6may risk management

8/12/2019 6may Risk Management

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RISK MANAGEMENT

MODULE B

A PRESENTATION

BY

K.ESWAR

ASST GENERAL MANAGER

CENTRAL BANK OF INDIA.


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RISK MANAGEMENT

RISK IN BANKING BUSINESS ?

WHAT IS RISK ?

RISK , CAPITAL AND RETURN.


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VALUATION OF SECURITIES.

VALUATION OF INVESTMENT PORTOLIOOF BANKS WILL BE

CLASIFIED AS UNDER :

HTM: VALUALTION METHOD: Investments classified under

HTM category need not be marked to market and will be

carried at acquisition cost unless it more than the face value.

In such case the premium is amortized over a period of

remaining maturity. .


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VALUATION OF SECURITIES

AFS : VALUATION METHOD : Individual scrip will be

marked to market at the quarter end . The net

depreciation under each classification should be

recognized and fully provided for and any appreciation

should be ignored. The book value of securities would not

undergo any change after the revaluation.

HTM. VALUATION METHOD : The individual scrips in the

HTM category will be revalued at monthly interval andnet appreciation or deprecation under each classification

will be recognized in income account. The book value of

the individual scrip will be changed with revaluation.


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Liquidity Risk.

Q Funding risk is :

A. Un anticipated withdrawal/non renewal of deposit.

B. Unable to provide funds to Head office of Bank.

C. Inadequate funds.

Q. The liquidity risk arising out of non receipt of expected in flow of funds due to accounts turning as NPA isknown as

a.Time Risk. b. Call Risk.

c. Operational Risk.

d. Funding risk.

Q. The liquidity risk arising out of crystallization of liabilities and conversion of non fund based limits to fundbased limits is known as :

a. Call risk.

b. Time risk. c. Operational risk.

d. Market risk.


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Interest Rate Risk.

Gap or Mismatch risk.

Yield curve risk. Basis Risk.

Embedded option risk.


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Market Risk

Forex Risk.

Equity price risk.

Interest rate risk. Mark to Market.

CREDIT RISK:

Counter Party risk.OPERATION RISK.


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MANAGEMENT OF RISK

RISK IDENTIFICATION.:

RISK MEASURMENT. Sensitivity, Volatility, Var.

RISK PRICING. RISK MONITORING.

RISK MITIGATION.


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Risk Regulations in Banking Industry.


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What is the Basel Committee?

Established at the end of 1974 by Central Bank Governors ofG10 to address cross-border banking issues

Reports to G10 Governors/Heads of SupervisionMembers are senior bank supervisors from G10, Luxembourgand Spain

Work undertaken through several working groups


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Outreach to other countries

Committee started as a closed shop

Over time, has developed close ties with non-members

Committee tries to address issues relevant for alljurisdictions worldwide

Core Principles Liaison Group (16 non-Committeejurisdictionsincluding Indiaplus IMF, World Bank)

Working Group on CapitalRegional groups

International Conference of Banking Supervisors (ICBS)

Participation in work of the Secretariat

Training, speeches, consultation


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The three Cs

Concordat (and subsequent papers dealing with cross-bordersupervision)

Core Principles for Effective Banking Supervision

Capital Adequacy Framework

Many other topics: risk management, corporate governance,accounting, money laundering, etc, on the Committees website(www.bis.org/bcbs)


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From Basel I to Basel II

1988 Capital Accord established minimum capital requirementsfor banks

In 1998, Committee started revising the 1988 Accord:

More risk sensitiveMore consistent with current best practice in banks riskmanagement

Numerator (definition of capital) remains unchanged

CapitalRisk weighted assets

8 %Minimum ratio:


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What are the basic aims of Basel II?

To deliver a prudent amount of capitalin relation to risk

To provide the right incentives for sound r isk management

To maintain a reasonable level playing field

Basel II is notintended to be neutral between differentbanks/different exposures


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Three pillars of the Basel II framework

Credit risk

Operational risk

Market risk

Banks own capital

strategy

Supervisors review

Enhanced disclosure

Minimum Capital

Requirements

Supervisory

Review ProcessMarket Discipline


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Market

Credit

Operational

BANKS TYPICALLY FACE THREE KINDS OF

RISK

Risk of loss due tounexpected re-pricing ofassets owned by the bank,caused by either

Exchange ratefluctuation

Interest ratefluctuations

Market price ofinvestment fluctuations

Risk of loss due tounexpected borrower default

Risk of loss due to a suddenreduction in operationalmargins, caused by eitherinternal or external factors

Daily pricechange (%)

Unexpectedprice volatility

Time

Time

Defaultrate (%)

UnexpecteddefaultAvg. default

Time

Monthly change

of revenue to cost(%)

Unexpectedlow costutilization

Example

Stocks

Loans with credit rating 3

Business unit A

Type of Risk

OUR

FOCUS

TODAY


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The three pillarsAll three pillars togetherare intended to achieve a level

of capital commensurate with a banks overall riskprofile


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Pillar I Credit Risk

Standardized

Approach

Foundation Internal

Ratings

Based Approach

Advanced

Internal

Ratings Based

Approach

Risk weights are based onassessment by external creditassessment inst i tu t ions

Banks use internal est imat ions ofprob abil i ty of d efault (PD) to calcu late riskweight s for exposu re classes. Other riskcom pon ents are standardized.

