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RISK MANGEMENT IN BANK

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CHAPTER: - 1
INTRODUTION
Peter L Bernstein in his celebrated book, Against the Gods- the Remarkable Story of Risk
stated that in the Dark Age risk was always associated with God as the mankind progressed
and business and markets grew the art of risk management grew from primitive stages to modern
day rocket science.
Risk is an inherent component of our life, be it in business or our personal life. The one
who is able to manage it properly emerge the winner.
In simple terms, risk can be defined as any uncertainty about a future event that threatens
the organizations ability to accomplish its mission. Business is a trade off between risk and
return. The word risk may have different meanings to different users. To a lay man, it has
connotations that one invariably associates with the games of gambling or reckless behaviors in
life. In contrast, to an information age company however, taking risk is one of the most
important critical success factors as it encourages innovation. Innovation demand trying of new
things, and trying something new again calls for uncertainty where one dose not know whether
one will succeed or fall. Therefore, it is said to be taking a risk. To some others risk or risk-based
functioning is a favorite hobby. Those who fall in this category are termed as speculators. Thus,
though risk in an inherent feature to take it. Having briefly discussed the overview of what risk is
all about, let us now turn our focus towards the definition of risk.
WHAT IS RISK?
Recalling our earlier statements we can say that risk means different things to different
people. For some, it is financial (exchange rate, interest-call money rates) and for others, an
event or commitment which has the potential to generate commercial liability or damage to the
brand image. Since risk is accepted in business as a trade off between reward and threat, it does
mean that taking risk brings froth benefits or well. In other words, it is necessary to accept risk, if
the desire is to reap the anticipated benefits. Risk in its pragmatic definition of risk is very
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pertinent today as the current business environment offers both challenges and opportunity to
organization, which have to manage them to their competitive advantage.
RISK MANAGEMENT
Risk management is a discipline that deals with the possibility that some future event will
cause them. The proper management of risk provides strategies, techniques, and an approach to
recognize and confront any threat faced by an organization that seeks to fulfill its mission.
It is to be always borne in mind that the process of risk management does not aim at risk
elimination, out enable the organization to bring its risk to manageable proportions while not
severely affecting their income. This balancing act between the risk level and the level of profits
earned, needs to be well-planned. Apart from bringing the risk to manageable extent, it is also to
be ensured that in risk does not get transformed in to any other undesirable risk. This
transformation takes place due to the inter-linkage present among the various risks. The focal
point in managing any risk is to understand the nature of the transaction so as to unbundle the
risks that it is exposed to.
It sharp contract to our country, the discipline of risk management is a more popular
subject in the western world. This is largely a result of the lesson from major cooperate failures,
a telling and visible example being the baring collapse. In additions, there has been the
introduction of regulatory requirements that expect organizations to have effective risk
management practices. In India, whilst risk management is still in its infancy, there has been
considerable debate on the need to introduce comprehensive risk management practices.
RISK MNANGEMENT IN BANK
Indian banking industry is going through a transformation process in its transformational
journey from the era of protected economy to the though world of market economy. Banks are
expanding their operations, entering new market and trading in new assets types. The change in
financial system product and structures has created new opportunity along with new risk. Risk
management has become internal part of financial activity of bank and other market participates.
Their risk cant be ignored and either has to be managed by market participates as part of assets-
liability management or hedge. Under their circumstances, creating an environment that
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promotes risk management assumes critical importance. This requires addressing certain policy
and institutional issues in developing in India.
First and foremost a well-developed market, repo market constitutes an important
prerequisite for the promotion of risk management practice among market participants.
Regulatory gaps and overlaps in debt markets need to be sorted out quickly to facilities the repeal
of the 1669 notification which will go a long way in aiding the process of ALM for banks. Indian
conditions are suitable for introduction of credit default swap in India. It offers advantages of
hedging credit risk without impairing the relationship with the borrowers. Forward, rate
agreements and interest rate swaps enables user to lock into spreads. Then RBI has already
permitted interest rates swaps. A major reason for lack of term money market is the obscene of
the practice of ALM system among bank for identifying mismatches in carols time periods. The
recent RBI guidelines to lend on a term and also offer two way quotes in the market. The
advisory group on banking supervision constituted by RBI recommended greater orientation of
banks management OECD principal of corporate governed recognizes the risk management as
area of increasing importance for board which is related to corporate strategy.










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CHAPTER: - 2
OBJECTIVES OF RISK MANAGEMENT
While discussing the basic objectives of a risk management function, one comes across two
schools of thoughts. One speaks about managing risks, maximizing profitability and creating
opportunity out of risks and the other concerns with minimizing risks or the loss associated with
the business operations and thus protecting corporate assets. The management of an organization
needs to consciously decide whether or not it wants to pursue risk management function to
mange or reduce risks. Managing risks essentially is about striking the right balance between
risks and controls and taking informed management decisions on opportunities and threats facing
an organization. Bothe these situations, i.e. over or under controlling risk are not desirable as the
former means higher costs and the latter means possible exposure to risk.
The process of mitigating or minimizing risks, on the other hand, means mitigating or
minimizing all risks even if may also mean that the opportunities are not adequately exploited. In
the context of the risk management function, identification and management of risk is more
prominent in the financial services sector and less so in the consumer products industry.








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CHAPTER: - 3
APPROACHES TO RISK MANAGEMENT
After the different types of risks are identified, the next step involves identifying the alternate
approaches available for managing/ reducing the risks. The various approaches are described
below:
Avoidance: The concept of risk is relevant if the bank is holding an asset/liability which
is exposed to risk. Avoidance refers to not holding such an asset/liability as a means of
avoiding the risk. Exchange risk can be avoided by not holding assets/liabilities
denominated in foreign currencies. Business risk is avoided by not doing the business
itself. This method can be adopted more as an exception than as a rule since any business
activity necessitates holding of assets and liabilities.
This approach has application when a bank is planning to decide exposure limits. For
example, a bank may decide to avoid a particular industry say, Aquaculture or Poultry,
while extending credit or it may decide not to lend to certain type of bank in the money
market.
Loss control: Loss control measure is used in case of the risks which are not avoided.
These risks might have been assumed either voluntary or because they cannot be avoided.
The objective of these measures either to prevent a loss or to reduce the probability of
loss. Insurance, for example, is a loss control measure. Introduction of system and
procedures, internal or external audit help in controlling the losses arising out of
personnel. Raising funds through floating rate interest bearing instruments can reduce the
losses due to interest rate risk.
Separation: the scope for loss by concentrating an asset as a single location can be
reduced by distributing it to different locations, assets which are needed for routine
consumption can be placed at multiple locations so that loss in case of any accident can
be minimized. However, does simultaneously increase the number of risk centers.
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Consider tow banks, one which has a wide network across the country and another which
is confined to one state. An adverse economic scenario of the set latter more than the
former. This is more conspectuses when one compares a cooperative bank with a
commercial bank.
Combination: This reflects the old adage of not putting all the eggs in one basket. The
risk of default is less when the financial assets are distributed over a number of issuer
intend of locking them with a single issuer. It pays to have multiple supplier of raw
material intend of relying on a sole supplier. A well-diversified company has a lower risk
of experiencing a recession.
Transfer: Risk reduction can be achieved by transfer. The transfer can be of three types.
In the first type, the risk can be transferred by transferring the asset/liability itself. For
instance, the risk emanating by holding a property or a foreign currency security can be
eliminated by transferring the same to another. The second type of transfer involves by
transferring the risk without transferring the asset/liability. The exchange risk involved in
holing a foreign currency asset/liability can be transferred to another by entering into a
forward contract/currency swap. Similarly, the interest rate risk can be involves making a
third party pay for the losses without actually transferring the risk. An insurance policy
covering the third party risk is an example.
When a bank takes a policy to cover the losses incurred on account of misuse of lost credit cards,
it is in effect finding someone to finance the losses while it still has the obligation to pay the
Merchant Establishment.
Except for the approach of avoidance, the bank can effectively adopt other since by avoiding risk
the bank will not be making any profits. From the above discussion on risk, it is now evident that
banks can neither do without profits nor risk. However, mere acceptances of risk to remain
profitable dose not an ultimate danger that the bank itself may fail. The question that arises at
this point is what should the bank do in order to take risk for greater returns and at the same time
not end up in losses? Risk management is the solution to such a situation.


