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PROJECT REPORT
COMPARISON OF RISK PROFILES OF PUNJAB NATIONAL BANK AND AXIS BANK
SUBMITTED TO: PROF. HIMANSHU PURI IILM SUBMITTED BY: ARSHDEEP SINGH GAGANDEEP SINGH HARENDRA PRATAP RISHUB PAL SATVINDER SINGH UPASANA BISWAS
TYPES OF RISKS
When we use the term Risk, we all mean financial risk or uncertainty of financial loss. If we consider risk in terms of probability of occurrence frequently, we measure risk on a scale, with certainty of occurrence at one end and certainty of non-occurrence at the other end. Risk is the greatest where the probability of occurrence or non-occurrence is equal. As per the Reserve Bank of India guidelines issued in Oct. 1999, there are three major types of risks encountered by the banks and these are Credit Risk, Market Risk & Operational Risk. In August 2001, a discussion paper on move towards Risk Based Supervision was published. Further after eliciting views of banks on the draft guidance note on Credit Risk Management and market risk management, the RBI has issued the final guidelines and advised some of the large PSU banks to implement so as to gauge the impact. A discussion paper on Country Risk was also released in May 02. Risk is the potentiality that both the expected and unexpected events may have an adverse impact on the banks capital or earnings. The expected loss is to be borne by the borrower and hence is taken care of by adequately pricing the products through risk premium and reserves created out of the earnings. It is the amount expected to be lost due to changes in credit quality resulting in default. Whereas, the unexpected loss on account of the individual exposure and the whole portfolio in entirely is to be borne by the bank itself and hence is to be taken care of by the capital. Thus, the expected losses are covered by reserves/provisions and the unexpected losses require capital allocation. Hence the need for sufficient Capital Adequacy Ratio is felt. Each type of risks is measured to determine both the expected and unexpected losses using VAR (Value at Risk) or worst-case type analytical model.
CREDIT RISK
Credit Risk is the potential that a bank borrower/counter party fails to meet the obligations on agreed terms. There is always scope for the borrower to default from his commitments for one or the other reason resulting in crystallization of credit risk to the bank. These losses could take the form outright default or alternatively, losses from changes in portfolio value arising from actual or perceived deterioration in credit quality that is short of default. Credit risk is inherent to the business of lending funds to the operations linked closely to market risk variables. The objective of credit risk management is to minimize the risk and maximize banks risk adjusted rate of return by assuming and maintaining credit exposure within the acceptable parameters. Credit risk consists of primarily two components, Quantity of risk, which is nothing but the outstanding loan balance as on the date of default and the quality of risk, the severity of loss defined by both Probability of Default as reduced by the recoveries that could be made in the event of default. Thus credit risk is a combined outcome of Default Risk and Exposure Risk. The elements of Credit Risk are Portfolio risk comprising Concentration Risk as well as
Intrinsic Risk and Transaction Risk comprising migration/down gradation risk as well as Default Risk. At the transaction level, credit ratings are useful measures of evaluating credit risk that is prevalent across the entire organization where treasury and credit functions are handled. Portfolio analysis help in identifying concentration of credit risk, default/migration statistics, recovery data, etc. In general, Default is not an abrupt process to happen suddenly and past experience dictates that, more often than not, borrowers credit worthiness and asset quality declines gradually, which is otherwise known as migration. Default is an extreme event of credit migration. Off balance sheet exposures such as foreign exchange forward can tracks, swaps options etc are classified in to three broad categories such as full Risk, Medium Risk and Low risk and then translated into risk Neighed assets through a conversion factor and summed up. The management of credit risk includes a) Measurement through credit rating/ scoring, b) Quantification through estimate of expected loan losses, c) Pricing on a scientific basis and d) Controlling through effective Loan Review Mechanism and Portfolio Management.
1. Exposure Ceilings:
Prudential Limit is linked to Capital Funds say 15% for individual borrower entity, 40% for a group with additional 10% for infrastructure projects undertaken by the group, Threshold limit is fixed at a level lower than Prudential Exposure; Substantial Exposure, which is the sum total of the exposures beyond threshold limit should not exceed 600% to 800% of the Capital Funds of the bank (i.e. six to eight times). 2. Review/Renewal: Multi-tier Credit Approving Authority, constitution wise delegation of powers, Higher delegated powers for better-rated customers; discriminatory time schedule for review/renewal, Hurdle rates and Bench marks for fresh exposures and periodicity for renewal based on risk rating, etc are formulated.
5. Portfolio Management:
The need for credit portfolio management emanates from the necessity to optimize the benefits associated with diversification and to reduce the potential adverse impact of concentration of exposures to a particular borrower, sector or industry. Stipulate quantitative ceiling on aggregate exposure on specific rating categories, distribution of borrowers in various industry, business group and conduct rapid portfolio reviews. The existing framework of tracking the non-performing loans around the balance sheet date does not signal the quality of the entire loan book. There should be a proper & regular on-going
system for identification of credit weaknesses well in advance. Initiate steps to preserve the desired portfolio quality and integrate portfolio reviews with credit decision-making process.
6.
