Prof.

NeelamTandon

Various Risks Associated With Banking System

Solvency Risk: Risk of total financial failure of a bank due to its chronic inability to meet obligations. Liquidity Risk: Risk arising out of a banks inability to meet the repayment requirements. Credit Risk: Risk of loss to the bank as a result of a default by an obligator.

Cont-- Interest Rate Risk: Vulnerability of net interest income , or the present values of a portfolio, to changes in interest rates. Price Risks: Risk of loss/gain in the value of assets , liabilities or derivative due to market price changes, notably volatility in exchange rate and share price movements Operating Risks: Risks arising from out of failures in operations, supporting system and human error.

The risk of direct or indirect loss resulting from inadequate or failed internal processes, people and systems or from external events=Operational risk

Technology Risk

Regulatory Financial Compliance Risk Control Risk

Social, Ethical and Environmental Risk

Product and Sales Risk

Service Delivery (Operations) Risk

Legal Risk

People Risk

Risk Management Philosophy

It is more than compliance it is about building value by optimizing, rather than minimizing risks

Risk creates opportunity

Opportunity creates value

Value creates shareholder wealth

Risk management is not about avoiding risk. It helps you be aware of the risks inherent in your business and take advantage of this knowledge to gain competitive advantage and enhance shareholder value

TYPES OF RISKS THAT BANK FACES IN PRESENT SCENARIO

OPERATIONAL RISK 1) INTERNAL PROCESS 2) PEOPLE 3)CORPORATE 3) EXTERNAL FACTORS 3) EQUITIES CREDIT RISK 1) RETAIL 2) PROJECT FINANCING MARKET RISK INFORMATION RISK 1) SYSTEM RISK 2) SECURITY & INTEGRETY RISK

1) INTEREST RATE
2)FOREIGN EXCHANGE

4) EQUITY
4) COMMODITIES

Operational Risk Management What it entails?

Risk Factor Identification Risk Assessment /Measurement Risk Monitoring & Control Risk & Performance Measurement

Develop a common definition of and classification scheme for Operational Risk Document Processes & Responsibilities

Self Assessment Loss Event Data Collection Key Risk Drivers Identification

Key Performance Metrics Operational Risk Economic Capital

Basel An Introduction
Basel Committee on Banking Supervision Established by Central Banks of G-10 countries in 1974. Today, it comprises of Central Banks and Supervisory Regulators from 13 countries.

What is Basel ?

It has no super-national supervisory or legislative powers.

Basel Capital Accord

Evolution of Basel Accord

Issued in 1988, it established minimum ratio of required capital to risk-weighted assets. Initially, risk weights assigned only for Credit Risk, based on simplistic categorization of assets and obligors. Accord amended in 1996 to include risk weights assigned for Market Risk.

Basel An Introduction (contd)

Basel II Framework is intended to ensure that banks have

adequate capital to support all the risks

Objective

To encourage banks to develop and use better risk management techniques in monitoring and managing their risks

Indian Position Reserve Bank of India has formed steering committees involving various bankers to finalize on approaches to be used by Banks operating in India. Draft guidelines on Basel II framework issued by RBI in February 2005 for public response. Likely implementation by March 2007 with parallel run for one year pre-implementation . At present implemented by all
commercial banks in India.

Indian Position

Approach to Basel II Transformation

A Journey of Seven Steps

Approach to Basel II Compliance: Seven Steps
Organization, Policies And Processes Redesign

Basel II Program Initiation

Gap Analysis

Implementation Roadmap

Data Management & IT Applications

Supervisory Certification, Parallel Run and Go Live

AnalyticsModels, Methodologies and Validation

Phase I: Gap Analysis

Phase II: Implementation Roadmap

Phase III: Implementation

Phase IV: Compliance And Certification

Key Basel II Drivers

External
Credit Rating
Corporate Governance Mandated Requirements

Internal
Risk Sensitive Pricing
Improved Risk Management Capital Management

Increased Disclosures
Competitive parity

Increased Profitability
Competitive Advantage Best Practice Centralization

Basel II the three pillars Mutually reinforcing

Basel II
Three Pillars

Minimum Capital Requirements

Supervisory Review

Market Discipline

Providing a flexible, risk-sensitive capital management framework

Three Pillars of Basel II

Supervisory Review

Minimum Capital

Market Discipline

Focus on internal capabilities Supervisors to review banks Capital charge internal for operational assessment risk and strategies Advanced methods for capital allocation

The new Basel Accord is based on Three Pillars

Focus on disclosure

TOOLS FOR MANAGING INFORMATION RISK ..