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CHAPTER 4
TYPES OF RISKS
As per the RESERVE BANK OF INDIA guidelines issued in October 1999, there are
three major types of risks encountered by the banks and these CREDIT RISK, MARKET RISK
AND OPERATIONAL RISK. In the article, we will see what the components of these three
major risks are. In August 2001, a discussion paper on move towards Risk based Supervision
was published. Further, in September 2001 a guidance note on Credit Risk Management was sent
to all the banks. Recently in March 2002, a guidance note on Market Risk Management was also
circulated to all the banks and this was followed by a discussion paper on Country Risk released
in May 2002.
Risk is the potentiality that both the expected and unexpected events may have as 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 entirety 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 and provisions and the unexpected
losses require capital allocation. Hence, the need for sufficient Capital Adequacy Ratio is felt.
Each type of risk is measured to determine both the expected and unexpected losses using VaR
(Value at Risk) or worst-case type analytical model.



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Types of Financial Risks

Financial Risks

Market Risk Credit Risk Operational Risk

[I] CREDIT RISKS:-
Credit risk or default risk may be defined as the potential that a bank borrower or counterparty
will fail no meet its obligations in accordance with the agreed terms. Sources of credit risk exist
throughout the activities of the bank, these are:
1. Loans, which are the largest and most important sources of credit risk. Loans and advances
constitute nearly 65% of the total assets of the scheduled commercial banks in India at the end of
any normal financial year.
2. Investment (in non-SLR instruments), including certificate of deposits, commercial paper,
equity shares of PSUs and private corporate sector, brands / debentures / preference shares issued
by PSUs and private corporate sector etc. The exposure to such investments in respect of the
scheduled commercial banks of India may be 7-9% of the total assets as at the end of March of
any normal financial year.
3 Off balance sheet activities / items. These item are not booked on the balance sheets and are
of a contingent nature, and hence carry a definite element of risk although they generate a fee
income for the banks, Indian banks are presently exposed to the off-balance sheet item such as
foreign exchange contracts, guarantees, acceptance etc. These, put together, constitute 6-7% of
the total assets in respect of the scheduled commercial bank in India at the end of the March of
any normal year. With further liberalization, banks are taking up new types of off-balance sheet
exposures such as future, swaps, options, etc.
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4. The remaining 25 to 30% of demand and time liabilities of the banks in locked up by way of
cash. Reserve Ratio (CRR) or Statutory Liquidity Ratio (SLR). Credit risk is generally made up
of transaction risk or default risk and portfolio risk. Transaction risk arises from individual credit
transactions of the bank at a micro-level and is evaluated through technical, financial and
economic analyses of individual borrowers Project. Whereas, portfolio risk arises out of the
total credit exposures of the bank at a micro-level. Portfolio risk may be intrinsic, e.g. a
particular group or type of customers or industry may have a higher risk profile as compared to
the other group or types. Portfolio risk may also arise out of undue concentration to credits to
single borrowers or counterparties, a group of connected borrowers or counterparties, particular
industries / sectors, borrowers in a particular geographic location, etc. In the event that a
particular group or industry experiences downturn, the entire portfolio may turn into non-
performing assets, at least at that pointed time.

The Bank considers rating of a borrower account as an important tool to manage the credit risk
associated with any borrower and accordingly a two dimensional credit rating system was
introduced in the Bank. Software driven rating / scoring models for different segments have been
customized to suit the Banks requirements.
Credit Rating
1. Obligor Rating
Financial Parameters
Managerial Parameters
Industrial Parameters
Operational Parameters
2. Facility Rating (Collateral Securities)
AAA Lowest Risk
AA Lower risk
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A Low Risk
BBB Moderate risk Entry Level
BB High risk
B Higher risk
C Highest risk
D Absolute risk
E Caution risk
CHALLENGES IN CREDIT RISK MANAGEMENT (CRM)
Bank in emerging markets like India, face intense challenges in managing Credit Risk, These
may be determined by factors external to the bank, such as:
Delay in production schedules/production difficulties of borrowers
Frequent instability in the business environment
Wide swings in commodity/equity prices, foreign exchange rates and interest rates
Legal framework less conductive to debt recovery, hence time consuming
Financial restrictions
Government policies and controls
Economic sanctions
Natural disasters, etc.
These may be further aggravated by internal factor/deficiencies in the management of Credit
risk within the bank like

Deficiencies in loan policies / administration
Lack of portfolio concentration limits
Excessive centralization or decentralization of lending authority
Deficiencies in appraisal of financial position of the borrowers/borrowed units
Poor industry analysis
Infrequent customer contact
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Inadequate post-sanction surveillance
Lack of articulated loan review mechanism
Failure to improve collateral position as credit portfolio deteriorates
Absence of stringent asset classification and loan loss provisioning standards
Inadequate checks and balances in the credit management process, and
Failure to control and audit the credit process effectively

These deficiencies may lead to weaknesses in the loan portfolio of the Bank, like over
Concentration of loans in one industry or sector, large portfolios of non-performing loans and
credit losses. These may, in turn, lead to cash crunch and ultimately insolvency. The fact that the
bank operating in an economic environment that poses formidable challenges for good credit
management gives all the more reason to them to strengthen their credit risk management
practices and sharpen their credit management skills, both pre-sanction and post-sanction.

CREDIT RISK ENVIROMENT
A fundamental prerequisite for credit risk management is establishment of an appropriate credit
risk environment. Banks should have a clear cut perspective on credit risk strategy and evolve
suitable policies and procedures to implement it. These should be effectively discussed across
various levels and then communicated throughout the organization for implementation. All
relevant personnel should clearly understand the banks approach to granting credit and should
comply with the established policies, practices and procedures, relating to pre-sanction appraisal
and post-sanction follow-up.

