risk management presentation on credit risk and market risk by s.d.bargir, joint director, iibf
TRANSCRIPT
Risk may be defined as “ exposure to uncertainty”
favourable or unfavourable outcomes
aims at mitigating the loss managing risk rather than on
eliminating it
Risk management is a four steps process
Identifying Measuring ( quantifying)Managing controlling, monitoring and
reviewing
Credit Risk
credit risk means default of the borrower or deterioration of borrowers’ credit quality.
Market Risk
arising from movement in market prices
Interest Rate Risk, Exchange Rate Risk, Commodities Price risk Equity Price Risk.
Operational Risk
loss resulting from inadequate or failed
internal processes People systems or external events.
Credit Riskdefaults take various forms
Direct Lending:Loan amount (Principal as well as interest) will not be paid
Guarantees/ Letter of Credit etc.Funds will not be forthcoming upon crystallization of liability
Credit Riskdefaults take various forms Treasury Products payment due
from the counter parties either stops or not forthcoming
Securities Trading Settlement will not be effected
Cross boarder exposure: free transfer of currency is restricted or comes to an end.
Default risk is the probability of an event of default depends upon credit standing of the
counter party. default probability cannot be measured
directly. guidance from historical statistics on large
sample over long period of time. bank faces difficulty in obtaining accurate
historical data.
Exposure risk uncertainty associated with future
amounts credit lines- repayment schedule-
exposure risk small other lines of credit -OD, project
financing , guarantees etc- risk cannot be predicted accurately
Recovery risk:
recoveries in the event of default not predictable
depend upon type of default availability of collaterals, third party
guarantees circumstances surrounding the
default.
Expected Losses & Unexpected Losses EL depends upon default
probability(PD), Loss given default (LGD)& exposure at risk (EAD)
EL = PD x LGD x EAD Unexpected losses (UL) is the
uncertainty around EL and it is Standard deviation of EL.
challenges faced by banks in r/o EL
aggregation of the risk-related information to assess the PD, LGD and EAD
implementation of a risk rating system that can correctly model these parameters which is statistically valid.
BASEL
Basel Committee on Banking supervision (BCBS) under the auspices of Bank for International Settlements (BIS)
Established in 1975 by group of 10 countries
Belgium, Canada, France, Germany, Italy, Japan, Luxembourg, the Netherlands, Spain, Sweden, Switzerland, the United Kingdom and the United States.
Basel II-Implementation in India
with effect from March, 31, 2007 by commercial banks.
90 commercial Banks in India 100 countries
Basel II capital requirements more risk sensitive directly related to the credit rating of
each counter-party instead of counter-party category
capital for credit and market risk but also for operational risk (OR)
where warranted for interest rate risks, credit concentration risks, liquidity risks
SME sector
BASEL II RESTS ON THE THREE PILLARS, Pillar I Minimum Capital
Requirements Pillar 2 Supervisory Review Process Pillar 3 Market Discipline
each pillar is as important as the other one
Pillar 1 – Minimum Capital Requirements
menu of approaches for computing capital adequacy
freedom to choose the approach minimum, the Standardized Approach for
credit risk Basic Indicator Approach for operational
risk standardised Approach or Internal Risk
Measurement Models approach for market risk
Various ApproachesCredit Risk Market Risk Operational
Risk
Standardized Approach(SA)
Standardized Approach(SA)
Basic Indicator Approach
Basic-Internal Risk Based(IRB)
Internal Risk
Measurement Model
Standardized Approach(SA)
Advanced IRB The internal measurement approach
Pillar 2- Supervisory Review encourage to adopt better risk
management techniques intervene to mandate a higher capital
requirement more inclusive –besides CR,MR,OR credit
concentration risk Interest rate risk in banking book, Liquidity risk, Business risk, Strategic risk and Reputation risk.
Takes into account Business cycle effects too
RISK BASED SUPERVISION (RBS)
Business Risk Factors1. Capital, 2. Credit Risk, 3. Market Risk, 4. Earnings risk, 5. Liquidity Risk, 6. Business Strategy
and Environment Risk,
7. Operational Risk 8. Group Risk.
Control Risk Factors1. Internal Controls
Risk, 2. Organisation risk, 3. Management Risk 4. Compliance Risk.
