Enterprise Risk

Management
Banking Industry
K Siddartha Shastry

Overview
The Indian banking industry is one of the largest and most complex in the world,
with over 100 scheduled commercial banks and more than 96,000 branches. It has
undergone a significant evolution since the country's independence in 1947, and
today it plays a vital role in the economic development of India.

The Indian banking system is divided into three categories:

• Scheduled Commercial Banks (SCBs): These are the largest banks in India
and are regulated by the Reserve Bank of India (RBI). SCBs account for the
majority of banking activity in India.

• Co-operative Banks: These banks are owned and operated by their members
and are regulated by the RBI and state governments. Co-operative banks play
an important role in providing banking services to rural and semi-urban areas.

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 • Non-Banking Financial Companies (NBFCs): These are financial institutions
that do not have a banking license from the RBI. NBFCs offer a variety of
financial products and services, such as loans, investments, and insurance.

The Indian banking industry is facing a number of challenges, including:

• High non-performing loans: The Indian banking system has a high level of
non-performing loans, which are loans that are not being repaid by borrowers.
This is a major challenge for the industry and is affecting its profitability.

• Low interest rates: Interest rates in India are at historic lows, which is making
it difficult for banks to make profits.

• Digital transformation: The Indian banking industry is undergoing a digital

transformation, which is changing the way banks operate. Banks need to
invest in new technologies to stay competitive.

• Regulatory changes: The RBI is constantly changing regulations, which can

be challenging for banks to keep up with.

Despite these challenges, the Indian banking industry is expected to continue to grow
in the coming years. The country's economy is growing rapidly, and there is a
growing demand for banking services. The industry is also expected to benefit from
the digital transformation.

Here are some of the key trends in the Indian banking industry:

• Digitalization: The Indian banking industry is undergoing a digital

transformation, with banks investing in new technologies to improve their

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 operations and customer service. This includes the use of mobile banking,
internet banking, and artificial intelligence.

• The rise of fintech: Fintech companies are using technology to provide

financial services that are more convenient and affordable than traditional
banking services. This is posing a challenge to traditional banks, but it is also
creating new opportunities for collaboration.

• The growth of the retail banking sector: The retail banking sector is growing
rapidly, as more and more people in India are becoming financially included.
This is driving demand for banking services such as loans, savings accounts,
and credit cards.

• The expansion of the rural banking sector: The RBI is expanding the reach of
banking services to rural areas. This is being done through the Pradhan Mantri
Jan Dhan Yojana (PMJDY), which aims to provide financial services to all
Indian households.

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PESTLE Analysis
POLITICAL Factors:

• Capital flight (long-term risk): Investors may withdraw their money from
banks in countries with political instability, which can lead to a shortage of
capital and make it difficult for banks to operate.

Example: - The Russian Financial Crisis of 1998: The Russian Financial

Crisis was a major financial crisis that affected Russia and several other
countries in Eastern Europe. The crisis was triggered by a number of factors,
including the collapse of the ruble, a decline in oil prices, and political
instability. Capital flight was a major factor in the crisis, as investors withdrew
their money from Russia in fear of losing their investments.

• Trade policies (Short-term risk): Governments can impose tariffs or other

trade restrictions on financial services, which can make it more difficult for
banks to operate across borders. This can reduce competition in the banking
industry and make it more difficult for banks to access foreign capital.

Example: - SWIFT ban on Russia leading to difficulties for Indian banks to

deal with Russian banks.

ECONOMIC Factors:

• Monetary policy (mid-term risk): Governments can set interest rates and
other monetary policy tools, which can affect the cost of borrowing for banks
and their customers. This can have a significant impact on the lending
activities of banks.

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 Example: - Repo and reverse repo rates affect Banks’ lending capacity.

• Inflation (mid-term risk): Inflation is the rate at which prices are rising.
When inflation is high, the value of money decreases, which can make it more
difficult for banks to make money.

• Unemployment (long-term risk): Unemployment is the rate at which people

are without jobs. When unemployment is high, people are less likely to be
able to repay their loans, which can lead to losses for banks.

• Exchange rates (short term risk): Exchange rates are the prices of
currencies relative to each other. When exchange rates fluctuate, it can make
it more difficult for banks to do business internationally.