Internationally, the responsibility for designing and implementing credit risk management
system (viz, identifying, measuring, monitoring and controlling credit risk), is vested with the
top management of the banks. The Basel committee document has recommended that:


The board of directors should have the responsibility for approving and periodically
reviewing the credit risk strategy and significant credit risk policies of the bank, The strategy
should reflect the banks tolerance for risk and the level of profitability the bank expect to
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achieve by creating a loan assets mix the carries various credit risk, within the tolerance level
fixed by the board.
Senior management should have the responsibility for implementing the credit risk strategy
approved by the board and developing the policies and procedures for identifying, measuring,
monitoring and controlling credit risk, such policies and procedures should address credit
risk in all the banks activities and at both individual credit and portfolio levels.
Bank should identify and manage credit risk inherent in all products and actives. New
Products and activities should be subject to close watch and adequate procedures and
Controls should be in place before they are introduced or launched.


CREDIT RISK STRATEGY

A credit risk strategy or plan established the objectives for guiding the banks credit-granting
Activities and its credit risk management functions. The strategies or directives:

Typically provide general parameters for the types of credits that the bank will offer and the
types of customers that the bank will serve, as dictated by current strategic decision. In a
particular year, the bank may like to concentrate on infrastructure finance, or may like to
expand in the retail finance segment. These strategies should be formulated by the credit
policy and credit administration Division, and faithfully implemented after getting approval
from the board of the Bank, Similarly loan-concentration levels in particular industries or
market segments should carefully be regulated and kept under constant watch.
Due attention should be given to the goals of credit quality, earnings and growth.
Ensure continuity in approach. These will need to take into account the cyclical patterns of
the industry and economy and the resultant shifts in the overall composition and quality of
the credit portfolio. These strategies should be viable in the long-run, and these, in turn;
Should be effectively communicated throughout the organization and feedback obtained to
ensure that the massage and concepts have correctly registered at levels down the line

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Credit Risk Management of ICICI
Credit risk, the most significant risk faced by ICICI Bank, is managed by the Credit Risk
Compliance & Audit Department (CRC & AD) which evaluates risk at the transaction level as
well as in the portfolio context. The industry analysts of the department monitor all major sectors
and evolve a sectorial outlook, which is an important input to the portfolio planning process. The
department has done detailed studies on default patterns of loans and prediction of defaults in the
Indian context. Risk-based pricing of loans has been introduced.
The functions of this department include:
Review of Credit Origination & Monitoring
Credit rating of companies/structures
Default risk & loan pricing
Review of industry sectors
Review of large exposures in industries/ corporate groups/ companies
Ensure Monitoring and follow-up by building appropriate systems such as CAS
Design appropriate credit processes, operating policies & procedures
Portfolio monitoring
Methodology to measure portfolio risk
Credit Risk Information System (CRIS)
Focused attention to structured financing deals
Pricing, New Product Approval Policy, Monitoring
Monitor adherence to credit policies of RBI
During the year, the department has been instrumental in reorienting the credit processes,
including delegation of powers and creation of suitable control points in the credit delivery
process with the objective of improving customer response time and enhancing the effectiveness
of the asset creation and monitoring activities.
Availability of information on a real time basis is an important requisite for sound risk
management. To aid its interaction with the strategic business units, and provide real time
information on credit risk, the CRC & AD has implemented a sophisticated information system,
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namely the Credit Risk Information System. In addition, the CRC & AD has designed a web-
based system to render information on various aspects of the credit portfolio of ICICI Bank.
[II] MARKET RISK:-

Traditionally, credit risk management was the primary challenge for banks. With
progressive deregulation, market risk arising adverse changes in market variables, such as
interest rate, foreign exchange rate, equity price and commodity price has become relatively
more important. Even a small change in market variables causes substantial changes in income
and economic value of banks.

MARKET RISK may be defined as the possibility of loss to a 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
framework 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 asses areas of potential
problems in a given portfolio. Identification of future changes in economic conditions like-
ECONOMIC / INDUSTRY OVERTURNS.
MARKET RISK EVENTS.
LIQUIDITY CONDITIONS.

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That could have unfavorable effect on banks portfolio is a condition precedent for
carrying out stress testing. As the underlying assumption keeps changing from time to time, out-
put of the test should be reviewed periodically.

Market risk arises out of the dynamics of market forces, which, for the banking industry,
may include interest rate fluctuations, maturity mismatches, exchange rate fluctuations, market
competition in terms of services and products, changing customer preferences and requirements
resulting in product obsolescence, coupled with changes national and international politico-
economic scenario. These risks are like perils of the sea, which can be caused by any change-
taking place anywhere in the national and international arena.

Market risks affect banks in two ways:

i. The customer requirements are changing because of the changing economic
scenario. Hence banks have to fine-tune/modify their products to make them customer
friendly, otherwise the obsolescence of products will divert the customers to other
banks thereby reducing the business and profits of the bank concerned.
ii. The macro-economic changes in the national and international politico-economic
scenario affect the risk element in different business activities differently. This aspect
has assumed greater importance in the modern age, because of the increasing
integration of global markets.

Since both these aspects are dynamic in nature, with change being the only constant
factor, market risks need to be monitored on a continuous basis and appropriate strategies
evolved to keep these risks within manageable limits. Again, given that one can manage only
what one can measure, measurement of risks on a continuous basis deserves immediate attention.

Market risk can be defined as the risk of losses in on and off balance sheet positions
arising from adverse movement of market variables.

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Market Risk Management

Management of market risk should be the major concern of top management of banks.
The Boards should clearly articulate market risk management policies, procedures, prudential
risk limits, review mechanisms and reporting and auditing systems. The policies should address
the banks exposure on a consolidated basis and clearly articulate the risk measurement systems
that capture all material sources of market risk and assess the effects on the bank. The operating
prudential limits and the accountability of the line management should also be clearly defined.
The Asset-Liability Management Committee (ALCO) should function as the top operational unit
for managing the balance sheet within the performance/risk parameters laid down by the Board.
The banks should also set up an independent Middle Office to track the magnitude of market
risk on a real time basis. The Middle Office should comprise of experts in market risk
management, economists, statisticians and general bankers and may be functionally placed
directly under the ALCO. The Middle Office should also be separated from Treasury Department
and should not be involved in the day to day management / ALCO / Treasury about adherence to
prudential / risk parameters and also aggregate the total market risk exposures assumed by the
bank at any point of time.

MARKET RISK TAKES THE FORM OF:-

1) Liquidity Risk
2) Commodity Price Risk and
3) Equity Price Risk

A concise definition of each of the above Market Risk factors and how they are managed is
described below:
LIQUIDITY RISK/MATURITY GAP RISK:-

Liquidity Planning is an important facet of risk management framework in banks.
Liquidity is the ability to efficiently accommodate deposit and other liability decreases, as well
as, fund loan portfolio growth and the possible funding of off-balance sheet claims. A bank has
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adequate liquidity when sufficient funds can be raised, either by increasing liabilities or
converting assets, promptly and at a reasonable cost. It encompass the potential sale of liquid
assets and borrowings from money, capital and forex markets. Thus, liquidity should be
considered as a defense mechanism from losses on fire sale of assets.