Banks u se internal est imat ions ofPD, loss giv en default (LGD) andexposure at default (EAD) tocalculate r isk w eights for expos ureclasses

Pillar 1 Credit Risk stipulates three levels of increasing sophistication. The more

sophisticated approaches allow a bank to use its internal models to calculate its

regulatory capital. Banks who move up the ladder are rewarded by a reduced capital

charge

Reduce Capital requirements


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Advantages of capital

Provides safety and soundness

Depositor protection

Limits leveraging

Cushion against unexpected losses

Brings in discipline in risk taking


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The Current Capital Accord

Focused on credit risk but formula based

Partially amended in 1996 to includemarket risk

Operational risk not addressed

Simple in its application

Produced an easily comparable and

verifiable measure of bankssoundness


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Need for a new frame-work

Financial innovation and growing complexity of

transactions

Categorized banks assets into one of only four

categories each representing a risk class

Made no allowance for the effect portfolio diversification

Requirement of more flexible approaches as opposed to

onesize fits allApproach

Requirement of Risk sensitivity as opposed to a broad-

brush Approach Operational Risk not covered

B l A d I & II


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Basle Accord I & II -

Differences

Talks of Credit Risk only

Capital Charge for Credit

Risk Does not mention

separate Capital charge

for Market and

Operational Risk

No mention about market

Discipline

No effort to quantify

Market and Operational

Risk

Talks of Credit, Marketand Operational Risks

Capital Charge

dependant on Risk rating

of assets Capital Charge to include

risks arising out of Credit,

Market and Operational

risks. Not a broad brushapproach

Quantitative approach for

calculation of Market and

Operational risks as forCredit Risk.


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Pillar I Minimum Capital

Requirements

The new Accord maintains the current definition of total capital and the minimum 8%requirement*

Total capital = Tier 1 + Tier 2

Tier 1: Shareholders equity + disclosed reserves

Tier 2: Supplementary capital (e.g. undisclosed reserves, provisions)

Total Capital

Market Risk The risk of losses in trading positions when prices move adversely

Credit Risk The risk of loss arising from default by a creditor or counterparty

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

Total capital

Credit risk + Market risk + Operational risk= Banks capital ratio

(minimum 9%)

* The revisions affect the denominator of the capital ratio - with more sophisticated measures for credit risk, and introducing an explicit capital charge foroperational risk


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Framework


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Internal Ratings Based Approach

Exposures in five categories because of

different risk characteristics

Sovereigns

Banks

Corporates

Retail NPA


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Internal Ratings Based Approach

Internal ratings based (IRB) approach

Foundation

Advanced

Goal: Should contain incentives for migration from standardized

to IRB approach

.


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IRB approach

Risk componentsPD, LGD, EAD,

Differentiation between IRB Advanced &Foundation


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Advanced approaches

Requires supervisorsapproval

Increased emphasis on banksinternal assessments

Banks to meet certain standards

Capital Management Policy Committee Process to review the quality of risk management &

control systems

Appropriateness of the capital level and composition to

the nature and scale of banksactivities


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General Market charge

Captures risk of loss arising from general changes in market

interest rates / other market variables

Two Approaches

Standardized Duration approach.

Internal risk management models

RBI adopted Standardized approach


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Market RiskInternal Models

BIS requirement:

1. VaR to be calculated daily

2. Confidence level of 99%

3. Holding period 10 days

4. Historical data for at least one year to be taken andupdated at least once in a quarter


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Operational Risk

Explicit charge on capital

Basic Indicator approach15% of grossincome

Gross income = net interest income plus net

non interest income


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GROSS INCOME

GROSS INCOME = NET PFORIT+

PROVISIONS+OPERATING EXPENSES-PROFIT

ON SALE OF INVSTEMENT-INCOME FROM

INSURANCE-EXTRA ORDINARY ITEM OFINCOME+ LOSS ON SALE OF INVESTMENT


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Operational Risk

Standardised Approach- Capital charge is calculated as a simple summation

of capital charges across 8 business lines

Business lines % of gross income

Corporate finance 18

Trading & sales 18

Retail Banking 12

Commercial Banking 15

Payment & Settlement 18Agency Services 15

Asset Management 12

Retail Brokerage 12


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Pillar II- Supervisory ReviewPrinciples:

