Risk Management & Compliance

with RBI Guidelines

PGP Jan 2008-10

Oct 4, 2008
Prof Chowdari Prasad
 Risk Management

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 Components of a Bank B/S
Liabilities Assets
1. Capital 1. Cash & Balances with
2. Reserve & Surplus RBI
3. Deposits 2. Bal. With Banks &
Money at Call and
4. Borrowings
Short Notices
5. Other Liabilities
3. Investments
4. Advances
5. Fixed Assets
6. Other Assets
Contingent Liabilities
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 What is Risk?

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 What is Risk? (2)
A Ship is very safe in a
shore.

But, it is not meant for that.

A Ship has to sail by
taking RISK.

Banking too is no exception.

A Bank has to carry

Business by taking
(Informed & calculated) RISK

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 What is Risk? (3)
• The threat that an event or action will
adversely affect an organization's ability to
achieve its business objectives and
execute its strategies successfully.

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 Sources of Risk
• Decision, Indecision • Political compulsions
• Business cycles/ • Regulations
Seasonality • Human resources,
• Economic/Fiscal skill sets
changes • Competition
• Policy Changes • Technology
• Market movements • Non-availability of
• Events information

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 Different Types of Risks
• Banks and Financial Institutions, in the process of
carrying their businesses, face various kinds of financial
and non-financial risks -
– Credit Risk
– Liquidity Risk
– Interest Rate Risk
– Market Risk
– Off-Balance Sheet Risk
– Foreign Exchange Risk
– Country or Sovereign Risk .................

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 Different Types of Risks (2)
– Operational Risk
– Technology Risk
– Compliance (Regulatory) Risk
– Legal Risk
– Reputation Risk
– Insolvency Risk

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 Inter-dependence of Risks
• These risks are highly interdependent and
events that affect each other

• One area of risk can have ramifications for

a range of other risk categories.

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 What is Risk Management?
• A system by which an organization
- evaluates, deals with and monitors risk
-to achieve its strategies successfully.
• It is the art of approximation
• It is a planned method of dealing with
uncertainties of possible danger of loss

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 Why Risk Management?
• All transactions undertaken have one or more
Risks. Risks are attached to Portfolio too.
• Aggregated Risk determines Capital needs of a
Bank / Financial Institution
• Hence, one of the objectives of Risk
Management is to enhance Risk Adjusted
Return on Capital (RAROC)
• RM facilitates implementation of Risk and
Business Policies simultaneously in a consistent
manner
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 Risk Management Framework
Risk Profiling
Risk Identification
Risk Measurement
Risk Pricing
Risk Monitoring, Compliance and Control
Risk Mitigation
Comprehensive Risk Management should address all
the risks faced by an organization and their inter
linkages

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 Risk Identification
• Identifying various Risks associated at the
Transaction Level and
• Examining its impact on the Portfolio and Capital
requirement.
• Risk identification helps Head Office of a Bank to
approve Products and their screening
procedures and appropriate safeguards; Fixing
Limit exposure - product-wise and amount wise
and provide necessary risk taking guidelines.

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 Risk Measurement
• Uses Quantitative measures of Risk
• Seek to measure variations in Earnings,
Market value, Losses due to default, etc.
• Quantitative Measures used are :
– Sensitivity
– Volatility
– Downgrade potential

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 Risk Pricing
• Implies factoring risks into pricing
• Pricing should take into account besides
Profit Margin, the following:
– Cost of Funds
– Operating Expenses
– Loss Probabilities
– Capital Charge

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 Risk Monitoring and Control
• Adequate internal control system for
monitoring compliance of internal policies
and reporting risk exposures
• Conduct periodic reviews, periodic
supervision and inspections
• Identification of large exposures and Risk
concentrations
• Top Management involvement - review
reports on Risk Profile and Capital needs
regularly and evaluate to make necessary
adjustments to Bank’s Business Plans

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 Risk Mitigation
• Achieved by adopting strategies that
eliminate or reduce various risks
• Uses variety of Financial Instruments and
techniques to mitigate risks
– Collateralizations, third party guarantee
– Insurance cover, Institutional Credit
Guarantee Schemes
– Hedging and
– Securitisation
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 RISK MANAGEMENT ORGANISATION

• The Board of Directors

• The Risk Management Committee –
Integrated Committee / Respective
Committees
• The Middle Office / Support Groups

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 RISK MANAGEMENT FRAMEWORK
OF BANKS IN INDIA
• The broad parameters of risk management
function encompass:
• Board approves risk management policies in
consonance with the
– broader business strategies
– capital strength
– management expertise and
– overall willingness to assume risk
– guidelines to govern risk including detailed structure of
prudential limits
• Periodical review and evaluation

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 RISK MANAGENET- COMMITTEE
• Risk Management Committee with the top Executives as
members - reports directly to the Board of Directors
• RMC will evaluate
– overall risks faced by the bank and
– determining the level of risks which will be in the best
interest of the bank .
• The Risk Management Committee will:
– identify, monitor and measure the risk profile of
the bank
– develop policies and procedures
– identify new risks
– Fixing the quantitative prudential limits on various
segments of banks’ operations

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 RISK MANAGEMENT COMMITTEES
• Asset - Liability Management Committee
deals with different types of market risks
• Credit Policy Committee (CPC) deals with
credit / counter party risk and country risk
• Market and Credit risks are managed in a
parallel two-track approach in banks

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