RISK MANAGEMENT

IN BANKS

Submitted by:Sunny mehriya

A30101913086
MBA-C
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CREDIT RISK
Inherent in banking.
Risks that banks take must bereasonable, controlled, within their
financial resources and competence
Covers- all risks related to a borrower
not fulfilling his obligations on time
Magnitude of risk dependant on likelihood of default by counter party,
potential value of outstanding contracts,
legally enforceable netting arrangements
allowing offsetting contracts, collateral
security
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6C`S OF CREDIT

Character (borrower's personal

character honesty, willingness and
commitment to pay debts)
Capacity
Capital (financial condition)
Condition (economic)
Compliance
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OBTSTACLES IN CREDIT RISK

MANAGEMENT

Governmental control
Asymmetric and unreliable Information
Legal framework
Political pressures
Production difficulties
Financial restrictions
Market disruptions
Delays in production
Instability in business environment
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CREDIT RISK MANAGEMENT OVERVIEW

Origin Client request, Prospect discovery,

Outside referral
Evaluation Purpose, Business, Management
Negotiation Tenor, Repayment, Covenants,
Security
Approval
Documentation Legal drafting, Collateral
Disbursement
Administration Repayment, Unforeseen
events, Compliance of terms and conditions
Reviews early recognition, Recovery Strategy
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Repayment

METHODS - REDUCTION OF CREDIT

RISKS
Raising credit standards to reject
Obtain collateral and Guarantees
Ensure compliance with loan
agreement
Transfer credit risk by selling
standardized loans
Transfer risk of changing interest by
Hedging, financial futures, options
Opt for loan syndication
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CREDIT DERIVATIVES
Unbundling of credit risk - Off-balance sheet
financial instruments that permit one party to
transfer credit risk of a reference asset, which it owns,
to another party without actually selling the asset
It is a bilateral contract between a protection buyer
(Lending bank) and a protection seller (Credit Risk
Buyer or Guarantor )
Upon happening of credit event Protection Seller
will make contingent payment (difference between full
face value and current resale value of a particular
bank loan)
Condition that trigger payout payment default,
insolvency, rating downgrading [ 8 different types of
credit events stipulated by International Swaps and
Derivatives Association]
Protection buyer will pay - periodic fee7to protection
seller

CREDIT RISK IN INDIA AND

SARFAESI ACT 2002

Credit Risk: The risk of non-payment of principal

and/or interest to investors can be at two levels:
a) SPV; and
b) underlying assets.
SPV is normally structured to have no other activity
apart from the asset pool sold by the originator
Credit risk principally lies with the underlying asset
pool.

A careful analysis of the underlying credit quality of

the Obligors and the correlation between the obligors
needs to be carried out to ascertain the probability of
default of the asset pool.

A well diversified asset portfolio can significantly

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reduce the simultaneous occurrence of default

PROCESS OF SECURITIZATION
ANCILLARY SERVICE PROVIDERS
OBLIGOR
OBLIGOR
(Borrower)
(Borrower)

ISSUE OF SECURITIES

SALE OF ASSETS
ORIGINATOR
ORIGINATOR
(Banker)
(Banker)

INVESTORS
INVESTORS
(QIBs)
(QIBs)

SPV

CREDIT RATING OF SECURITIES

CREDIT RATING
RATING AGENCY
AGENCY
CREDIT
BANKER
BANKER

RISKS IN COMMERCIAL BANKING

Credit Risk

Management & Internal

Controls

Interest Rate Risk

Foreign Exchange
Risk

Lending Operations

Liquidity Risk
Operation Risk

Market Operations, ALM

EDP Risk
Systemic Risk
Management Risk

Business Operations
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CROSS BORDER MONEY FLOWS

AND REGULATIONS
Growth of cross-border money flows highlighted lack
of efficient banking supervision on an international
level
National banking supervisory authorities regulate
domestic banks and domestic activities of
international banks
Failure of some US Banks prompted G10 central bank
Governors to set up Basel Committee on Banking
Supervision
Committee issued Basel Capital Accord, credit risk
measurement framework for internationally active
banks, became a globally accepted standard (Basel I)
Revised by Basel II- to achieve a better transparent
measurement of various risks incurred by
internationally active banks, limiting possibility
of
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contagion in case of a crisis

