risk mangemnet

8/13/2019 Risk mangemnet

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RISK MANAGEMENTPRESENTATION ON

CREDIT RISKAND

MARKET RISK

By

S.D.BARGIR, Joint Director, IIBF


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Risk may be defined as

exposure to uncertainty

favourable or unfavourable

outcomes

aims at mitigating the loss

managing risk rather than oneliminating it


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Risk management is a foursteps process

IdentifyingMeasuring ( quantifying)

Managingcontrolling, monitoring andreviewing


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Three generic categories ofrisk

Credit risk

Market risk

Operational risk


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Credit Risk

credit risk means default of the

borrower or deterioration of

borrowers credit quality.


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Market Risk

arising from movement in market prices

Interest Rate Risk,

Exchange Rate Risk,

Commodities Price risk

Equity Price Risk.


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Operational Risk

loss resulting from inadequate or failed

internal processes

People

systems or

external events.


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Credit Riskdefaults take various forms

Direct Lending:Loan amount

(Principal as well as interest) will notbe paid

Guarantees/ Letter of Credit

etc.Funds will not be forthcomingupon crystallization of liability


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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.


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credit risk, consists of three

risks

Default risk

Exposure risk

Recovery risk


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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 predictedaccurately


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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.


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Expected Losses &Unexpected Losses

EL depends upon defaultprobability(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 isStandard deviation of EL.


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challenges faced by banksin r/o EL

aggregation of the risk-relatedinformation to assess the PD,

LGD and EAD

implementation of a risk ratingsystem that can correctly modelthese parameters which isstatistically valid.


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BASEL

Basel Committee on Banking supervision(BCBS) under the auspices of Bank forInternational Settlements (BIS)

Established in 1975 by group of 10countries

Belgium, Canada, France, Germany, Italy,

Japan, Luxembourg, the Netherlands,Spain, Sweden, Switzerland, the UnitedKingdom and the United States.


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Basel II-Implementation inIndia

with effect from March, 31,2007 by commercial banks.

90 commercial Banks in

India100 countries


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Basel II

capital requirements more risk sensitive

directly related to the credit rating ofeach counter-party instead of counter-party category

capital for credit and market risk but alsofor operational risk (OR)

where warranted for interest rate risks,credit concentration risks, liquidity risks

SME sector


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BASEL II RESTS ON THETHREE PILLARS,

Pillar I Minimum CapitalRequirements

Pillar 2 Supervisory Review Process Pillar 3 Market Discipline

each pillar is as important as the other one


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Pillar 1 Minimum Capital

Requirements

menu of approaches for computingcapital adequacy

freedom to choose the approach minimum, the Standardized Approach for

credit risk

Basic Indicator Approach for operationalrisk

standardised Approach or Internal RiskMeasurement Models approach formarket risk


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Various Approaches

Credit Risk Market Risk OperationalRisk

StandardizedApproach(SA) StandardizedApproach(SA) BasicIndicatorApproach

Basic-

Internal RiskBased(IRB)

Internal RiskMeasurementModel

Standardized

Approach(SA)

Advanced

IRB

The internalmeasurement

approach


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Pillar 2- SupervisoryReview

encourage to adopt better riskmanagement techniques

intervene to mandate a higher capitalrequirement

more inclusive besides CR,MR,OR creditconcentration risk Interest rate risk inbanking book, Liquidity risk, Businessrisk, Strategic risk and Reputation risk.

Takes into account Business cycle effectstoo


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RISK BASED SUPERVISION(RBS)

Business Risk Factors

1. Capital,

2. Credit Risk,

3. Market Risk,4. Earnings risk,

5. Liquidity Risk,

6. Business Strategy

and EnvironmentRisk,

7. Operational Risk

8. Group Risk.

Control Risk Factors

1. Internal ControlsRisk,

2. Organisation risk,

3. Management Risk

4. Compliance Risk.


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Pillar 3- MarketDiscipline

disclosures to enhance marketdiscipline

Monitoring by markets- other banks,customers, depositors, subordinateddebt instrument holders, analysts &rating agencies

disclosure policy approved by Board

financial penalty, for non-compliance


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Standardised Approach Different

categories of obligors

Corporates

Sovereign

Bank

Retail

Real Estate

Specialized Lending


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Issues emerging out ofBasel II

higher capital requirements

improved IT architectures

data issues

consolidation

capacity building

external ratings use of national discretion

validating the concept of economiccapital


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Capital requirements forCORPORATES in Basel II

creditrating

AAA toAA

A+ toA-

BBB+to BB-

BelowBB-

Unrated

RWBasel I

100% 100% 100% 100% 100%

Capital-Basel I

8% 8% 8% 8% 8%

RWBasel II

20% 50% 100% 150% 100%

Capital-Basel II

1.6% 4% 8% 12% 8%


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Capital requirements forSOVEREIGN in Basel II

AAA toAA

A+ toA-

BBB+to BB-

BB toBB-

BelowBB-

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%


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Capital requirements forBANKS in Basel II

AAA toAA

A+ toA-

BBB+to BB-

BB toBB-

BelowBB-

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%


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Capital requirements forBANKS in Basel II

AAA toAA

A+ toA-

BBB+to BB-

BB toBB-

BelowBB-

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%


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Capital requirements forRETAIL in Basel II

RETAIL INDIVIDUALOR SMALLBUSINESS

DEFAULT

RW underBasel I

100% 100%

RW underBasel II

75% From 150%to 50%

Capital underBasel II

6% 4% to 12%


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Capital requirements for REALESTATE in Basel II

RETAIL

RW BASEL I

RESIDENTIAL

50%

COMMERCIAL

100%

Capital underBasel I

4% 8%

RW under

Basel II

35% 100%

Capital underBasel II

2.7% 8%


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SPECIALISED LENDDING

PROJECT FINANCE

COMMODITIES,COM.

REAL ESTATERW UNDER BASEL I 100%

CAPITAL Basel I 8%

RW UNDER BASEL II 100%

CAPITAL BASEL II 8%


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Assessing exposure customer

wise and facility wise

Probability of Default (PD) - theprobability that a specific customer will

default within the next 12 months.

Loss Given Default (LGD) - thepercentage of each credit facility that will

be lost if the customer defaults. Exposure at Default (EAD) - the

expected exposure for each credit facilityin the event of a default.


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MARKET RISKMarket risk takes the form ofinterest rate risk, exchange

rate risk, commodity price riskand equity price risk , majorrisk presently faced by banks in

India are interest rate,exchange rate and liquidityrisk.


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MARKET RISK-CONTINUED

Basel-I focused only on credit riskexcluding the market risk

Risk brought vide amendments in 1996

usually measured with a Value-at-Riskmethod and on daily basis

capital charge should be either theprevious days VaR or three times theaverage of the daily VaR for thepreceding 60 working days.


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Stipulations of RBI

Assign additional risk weight of 2.5% onthe entire investment portfolio

Assign risk weight of 100% on the openposition limit on foreign exchange andgold

Build investment fluctuation reserve up

to a minimum of 5% of the investmentheld in Held for Trading(HFT) andavailablefor sale(AFS)category in theirinvestment portfolio


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Linking risk to capital-single metric

Risk measurement focuses on unexpectedlosses

Different business activities lead tovarious unexpected losses

These different risks must be measuredindividually and aggregated to a single

risk metric, both by business line andacross the bank as a whole


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WINNING FORMULA

Overall risk should always

be lower than overalleconomic capital


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