Rating can be used for the anticipatory provisioning. Certain level of reasonable over-provisioning as Best practice. Given the past experience and assumptions about the future, the credit risk model seeks to determine the present value of a given loan or fixed income security. It also seeks to determine the quantifiable risk that the promised cash flows will not be forthcoming. Thus, credit risk models are intended to aid banks in quantifying, aggregating and managing risk across geographical and product lines. Credit models are used to flag potential problems in the portfolio to facilitate early corrective action. The risk-rating model should capture various types of risks such as Industry/Business Risk, Financial Risk and Management Risk, associated with credit. Industry/Business risk consists of both systematic and unsystematic risks which are market driven. The systematic risk emanates from General political environment, changes in economic policies, fiscal policies of the government, infrastructural changes etc. The unsystematic risk arises out of internal factors such as machinery break down, labour strike, new competitors who are quite specific to the activities in which the borrower is engaged. Assessment of financial risks involves appraisal of the financial strength of a unit based on its performance and financial indicators like liquidity, profitability, gearing, leverage, coverage, turnover etc. It is necessary to study the movement of these indicators over a period of time as Also its comparison with industry averages wherever possible. A study carried out in the western corporate world reveals that 45% of the projects failed to take off simply because the personnel entrusted with the test were found to be highly wanting in qualitatively managing the project. The key ingredient of credit risk is the risk of default that is measured by the probability that default occurs during a given period. Probabilities are estimates of future happenings that are uncertain. We can narrow the margin of uncertainty of a forecast if we have a fair understanding of the nature and level of uncertainty regarding the variable in question and availability of quality information at the time of assessment. The expected loss/unexpected loss methodology forces banks to adopt new Internal Ratings Based approach to credit risk management as proposed in the Capital Accord II. Some of the risk rating methodologies used widely is briefed below: a. Altmans Z score Model involves 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. b. Credit Metrics focuses on 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. c. Credit Risk +, a statistical method based on the insurance industry, is for measuring credit risk. The model is base on actuarial rates and unexpected losses from defaults. It is based on insurance industry model of event risk. d. KMV, through its Expected Default Frequency (EDF) methodology derives the actua probability of default for each obligor based on functions of capital structure, the volatility of asset returns and the current asset value. It calculates the asset value of a firm from the market value of its equity using an option pricing based approach that recognizes equity as a call option on the underlying asset of the firm. It tries to estimate the asset value path of the firm over a time horizon. The default risk is the probability of the estimated asset value falling below a pre-specified default point.
MARKET RISK
Market Risk may be defined as the possibility of loss to bank caused by the changes in the market variables. It is the risk that the value of on-/off-balance sheet positions will be adversely affected by movements in equity and interest rate markets, currency exchange rates and commodity prices. Market risk is the risk to the banks earnings and capital due to changes in the market level of interest rates or prices of securities, foreign exchange and equities, as well as the volatilities, of those prices. Market Risk Management provides a comprehensive and dynamic frame work for measuring, monitoring and managing liquidity, interest rate, foreign exchange and equity as well as commodity price risk of a bank that needs to be closely integrated with the banks business strategy. Scenario analysis and stress testing is yet another tool used to assess areas of potential problems in a given portfolio. Identification of future changes in economic conditions like economic/industry overturns, market risk events, liquidity conditions etc that could have unfavorable effect on banks portfolio is a condition precedent for carrying out stress testing. As the underlying assumption keep changing from time to time, output of the test should be reviewed periodically as market risk management system should be responsive and sensitive to the happenings in the market.
Liquidity Risk
Bank Deposits generally have a much shorter contractual maturity than loans and liquidity management needs to provide a cushion to cover anticipated deposit withdrawals. Liquidity is the ability to efficiently accommodate deposit as also reduction in liabilities and to fund the loan growth and possible funding of the off-balance sheet claims. The cash flows are placed in different time buckets based on future likely behavior of assets, liabilities and off-balance sheet items. Liquidity risk consists of Funding Risk, Time Risk & Call Risk. a. Funding Risk: It is the need to replace net out flows due to unanticipated withdrawal/non- Renewal of deposits. b. Time risk: It is the need to compensate for non receipt of expected inflows of funds, i.e. Performing assets turning into non performing assets. c. Call risk: It happens on account of crystallization of contingent liabilities and inability to undertake profitable business opportunities when desired. The Asset Liability Management (ALM) is a part of the overall risk management system in the banks. It Implies examination of all the assets and liabilities simultaneously on a continuous basis with a view to ensuring a proper balance between funds mobilization and their deployment with respect to their a) Maturity profiles, b) Cost, c) Yield, d) Risk exposure, etc. Tolerance levels on mismatches should be fixed for various maturities depending upon the asset liability profile, deposit mix, nature of cash flow etc. Bank should track the impact of pre-payment of loans & premature closure of deposits so as to realistically estimate the cash flow profile.
a. Gap/Mismatch risk:
It arises from holding assets and liabilities and off balance sheet items with different principal amounts, maturity dates & re-pricing dates thereby creating exposure to unexpected changes in the level of market interest rates.
b. Basis Risk:
It is the risk that the Interest rat of different Assets/liabilities and off balance items may change in different magnitude. The degree of basis risk is fairly high in respect of banks that create composite assets out of composite liabilities.
e. Reprice risk:
When assets are sold before maturities. Reinvestment risk: Uncertainty with regard to interest rate at which the future cash flows could be reinvested.
The traditional Maturity Gap Analysis to measure the interest rate sensitivity, Duration Gap Analysis to measure interest rate sensitivity of capital, Simulation Value at Risk for measurement of interest rate risk. The approach towards measurement and hedging interest rate risk varies with segmentation of banks balance sheet. Banks broadly bifurcate the asset into Trading Book and Banking Book. While trading book comprises of assets held primarily for generating profits on short term differences in prices/yields, the banking book consists of assets and liabilities contracted basically on account of relationship or for steady income and statutory obligations and are generally held till maturity/payment by counter party. Thus, while price risk is the prime concern of banks in trading book, the earnings or changes in the economic value are the main focus in banking book. Value at Risk (VAR) is a method of assessing the market risk using standard statistical techniques. It is a statistical measure of risk exposure and measures the worst expected loss over a given time interval under normal market conditions at a given confidence level of say 95% or 99%. Thus VAR is simply a distribution of probable outcome of future losses that may occur on a portfolio. The actual result will not be known until the event takes place. Till then it is a random variable whose outcome has been estimated. As far as Trading Book is concerned, bank should be able to adopt standardized method or internal models for providing explicit capital charge for market risk.