BASEL ACCORD AND

BASEL II NORMS

Basel accord - regulations for banks set by

Basel Committee, to protect interest of
depositors in a Bank.
Basel- I accord was accountable for two
risks viz, Credit Risk and Market Risk
Basel II uses a "three pillars" concept
(1) minimum capital requirements
(2) supervisory review and
(3) market discipline to promote greater
stability in the financial system
The Basel I accord dealt with only parts of
each of these pillars
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ASSET LIABILITY MANAGEMENT

Asset-Liability Management [ALM] models
enable institutions to
measure and monitor risk, and
provide suitable strategies for their
management
Even in the absence of a formal ALM program,
understanding of these concepts is of value to
an institution as it provides a truer picture of
risk/ reward trade-off in which institution is
engaged
The various aspects of B/S management deal
with planning as well as direction and control
of levels, changes and mixes of assets,
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liabilities, and capital

ALM STRUCTURE
GENERAL
GENERAL
ASSET, LIABILITY
LIABILITY &
& CAPITAL
CAPITAL MANAGEMENT
MANAGEMENT
ASSET,
SPECIFIIC
SPECIFIIC
LIBILITY MANGEMENT

ASSET MANAGEMENT

FINANCIAL
FINANCIAL
BALANCE SHEET
MANAGEMENT

INCOME & EXPENDITURE

MANAGEMENT
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ALM process

a) Liquidity Risk Management process to measure

liquidity positions of bank on an ongoing basis and
also to examine how liquidity requirements are likely
to evolve under crisis scenarios - assuring bank's
ability to meet its liabilities as they become due
b) Currency Risk - banks are free to set gap limits with
RBI's approval by adopting Value at Risk (VaR)
approach to measure risk associated with forward
exposures.
) Gap - difference between Rate Sensitive Assets and
Rate Sensitive Liabilities for each time bucket.
c) Interest Rate Risk - risk where changes in market
interest rates might adversely affect a bank's
financial condition
) Risk from earnings perspective can be measured as
changes in Net Interest Income (NII) or Net Interest
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Margin (NIM)

CAPITAL ADEQUACY RATIO

Objectives : to strengthen soundness and stability of

banking system; Standardised Approach for credit
risk and Basic Indicator Approach for operational risk
Effective date of migration 31st March 2009.
Capital Adequacy Ratio (CAR or CRAR) : ratio of
Eligible total capital funds
Credit Risk RWA + Market Risk RWA + Operational
Risk RWA
Capital Fund has two tiers
Tier I capital - PUC, Free Reserves
Tier II capital - Revaluation Reserves and other
non free reserves
Reckoning of Tier 2 capital reckoned as capital
funds up to a maximum of 100 % of Tier 1 capital,
after making necessary deductions/ adjustments
Minimum requirements of capital fund - 9 % on an
ongoing basis
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Capital Adequacy Ratio (Contd.)

Risk Weighted Assets
Fund Based : cash, loans, investments and
other assets.
Non Fund Based -The credit risk exposure
attached to off-balance sheet items
Risk factors considered by RBI
effectiveness of banks risk management
systems in identifying, assessing /
measuring, monitoring and managing
various risks including interest rate risk,
liquidity risk, concentration risk and
residual risk
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INTEREST RATE RISK

Determinant of banks` profitability - difference
between interest income and interest expense (called
Net Interest Income)
Why Risk - mismatch of Assets and Liabilities gives
rise to interest rate risk ;may arise due to higher
borrowing charges and preferences of its constituents
Objective of Risk Management to insulate Net
Interest Income
Methods of risk analysis by Maturity; Funding
Gap Analysis, duration analysis and value at risk
Risk Management Tool transacting in derivative
instruments provide flexibility to banks; Forward
Rage Agreements; Interest Rate Swap
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THANK YOY

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