Liquidity risk is the potential inability of a bank to meet its payment obligations in a
timely and cost effective manner. It arises when the bank is unable to generate cash to cope with
a decline in deposits/liabilities or increase in assets.
The cash flows are placed in different time buckets based on future behavior of assets,
liabilities and 0ff-balance sheet items.
LIQUIDITY may be defined as the ability to meet commitments and/or undertake new
transactions. The most obvious form of liquidity risk is the inability to honor desired withdrawals
and commitments, that is, the risk of cash shortages when it is needed which arises due to
maturity mismatch.
BANKING can also be described as a business of maturity transformation. Usually
banks, lend for a longer period than for which they borrow.
Therefore, they generally have a mismatched balance sheet in so far as their short-term
liabilities are greater than short-term assets and long-term assets are greater than long term
liabilities.
i. Liquidity risk is measured by preparing a maturity profile of assets and liabilities,
which enables the management to form a judgment on liquidity mismatch. As the
basic problem for a bank is to ascertain whether it will be able to meet maturing
obligations on the date they fall due, it must prepare a projected cash-flow statement
and estimate the probability of facing any liquidity crisis.
Liquidity measurement is quite a difficult task and can be measured through stock or cash
flow approaches. The key ratios, adopted across the banking system are: the other methods of
measuring liquidity risk are: _
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To manage liquidity risk, banks should keep the maturity profile of liabilities
compatible with those of assets.
The behavioral maturity profile of various components of on/off balance sheet
items is being analyzed and variance analysis is been undertaken regularly.
Efforts are also being made by some banks to track the impact of repayment of
loans and premature closure of deposits to estimate realistically the cash flow
profile.
Banks are closely monitoring the mismatches in the category of 1-14 days and 15-
28 days time bands and tolerance levels on mismatches are being fixed for
various maturities, depending on asset-liability profile, stand deposit base nature
of cash flows, etc.
Liquidity Risk means, the bank is not in a position to make its repayments, withdrawal,
and other commitments in time. For EXAMPLE two Canadian banks, Northland Bank and
Continental Bank of Canada suffered a run on deposits because of a credit crisis at Canadian
commercial bank.
Liquidity risk consists of FUNDING RISK, TIME RISK, and CALL RISK.
The liquidity risk in banks manifest in different dimensions:
Funding Risk It is the need to replace net outflows due to unanticipated
withdrawals/non-renewal of deposits (wholesale and retail)

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; and

Call Risk It happens due to crystallization of contingent liabilities and unable to
undertake profitable business opportunities when desirable.

EQUITY PRICES RISK:-
Equity Price Risk is the risk of loss in value of the banks equity investments and/or equity
derivative instruments arising out of change in equity prices.
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COMMODITY PRICE RISK:-
The risk of loss in value of commodity held/traded by the bank, arising out of changes in prices,
basis mismatch, forward price etc.
[III] OPERATIONAL RISK:-
Operational Risk is defined as the risk of direct or indirect loss resulting from
inadequate or failed internal processes, people and system or from external events.
Generally, operational risk is defined as any risk, which is not categorized as market or
credit risk, or the risk of loss arising from various types of human or technical error. It is also
synonymous with settlement or payments risk and business interruption, administrative and legal
risks. Operational risk has some form of link between credit and market risks. An operational
problem with a business transaction could trigger a credit or market risk.
Indeed, so significant has operational risk become that the bank for International
Settlement (BIS) has proposed that, as of 2006, banks should be made to carry a Capital cushion
against losses from this risk.

Managing operational risk is becoming an important feature of sound risk management
practices in modern financial markets in the wake of phenomenal increase in the volume of
transactions, high degree of structural changes and complex support systems.
The most important type of operational risk involves breakdowns in internal controls and
corporate governance. Such breakdowns can lead to financial loss through error, fraud, or failure
to perform in a timely manner or cause the interest of the bank to be compromised.
The objectives of Operational Risk Management is to reduce the expected operational
losses that focuses on systematic removal of operational risk sources and uses a set of key risk
indicators to measure and control risk on continuous basis. The ultimate objective of operational
risk management is to enhance the shareholders value by being ready for risk based capital
allocation.
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There is no uniformity of approach in measurement of Operational Risk in the banking system at
present
The banks operational risks can be classified into following six exposure classes
People
Process
Management
System
Business and
External
Bank has also identified 5 business lines viz..
Corporate finance
Retail banking
Commercial banking
Payment and Settlement and
Trading and Sales (Treasury operations) also
To each of this exposure classes within each business line are attached certain risk
categories under which the bank can incur losses or potential losses.
Bank collected information at first instance for a 5 year period and is being updated on a
six monthly basis June and December. These date help in qualifying the overall potential / actual
loss on account of Operational Risk and initiate measure for plugging these risk areas.
Bank may suitably at a latter date move to appropriate models for measuring and
managing Operational Risk also after receipt of RBIs Guidance Note.
MEASUREMENT
There is no uniformity of approach in measurement of operational risk in the banking
system. Besides, the existing methods are relatively simple and experimental, although some of
the international banks have made considerable progress in developing more advanced
techniques for allocating capital with regard to operational risk.
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Measuring operational risk requires both estimating the probability of an operational loss
event and the potential size of the loss. It relies on risk factor that provides some indication of the
likelihood of an operational loss event occurring. The process of operational risk assessment
needs to address the likelihood (or frequency) of a particular operational risk occurring, the
magnitude (or severity) of the effect of the operational risk on business objectives and the
options available to manage and initiate actions to reduce/mitigate operational risk. The set of
risk factors that measure risk in each business unit such as audit ratings, operational data such as
volume, turnover and complexity and data on quality of operations such as error rate or measure
of business risks such as revenue volatility, could be related to historical loss experience. Banks
can also use different analytical or judgmental techniques to arrive at an overall operational risk
level. Some of the international banks have already developed operational risk rating matrix,
similar to bond credit rating. The operational risk assessment should be bank-wide basis and it
should be reviewed at regular intervals. Banks, over a period, should develop internal systems to
evaluate the risk profile and assign economic capital within the RAROC framework..
Indian Banks have so far not evolved any scientific methods for quantifying operational
risk. In the absence any sophisticated models, banks could evolve simple benchmark based on an
aggregate measure of business activity such as gross revenue, fee income, operating costs,
managed assets or total assets adjusted for off-balance sheet exposures or a combination of these
variables.
At present, scientific measurement of operational risk has not been evolved. Hence, 20%
charge on the Capital Funds is earmarked for operational risk.
Operational Risk Management of ICICI
ICICI Bank, like all large banks, is exposed to many types of operational risks. These include
potential losses caused by events such as breakdown in information, communication, transaction
processing and settlement systems/ procedures.
The Audit Department, an integral part of the Risk Compliance & Audit Group, focuses on the
operational risks within the organization. In recent times, there has been a shift in the audit focus
from transactions to controls. Some examples of this paradigm shift are:
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Adherence to internal policies, procedures and documented processes
Risk Based Audit Plan
Widening of Treasury operations audit coverage
Use of Computer Assisted Audit Techniques (CAATs)
Information Systems Audit
Plans to develop/ buy software to capture the workflow of the Audit Department
The Audit Department conceptualized and put into operation a Risk Based Audit Plan during the
year 1998-99. The Risk Based Audit Plan envisages allocation of audit resources in accordance
with the risk constituents of ICICI Banks business.