Forex Risk
Foreign exchange risk is the risk that a bank may suffer loss as a result of adverse exchange rate movement during a period in which it has an open position, either spot or forward or both in same foreign currency. Even in case where spot or forward positions in individual currencies are balanced the maturity pattern of forward transactions may produce mismatches. There is also a settlement risk arising out of default of the counter party and out of time lag in settlement of one currency in one center and the settlement of another currency in another time zone. Banks are also exposed to interest rate risk, which arises from the maturity mismatch of foreign currency position. The Value at Risk (VAR) indicates the risk that the bank is exposed due to uncovered position of mismatch and these gap positions are to be valued on daily basis at the prevalent forward market rates announced by FEDAI for the remaining maturities. Currency Risk is the possibility that exchange rate changes will alter the expected amount of principal and return of the lending or investment. At times, banks may try to cope with this specific risk on the lending side by shifting the risk associated with exchange rate fluctuations to the borrowers. However the risk does not get extinguished, but only gets converted in to credit risk. By setting appropriates limits-open position and gaps, stop-loss limits, Day Light as well as overnight limits for each currency, Individual Gap Limits and Aggregate Gap Limits, clear cut and well defined division of responsibilities between front, middle and back office the risk element in foreign exchange risk can be managed/monitored.
Country Risk
This is the risk that arises due to cross border transactions that are growing dramatically in the recent years owing to economic liberalization and globalization. It is the possibility that a country will be unable to service or repay debts to foreign lenders in time. It comprises of Transfer Risk arising on
account of possibility of losses due to restrictions on external remittances; Sovereign Risk associated with lending to government of a sovereign nation or taking government guarantees; Political Risk when political environment or legislative process of country leads to government taking over the assets of the financial entity (like nationalization, etc) and preventing discharge of liabilities in a manner that had been agreed to earlier; Cross border risk arising on account of the borrower being a resident of a country other than the country where the cross border asset is booked; Currency Risk, a possibility that exchange rate change, will alter the expected amount of principal and return on the lending or investment. In the process there can be a situation in which seller (exporter) may deliver the goods, but may not be paid or the buyer (importer) might have paid the money in advance but was not delivered the goods for one or the other reasons. As per the RBI guidance note on Country Risk Management published recently, banks should reckon both fund and non-fund exposures from their domestic as well as foreign branches, if any, while identifying, measuring, monitoring and controlling country risk. It advocates that bank should also take into account indirect country risk exposure. For example, exposures to a domestic commercial borrower with large economic dependence on a certain country may be considered as subject to indirect country risk. The exposures should be computed on a net basis, i.e. gross exposure minus collaterals, guarantees etc. Netting may be considered for collaterals in/guarantees issued by countries in a lower risk category and may be permitted for banks dues payable to the respective countries. RBI further suggests that banks should eventually put in place appropriate systems to move over to internal assessment of country risk within a prescribed period say by 31.3.2004, by which time the new capital accord would be implemented. The system should be able to identify the full dimensions of country risk as well as incorporate features that acknowledge the links between credit and market risks. Banks should not rely solely on rating agencies or other external sources as their only country riskmonitoring tool. With regard to inter-bank exposures, the guidelines suggests that banks should use the country ratings of international rating agencies and broadly classify the country risk rating into six categories such as insignificant, low, moderate, high, very high & off-credit. However, banks may be allowed to adopt a more conservative categorization of the countries. Banks may set country exposure limits in relation to the banks regulatory capital (Tier I & II) with suitable sub limits, if necessary, for products, branches, maturity etc. Banks were also advised to set country exposure limits and monitor such exposure on weekly basis before eventually switching over to real tie monitoring. Banks should use variety of internal and external sources as a means to measure country risk and should not rely solely on rating agencies or other external sources as their only tool for monitoring country risk. Banks are expected to disclose the Country Risk Management policies in their Annual Report by way of notes.
OPERATIONAL RISK
Always banks live with the risks arising out of human error, financial fraud and natural disasters. The recent happenings such as WTC tragedy, Barings debacle etc. has highlighted the potential losses on account of operational risk. Exponential growth in the use of technology and increase in global financial inter-linkages are the two primary changes that contributed to such risks. Operational risk, though defined as any risk that is not categorized as market or credit risk, is the risk of loss arising from inadequate or failed internal processes, people and systems or from external events. In order to mitigate this, internal control and internal audit systems are used as the primary means. Risk education for familiarizing the complex operations at all levels of staff can also reduce operational risk. Insurance cover is one of the important mitigators of operational risk.
Operational risk events are associated with weak links in internal control procedures. The key to management of operational risk lies in the banks ability to assess its process for vulnerability and establish controls as well as safeguards while providing for unanticipated worst-case scenarios. Operational risk involves breakdown in internal controls and corporate governance leading to error, fraud, performance failure, compromise on the interest of the bank resulting in financial loss. Putting in place proper corporate governance practices by itself would serve as an effective risk management tool. Bank should strive to promote a shared understanding of operational risk within the organization, especially since operational risk is often intertwined with market or credit risk and it is difficult to isolate. Over a period of time, management of credit and market risks has evolved a more sophisticated fashion than operational risk, as the former can be more easily measured, monitored and analyzed. And yet the root causes of all the financial scams and losses are the result of operational risk caused by breakdowns in internal control mechanism and staff lapses. So far, scientific measurement of operational risk has not been evolved. Hence 20% charge on the Capital Funds is earmarked for operational risk and based on sub sequent data/feedback; it was reduced to 12%. While measurement of operational risk and computing capital charges as envisaged in the Basel proposals are to be the ultimate goals, what is to be done at present is start implementing the Basel proposal in a phased manner and carefully plan in that direction. The incentive for banks to move the measurement chain is not just to reduce regulatory capital but more Importantly to provide assurance to the top management that the bank holds the required capital.