Pillar 3- Market Discipline disclosures to enhance market
discipline Monitoring by markets- other banks,
customers, depositors, subordinated debt instrument holders, analysts & rating agencies
disclosure policy approved by Board financial penalty, for non-compliance
INITIATIVES BY RBI each bank has suitable risk management
framework and the expected level of capital introduced RBS In 23 banks on a pilot basis encouraged all banks to operationalise CAAP expanded the area of disclosures encouraged some banks to migrate from SA
to IRB approaches
Standardised Approach Different categories of obligors Corporates Sovereign Bank Retail Real Estate Specialized Lending
Issues emerging out of Basel II
higher capital requirements improved IT architectures data issues consolidation capacity building external ratings use of national discretion validating the concept of economic
capital
Capital requirements for CORPORATES in Basel II
credit rating
AAA to AA
A+ to A-
BBB+ to BB-
Below BB-
Unrated
RW Basel I
100% 100% 100% 100% 100%
Capital-Basel I
8% 8% 8% 8% 8%
RW Basel II
20% 50% 100% 150% 100%
Capital-Basel II
1.6% 4% 8% 12% 8%
Capital requirements for SOVEREIGN in Basel II
AAA to AA
A+ to A-
BBB+ to BB-
BB to BB-
Below BB-
Unrated
100% 100% 100% 100% 100% 100%
8% 8% 8% 8% 8% 8%
0 20% 50% 100% 150% 100%
0 1.6% 4% 8% 12% 8%
Capital requirements for BANKS in Basel II
AAA to AA
A+ to A-
BBB+ to BB-
BB to BB-
Below BB-
Unrated
100% 100% 100% 100% 100% 100%
8% 8% 8% 8% 8% 8%
20% 50% 100% 100% 150% 100%
1.6% 4% 8% 12% 8% 8%
Capital requirements for BANKS in Basel II
AAA to AA
A+ to A-
BBB+ to BB-
BB to BB-
Below BB-
Unrated
100% 100% 100% 100% 100% 100%
8% 8% 8% 8% 8% 8%
20% 50% 100% 100% 150% 100%
1.6% 4% 8% 12% 8% 8%
Capital requirements for RETAIL in Basel II
RETAIL INDIVIDUAL OR SMALL BUSINESS
DEFAULT
RW under Basel I
100% 100%
RW under Basel II
75% From 150% to 50%
Capital under Basel II
6% 4% to 12%
Capital requirements for REAL ESTATE in Basel II
RETAILRW BASEL I
RESIDENTIAL50%
COMMERCIAL100%
Capital under Basel I
4% 8%
RW under Basel II
35% 100%
Capital under Basel II
2.7% 8%
SPECIALISED LENDDING
PROJECT FINANCECOMMODITIES,COM. REAL ESTATE
RW UNDER BASEL I 100%
CAPITAL Basel I 8%
RW UNDER BASEL II 100%
CAPITAL BASEL II 8%
Assessing exposure customer wise and facility wise
Probability of Default (PD) - the probability that a specific customer will default within the next 12 months.
Loss Given Default (LGD) - the percentage of each credit facility that will be lost if the customer defaults.
Exposure at Default (EAD) - the expected exposure for each credit facility in the event of a default.
MARKET RISKMarket risk takes the form of interest rate risk, exchange rate risk, commodity price risk and equity price risk , major risk presently faced by banks in India are interest rate ,exchange rate and liquidity risk.
MARKET RISK-CONTINUED
Basel-I focused only on credit risk excluding the market risk
Risk brought vide amendments in 1996 usually measured with a Value-at-Risk
method and on daily basis capital charge should be either the
previous day’s VaR or three times the average of the daily VaR for the preceding 60 working days.
Stipulations of RBI
Assign additional risk weight of 2.5% on the entire investment portfolio
Assign risk weight of 100% on the open position limit on foreign exchange and gold
Build investment fluctuation reserve up to a minimum of 5% of the investment held in ‘Held for Trading’(HFT) and ‘available for sale’(AFS) category in their investment portfolio
Linking risk to capital- single metric Risk measurement focuses on unexpected
losses Different business activities lead to
various unexpected losses These different risks must be measured
individually and aggregated to a single risk metric, both by business line and across the bank as a whole