1) ADOPTING NETWORKING SECURITY PROTECTION SOFTWARES SUCH AS: FIREWALL ETC 2) GIVING RESTRICTED ACCESS TO THE EMPLOYEES AS WELL AS CUSTOMERS OF THE BANK 3) UPDATING THE SYSTEM WITH LATEST ANTI VIRUS SOFTWARES AND LATEST VERSIONS OF SECURITY PROITECTION SOFTWARE 4) DEVELOPING A MONITORING SYSTEM WHEREBY EACH AND EVERY TRANSACTION DONE IN THE SYSTEM COULD BE MONITERED

Benefits of Effective risk management

Strategic Advantage

Shareholder Value Objective

Maximize Earnings Potential

Measuring risk adjusted business performance Linking Risk and Return

Allocating Capital

Evaluating Value creating business

Earnings Stability

Protection Against Unforeseen Losses

Control

Consistent Measurement Across Risks

Identification of Risks

Most organizations

Risk Management Sophistication

Banks Make Money By Taking Risk

By playing term of funds: Long v/s short. By playing risk levels- accept lower risk and place in higher risk- play safety as a market mantra Dispersed source v/s concentrated use. Trading in the market

Essentially by taking risk

Generic and Unique risks

Industry Unit/firm/company related Location specific Ownership related Sector specific HRD/Structure related

Sources of Risk
Decision ,Indecision Business cycles/ Seasonality Economic/Fiscal changes Policy Changes Market movements Events Political compulsions Regulations Human resources, skill sets Competition Technology Non-availability of information

Goals of risk Management

Safety and soundness of banks. Ensuring a level playing field. Capital Adequacy Ratio (1) own funds (i.e. available capital and reserves) (2) risk-weighted assets (i.e. the amount of money the bank has put at risk in the course of its business)
A level playing field !!

Source: BIS

How to manage risk

Hedging Exposure limits Reserves and Provisioning

Basle II. Minimum Capital Requirements-Pillar 1

Sets minimum acceptable capital Capital arrived by enhanced approach with credit ratings
External or Public rating Internal rating

Explicit treatment to operational risk

Supervisory Review _ Four Principles- Pillar 2

Banks must attain solvency relative to their risk profile Supervisors should review each banks own risk assessment & capital strategies Banks should maintain excess of minimum capital Regulators would intervene at an early stage Possibility of rewarding banks with better risk management systems. RBI has already taken steps to conduct supervisory review

Market Discipline- Pillar 3

Improved disclosure of Capital structure Risk measurement and management practices Risk profile Capital adequacy

Computation of Capital
Standardized No change over 1988

Market Risk

Foundation No change over 1988 in VaR

Advanced No change over 1988 in VaR

Computation of Capital
Standardized Capital change based on single risk indicator
Operational Risk Foundation Capital based on business lines and industry standards

Advanced Capital based on business lines and internally calculated standards

Decision areas for Banks

Choice of methodology and convincing the regulators IT supports needed Software requirements Staff training on compliance Consultancy requirements Risk mitigation opportunities Outsourcing possibilities New jobs creation Implementation cost and time

Risk Management a data intensive function

Credit Risk
Banks

Market Risk

Operational Risk

Transaction Data

Operational CRM Data

Analytical CRM Data

Risk Management Data

Economy & Industry Data

Borrower Data Guarantor Data Asset-specific Data Default Data Data on Recoveries External Default Data Data on Rating and Migration Macro & Industry Data Correlation Data

Data on Exchange Rates Data on Interest Rates Data on Security Prices Data on Correlations Data on Instruments (non-linear)

Loss Event Data Causal Data Loss Effect Key Risk Indicators (KRIs) Proxies Risk Inventories Structured Self Assessment Data External Data

Basle Accord and IT

Basle II promises significant business benefits to those who have systems in place to access and utilize far more detailed and precise information Integration of data on finance, operations and risk management necessary Opportunity to get out of legacy systems and procedures including IT system Fundamental rethinking on how a banks data and information is provided and controlled Pillars are interdependent and must be addressed to concurrently

Basle Accord and IT

Internal Rating based approaches revolve around Probability of default Loss given default Exposure at default Other parameters Main requirements would include Defining and capturing loss data Capturing and extracting exposure data Identifying and capturing risk mitigation data Data issues would be Sources/ Data types/ Quality requirements and Granularity (level of data)

Basle Accord and IT

Operational Risk Management pre-supposes Framework and systems in data integration Low frequency-high severity occurrences Structure for risk management and interaction amongst functionaries Potential for mitigation, outsourcing and alike issues Shared facilities feasibility More synergy and little overlap

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