Banks should have

(a) process for assessing their Capital adequacyin relation to their Risk Profile and a strategy formaintaining their capital levels

(b) Supervisors should review these and takeaction if they are not satisfied


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Pillar II Principles:

(c) Supervisors should expect banks to operate

above the minimum CAR and should have theability to require banks to hold capital in excess of

the minimum

(d) Supervisors should intervene at an early stage

to prevent capital from falling below required level

and initiate rapid remedial action


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Pillar II

Risk Based Supervision

Business risk and control risk

Prompt Corrective Action CRAR

Net NPAs

ROA Structured and discretionary actions


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Pillar III Sets out disclosure requirements and

recommendations (core and supplementary)

Required disclosures on capital, risk exposures,risk assessment (credit risk, market risk,Operational risk etc) and hence the capitaladequacy.

Allows market participants to assess keyinformation about a banks risk profile and levelof capitalisation


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MARKET DISCIPLINE

a. Third Pillar to supplement first two pillars namelyminimum capital requirement and supervisory review.

b. The aim of this pillar is o encourage market discipline bydeveloping a set of disclosure requirements which allowsmarket participants to assess :

Scope of application

Capital

Risk Exposures

Risk assessment processes

Ultimately Capital Adequacy


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e. Interaction with accounting disclosures :

Disclosure framework not to conflict with requirementsunder accounting standards.

f. Scope and frequency of disclosures

All banks should provide Pillar-III disclosures bothqualitative and quantitative as on March end each yearalong with annual financial statements.

Banks with capital funds of more than Rs.500 crores andtheir significant subsidiaries must disclosure on quarterlybasis.

- Tier1 Capital

- Total Capital- Total required capital

- Total Capital adequacy ratios


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g. Validation :

No need of audit of disclosures as they are either consistent

with audited financial statements or gone through

internal assessment/control procedures and systems.

h. Materially

Information is regarded as material if its omission or

misstatement could change or influence the assessment ordecision of a user relying on that information for the

purpose of making economic decision.

- RBI will prescribe certain materiality threshold for

certain limited disclosures to provide greatercomparability among banks.


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i. Proprietory and Confidential Information

Proprietory InformationOn products or

Systems

Confidential InformationOn customers

RBI has prescribed in the form of various tables(1-11), a system of disclosures striking a balance

between the need for meaningful disclosures and

protection of proprietory and confidential

information.


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j. General Disclosure Principle

Each bank to have formal disclosure policy

approved by Board.

Approach for disclosures

Internal control over disclosure process

Process to assess appropriateness of its

disclosures including validation and frequency

k. Scope of application

Parent bank need not make disclosures of

individual banks/entities except disclosure of Tier-Iand total capital of each subsidiary bank.

All Units to make Pillar-III disclosures.


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Scope and frequency of disclosures

Annual disclosuresqualitative & quantitative

Interim disclosures for banks with capital >100 crore

Quantitative aspects in websites Quarterly disclosures for banks with capital >

500 crore

Tier I capital, Total capital, CRAR and Totalrequired capital (including subsidiaries)

Banks to have formal disclosure policy


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New Capital instruments

Innovative Perpetual Debt Instruments eligiblefor inclusion as Tier 1 capital

Debt capital instruments eligible for inclusion as

Upper Tier 2 capital

Perpetual non-cumulative Preference shareseligible for inclusion as Tier 1 capital

Redeemable cumulative Preference shareseligible for inclusion as Tier 2 capital


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Innovative Perpetual Debt

Instruments for inclusion as Tier 1 capital

Amount to be raised may be decided by the Board of Directors ofbanks

Limited to 15 per cent of total Tier 1 capital

Excess of the above limits shall be eligible for inclusion under Tier 2

Interest at a fixed rate or at a floating rate referenced to a marketdetermined rupee interest benchmark rate

Step-up option after 10 years - not more than 100 bps.

Superior to the claims of investors in equity shares and Subordinatedto the claims of all other creditors


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One year transition matrix

19.7964.8611.242.381.300.2200C

5.204.0783.466.480.430.240.010C+

1.061.008.8480.537.730.670.140.03B

0.180.121.175.3086.935.950.330.02B+0.060.010.260.745.5291.052.270.09A

00.020.140.060.647.7990.650.70A+

00000.180.688.3390.81A++

DefaultCC+BB+AA+A++Initial

Rating


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Thank You!

6may risk management

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