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CMA Final · Risk Management in Banking and Insurance

Credit Risk Management for CMA Final Paper 20B

Credit risk is the chance that a borrower or counterparty fails to pay what it owes on time. To handle questions, define the risk, name its components, then apply the tool: expected loss = PD × LGD × EAD, Basel risk weights for capital, mitigants to cut exposure, and RBI norms for NPAs and provisions.

What this chapter covers

This chapter in Paper 20B, Risk Management in Banking and Insurance, covers how a lender identifies, measures, controls and reports the risk that borrowers will not repay. It starts with what credit risk is and its parts, such as default risk, exposure risk, concentration risk and counterparty risk. It then moves to policy, appraisal and rating, measurement with PD, LGD and EAD, capital under Basel, mitigation, and the treatment of bad loans.

The chapter is the base for much of the rest of the paper. Capital adequacy, stress testing, and the overall bank risk framework all use credit risk as the largest input. Ideas such as expected and unexpected loss, risk weights and provisioning come back when you study market risk, operational risk and integrated risk management. Insurance links appear through credit insurance, guarantees and reinsurance counterparty risk.

Questions can be a 2-mark MCQ, a numerical on expected loss or risk-weighted assets, or a 14-mark written answer that asks you to apply a framework to a bank or lender in a given case. You need both the concepts and the working.

Credit risk is the biggest risk for most banks, so examiners return to it often, and it suits both MCQs and numerical questions. The chapter has clear formulas, defined terms and step-based frameworks, so careful practice converts directly into marks. It also supports other chapters of the paper, so time spent here pays back more than once. Since Section A has no negative marking per the question papers, you can attempt every MCQ, and sound concepts help you eliminate wrong options.

Credit Risk Management: topics in the order to study them

  1. 1Introduction to Credit Risk and Its ComponentsStart with the definitions and types of credit risk, because every later topic uses these terms.
  2. 2Credit Risk Management Framework and PolicyNext, see how a bank organises itself to control credit risk, which gives context for the tools that follow.
  3. 3Credit Appraisal and Credit RatingAppraisal and rating are the first practical steps in lending and lead naturally into quantitative measurement.
  4. 4Measurement of Credit Risk: PD, LGD and EADLearn the expected loss formula here, since Basel capital and provisioning both build on these three inputs.
  5. 5Basel Norms for Credit Risk CapitalCapital rules make sense only after you know how risk is measured, so study them after PD, LGD and EAD.
  6. 6Credit Risk Mitigation and TransferMitigants reduce exposure and capital, so you need the capital rules first to see their effect.
  7. 7Asset Classification, NPAs and ProvisioningEnd with what happens when credit risk turns into loss, which ties together policy, measurement and capital.

How to prepare Credit Risk Management

Treat this chapter as a mix of definitions, frameworks and a few calculations. Build the concepts first, then drill the numbers, then practise written answers.

  1. Read the topics in the study order and write a one-line definition for every term, such as default, exposure, recovery and concentration.
  2. Learn expected loss = PD × LGD × EAD. Practise with small figures in rupees, and keep PD as a probability and LGD as a percentage of exposure.
  3. Make a one-page note of the Basel idea: capital as a minimum ratio to risk-weighted assets, with risk weights depending on the approach. Check exact ratios and weights in your ICMAI study material before you memorise them.
  4. Prepare a list of credit risk mitigants, grouped as collateral, guarantees, netting and credit derivatives or securitisation, with one line on how each reduces loss.
  5. Learn the NPA classification stages and provisioning idea from the RBI norms in the study material, and confirm the current time limits and provision rates there.
  6. Solve past and practice MCQs, then write two or three 14-mark answers on case situations, using the structure: issue, framework, application, recommendation.
  7. In the last week, revise only your notes and redo every numerical you got wrong.

Common mistakes in Credit Risk Management

  • Mixing up PD, LGD and EAD or using LGD as a rupee amount.

    Fix: Write each as probability, percentage and rupee amount. Then multiply and check that the result is in rupees.

  • Confusing expected loss with unexpected loss.

    Fix: Remember that expected loss is met by pricing and provisions, while capital is held against unexpected loss.

  • Quoting Basel ratios, risk weights or NPA limits from memory without checking them.

    Fix: Use the ICMAI study material and current RBI norms as your single source and note the approach each number belongs to.

  • Writing generic theory in 14-mark case answers.

    Fix: Pick the facts from the case, link each to a risk or tool, and end with a clear recommendation.

  • Treating mitigation as removing risk completely.

    Fix: State that mitigation reduces loss or exposure but leaves residual risks such as collateral value falls and guarantor default.

  • Memorising NPA stages without understanding the link to provisioning.

    Fix: Study it as a ladder: longer overdue means weaker asset and higher provision, and explain the logic in answers.

Last-day revision: Credit Risk Management

  • Credit risk is the risk of loss when a borrower or counterparty fails to meet its obligation on time.
  • Components include default risk, exposure risk, recovery risk, concentration risk and counterparty risk.
  • Expected loss = PD × LGD × EAD.
  • PD is the likelihood of default over a stated period, usually one year.
  • LGD is the share of exposure lost after recoveries; recovery rate = 1 − LGD.
  • EAD is the amount outstanding at the time of default, including expected drawdown of undrawn limits.
  • Expected loss is covered by pricing and provisions; unexpected loss is covered by capital.
  • Risk-weighted assets = exposure × risk weight; capital ratio = capital ÷ RWA.
  • Collateral, guarantees and netting reduce exposure; credit derivatives and securitisation transfer risk.
  • A credit policy sets limits, delegation of powers, pricing and monitoring rules.
  • Credit rating gives an opinion on the likelihood of timely repayment.
  • Asset classification moves a loan from standard to NPA stages based on overdue period; provisions rise as the asset worsens.

Credit Risk Management practice questions

Credit Risk Management in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Credit Risk Management: frequently asked questions

Which paper has Credit Risk Management in CMA Final?

It is part of Paper 20B, Risk Management in Banking and Insurance, an elective in Group IV. You choose the elective at the time of enrolment for the Final Course.

What is the expected loss formula for credit risk?

Expected loss = PD × LGD × EAD. For example, PD of 2%, LGD of 40% and EAD of ₹50,00,000 gives 0.02 × 0.40 × 50,00,000 = ₹40,000.

Will I get numericals from this chapter?

Numericals on expected loss, risk-weighted assets and capital ratio are possible in both MCQs and written questions. Practise them along with the theory, since written answers also test application to a case.

Is there negative marking in the MCQs?

The question papers and the ICMAI prospectus do not provide for negative marking. You can attempt all 15 MCQs in Section A, but still avoid pure guesses where you can eliminate options.