group6 marketriskprsn final

8/13/2019 Group6 MarketRiskPrsn Final

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N I S H A R A G H U V A N S H I ( 0 6 )

V A S I S T A M ( 1 8 )

R U P A L I S H I R O L E ( 3 0 )

S I D D H A R T H B I J O O R ( 4 2 )

S R I S H T I M I T T A L ( 5 4 )

CAPITAL CHARGE FOR

MARKET RISK1


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INTRODUCTION2

MARKET RISK

It is the risk of the banks losses due to unfavorable changes inthe market value of financial instruments in the tradingportfolio or financial derivatives of the credit institution, as

well as foreign currency and/or precious metals exchangerates.

CAPITAL CHARGE It is the estimate of capital requirement to cover the risk.


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CAPITAL CHARGE FOR MARKET RISK3

The market risk positions subject to capital chargerequirement are:

The risks pertaining to interest rate related instruments andequities in the trading book; and

Foreign exchange risk (including open position in preciousmetals) throughout the bank (both banking and tradingbooks).


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Scope and coverage of capital charge for MarketRisks

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Trading book for the purpose of capital adequacy willinclude:

Securities included under the Held for Trading category

Securities included under the Available for Sale category Open gold position limits

Open foreign exchange position limits

The open position in a currency is the sum of (a) the net spotposition, (b) the net forward position and (c) the net optionsposition.

Trading positions in derivatives, and

Derivatives entered into for hedging trading book exposures.


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POSITION OF BANK5

S.No Details Amount Rs.Crore

1Cash & Balances with RBI 200.002Bank balances 200.00

3Investments:Held for Trading 500.00

Available for Sale 1,000.00

Held to Maturity 500.00

Equities 300.00

4Advances (net) 2,000.005Other Assets 300.006Total Assets 5,000.00


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COMPONENTS OF MARKET RISK

Generalmarket risk

Specificmarket risk

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GENERAL MARKET RISK

Interest Rate Risk

Foreign Exchange Rates

Currency Valuation

Equity Prices Commodity Prices

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SPECIFIC MARKET RISK

Default risk

Credit Migration risk

Credit Spread Risk

Incremental risk

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MEASUREMENT OF CAPITAL CHARGE FORINTEREST RATE RISK

Capital charge for specific risk:

Standardized capital charge given by RBI guidelines which

depends upon:1. Issuer

2. Type of Security

3. Remaining maturity of Security

It is 0% for central and state government securities and100% for securities rated B and below or those securitieswhich are unrated.

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GENERAL MARKET RISK10

Capital Charge for General Market Risk:

Computed under Standardized Duration Method using theformula given below:

Capital Charge for General Market Risk =

Modified Duration x Market Value of Security x AssumedChange in Yield


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EQUITY RISK12

Equity risk is the risk that one's investments willdepreciate because of stock market dynamics causingone to lose money.

The measure of risk used in the equity markets istypically the standard deviation of a security's priceover a number of periods.

The standard deviation will describe the normal

fluctuations one can expect in that particular securityabove and below the mean, or average.


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MEASUREMENT OF CAPITAL CHARGE FOREQUITY RISK

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The capital charge for equities would apply on their currentmarket value in banks trading book.

Capital charge for banks capital market investments,including those exempted from CME norms, for specific risk

will be 11.25 per cent or higher and specific risk is computedon banks gross equity positions.

The general market risk charge will be 9 per cent on the grossequity positions.

Specific Risk Capital Charge for banks investment in Security

Receipts will be 13.5 per cent (equivalent to 150 per cent riskweight). Since the Security Receipts are by and large illiquidand not traded in the secondary market, there will be noGeneral Market Risk Capital Charge on them.


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Measurement of Capital Charge for ForeignExchange Risk

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The open position must first be measured separatelyfor each foreign currency. The open position in acurrency is the sum of

The net spot position

The net forward position and

The net options position.


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Net Spot Position- The net spot position is the difference betweenforeign currency assets and the liabilities in the balance sheet. This shouldinclude all accrued income/expenses.

Net Forward Positionrepresents the net of all amounts to be receivedless all amounts to be paid in the future as a result of foreign exchange

transactions which have been concluded. These transactions which arerecorded as off-balance sheet items in the bank's books would include:

spot transactions which are not yet settled; forward transactions; guarantees and similar commitments denominated in foreign currencies

which are certain to be called; net of amounts to be received/paid in respect of currency futures, and the

principal on currency futures/swaps.

Options Position- The net delta-based equivalent of the total book offoreign currency options

CONTD


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Calculation of the Overall Net Open Position

This involves measurement of risks inherent in a bank's mix of longand short position in different currencies. It has been decided toadopt the 'shorthand method' which is accepted internationally forarriving at the overall net open position. Banks may, therefore,calculate the overall net open position as follows:

I. Calculate the net open position in each currency.II. Convert the net position into rupees at the FEDAI indicative spot rates for the

day.III. Arrive at the sum of all the net short positions.IV. Arrive at the sum of all the net long positions.

Overall net foreign exchange position is the higher of (iii) and (iv).The overall net foreign exchange position arrived at as above must

be kept within the limit approved by Reserve Bank.

CONTD


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MEASUREMENTOFCAPITALCHARGEAs seen above capital charges for specific risk and general market risk

are to be computed separately before aggregation.

For computing the total capital charge for market risks, the calculations

may be plotted in the following table:

Risk Category Capital Charge

I. Interest Rate (a+b)

a. Specific Risk

b. General market risk

II. Equity

III. Foreign Exchange & Gold

IV. Total capital charge for market risks (I+II+III)

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Sr. No. Details Amount (cr.)