SOCIAL Factors:

• Customer Behavior: Improper service may lead to dissatisfied customers

affecting banks’ reputation and customers’ confidence in them.

Example: - In 2022, a customer of the ICICI Bank had her account hacked and her
money was stolen. The bank was slow to respond to the customer's complaint and
did not reimburse her for her losses. This caused the customer a great deal of
financial hardship and stress.

The customer, identified as Mr. Rahul Gupta, had his account hacked and
Rs. 50,000 was stolen. He immediately reported the incident to the bank, but the
bank was slow to respond. It took the bank two weeks to investigate the matter and
to reimburse Mr. Gupta for his losses.

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 • Public trust: Banks need to maintain the trust of the public in order to attract
and retain customers. Any perceived wrongdoing, such as money laundering
or fraud, can damage a bank's reputation and make it difficult to attract new
customers

Example: - Nirav Modi fraud led to a lot of consumers pulling out their deposits
from Punjab National Bank.

TECHNOLOGICAL Factors:

• The rise of fintech companies (long term risk): Fintech companies are
startups that use technology to provide financial services. These companies
are often more agile and innovative than traditional banks, and they can offer
lower fees and better customer service. This is forcing banks to innovate and
improve their services in order to compete.

Example: - Zerodha as a discount broker against brokerage offered at high

fees by traditional banks.

• Development of new technologies and risks associated with them (UPI):

System Rundowns (short term risk): Bank servers often fail and since a
huge part of economy runs on UPI these days, the bank operations are affected
on a large scale.

• Cybersecurity threats (short term risk): Almost all of confidential

information related to bank accounts these days are stored on cloud servers

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 and constant cyberattacks from hackers can expose the confidential
information.

• The development of new financial technologies (: New financial

technologies, such as blockchain and artificial intelligence, can disrupt the
banking industry and make it more difficult for banks to compete. For
example, blockchain technology could be used to create a more secure and
efficient way to process payments. This could make it easier for customers to
send and receive money, and it could also reduce the need for banks to
intermediary.

ENVIRONMENTAL Factors:

• Climate change: Climate change is a major environmental challenge that is

affecting banks in a number of ways. For example, rising sea levels could
inundate coastal areas where banks have branches and ATMs. Extreme
weather events, such as hurricanes and floods, could also damage bank
infrastructure and disrupt operations.

• Public opinion: Public opinion about environmental issues is also important

for banks. If the public perceives that a bank is not doing enough to address
environmental concerns, it could damage the bank's reputation and make it
more difficult to attract customers.

Example: - If banks are not issuing enough green bonds these days, it’s
affecting their public image. Environmentally aware citizens are better
retained with good sustainable practices.

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LEGAL Factors:

• Litigation: Banks are also exposed to litigation, which can be costly and time-
consuming. For example, banks may be sued by customers who allege that
they were the victims of fraud or that the bank failed to meet its obligations.

Example: - Banks have been sued by customers who allege that they were the
victims of fraud, such as identity theft or credit card fraud. For example, in
2017, Wells Fargo was sued by customers who alleged that the bank had
opened unauthorized accounts in their names. The lawsuit resulted in a $142
million settlement.

• Anti-money laundering laws: Banks are also subject to anti-money

laundering laws, which are designed to prevent the financing of terrorism and
other criminal activities. These laws can make it more difficult for banks to
do business with certain customers or to process certain types of transactions.

Example: - Standard Chartered Bank has been accused of facilitating terrorist

financing on multiple occasions. In 2012, the bank was fined $340 million by
the New York Department of Financial Services for violating anti-money
laundering laws. The bank was accused of processing payments for sanctioned
entities and individuals, including al-Qaeda and the Taliban.

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Bow Tie Analysis

Hazard 1:

THREATS CONSEQUENCES

Poor performance of the More stringent procedures before

corporates will affect their ability
to pay back their loans
simultaneously affecting balance
sheet of the bank it has taken
loan from.
Higher Interest rates on floating
loans given out by bank may lead
to inability of debtors to pay back
their loans timely.
lending and cautiousness leading to
lower credit creation resulting in
lower revenues for the bank.
Giving out
loans.
Banks will charge higher interest
rates if risk of default increases,
which will make it expensive to
borrow, ultimately hampering credit
capacity of the bank and their
revenues.