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CHAPTER: - 5
PROCESS OF RISK MANAGEMENT
At the outset it is to be noted that risk management dose not aim at risk reduction. Risk
management enables the banks to bring their risk level to manageable proportions while not
severely reducing their income. Thus, risk management enables the bank to take required level of
exposures in order to meet its profit targets. This balancing act between the risk levels and profits
need to be well-planed. Risk management basically is a five-step process which involves:
(Draw a diagram)
A. IDENTIFICATION OF RISK: Risk can be anything that can hinder the from meeting
its targeted results. Each risk must be defined precisely in order to facilitate the
identification of the same by the banking organizations. This will also enable the banks to
have a fundamental understanding of the activities from which risks originate. This
understanding will be essential to evaluate aspects related to the magnitude of the risks,
the tenor and the implications they have on the accounting aspects. Unless the bank
identifies and understand the nature of exposures involved in a transaction, it will not be
able to mange them. Further, such unbundling also helps to bank in deciding which risk it
will have to manage and which it would prefer to eliminate. The process of unbundling
also helps a bank in pricing the risk.
B. QUANTIFICATIN OF RISKS: by measuring the risk, the bank is indirectly
quantifying the consequences of the decision taken. If risks are not quantified, the bank
will neither be aware of the consequences of its decision nor will it be in a position to
manage the risks. Thus, all risks to which the bank is exposed need to be quantified.
Quantification of risks is a crucial task and accurate measurement of the same depends
extensively on the information available. The quality of information coming from various
branches, however, depends on the reporting system. The information provided needs to
be further evaluated to ensure that there is an effective and ongoing flow of information.
Technology and MIS pay a crucial role here.
C. POLICY FORMATION: The next stem will be developing a policy that gives the
standard level of exposures that the bank will have to maintain in order to protect cash
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flows. Policy is a long-term framework to tackle risk and hence the frequency of changes
taking place in it is very low. Setting policies for risk management will depend on the
banks objectives and its risk tolerance levels. The risk levels set by the bank neither
should neither be too high that goes beyond the banks capacity to manage it nor should it
be too low that the profitability is affected. The bank should decide on a particular risk
exposure level only if it aids in achieving the banks objectives and also if it believe s that
it has the capacity to manage the risk for a gain. If either of the conditions is not met, the
bank will have to try and eliminate/minimize the risk.
D. STRATEGY FORMULATION: A strategy is that which is developed to implement a
policy. Clearly, a strategy will then be relatively for a shorter period. Given the exposure
and volatilities, a strategy helps in managing these risks. Firstly, the possible options and
the risks attached to them are examined in order to known the affect on each option on
the cash flows and the earnings. With this information, a strategy will be developed to
identify the sources of losses/gains and how efficiently the risks can be shifted to enhance
profits while reducing the exposure. Strategy differ widely depending on the nature of
exposure , the type of transaction, etc. and will also state the instruments that are to be
used to manage exposure, tenors and counterparties.
E. MONITERING RISK: laying down strategy will not less to risk management since risk
profile cannot be static. Volatile circumstance may change the risk level of the
investment and hence require the banks to restore the same to the set targets levels. For
instance, the bank takes a long position on a loan of US $1mn. At an exchange rate so
Rs.43.50, the risk which the bank is ready to take is up to Rs.0.10 variation. In absolute
terms this will be Rs. 1 lakh. However, the exchange rate goes down by Rs. 0.15 due to
which the loss to the bank is Rs. 1.5 lakh. This is beyond the target set by the bank. In
such circumstances, the bank can take a long position in US $ if it believes that the rate
will move up. And in case the rates are expected to go down further, it can either enter
into a forward contract or exit from the long position taking up the loss. In either case the
bank needs to have a view about the market regarding its future behavior.
While this is the general process for managing any type of risk, by any business firm, for a bank,
the risk management process primarily involves Asset-Liability Management (ALM). ALM is
discussed elaborately in subsequent chapters.
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CHAPTER: - 6
HOW RISK IS MANAGED
An independent Risk Management department is functioning for effective risk management
enterprise wide. Risk is managed through following three Apex committees viz.,
(i) Credit Risk Management Committee (CRMC)
(ii) Asset and Liability Management Committee (ALMC) and
(iii) Operational Risk Management Committee (ORMC)
These committees work within the overall guidelines and policies approved by the Risk
Management Committee of the Board.
The Bank has put in place various policies to manage the risk. To analyze the risk enterprise
wide and with the objective of integrating all the risks of the Bank Integrated Risk Management
Policy has also been put in place. The important risk policies comprise of Credit Risk Policy,
Asset and Liability Management Policy, Operational Risk, Management Policy, Business
Continuity Planning, Whistle Blower Policy and Policy on Corporate Governance.
The risk management systems are in place to identify and analyze the risks at the early stage, set
and maintain prudential limits and manage them to face the changing risk environment. Software
driven rating mechanism is in place to confirm the rating to ensure credit quality. An entry level
scoring system is also put in place. Loan Review Management Committee reviews the Loan
Review Mechanism and Credit Audit functions periodically. In addition, Standard Assets
Monitoring Committee reviews the Special Mention Accounts to initiate timely action to prevent
slippage of standard assets to non-performing assets. The liquidity risk is managed through
studying structural liquidity on a daily basis, which is being discussed in the Funds and
Investments Committee and reviewed every month by ALMC .The interest rate risk is managed
through monthly interest rate sensitivity statements monitored by ALMC. The mid offi ce,
directly reporting to Risk Management Department, monitors treasury transactions
independently.
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Operational risk is managed by integrating the operational risk management systems into day to
day management processes and adopting various risk mitigating strategies. The risk perception in
various products / procedures is critically analyzed. Stress tests are conducted periodically for the
credit risk, liquidity risk and interest rate/exchange rate risk.
Policy on Internal Capital Adequacy Assessment Process (ICAAP) is put in place whereby the
Bank identifies/measures and allocates Capital for various residual risks identified under Pillar II
on quarterly basis and is reviewed by the Board half yearly. The CRAR position of the Bank is
reviewed by the Board on a half yearly basis and assessment for the next three years is also
provided based on projected business position.
In compliance with the Reserve Bank of India guidelines on Basel II Pillar 3 Market
Discipline, the Bank has put in place a Disclosure Policy duly approved by the Board and
the disclosures on Quarterly / Half-yearly / Annual basis as per the policy are made in the Banks
Website / Annual Report.











