"Risk Management In Indian Banks"

Abstract

Risk management is relatively new and emerging practice as far as Indian banks are concerned
and has been proved that it�s a mirror of efficient corporate governance of a financial institution.
Globalisation and significant competition between foreign and domestic banks, survival and
optimizing returns are very crucial for banks and financial institutions. However, selecting the
efficient customer and providing innovative and value added financial products and services are
another paramount factors. In a volatile and dynamic market place for achieving sustainable
business growth and shareholder�s value, it is essential to develop a link between risks and
rewards of all products and services of the bank. Hence, the banks should have efficient risk
management framework to mitigate all internal and external risks.

Objjective

The objective of this article is to envisage ideal framework of bank-wide risk management for
Indian Banks. The presence of accurate measures of bank-wide risk management practice
increase shareholder�s returns and allows the risk-taking behavior of bank to be more closely
aligned with strategic objectives. Bank-wide risk management practice should aim to enhance the
drivers of shareholder�s value such as: -

• Growth;
• Risk adjusted performance measurement;
• Consistency of earnings; and
• Quality and transparency of management.

The important steps of the efficient framework of banking concern should ensure all risks are
identified, prioritized, quantified, controlled and managed in order to achieve an optimal risk-
reward profile. This entails ideal and dedicated coordination of risk management across the
bank�s various business units. However, the approach to monitoring and enforcing the
adherence of business units within the bank may vary. The factors that influence this decision
are: -

• The feasibility decisions of the business unit.

• The regulatory requirements in respect of the business unit.
• The cost of effective monitoring and controlling steps.

Benefits of Bank-wide risk management

Risk management is a line function that needs to be addressed by each individual cost
center and business unit. However, a centralized bank-wide risk management framework
has certain advantages for the Bank. The advantages are: -

Current state of Risk management practices in Indian banks

Most of the banks do not have dedicated risk management team, policy, procedures and
framework in place. Those banks have risk management department, the risk
manager�s role is restricted to prefact and postfact analysis of customer�s credit and
there is no segregation of credit, market, operational and strategic risks. There are few
banks have articulated framework and risk quantification. However, the outputs are far
from the stressed or actual losses due to usage of un-compatible implications.

The traditional lending practices, assessment of credits, handling of market risks *,

treasury functionality and culture of risk-rewards are hauls of public sector banks. Where
as private sector banks and financial institutions are some-what better in this context.

The sheer size and wide coverage of banks is a big hurdle to integrate and generate a
cost effective real time operational data for mapping the risks. Most of the financial
institutions processes are encircled to �functional silos� follows bureaucratic structure
and yet to come up with a transparent and appropriate corporate governance structure to
achieve the stated strategic objectives.

Steps to achieve stated objjective

1. Corporate governance

Establishment of dedicated risk management department * with the articulation of roles

and responsibilities pertaining to identifying, measuring, controlling, monitoring and
managing bank-wide risks and a comprehensive articulation of risk management
framework comprising the following: -

The key responsibilities of the Board of Directors should be: -

The key responsibility of the Risk Committee should be: -

2. Quallitative measures and risk reporting

Qualitative measures ensure that all risk types are properly identified and may not take
account of risk quantification. The bank should place a formalized risk-reporting
framework and should have appropriate escalation procedures between risk takers to risk
managers. Qualitative measures cover the issues relevant to identifying quality of
customer, compliance risks, operational risks, money laundering, control and assurance
profiles.

The consolidated risk reporting are classified as follows: -

3. Quantitative measures

Bank should design performance measures that align the objectives of business unit
managers and executives with respect to mission and vision of Bank and the
shareholders are central to the value creation process. In order to ensure that value
creation remains the ultimate objective of a business unit, target performance measures
(Risk adjusted performance management or RAROC ** approach) should be set.
Quantification of bank�s risks includes the maximum acceptable loss in terms of credit,
market risk and operational risk.