Credit
Events like recession or inflation
mean that debtors will spend
Defaults Rising NPAs in a bank can reduce
more than their basic needs, customer confidence and trust
reducing their ability to have leading to withdrawals and lower
enough cash to pay back loans. no of deposits; making it difficult
to raise capital due to poor
financials.

Earthquakes, Tsunamis,
hurricanes may disrupt
operations of corporates who
have taken out loans from the High no of NPAs would mean Bank
bank. would not be able to recover
interest on their loans and
consequently not be able to pay
back interests to its depositors.
Eg;- Maturity Mismatch, Interest
Fluctuation in foreign exchange Rate Mismatch
rates may lead to international
debtors to not be able to payback
their loans timely.

Controls:

1. Using interest rate derivatives: Interest rate derivatives, such as

interest rate swaps and futures, can be used to hedge against interest
rate risk. These instruments allow companies to exchange their interest
rate exposure with another party, which can help to reduce their risk.

2. Strengthening their credit risk management: Banks need to improve

their ability to assess the creditworthiness of their borrowers. This

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 includes having better systems for collecting and analyzing data, and
using more sophisticated risk models.

3. Hedging: Hedging is a technique that can be used to reduce the risk of

losses due to exchange rate fluctuations. Banks can hedge their
exposure to foreign exchange risk by using a variety of instruments,
such as forward contracts, futures contracts, and options.

4. Insurance: Banks can protect themselves from financial losses by

purchasing insurance against natural disasters. This insurance can help
to cover the costs of repairing or rebuilding damaged property, as well
as the costs of lost revenue.

Hazard 2:

THREATS CONSEQUENCES
Online
Banking
System

System
Breakdowns

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Controls:

1. Periodic review and maintenance of bank management systems.

2. Strong Cybersecurity framework

3. Train Employees on the systems and hire software providers after proper due
diligence.

4. Increasing physical security of cloud systems

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 Risk Assessment Matrix
Based on above information, 14 key risks have been defined and they are scored on
basis of Impact (how much it will affect the bank) and Likelihood (how often they
can occur). The scale for scoring is from 1-5, defined as:

Score Category
1 Very low
2 low
3 Moderate
4 High
5 Very High

Risk Score is calculated on the basis of multiplying likelihood and impact scores;

Risk Score = Likelihood * Impact.

Risk
Risk Risk Description Likelihood Impact Score
R1 Exchange Rates Fluctuations 5 3 15
R2 Natural Disasters 1 5 5
R3 Asset Liability Mismatch 3 5 15
R4 Political Instability 2 4 8
R5 Rising Non-Performing Assets 2 4 8
R6 Liquidity Crunch 3 4 12
R7 Server/Network Failure 5 4 20

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 R8 Corporate Defaults (twin b/s) 2 5 10
R9 Dealing with sanctioned banks 1 3 3
R10 Technological Disruption 4 5 20
R11 Litigation 2 3 6
R12 Economic Downturns 3 5 15
R13 Interest rate/Monetary Policy changes 5 2 10
R14 Climate Change-Lack of green financing 5 4 20

GRAPHICAL PRESENTATION:

Impact: Very Low Low Medium High Very High

Very Severe R13 Severe Critical R7,
Moderate R1 R14 Critical
High

R10
Sustainable Moderate Severe Critical Critical
Likelihood

High
Severe Critical
R6 R3,
Sustainable Moderate Moderate
R12
Medium

Moderate Critical
Sustainable Sustainable R11 Severe R4 R8
Low ,R5

Very Sustainable Severe

Sustainable Sustainable R9 Moderate R2
Low

Risk Assessment Matrix for the Banking Industry

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 Key areas of ESG compliance in the Indian
Banking Industry:
Green Products already used in the banking sector:

Go Online: Online banking includes internet banking, mobile banking, tab

banking, phone banking, RTGS and NEFT transactions etc. The functions involved
are pay bills online, online deposits, fund transfer, account statements etc. Through
these banking activities banks are ultimately consume less paper, less energy and
less expenditure on natural resources.

Card based transactions: Banks have introduced a variety of card-based

transactions by launching green channel counters (GCC). GCC promotes card-based
transactions to their customers not only to reduce the consumption of paper and
energy but also to save the time of customers. A variety of cards such as ATM, Credit
and Debit cards, green remit cards, Foreign Travel Card, eZ Pay Card, Gift Card,
Smart Payout Card etc. are available for customers.