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CHAPTER: - 7
ASSET-LIABILITY MANAGEMENT
Asset-liability management (ALM) is concerned with strategic b balance sheet management
involving risks caused by changes in the interest rates, exchange rates and the liquidity position
of the bank. While managing these risks forms the crux of ALM, credit risk and contingency risk
also form a part of the ALM. The significance of ALM to the financial sector is further
highlighted due to the dramatic changes that have occurred in recent years in the assets (use of
funds) and liabilities (sources of funds) of banks.
In India, the post-liberalization witnessed a rapid industrial growth, which has further stimulated
the growth in the fund rising activates. With the rise in the demand for funds there has also been
a remarkable shift in the futures of the sources and uses of funds of banks. Traditionally
administrated rates were used to price the assets and liabilities of banks. However in the
deregulated rates were used to price the assets and liabilities of banks. This led to discriminate
pricing policy, and also highlighted the need to match the maturities of the assets and liabilities.
The changes in the profile of the sources and uses of funds are reflected in the borrowers profile,
in the interest rate structure for deposits and advance etc. the developments that took places since
liberalization led to a remarkable transition in the risk profile of the financial intermediaries led.
The main reasons for the growing significance of ALM are:
Volatility
Products innovations
Regulatory environment
Management recognition
VOLATILITY: An increasing number of free economics are being witnessed in recent
times with more and more nation globalizing their operations. Closely regulated markets
are paving way of market-driven economics. Such deregulation has changed the
dynamics of the financial markets. The vagaries of such free economic environment are
reflected in the market, the exchanged rates and price levels. For a business which
involves trading in money, rate fluctuations invariably affect the market value
yields/costs of the assets/liabilities which further affect the market value of bank and its
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Net Interest Income (NIL). Tacking this situation would have been a very easy task, in a
set-up where the interest rate movements are known with accuracy and where the
volatility in the exchange rates is considerably lower.

PRODUCT INNOVATION: The second reason for the growing importance of ALM is
the rapid innovations taking place in the financial product of the bank. While some
innovations came as passing fads, other has received tremendous response. In several
cases, the same product has been repackaged with certain differences and offered by
various banks. Whatever maybe the features of the products, most of them have an
impact on the risk profile of the banks thereby enhancing the near for ALM. Consider the
flexi-deposit facility banks are now offering for their term deposits. Earlier, if a
depositor, who has a term deposit of Rs.1 Lake, was in need of funds, say rs.25, 000,
before the date of maturity of the term deposit, then the depositor would go for a
premature withdrawal of the term deposit of raise a loan. In order to discourage this,
banks charge a penalty on the entire amount for premature withdrawal. This served as a
disincentive for premature withdrawals and also reduced the risk for the bank. This
enables the investor to withdraw the required amount before maturity since the burden of
penalty is limited. However it will also enhance the risk of the bank. With a reduction in
the penalty amount, the depositor would make a demand for the premature withdrawal at
any time. To reduce the impact of the assets-liability mismatch that arise due to this early
withdrawal of funds, the bank will have to raise a liability risk when there is sudden
outflow of funds as well s interest rate risk since it may have to raise a liability at a higher
cost.
REGULATORY ENVIRONMENT: In order to enable the banks to cope with the
changing environment that has resulted due to the integration of the domestic markets
with the international markets, the regulatory bodies of various financial markets have
initiated a number of measures. These measures were taken with an objective to prevent
major losses that may arise due to market vagaries one step in this direction was the
increased focus on the management of the bank assets and liability. The RBI is also
following this direction and has recently issued a framework for banks to develop ALM
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policies. In addition to this, there are various guidelines issued by the regular on the risk
based capital to be maintained by the banks in order to tackle the credit risk.
MANAGEMENT RECOGNITION: All the above mentioned aspect forced the
managements of the banks to give a serious thought about the management of the asset
and liability. Managements have realized that it is just not sufficient to have very good
retail deposits base. In addition to these, the banks should be in a position to relate and
link the asset side with liability side. And this calls for efficient asset-liability
management.
There is increasing awareness in the top management that banking is now a afferent game
altogether because all the rules of the game have since been changed.
PURPOSE OF ALM
This enhanced level of importance to the ALM has led to a change in the nature of its
functions. It is no longer a stand-alone analytical function. While there are macro- and micro-
level objectives of ALM, it is however the micro-level objectives that hold the key for attaining
the macro-level objectives. At the macro-level, ALM leads to the formulation of critical business
policies. Efficient allocation of the capital and designing of product with appropriate pricing
strategies. And at the macro-level, the objective function of the ALM is two-fold. They aim at
profitability through price-matching whole ensuring liquidity by means of maturity matching.
Price-matching basically aims to maintain speeds by ensuring that the deployment of liabilities
will be at the rate higher than the cost. Similarly, liquidity is ensured by groping the
assets/liabilities based on their maturing profiles. The gap is then assessed to identify the future
financing requirement. This ensures liquidity. However, maintaining profitability by matching
prices and ensuring liquidity by matching the maturity levels is not an easy task. `
MACRO- AND MICRO-LEVEL ALM
Management of risks should be at two levels: macro-level and micro-level. The macro-
level risk management will involve providing a risk management framework for the bank and
hence the decision makers will clearly comprise the banks board and the top management. On
the other hand, at the micro-level business decision taken by the business managers, but within
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the board framework laid at the macro-level. Consider the following illustration that
distinguishes between the macro- and micro-level decisions for ALM:
Term loan for an aqua firm;
Investment in 10-year government paper;
Investment in the commercial paper issue of a company;
Acceptance of FCNR (B) deposit
At the macro-level the bank will have to decide on-
Whether or not to land to the aquaculture industry and in case it decides to lend, then
exposure level for lending;
Whether or not invest in a government paper/other securities having maturity, of say
over 5 years and the limit that can be set for such investment;
Whether or not to invest in the CPs issued by a company having a rating of less than
P1+; and
Lastly whether to accept FCNR (B) deposits and the limit for such acceptance.
Thus at the macro-level, broad guidelines will be given in order to enable day-to-day
decision to be taken relating to individual proposals for investment and borrowing without
the involvement of the top management. The board should clearly communicate to the
business managers the acceptable level of risks in terms of parameters chosen. This macro-
level management of risk will be conducted by the Asset-Liability management committee
(ALCO). ALSO shall not consider individual cases for decision making.
In the above instances, if the ALSO decides that the bank shall not extend any loan facility
to aqua projects, shall not invest in securities having maturity greater than 5 years and in
CPs of firms having a credit rating of less than P1+and shall not accept any FCNR (B)
deposits, then the business managers should take decisions within this framework.
Interest rate views of the bank and base its decision for future business strategy on this view.
In respect of the funding policy, for instance, its responsibility would be to decide on source
and mix of liability or sale of assets. Towards this end, it will have to develop a view on
further direction of interest rate movements vs. retail deposits, money market vs. capital
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market funding, domestic vs. foreign currency funding etc. individual banks will have to
decide the frequency for holding their ALSO meetings



