REGULATORY RISK
When owned funds alone are managed by an entity, it is natural that very few regulators operate and supervise them. However, as banks accept deposit from public obviously better governance is expected of them. This entails multiplicity of regulatory controls. Many Banks, having already gone for public issue, have a greater responsibility and accountability. As banks deal with public funds and money, they are subject to various regulations. The very many regulators include Reserve Bank of India (RBI), Securities Exchange Board of India (SEBI), Department of Company Affairs (DCA), etc. Moreover, banks should ensure compliance of the applicable provisions of The Banking Regulation Act, The Companies Act, etc. Thus all the banks run the risk of multiple regulatory-risks which inhibits free growth of business as focus on compliance of too many regulations leave little energy and time for developing new business. Banks should learn the art of playing their business activities within the regulatory controls.
ENVIRONMENTOL RISK
As the years roll by and technological advancement take place, expectation of the customers change and Enlarge. With the economic liberalization and globalization, more national and international players are operating the financial markets, particularly in the banking field. This provides the platform for environmental change and exposes the bank to the environmental risk. Thus, unless the banks improve their delivery channels, reach customers, innovate their products that are service oriented; they are exposed to the environmental risk resulting in loss in business share with consequential profit.
the world. In consultation with the supervisory authorities of a few non-G-10 countries including India, core principles for effective banking supervision in the form of minimum requirements to strengthen current supervisory regime, were mooted. The 1988 Capital Accord essentially provided only one option for measuring the appropriate capital in relation to the risk-weighted assets of the financial institution. It focused on the total amount of bank capital so as to reduce the risk of bank solvency at the potential cost of banks failure for the depositors. As an improvement on the above, the New Capital Accord was published in 2001, to be implemented by the financial year 2003-04. It provides spectrum of approaches for the measurement of credit, market and Operational risks to determine the capital required. The spread and nature of the ownership structure is Important as it impinges on the propensity to induct additional capital. While getting support from a large body of shareholders is a difficult proposition when the banks performance is adverse, a smaller shareholder base constrains the ability of the bank to garner funds. Tier I capital is not owed to anyone and is available to cover possible unexpected losses. It has no maturity or repayment requirement, and is expected to remain a permanent component of the core capital of the counter party. While Basel standards currently require banks to have a capital adequacy ratio of 8% with Tier I not less than 4%, RBI has mandated the banks to maintain CAR of 9%. The maintenance of capital adequacy is like aiming at a moving target as the composition of risk-weighted assets gets changed every minute on account of fluctuation in the risk profile of a bank. Tier I capital is known as the core capital providing permanent and readily available support to the bank to meet the unexpected losses. In the recent past, owner of PSU banks, the government provided capital in good measure mainly to weaker banks. In doing so, the government was not acting as a prudent investor as return on such capital was never a consideration. Further, capital infusion did not result in any cash flow to the receiver, as all the capital was required to be reinvested in government securities yielding low interest. Receipt of capital was just a book entry with the only advantage of interest income from the securities.
CAPITAL ADEQUACY
Subsequent to nationalization of banks, capitalization in banks was not given due importance as it was felt necessary for the reason that the ownership of the banks rested with the government, creating the required confidence in the mind of the public. Combined forces of globalization and liberalization compelled the public sector banks, hitherto shielded from the vagaries of market forces, to come to terms with the market realities where certain minimum capital adequacy has to be maintained in the face of stiff norms in respect of income recognition, asset classification and provisioning. It is clear that multi pronged approach would be required to meet the challenges of maintaining capital at adequate levels in the face of mounting risks in the banking sector. In banks asset creation is an event happening subsequent to the capital formation and deposit mobilization. Therefore, the preposition should be for a given capital how much asset can be created? Hence, in ideal situation and taking a radical view, stipulation of Asset Creation Multiple (ACM), in lieu of capital adequacy ratio, would be more appropriate and rational. That is to say, instead of Minimum Capital Adequacy Ratio of 8 percent (implying holding of Rs 8 by way of capital for every Rs 100 risk weighted assets), stipulation of Maximum Asset Creation Multiple of 12.5 times (implying for maximum Asset Creation Multiple of 12.5 time for the given capital of Rs 8) would be more meaningful. However as the assets have been already created when the norms were introduced, capital adequacy ratio is adopted instead of asset creation multiple. At least in respect of the new banks (starting from zero), Asset Creation Multiple (ACM) may be examined/thought of for strict implementation.
The Economic Capital is the amount of the capital (besides the Regulatory Capital) that the firm has to put at risk so as to cover the potential loss under the extreme market conditions. In other words, it is the difference in mark-to-market value of assets over liabilities that the bank should aim at or target. As against this, the regulatory capital is the actual Capital Funds held by the bank against the Risk Weighted Assets. After measuring the economic capital for the bank as a whole, banks actual capital has to be allocated to individual business units on the basis of various types of risks. This process can be continued till capital is allocated at transaction/customer level.
