RISK MANAGEMENT

TYPES OF RISKS, RISK MITIGATION AND RISK MANAGEMENT SOLUTIONS

S.RAJESH 11MBA0050

TYPES OF RISKS

Credit Risk Market Risk

Liquidity Risk Interest Rate Risk

Gap or Mismatch Risk Basis Risk Embedded Option Risk Yield Curve Risk Price Risk Reinvestment Risk Net Interest Position Risk

Foreign Exchange Risk

Operational Risk Regulatory Risk

CREDIT RISK

Credit Risk Arises due to inability of the borrower to repay.

MARKET RISK

Market Risk Arises due to adverse changes in the market, and include

Liquidity Risk Arises due to inability to efficiently accommodate deposits, using short term deposits to fund long term purposes.

Funding Risk Arises when there is a need to replace cash outflows owing to unanticipated withdrawals.
Time Risk Arises owing to non-receipt of cash inflows.

Call Risk Arises when contingent liabilities are crystallized resulting in banks being unable to utilize them in profitable opportunities.

MARKET RISK (CONTINUED)

Interest Rate Risk It arises due to impact of interest rates, which affects the Net Interest Margins and the market value of equity.

Gap or Mismatch Risk - Different assets in terms of maturity, duration will create exposure to unexpected changes in market rates. Basis Risk - Interest rates of different assets with different principal amounts and maturity period change in different magnitudes. Embedded Option Risk - Significant changes in market rates will cause preclosure, premature withdrawals, credit demand, call/put options. Yield Curve Risk - Different assets will cause non parallel and frequent movements in the yield curve when economy moves through business cycle.

Price Risk - Assets are sold before maturity. (inverse relation between bond value and yield)

MARKET RISK (CONTINUED)

Interest Rate Risk

Reinvestment Risk Uncertainty in interest rates at which future cash flows can be reinvested. Mismatch in cash flows will impact NIM. Net Interest Position Risk When market interest rates decline, the NIM will decline.

Foreign Exchange Risk Risks owing to adverse changes in the currency exchange rates, counter party default, limitations on cross border remittances, changes in time zones (Herstatt Risk)

OPERATIONAL RISK, REGULATORY RISK

Operational Risk - Risk of loss arising from various types of human or technical error, issues in settlement or payments, business interruption, administrative and legal issues. Regulatory Risk - Risk of changes in operations due to regulatory interferences.

RISK MANAGEMENT

Credit Risk

Exposure Ceilings 15% for individuals and 40% for a group with additional 10% for infra projects taken by the group. Review/Renewal Multi Tier credit approving authority. Risk Rating Model Create a risk scoring system and rate risks on a scale. Identify thresholds and review periodically. Risk based Scientific Pricing High risk category loans should be priced at higher interest rates. RAROC Framework can be used. Maintain an effective credit portfolio. Independent loan review mechanism should be adopted.

RISK MANAGEMENT RAROC FRAMEWORK

Risk Adjusted Return On Capital gives insights into decision making with respect to extending credit.
Bankers can compare returns on credits extended with varying risk levels over a time period. It is given by the formula
(revenue expenses expected loss + income from capital) RAROC = ---------------------------------------------------------------------------------capital

where.,

Expected loss = average anticipated losses over the time period observed.

RISK MANAGEMENT RISK RATING

MODELS

Altmans Z Score - forecasting the probability of a company entering bankruptcy. It separates defaulting borrower from non-defaulting borrower on the basis of certain financial ratios converted into simple index. Credit Metrics - estimating the volatility of asset values caused by variation in the quality of assets. The model tracks rating migration which is the probability that a borrower migrates from one risk rating to another risk rating. Expected Default Frequency deriving the actual probability of default by borrowers by measuring the asset value of the firm from the market value of its equity. When estimated asset value falls below a pre-specified default point, probability of risk is higher. McKinseys Credit Portfolio View - using a multifactor approach to stimulate the distribution of default probabilities, as well as migration probabilities conditioned on the value of macro-economic factors.

RISK MANAGEMENT (CONTINUED)

Market Risk
Create a framework for measuring, monitoring and controlling liquidity, interest rate, foreign exchange risk and integrate the same with the banks strategy. Perform scenario analysis and stress testing. Identify future changes in economic and market conditions and identify the impact of the unfavorable changes on the banks portfolio. A good portfolio will survive the stress testing. Liquidity Risk

Asset Liability Management (ALM) should be deployed to ensure a proper balance between funds mobilization and deployment. Tolerance level should be set according to the mismatch.

RISK MANAGEMENT (CONTINUED)

Interest Rate Risk

Measure the volatility of the portfolio as a result of fluctuations of the interest rates.

Gap Analysis

Duration Gap Analysis Duration ( t * Wt ) gap is the measure of difference between duration of assets and liabilities. Lower the duration gap, lower the interest rate risk. VaR Model Measures the impact of market risk and measures the worst expected loss at a given instance with a confidence level of 99%. Lower the loss, lower the impact of market risk.

RISK MANAGEMENT (CONTINUED)

Operational Risk
Internal Controls and Internal Audit Insurance Risk education to familiarize complex operations

RISK MANAGEMENT SOLUTIONS

RISK IDENTIFICATION RISK MEASUREMENT RISK MITIGATION

EXTERNAL DATA RISK DATA REPOSITORY

CREDIT RISK ACTIONS

BANK MIS DATA

MARKET RISK

OPERATIONAL RISK

CRM DATA

Capital Allocation Credit Review Operating Efficiency Hedging

RISK MANAGEMENT SOLUTIONS

Wipro Enterprise Risk Management (ERM) for banks

Establishing company-wide risk framework (view, definitions, assumptions). Setting risk objectives and ensuring alignment to corporate objectives. Ensuring that risk management remains independent of business. Identifying risk areas and defining boundaries of risk management. Creating risk profile for each risk area. Identifying and selecting strategy for risk mitigation.

RISK MANAGEMENT SOLUTIONS

IBM Integrated Risk Management Solution

Financial Risk
Set up of centrally managed repository of financial risk data. Risk scenarios that can be applied and tested. Risk insight and control in real time.

Operational and IT Risk

Manage access to critical applications. Enforce process standards and controls. Manage workflows. Automate policy based user roles and access rights.

Governance and Compliance

Identifying market conduct breaches. Ensuring safety of depositors funds with compliance. Using compliance framework to stay updated with regulations

RISK MANAGEMENT SOLUTIONS

Infosys Risk Management Solution

Implement Regulatory Risk programs within time and budget. Accelerate enterprise wide risk management. Reduce operational risk by managing bankruptcies using collection and recovery framework. Achieve superior operational efficiency through effective governance, data and system management models Improve Risk analytics and Risk model validation and testing. Provide enhanced reporting services with investigative reporting features

RISK MANAGEMENT SOLUTIONS

TCS Risk Management BASEL II

Providing extensive support to the risk management activities by consulting, data management, product implementation and modelling. Providing a set of tools, methodologies, ready to deploy assets to accelerate Basel II implementation. Providing a holistic and robust implementation framework across Credit, Operational Risk and Pillar II facilitating a seamless integration. Improved data quality and data integration, thereby facilitating decisions based on accurate and holistic data.