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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