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CHAPTER: - 8
THE NEW BASEL ACCORD
Effective risk management strategies can be implemented by integrating effective bank
level management, operational supervision and market discipline. It is also imperative for
financial institutions to update their risk management practices in accordance with prevalent
legislation and regulatory environment. With these aspects in mind, the Basel committee on
Banking Supervision published the Capital Adequacy Accord, also known as the Basel Accord,
in 1988. The Basel Accord defined the parameters of risk management and capital adequacy for
Financial Service Providers (FSPs). With the growth in financial service sector, the committee
felt the need to update the Accord in line with new developments. As a result, it proposed the
New Basel Capital Accord, also known as Basel II, in June 1999. With its new risk-sensitive
framework, Basel II aims to fill the gap left by the p[pervious Accord. Basel II was devised to
improve the soundness of the financial system by aligning regulatory capital requirement to the
underlying risks of the banking industry. It encourages banks to conduct better risk management
and enhance market discipline. According to the committee, financial institutions should
integrate Basel II in their operations by the year-end 2006. Efficient risk management, as
outlined by Basel II, can be ensured by leveraging information technology.
A Basel II implementation allows banker to adequately emphasize their own internal risk
management methodologies. Bankers can also provide more incentive and options for risk
management, thereby increasing flexibility of their systems. In addition to this, Basel II provides
a variety of benefits to the banking system. These include enhanced risk management, efficient
operations, and higher revenues to the banking community.
Along with the increased benefits, Basel II has also laid down some control on the
international banking system. This is primarily in the form of a higher capital requirement to
underwrite management of risk and lace of infrastructural controls in many economies. The
global acceptance for Basel II is not far and most banks across the world will soon come under
the preview of this Accord
Comparing the new Accord with the existing one.
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Existing Accord New Accord
1. Focus on single risk. 1. More emphasis on banks measure own internal
methodology, supervisory review and market
discipline.
2. One size fits all. 2. Flexibility, menu of approaches, incentive for better
risk management.
3. Board brush structure. 3. More risk sensitivity.
After a series of revisions, Basel II has been finalized. A major part of it will be applicable by the
end of 2006. During this intervening period, bank and supervisors must develop the necessary
systems and processes to comply with the standards laid down by Basel II. For instance,
financial institutions have to maintain a history of vital data sets built prior to the implementation
date of Basel II. This will help them seamlessly migrate to Basel II. In addition, many
countries have already started work on draft rules that would integrate Basel capital standards
with their national capital regimes. The Basel II Accord aims to ensure effective risk
management and security systems in the financial sector. It has undergone rigorous revisions
before its framework has been finally frozen for implementation.
THE BASEL II FRAMEWORK
Basel II intends to provide more risk-sensitive approaches while maintaining the overall level of
regulatory capital within the financial system. This can be achieved through its meticulously
designed framework that consists of three mutually reinforcing pillars as summarized in below
figure .1
Figure 1: The Three Pillar Architecture as defined by Basel II
PILLAR FOCUS AREA
First Pillar Minimum Capital Requirements
Second Pillar Supervisory Review Process
Third Pillar Market Discipline
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PILLAR 1
MINIMUM CAPITAL REQUIREMENTS
The first pillar is designed to help cover risks within a financial institution. It aims to
set minimum capital requirements and defines the current amount of capital. The pillar also
stress on defining the capital amount by qualifying risks such as Credit Risk, Operation Risk and
Market Risk.
MEASURING CREDIT RISK
Credit Risk defines the minimum capital required to cover exposure to customers and
counter parties. The Basel II framework provides a menu of approaches in respect of credit risk.
They are:
I. Standard approach,
II. Internal rating based(IRB) approach
a. Foundation
b. Advanced

I. STANDARDIZED APPROACH: In this approach, the bank allocates a
risk- weight to each of its assets and off-balance sheet positions. It then
calculates a sum of risk-weighted asset values. A risk weight of 100%
indicates that an exposure is included in calculation of assets at full value.
The capital charge is equal to 8% of the assets value this approach, while
remaining essentially the same as in the earlier Accord, however, includes
a higher sensitivity to risk. As per the earlier Accord, individual risk
weight was dependent on the category of borrowers such as sovereign
nations or banks. In Basel II however, these weight can be defined by
referring to a rating provided by an external credit assessment agency

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II. INTERNAL RATING BASED APPROACH (IRB): In this approach,
bank use their internal evaluation systems to assess a borrowers credit
risk. The results, attained by this process, are translated into estimates of a
potential future loss, thereby defining the basis of minimum capital
requirements. The IRB approach supports the following methodologies for
cooperate, sovereign and bank exposures:

FOUNDATION- Using this methodology, bank can estimate the risk of
default or the Probability of Default (PD) associated with each borrowers.
Additional risk factor such as Loss Given Default (LGD) and Exposure at
Defaults (EAD) are standardized by supervisory rules that are laid down
and monitored by regularizing authorities.

ADVANCED- This mythology allows banks with sufficient internal
capital to assess additional risk factors. These factors include Exposure as
Default
(EAD), Loss given Default (LGD) and Maturity (M). It also allows bank
to provide guarantees and credit derivatives on the risk of exposure. The
ranges of risk in both these methodologies are more diverse than in
standardized approach, resulting in greater risk sensitivity.
MEASURING OPERATIONAL RISK
In Basel II, the operational risk can be measured using the following three
approaches:
1. BASIC INDICATOR APPROACH- This is a traditional approach,
which links the capital charge for operational risk to a single operational
parameters, such as percentage of this parameter, defined as the Alpha
Factor.

2. STANDARDIZED APPROACH- This approach is a variant of the
Basic Indicator Approach. Here, the activities of a bank are divided into
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standard industry business lines, such as corporate banking, trade
finance and many more. These business lines are then mapped by bank
into their internal framework. A percentage of capital charge, knows as
the Beta Factor, is defined for each business line. The bank can
calculate its capital charge for a business line by applying the Beta
Factor to the indicator value for the business line. The total capital
charge for the bank is calculated as the sum total of all capital charges
for individual business lines.

3. INTERNAL MEASUREMENT APPROACH(IM)- this is the most
sophisticated of all the approaches. Here, risk is measured using the
banks internal loss data. Typically, a bank collects data inputs for a
specified set of business lines and risk types. These inputs include an
operational risk indictor, data indicating the probability of a loss event,
and the losses in case these events take place.