1 Cash and bank balances with RBI 200

2 Bank balances 200

3 Investments:

Government Securities (HFT & AFS) 700

Bank Bonds (HFT & AFS) 500

Other Securities (AFS & HFT) 300

Securities and Bonds (HTM) 500

Equities 300

4 Advances (net) 2000

5 Other Assets 300

6 Total assets 5000

A bank may have the following position:

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As, in case of measurement of capital charge for market risk, only trading book

is considered and not the banking book, thus securities which are held to

maturity have been ignored along with advances and other assets (these are

considered in case of credit risk)

Sr. No. Details Amount (cr.)

1 Cash and bank balances with RBI 200

2 Bank balances 200

3 Investments:Government Securities (HFT & AFS) 700

Bank Bonds (HFT & AFS) 500

Other Securities (HFT & AFS) 300

Equities 3004 Total assets 5000

In Addition,

Foreign exchange open position is assumed to be Rs. 60 crore

Gold open position is assumed to be Rs. 40 crore


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Calculation of Capital Charge of Specific Risk

Interest Rate related

Securities

Trading

Book Value

Book

Value

Total

Value

Capital

Charge

Capital

Charge in

Rs.

Govt. Securities 700 300 1000 0% 0

Bank Bonds 500 0 500 1.07% 5.325

Other Securities 300 0 300 9.00% 27

Total 32.325

Capital charge for specific risk for equities is 9%. Thus, specific risk capital

charge on equities would work out to be = 9% of 300 = 27 cr.

Thus, Total capital charge on specific risk = 32.325 + 27= 59.325 cr.

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Calculation of Capital Charge of General Risk

Counter Party

Maturity

Date

Amount

market value

Coupon

(%)

Capital Charge for general

market risk

Government 01-03-2004 100 12.50 0.84

Government 01-05-2003 100 12.00 0.08

Government 31-05-2003 100 12.00 0.16

Government 01-03-2015 100 12.50 3.63

Government 01-03-2010 100 11.50 2.79

Government 01-03-2009 100 11.00 2.75

Government 01-03-2005 100 10.50 1.35

Bank Bonds 01-03-2004 100 12.50 0.84

Bank Bonds 01-03-2005 100 12.00 0.08Bank Bonds 01-03-2004 100 12.00 0.16

Bank Bonds 01-05-2003 100 12.50 1.77

Bank Bonds 31-05-2003 100 11.50 2.29

Other Securities 01-03-2006 100 12.50 0.84

Other Securities 01-03-2007 100 12.00 0.08

Other Securities 01-03-2004 100 12.00 0.16Total 1500 17.82

Capital charge for general risk for equities is 9%. Thus, general risk capital chargeon equities would work out to be = 9% of 300 = 27 cr.Thus, Total capital charge on general risk = 17.82 + 27

= 44.82 cr.


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Capital charge on foreign / gold position would be computed at 9%. Thus the

same works out to be = 9% * (60+40)

= 9 cr.

Thus, capital charge for market risk in this example is calculated as follows:

Risk Category Capital Charges (Rs.)

I. Interest Rate Risk (a+b) 50.145

a. Specific Risk 32.325

b.General Market Risk 17.82

II. Equity (a+b) 54

a. Specific Risk 27

b. General Market Risk 27

III. Foreign Exchange & Gold 9

Total Capital Charge for Market Risk (I+II+III) 113.145


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Models - Capital Charge for Market Risk

Basel II Framework offers a choice between two broad methodologies inmeasuring market risks for the purpose of capital adequacy.

1. Standardised Measurement Method (SMM)

2. Internal Models Approach (IMA)

Banks have been using Standardized Measurement Method

(SMM) since March 31, 2005 forboth held-For-Trading (HFT) and

Available for Sale (AFS) portfolios.

Under the standardised method there are two principal methods of measuringmarket risk :-

maturity method

duration method

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Capital Charge for Market Risk: StandardizedMaturity Method

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Standardised Maturity method

Positions weighted by prescribed price sensitivity factor

Partial offset (10% capital charge) for weighted longs and shorts in each

time band

Two rounds of horizontal partial offsetting between time bandspursuant to prescribed scale


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Capital Charge for Market Risk: StandardizedDuration Method

Under standardised Duration method banks are required to measurethe general market risk charge by calculating the price sensitivity(modified duration) of each position separately.

Under this method, the mechanics are as follows:

first calculate the price sensitivity (modified duration) of each instrument apply the assumed change in yield to the modified duration of each

instrument between 0.6 and 1.0 percentage points depending on thematurity of the instrument

slot the resulting capital charge measures into a maturity ladder with thefifteen time bands

subject long and short in each time band to a 5 per cent vertical disallowancedesigned to capture basis risk

carry forward the net positions in each time-band for horizontal offsettingsubject to the disallowances set out in

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Capital Charge for Market Risk: InternalModels Approach

This approach allows banks to use risk measures derived from theirown internal market risk management models

The permissible models under IMA calculates a value-at-risk (VaR) -

based measure of exposure to market risk This model can be used to measure both General Market Risk and

Specific Risk

Banks interested in migrating to IMA for computing capital charge for

market risk are advised to assess their preparedness with referenceto these Guidelines :-

1. give Reserve Bank of India a notice of intention for the same

2. RBI will first make a detailed assessment of the banks riskmanagement system and its modelling process.

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Comparison between SMM and IMA

IMA is more risk sensitive than SMM

Positions held in the AFS are more illiquid and market prices forthem may not be available. So, it would not be feasible to

compute meaningful VaR measures for AFS portfolios. The AFSportfolio should continue to be under SMM for computation ofcapital charge for market risk.

IMA Aligns the capital charge for market risk more closely to theactual losses than SMM

SourceRBI Guidelines on Implementation ofInternal Models Approach for Market Risk7thApril 2010

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group6 marketriskprsn final

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