Quantification consists of applying value-at-risk (VaR *) and earning-at-risk (EaR)

approach for measuring and controlling quantifiable bank-wide risks (across risk types
and business units). However, quantification does not specifically address the following: -
Bottllenecks to establlish efficient bank-wide risk management framework

a. Data Adequacy
There are several significant VaR models and techniques available for the banks.
However, all these models require lot of qualitative and quantitative historical data
inputs/information related to credit and facility scoring, probability of customer�s defaults
(PD **), articulate information of different collaterals to evaluate recovery rates (RR ***).

Significant conceptual and practical issues pertaining to resources, technology, data,

processes and culture have to be taken into account when implementing this process.
Because risks are highly interdependent and cannot be segmented and managed solely
by independent business units. Bank should adopt an evolutionary bank-wide risk
management, which would add significantly more value than fragmented risk
management process. The objective of bank-wide risk management should continuously
enhance the integration of credit, market, operational and strategic risks.

b. Lack of efficiency
As stated above most of the employees� skill set in risk management department are
restricted to verification of documents and related accounting calculations as part of pre
and post fact analysis of the credit. The simple apprehension of our study is most of the
banks particularly nationalized banks does not have appropriate data and efficient people
to comprehend and go forward for advance measurements as per Basel II. Also, risk
management seemed as part of corporate banking. Is this parlance appropriate?

So, banks must ensure that risk management is a custodian of overall banking activities
to mitigate the risks. Banks must reengineer the process of executing the risk
management function with young and dynamic professional risk managers who can offer
innovative and sustainable solutions to banks to achieve the stated objectives. Also,
need to train the concerned employees new concepts and market dynamics of risk
management.

4. Complliance

a. Internall complliance
The banks should articulate the fair compliance and set MIS process between all
functional units to risk management department. The MIS includes the reporting of
identified risks, controls, action points, and frequency of risk occurrence etc., should help
the risk management to work out the economic capital requirement for the bank to meet
the loss. Strong interaction of functional units help the risk management to have
proactive measures in placing appropriate controls to mitigate the risks. And, finally it�s
the responsibility of risk management to monitor the risk events and to change the
control standards as per the risk eventuality.

b. Externall complliance
The regulator might recommend the banks to maintain the required capital adequacy
but the banks must ensure the suggested capital is sufficient to meet any unforeseen
circumstances. Maintaining appropriate capital adequacy is different than optimize the
bank�s capital efficiency. The efficient bank may come up and discuss with regulator
(RBI) to minimize the capital adequacy based on the performance and controlling
capacity to mitigate any sort of risks.

To do this the bank requires the transparency of information, fair accounting practice,
appropriate records to justify the argument and efficiency of risk management as well as
good corporate governance.
5. Efficient decision-making

Appropriate decision at right time changes the velocity of risks. In terms of credit the
appropriateness might start from initial interaction of customer seeking credit whereas,
market risk, decision making start from identifying and selecting the right deal, right
investment avenue and for operational risk the process of decision-making starts from
evaluation of policy and procedures of each credit or investment.

Ideally, there should be decentralized decision-making system but the risk evaluation of
deal ie, lending or investment decisions must be with in the risk management, investment
and credit policy framework and procedural structure. Risk management department
should have clear vision and right to suggest the concerned business or functional units
to roll back of credits / investments as per the continuous monitoring of risks and day-to-
day business trend.

We must discuss one point in this context ie, accountability of employee - no

structure and system works without the employee accountability and ethics.

Concllusion

There are many banks like HSBC, Citibank, Deutsche bank have bank-wide risk
management practice which contributed in their global success whereas banks and
institutions like Sumitomo Corp, Barings, Bank of America, CSFB and UTI have failed
due to lack of efficient bank-wide risk management practice (compliance and operational
risks).

So the above comments emphasis the necessity of having bank-wide risk management
to achieve the stated strategic objectives in a competitive, volatile and dynamic market
conditions in an emerging Indian economy. We believe the above-described bank-wide
risk management framework is easy workable, cost effective and efficient process without
any hassles or hurdles of high-tech tools and techniques.