Green Finance: Bank should finance environment friendly projects and

environment friendly products such as solar equipment, recycled furniture, vehicle
finance for low carbon emissions vehicles, home finance for green buildings etc.
with giving some concessions in processing fee and concessional rate of interest.

Green Infrastructure: Green infrastructure includes IT infrastructure (Data

Centers), green buildings with sufficient natural lightening and air, generate
electricity for their own use and waste recycling plants for recycle their own waste.
Green infrastructure may also be considered Self Service Passbook Printers, Kiosks
(Multi-Function Kiosks and Self-Service Kiosks), Cash Deposit Machines and
Contact Centre etc. It facilitates to reduce banks internal carbon footprint.

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ESG Compliance guidelines set by RBI for Indian banks:

• Sustainable Banking Framework: The Sustainable Banking Framework

was issued by the Reserve Bank of India (RBI) in 2020. The framework sets
out the RBI's expectations of banks in terms of their ESG risk management,
governance, and disclosure. The framework requires banks to:

o Identify, assess, and manage their ESG risks.

o Integrate ESG factors into their decision-making processes.

o Report on their ESG performance.

• Environmental Stress Testing: The RBI has mandated that banks conduct
environmental stress tests to assess their resilience to climate change risks.
These tests should be conducted at least once a year and should cover a range
of climate change scenarios.

• Green Banking: The RBI has encouraged banks to promote green banking
practices, such as lending to renewable energy projects and energy efficiency
initiatives. Banks can also offer green banking products and services, such as
green loans and green deposits.

• Social Banking: The RBI has encouraged banks to promote social banking
practices, such as lending to microfinance institutions and social enterprises.
Banks can also offer social banking products and services, such as social
impact bonds and social impact loans.

• Climate Change Risk Management Framework: The RBI has issued a

Climate Change Risk Management Framework for banks in 2022. The
framework provides guidance on how banks can identify, assess, and manage
their climate change risks.

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 • Sustainable Finance: The RBI has also issued guidelines on Sustainable
Finance for banks in 2022. These guidelines provide guidance on how banks
can promote sustainable finance and support the transition to a low-carbon
economy.

Key features of the Climate Change Risk Management Framework set by the
Reserve Bank of India (RBI):

• Scope: The framework applies to all banks, including scheduled commercial

banks, urban cooperative banks, and regional rural banks.

• Risk identification and assessment: Banks are required to identify and assess
their climate change risks, both physical and transition risks. This can be done
by conducting climate risk assessments, and by developing climate risk stress
tests.

• Mitigation and adaptation: Banks are required to develop mitigation and

adaptation strategies to address their climate change risks. This can be done
by investing in renewable energy, energy efficiency, and climate-resilient
infrastructure.

• Reporting: Banks are required to report on their climate change risk

management practices. This can be done by publishing an annual climate risk
report, or by disclosing climate risk information in their financial statements.

• Governance: Banks are required to establish a climate change risk

management committee to oversee their climate change risk management
practices.

• Training: Banks are required to train their staff on climate change risk
management.

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key features of the Sustainable Finance Guidelines set by the Reserve Bank of
India (RBI):

• Identification and assessment of ESG risks: Banks are required to identify and
assess their ESG risks, such as their exposure to climate change and other
environmental challenges. This can be done by conducting environmental and
social impact assessments, and by developing climate risk stress tests.

• Integrating ESG factors into decision-making: Banks are encouraged to

integrate ESG factors into their decision-making processes, such as when
lending money or investing in projects. This can be done by considering the
environmental and social impact of their lending decisions, and by supporting
sustainable businesses and projects.

• Reporting on ESG performance: Banks are required to report on their ESG

performance, such as the amount of money they have lent to sustainable
projects. This can be done by publishing an annual ESG report, or by
disclosing ESG information in their financial statements.

• Promoting green banking: Banks are encouraged to promote green banking

practices, such as lending to renewable energy projects and energy efficiency
initiatives. This can be done by developing green banking products and
services, and by providing training to their staff on green banking.

• Supporting the transition to a low-carbon economy: Banks are encouraged to

support the transition to a low-carbon economy by financing sustainable
projects and by developing green products and services.

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