PNB was founded in the year 1895 at Lahore (presently in Pakistan) as an off-shoot of the Swadeshi Movement. Among the inspired founders were Sardar Dayal Singh Majithia, Lala HarKishen Lal, Lala Lalchand, Shri Kali Prosanna Roy, Shri E.C. Jessawala, Shri Prabhu Dayal, Bakshi Jaishi Ram, Lala Dholan Dass. With a common missionary zeal they set about establishing a national bank; the first one with Indian capital owned, managed and operated by the Indians for the benefit of the Indians. The Lion of Punjab, Lala Lajpat Rai, was actively associated with the management of the Bank in its formative years. The Bank made steady progress right from its inception. It has shown resilience to tide over many a crisis. It withstood the crisis in banking industry of 1913 and the severe depression of the thirties. It survived the most critical period in its history the Partlition of 1947 when it was uprooted from its major area of operations. It was the farsightedness of the management that the registered office of the Bank was shifted from Lahore to Delhi in June 1947 even before the announcement of the Partition. With the passage of time the Bank grew to strength spreading its wings from one corner of the country to another. Some smaller banks like, The Bhagwan Dass Bank Limited, Universal Bank of India, The Bharat Bank Limited, The Indo-Commercial Bank Limited, The Hindustan Commercial Bank Limited and The Nedungadi Bank were brought within its fold. PNB has the privilege of maintaining accounts of the illustrious national leaders like Mahatma Gandhi, Shri Jawahar Lal Nehru, Shri Lal Bahadur Shastri and Shrimati Indira Gandhi besides the account of the famous Jalianwala Bagh Committee. Nationalisation of the fourteen major banks on 19th July, 1969 was a major step for the banking industry. PNB was one amongst these. As a result, banking was given a new direction and thrust. The banks were expected to reach people in every nook and corner, meet their needs, and work for their economic upliftment. Removal of poverty and regional imbalances were accorded a high priority. PNB has always responded enthusiastically to the nation's needs. It has been earnestly engaged in the task of national development. In the process, the bank has emerged as a major nationalized bank.
DISCLOSURES UNDER THE NEW CAPITAL ADEQUACY FRAMEWORK (BASEL II GUIDELINES) FOR THE YEAR ENDED 31 March, 2012: 1. Capital Structure;
Banks Tier I capital comprises of Equity Shares, Reserves and Innovative Perpetual Bonds. Bank has issued Innovative Perpetual Bonds (Tier 1 capital) and also other bonds eligible for inclusion in Tier 2 capital.
2. Capital Adequacy:
The bank believes in the policy of total risk management. Bank believes that risk management is one of the foremost responsibilities of top/senior management. The Board of Directors decides the overall risk management policies and approves the Risk Management Philosophy & Policy, Credit Management & Risk policy, Investment policy, ALM policy, Operational Risk Management policy, Policy for internal capital adequacy assessment process (ICAAP), Credit Risk Mitigation & Collateral Management Policy, Stress Testing Policy and Policy for Mapping Business Lines/Activities, containing the direction and strategies for integrated management of the various risk exposures of the Bank. These policies, interalia, contain various trigger levels, exposure levels, thrust areas etc.
The bank has constituted a Board level subcommittee namely Risk Management Committee. The committee has the overall responsibility of risk management functions and oversees the function of Credit Risk Management Committee (CRMC), Asset Liability Committee (ALCO) and Operational Risk Management Committee (ORMC). The meeting of RMC is held at least once in a quarter. The bank recognizes that the management of risk is integral to the effective and efficient management of the organization.
(iv) The installment or principal or interest thereon remains overdue for two crop seasons for short duration and the installment of principal or interest thereon remains overdue for one crop season for long duration crops. Credit approving authority, prudential exposure limits, industry exposure limits, credit risk rating system, risk based pricing and loan review mechanisms are the tools used by the bank for credit risk management. All these tools have been defined in the Credit Management & Risk Policy of the bank. At the macro level, policy document is an embodiment of the Banks approach to understand measure and manage the credit risk and aims at ensuring sustained growth of healthy loan portfolio while dispensing the credit and managing the risk. Credit risk is measured through sophisticated models, which are regularly tested for their predictive ability as per best practices.
As an integral part of Risk Management System, bank has put in place a well-defined Loan Review Mechanism (LRM). This helps bring about qualitative improvements in credit administration. A separate Division known as Credit Audit & Review Division has been formed to ensure LRM implementation. The credit risk ratings are vetted/ confirmed by an independent authority. The risk rating and vetting process are done independent of credit appraisal function to ensure its integrity and independency. All loan proposals falling under the powers of GM & above at HO/ Field General Manager and Circle Head at field are routed through Credit Committee. To ensure transparency and to give wider coverage, the committee consists of one representative each from risk management department, Credit Department and one representative from an area not connected with credit. The proposals are deliberated in the Credit Committee from business objectives, risk management objectives, and policies perspectives. The rating category wise portfolio of loan assets is reviewed on quarterly basis to analyze mix of quality of assets etc. In order to provide a robust risk management structure, the Credit Management and Risk policy of the bank aims to provide a basic framework for implementation of sound credit risk management system in the bank. It deals with various areas of credit risk, goals to be achieved, current practices and future strategies. Though the bank has implemented the Standardized Approach of credit risk, yet the bank shall continue its journey towards adopting Internal Rating Based Approaches. As such, the credit policy deals with short term implementation as well as long term approach to credit risk management. The policy of the bank embodies in itself the areas of risk identification, risk measurement, risk grading techniques, reporting and risk control systems /mitigation techniques, documentation practice and the system for management of problem loans
Once the borrower has failed to make interest or principal payments for 90 days the loan is considered to be a non-performing asset. Non-performing assets are problematic for financial institutions since they depend on interest payments for income.
Asset Liability Management Committee (ALCO) is primarily responsible for establishing the market risk management and asset liability management of the bank, procedures thereof, implementing risk management guidelines issued by regulator, best risk management practices followed globally and ensuring that internal parameters, procedures, practices/policies and risk management prudential limits are adhered to. ALCO is also entrusted with the job of fixing Base rate and pricing of advances & deposit products and suggesting revision of BPLR to Board. The policies for hedging and/or mitigating risk and strategies & processes for monitoring the continuing effectiveness of hedges/mitigates are discussed in ALCO and based on views taken by /mandates of ALCO, hedge deals are undertaken. Liquidity risk of the bank is assessed through gap analysis for maturity mismatch based on residual maturity in different time buckets as well as various liquidity ratios and management of the same is done within the prudential limits fixed thereon. Advance techniques such as Stress testing, simulation, sensitivity analysis etc. are used on regular intervals to draw the contingency funding plan under different liquidity scenarios.
