecessary default and credit risk to the bank. Moreover, in order to reduce credit risk the banks need to consider the average income ratio and credit history and performance records, as well as the details of the personal loan applicant’s work it is because of this information allows the loan officer to distinguish the borrower that they is no financial ability to repay the loan and it will not expose the bank to facing credit risk.

Besides that, according to the researches (Basel committee on Banking Supervision, 1999, 3) that describes a type of debt that a bank cannot recover within the time limit that in the loan contract that the amount of credit that cannot be recovered is recognized as a debt in the bank’s financial report. Furthermore, based on this cases that the borrower make the loan that they are unable to pay back it will causes the bank facing credit risk.
Author Years Findings
Swaren1990 Suggested that a loan to those borrowers that had been over-debt or had an unfavorable credit record to give them a letter.

Basel committee on Banking Supervision 1999,3 Type of debt that a bank cannot recover within the time limit that in the loan contract that the amount of credit that cannot be recovered is recognized as a debt in the bank’s financial report.

2.1.5 Macroeconomic
Al-Smadi and Ahmed (2009) show that at the macro level, it is helpful to reduce the credit risk of banks under the conditions of a good economic period.

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