Interest Rate Risk in the Banking Book (IRRBB): The interest rate risk is managed through gap analysis and duration gap analysis. Duration gap analysis is being carried out at quarterly intervals to assess the interest rate risk of both banking book and trading book. Prudential limits have been fixed for impact on Net Interest Income (NII), Net Interest Margin (NIM), minimum ROA & minimum duration gap for the bank. Behavioral studies are being done for assessing and apportioning volatile and nonvolatile portion of various non-maturity products of both assets and liabilities. The tools used are: Earning Approach (Interest rate sensitivity Statement- Net Gaps) Table 1: Interest rate sensitivity - net gaps
The reprising assumptions on assets and liabilities are taken as per RBI guidelines. The floating rate advances are assumed to be reprised in 29 days to 3 months. Earning at Risk: Impact of 0.5 % change upward/downward in interest rate on NII/NIM
Operational Risk:
The bank adopts three lines of defense for management of operational risk, the first line of defense represented by Various HO Divisions which are Control Units(CU), Business Units(BU) or Support Units(SU) ; Second line of defense represented by independent Corporate Operational Risk Management Function (CORF) being Operational Risk Management Department(ORMD) as envisaged under Basel guidelines ; Third lines of defense represented by Inspection & Audit Division/Management Audit Division(IAD/MARD) which is a challenge function to the first two lines of defense Operational Risk Management Committee (ORMC) headed by CMD with both the EDS and key divisional heads as members is the Executive level committee to oversee the entire operational risk management of the bank.
AXIS BANK
INTRODUCTION OF AXIS BANK:
Axis Bank Limited is an Indian financial services firm headquartered in Mumbai, Maharashtra. It had begun operations in 1994, after the Government of India allowed new private banks to be established. The Bank was promoted jointly by the Administrator of the Specified Undertaking of the Unit Trust of India (UTI-I), Life Insurance Corporation of India (LIC), General Insurance Corporation Ltd., National Insurance Company Ltd., The New India Assurance Company, The Oriental Insurance Corporation and United India Insurance Company UTI-I holds a special position in the Indian capital markets and has promoted many leading financial institutions in the country. As on the year ended 31 March, 2012, Axis Bank had operating revenue of 13,437 crores and a net profit of 4,242 crores. Axis Bank (UTI Bank) opened its registered office in Ahmedabad and corporate office in Mumbai in December 1993. The first branch was inaugurated in April 1994 in Ahmedabad by Dr. Manmohan Singh, then the Honorable Finance Minister. The Bank, as on 31st March, 2012, is capitalized to the extent of Rest. 413.20 crores with the public holding (other than promoters and GDRs) at 54.08%.
DISCLOSURES UNDER THE NEW CAPITAL ADEQUACY FRAMEWORK (BASEL II GUIDELINES) FOR THE YEAR ENDED 31 March, 2012: 1. SCOPE OF APPLICATION:
Axis Bank Limited (the Bank) is a commercial bank, which was incorporated on 3 December, 1993. The Bank is the controlling entity for all group entities that include its six wholly owned subsidiaries. While computing the consolidated Banks Capital to Risk-weighted Assets Ratio (CRAR), the Banks investment in the equity capital of the wholly-owned subsidiaries is deducted, 50% from Tier 1 Capital and 50% from Tier 2 Capital. The subsidiaries of the Bank are not required to maintain any regulatory capital.
Equity Capital
The Bank has authorized share capital of `500.00 crores comprising 500,000,000 equity shares of `10/each. As on 31 March, 2012 the Bank has issued, subscribed and paid-up equity capital of `413.20 crores, constituting 413,203,952 numbers of shares of `10/- each. The Banks shares are listed on the National Stock Exchange and the Bombay Stock Exchange. The GDRs issued by the Bank are listed on the London Stock Exchange (LSE).During the year, the Bank has also allotted equity shares to employees under its Employee Stock Option Plan. The provisions of the Companies Act, 1956 and other applicable laws and regulations govern the rights and obligations of the equity share capital of the Bank.
3. CAPITAL ADEQUACY:
Axis Bank is subject to the capital adequacy guidelines stipulated by RBI, which are based on the framework of the Basel Committee on Banking Supervision. As per the capital adequacy guidelines under Basel I, the Bank is required to maintain a minimum ratio of total capital to risk weighted assets (CRAR) of 9.0%, at least half of which is required to be Tier 1 Capital. As per Basel II guidelines, Axis Bank is required to maintain a minimum CRAR of 9.0%, with minimum Tier 1 Capital ratio of 6.0%. In terms of RBI guidelines for implementation of Basel II, capital charge for credit and market risk for the financial year ended 31 March, 2012 will be required to be maintained at the higher levels implied by Basel II or 80% of the minimum capital requirement computed as per the Basel I framework. For the year ended 31 March, 2012, the minimum capital required to be maintained by Axis Bank as per Basel II guidelines is higher than that required at 80% of the capital requirements under Basel I guidelines.
Credit Risk, Market Risk and Operational Risk and the head of each team reports to the Chief Risk Officer.
5. CREDIT RISK: Credit risk covers the inability of a borrower or counter-party to honor
commitments under an agreement and any such failures, which have an adverse impact on the financial performance of the Bank. The Bank is exposed to credit risk through lending and capital market activities
i. Rating linked single borrower exposure norms, ii. Delegation of powers, iii. Review frequency These methods have been adopted by the Bank. The Bank has developed rating tools specific to market segments such as large and mid corporate, SME, financial companies, microfinance companies and project finance to objectively underlying risk associated with such exposures. The credit rating tool uses a combination of quantitative inputs and qualitative inputs to arrive at a point-in-time view of the risk profile of counterparty. Each internal rating grade corresponds to a distinct probability of default over one year. Go/No-Go score cards are used for various SME schematic products and retail agri schemes. Statistical application and behavioral scorecards have been developed for all major retail portfolios.
Concentration Risk:
The Bank manages concentration risk by means of appropriate structural limits and borrowerwise limits based on creditworthiness. Credit concentration in the Banks portfolios is monitored for the following: Large Exposures to Individual Clients or Group: The Bank has individual borrower-wise exposure ceilings based on the internal rating of the borrower as well as group-wise borrowing limits which are continuously tracked and monitored. Geographic concentration on sensitive sectors. Residual maturity concentration of loans and advances. Concentration of unsecured loans to total loans and advances. Concentration by Industry: Industry analysis plays an important part in assessing the concentration risk within the loan portfolio. Industries are classified into various categories based on factors such as Demand-supply, Input related risks, Government policy stance towards the sector and financial strength of the sector in general. Non-Performing Assets: Advances are classified into performing and non-performing advances (NPAs) NPAs are further classified into sub-standard, doubtful and loss assets.
i. ii. iii.
An asset, including a leased asset, becomes non-performing when it ceases to generate income for the Bank. An NPA is a loan or an advance where:
Interest and/or installment of principal remains overdue for a period of more than 90 days In respect of a term loan; the account remains out-of-order for a period of more than 90 days in respect of an Overdraft or Cash Credit (OD/CC) The bill remains overdue for a period of more than 90 days in case of bills purchased and discounted A loan granted for short duration crops will be treated as an NPA if the installments of principal or interest thereon remain overdue for two crop seasons; and A loan granted for long duration crops will be treated as an NPA if the installments of principal or interest thereon remain overdue for one crop season.
Impairment:
At each balance sheet date, the Bank ascertains if there is any impairment in its assets. If such impairment is detected, the Bank estimates the recoverable amount of the asset. If the recoverable amount of the asset or the cash-generating unit to which the asset belongs is less than its carrying amount, the carrying amount is reduced to its recoverable amount.
The reduction is treated as an impairment loss and is recognized in the profit and loss account
The Bank revalues various financial collaterals at varied frequency depending on the type of collateral. The Bank has a valuation policy that covers processes for collateral valuation.
7. SECURITISATION:
The primary objectives for undertaking securitisation activity by the Bank are enhancing liquidity, optimization of usage of capital and churning of the assets as part of risk management strategy. The securitisation of assets generally being undertaken by the Bank is on the basis of True Sale, which provides 100% protection to the Bank from default. All risks in the securitised portfolio are transferred to a Special Purpose Vehicle (SPV), except where the Bank provides sub-ordination of cash flows to Senior Pass-Through Certificate (PTC) holders by retaining the junior tranche of the securitised pool. The Bank has not sponsored any special purpose vehicle which is required to be consolidated in the consolidated financial statements as per accounting norms. Bank may also invest in securitised instruments which offer attractive risk adjusted returns. During FY 2012 no fresh investments in securitised instruments had been made. The Bank enters into purchase/sale of corporate and retail loans through direct assignment/SPV. In most cases, post securitisation, the Bank continues to service the loans transferred to the assignee/SPV. The Bank also provides credit enhancement in the form of cash collaterals and/or by subordination of cash flows to Senior PTC holders. The Bank however does not follow the originate to distribute model and pipeline and warehousing risk is not material to the Bank. Valuation of securitised exposures is carried out in accordance with FIMMDA/RBI guidelines. Gain on securitisation is recognized over the period of the underlying securities issued by the SPV. Loss on securitisation is immediately debited to profit and loss account. In respect of credit enhancements provided or recourse obligations (projected delinquencies, future servicing etc.) accepted by the Bank, appropriate provision/disclosure is made at the time of sale in accordance with AS 29 Provisions, contingent liabilities and contingent assets.
The Bank follows the standardized approach prescribed by the RBI for the securitisation activities. The Bank uses the ratings assigned by various external credit rating agencies viz. CRISIL, ICRA, Fitch and CARE for its securitisation exposures. All transfers of assets under securitisation were affected on true sale basis. However in the financial year ended 31 March, 2012, the Bank has not securitised any asset.
Concentration Risk:
Concentration risk is a banking term denoting the overall spread of a bank's outstanding accounts over the number or variety of debtors to whom the bank has lent money. This risk is calculated using a "concentration ratio" which explains what percentage of the outstanding accounts each bank loan represents. In order to remove concentration risk the Bank has allocated the internal risk limits wherever applicable. For example, the Aggregate Gap Limit is allocated to various currencies and maturities as Individual Gap Limits to monitor concentrations. Similarly, stop-loss limits and duration limits have been set up for different categories within a portfolio.
Liquidity Risk:
Liquidity risk arises from a banks inability to meet its short term, current or future obligations on the due date. It has got two dimensions: 1) Risk of being unable to fund portfolio of assets at appropriate maturity and rates (liability dimension) 2) The risk of being unable to liquidate an asset in a timely manner at a reasonable price (asset dimension). The goal of Liquidity Risk Management is to meet all commitments on the due date and funding new investment opportunities. These objectives are ensured by setting up policies, operational level committees, measurement tools and monitoring and reporting mechanism using effective use of IT systems for availability of quality data. The Bank manages its liquidity on a static as well as dynamic basis using various tools such as gap analysis, ratio analysis, dynamic liquidity statements and scenario analysis. The Banks ALM policy defines the tolerance limits for its structural liquidity position. The liquidity profile of the Bank is analyzed on a static basis by tracking all cash inflows and outflows in the maturity ladder based on the expected occurrence of cash flows. The liquidity profile of the Bank is also estimated on a dynamic basis by considering the growth in deposits and loans, investment obligations, etc. for a short-term period of three months. The Bank undertakes behavioral analysis of the non maturity products viz. savings and current deposits and cash credit/overdraft accounts on a periodic basis, to ascertain the volatility of residual balances in those accounts. The concentration of large deposits is monitored on a periodic basis. The liquidity positions of overseas branches are managed in line with the Banks internal policies and host country regulations. Such positions are also reviewed centrally by the Banks ALCO along with domestic positions.
Counterparty Risk:
The risk to each party of a contract that the counterparty will not live up to its contractual obligations. Counterparty risk as a risk to both parties and should be considered when evaluating a contract. It is often described as the default risk. For Counterparty Risk management the Bank has a Counterparty Risk management policy incorporating well laid-down guidelines, processes and measures. Separate Counterparty rating models are used for commercial banks, foreign banks and cooperative banks for determining maximum permissible limit for counterparties. The counterparty exposure limits are reviewed at periodic intervals based on financials of the counterparties, business need, past transaction experiences and market conditions. The Bank has also put in place the Suitability & Appropriateness Policy and Loan Equivalent Risk (LER) Policy to evaluate counterparty risk arising out of all customer derivatives contracts.
Country Risk:
In order to monitor the country exposure the Bank uses seven-category classification i.e. insignificant, low, moderate, high, very high, restricted and off-credit followed by the Export Credit Guarantee Corporation Ltd. (ECGC) and ratings of international rating agency Dun & Bradstreet. Exposure to a country includes all credit-related lending, trading and investment activities, whether cross border or
locally funded. The Bank has set up exposure limits for each risk category which are monitored at regular intervals. As a proactive measure of Country Risk Management, Risk Department issues Rating Watch from time to time.
Capital Requirement for Market Risk - Position as on 31 March, 2012 Amount of Capital required (` in crores)
Interest rate risk Equity position risk Foreign exchange risk (including gold) OPERATIONAL RISK: Strategies and Processes
Operational Risk is that risk which comes out of the inadequate or failed internal processes, people or systems, or from external events. In order to ensure that operational risk within the Bank is properly identified, assessed, monitored, controlled/mitigated and reported in a structured manner certain Operational Risk Management framework ( ORM), ORM policy, operational risk loss data collection methodology, risk & control self-assessment framework, key risk indicator framework, roles and responsibilities of ORM function have been approved by the Bank. The Bank formed several internal committees viz., Operational Risk Management Committee (ORMC), Product Management Committee (PMC), Change Management Committee (CMC), Outsourcing Committee, Software Evaluation Committee and IT Security Committee in order to manage Operational Risk efficiently. The Bank has further enhanced its capability for effective management of operational risk with the implementation of a software solution (OR Monitor) which creates a database on loss events experienced by the different business lines of the Bank, identify areas which show manifestation of weak controls through Risk & Control Self Assessment (RCSA) and Key Risk Indicator (KRI) modules, and over a period would enable the Bank to adopt sophisticated approaches for the computation of capital for operational risk.
The Non-Discretionary Investment Advisory Service is subject to risk arising from the investment objective, investment strategy and asset allocation. Non-Discretionary Investment Advisory Service is subject to risk arising out of nondiversification. The value of the Portfolio may increase or decrease depending upon various market forces affecting the capital markets such as de-listing of Securities, market closure, relatively small number of scripts accounting for a large proportion of trading volume. Consequently, the Portfolio Manager makes no assurance of any guaranteed returns on the Portfolio. Past performance of the Portfolio Manager does not guarantee the future performance of the same. The Client stands a risk of loss due to lack of adequate external systems for transferring, pricing, accounting and safekeeping or record keeping of securities. Transfer risk may arise due to the process involved in registering the shares physical and demat, in the Portfolio Managers name, while price risk may arise on account of availability of share price from stock exchanges during the day and at the close of the day. Equity and Equity related Risks: Equity instruments carry both company specific and market risks and hence no assurance of returns can be made for these investments. Macro-economic risks: Overall economic slowdown, unanticipated corporate performance, environmental or political problems, changes to government policies and regulations with regard to industry and exports may have direct or indirect impact on the investments, and consequently the growth of the Portfolio. Credit Risk: Debt Securities are subject to the risk of the issuers inability to meet the principal and interest payment on the obligations and may also be subject to the price volatility due to such factors as interest sensitivity, market perception, or the credit worthiness of the issuer and general market risk. Interest Rate Risk: Clients intending to avail securities linked to interest are aware that such securities is associated with movements in interest rate, which depend on various factors such as government borrowing, inflation, economic performance etc. The value of investment will appreciate/depreciate if the interest rates fall/rise. Fixed income investments are subject to the risk of interest rate fluctuations, which may accordingly increase or decrease the rate of return thereon. Acts of state, or sovereign action, acts of nature, acts of war, civil disturbance. The Client stands the risk of total loss of value of an asset, which forms parts of the Portfolio. The Client also bears the risk of its recover through legal process, which could be expensive. Some of the risks by way of illustration include default or non performance of a third party, companys refusal to register a Security due to legal stay or otherwise or disputes raised by third parties. Derivative risks: The derivatives will entail a counter party risk to the extent of amount that can become due from the party. The cost of the hedge can be higher than adverse impact of market movements. An exposure to derivatives can also limit the profits from a genuine investment transaction. Efficiency of a derivatives market depends on the developments of a liquid and efficient market for underlying securities and also on the suitable and acceptable benchmarks. Non-Diversification risk: This risk arises when the Portfolio is not sufficiently diversified by investing in a wide variety of instruments. Mutual Fund Risk: This risk arises from investing in units of mutual funds. Risk factors inherent to equities and debt securities are also applicable to investments in mutual fund units. In addition, events like change in name of the Fund Manager of the Scheme, take over and mergers of mutual funds, foreclosure of Schemes or plans, change in government policies could affect performance of the investment in mutual fund units. Price/Volatility Risk: Equity Markets can show large fluctuations in price, even in short periods of time. Investors should be aware of this and only invest in equity or equity related products if their investment horizon is long enough to support these important price movements.