MEASUREING MARKET RISKS
Market Risk determines the capital required to cover exposure to changes in
market conditions- such as flections in interest rates, foreign exchange rates, equity prices, and
commodity prices. The approaches to determine market risk are the same as those defined in
earlier Accord
BENEFITS OF THE FIRST PILLAR
The first pillar aims to refine the measurement the framework set out in
the1988 Accord by effectively reducing risk across the banking system. Different reporting
system, which comply with objectives set by this pillar, will help track and report risk as they
occur, thus eliminating them at the outset. It will be allow banks to set-up independent audit
functions to scrutinize the possibilities of risks. The minimum capital requirement is expected to
be reducing considerably for bank and other financial institutions. Furthermore, bank will
support a complete alignment of regulatory, book and economic capital.
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PILLAR 2
SUPERVISORY AND REVIEW PROCESS
The second pillar of Basel II intends to ensure the presence of sound processes at each bank.
This pillar would also provided framework to assess the adequacy of the banks capital, based on
a thorough evaluation of its risks. The Basel II framework emphasizes the development of an
internal capital assessment process by the bank management. Additionally, management should
set targets for capital corresponding with the bank risk profile and control environment.
Regulatory and supervisory bodies (either the Central Bank or bodies set by the Central Bank or
government, for regulation and control) will review the internal process. This is done so that an
assessment of the banks capital adequacy in reaction to its risk can be made. A point to note is
that compliance with internal measurement methodologies, mitigation policies of credit risk, and
securitization policies for minimum qualifying standards are subject to supervisory control. The
supervisory authority will also be responsible for reviewing operations and processes in trading,
Internet banking and security processing.
BENEFITS OF THE SECOND PILLAR
The implementation of the second pillar demand increased interaction between bank
mangers and supervisory bodies. This increased level of interaction enhances the level of
transparency within the organization. The second pillar helps achieve a higher level of security
within the organization. A level of standardization and conformity is established across the
enterprise. This in turn would help achieve higher returns with lower risk.
PILLAR 3
MARKET DISCIPLINE
The third pillar of the new framework attempt to boost market discipline through
enhanced disclosure by bank. Basel II identifies the disclosure requirement and provides
recommendation both on the defining method of calculating capital adequacy, and risk
management strategies. Effective disclosures by bank help market participants understand the
banks risk profile and adequacy of its capital position, thereby facilitating market discipline.
This strategy plays an important role in maintaining the confidence in a financial institution.
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A guidance paper presented in January 2000 has six board recommendations related to
capital, risk exposure and capital adequacy. Based on these recommendations, the committee has
laid down more specific quantitative and qualitative disclosure in key areas. These include the
scope of application, composition of capital, risk exposure assessment and management
processes, and capital adequacy. In general, it provides enhanced disclosure on risk and capital
adequacy.
BENEFITS OF THE THIRD PILLAR
The third pillar of the Basel II framework helps to increase awareness of all the risk in the
banking sector through a process of detailed disclosure. It also helps align economic capital data
to book and risk capital data. Further, this pillar reveals the annual losses incurred by business
lines and asset classes. This helps increase transparency.
ORGANIZATIONS AFFECTED BY BASEL II
All banks and financial institutions in the G10 countries intend to incorporate the Basel
II Accord through local regulators. A high possibility of the earlier accord being replaced by
Basel II in the other countries also exists. The European Union is the first adopter of this accord,
and the recommendations of this accord are being integrated in to a new EU directive. In
addition, the European Commission intends to apply this accord to all investments, businesses
and credit institutions. The accords adoption `in other continents like Australia, Asia and in
North and South America would be phased. It would primarily depend on proposals submitted
by the regulatory authorities on implementation of the accord. The accords scope of application
will include banks and enterprises involved in securitization and with long-term equity holding
such as private equity and venture capital. It will also apply to the patent and subsidiary
companies of banking group.
Basel II will be applicable to organizations offering the following financial services:
Corporate finance,
Retail banking,
Asset management,
Trading and sales,
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Payments and settlements,
Commercial banking,
Retail brokerage,
Agency and custodial services.


















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CHAPTER: - 9
VALUE-AT-RISK
Value-at- Risk (VaR) is a category of risk measure that describes probabilistically the market
risk of a trading portfolio. VaR is widely used by banks, securities firms, commodity and energy
merchants, and other trading organizations. Such firm could track their portfolios market risk by
using historical volatility as a risk metric; calculate their portfolios market value. For managing
risk, institutions must know about risks while they are being taken. If a trader misjudges a
portfolio, his employer needs to find it out it before a loss is incurred. VaR gives institutions the
ability to do so. Unlike retrospective risk metrics, such a historical volatility, VaR is prospective.
It qualitifies risk while it is being taken.
Muck of the debate in recent times within banks focuses on the application of so called Value-at-
Risk (VaR) models. These models are designed to estimate, for a given trading portfolio, the
maximum amount that a bank could lose over a specific time period with a given probability. In
this way, they provide a summary measure of the risk exposure generated by a given portfolio.
Though the VaR model can be developed to varying degrees of complexity, the simplest
approach takes as its starting point the estimates of the sensitivity of each of the components of a
portfolio to small price changes (for example, a one basis point change in interest rates or a one
percent change in exchange rates). It then assumes that market price movements follow a
particular statistical distribution (usually the normal or log-normal distribution). This simplifies
the analysis by enabling a risk manger to use statistical theory to drawn inferences about
potential losses with a given degree of statistical confidence. For example, on a given portfolio it
might be possible to show that there is a 99% probability that a loss over any one week period
will not exceed Rs. 1 million. Elaborations to basic VaR model can allow for correlation between
different components of a portfolio by modeling the extent to which prices in different markets
tend to move together; in this way, the method takes in to account possible effect of portfolio
diversification. Still further elaborations permit the measurement of more difficult aspects of risk
such as the liquidity of the instrument making up the portfolio. This might not be the case,
however, for that part of the portfolio comprising relatively poorly traded securities. Standard
VaR method takes no direct account of this although it can be indirectly taken into account by
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the choice of the portfolio holding period. The more illiquid the portfolio, the longer the holding
period that should be applied and the more susceptible it will be to price changes.
VaR method has a number of shortcomings in dealing with large price movements. It is
recognized that the models do not address all types of risks, well, for example, risk associated
with options where the number of extreme observations are at the tails of the distributions than is
implied by the statistical theory of normal distributions. Further on average, the risk estimate
based on a 95% confidence interval will be exceeded once every 20 trading days. Using a 99%
confidence interval will be exceeded once every 20 trading days. Using a 99% confidence
interval reduces the uncertainty but still suggests that estimates of risk will be exceeded on an
average 2 or 3 times a year (assuming a normal distribution).Given below is schematic
representation of how VaR measures work:
All practical VaR measures accept portfolio data and historical market data inputs. They process
these with a mapping procedure, inference procedure, and transformation procedure. Output
comprises the value of a VaR metric. That value is the VaR measurement. Value-at-Risk (VaR),
though is a powerful tool for assessing market risk, it must be remembered that, sometimes, it
also poses a challenge. The power of VaR power is its generality. Unlike market risk metrics,
which are applicable to only certain asset categories or certain sources of market risk, VaR is
general. It is based on the probability distribution for a portfolios market value. All liquid assets
have uncertain market values, which can be characterized with probability distributions. All
sources of market risk contribute to those probability distributions. Being applicable to all liquid
assets and encompassing, at least in theory, all sources of market risk, VaR is an all-
encompassing measure of market risk. As with its power, the challenge of VaR also stems from
its generality. In order to measure market risk in a portfolio using VaR, some means must be
found for determining the probability distribution of that portfolios market value. Obviously, the
more complex a portfolio is i.e., the more asset categories and sources of market risk it is
exposed to the more challenging becomes task.



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CHATER: - 10
INTEREST RATE RISK IN BANKS
The regulatory restriction on bank had greatly reduced many of the risks in the banking system.
The deposit were taken in at mandatory rates and loaned out at legally established rates. Interest
rate, therefore, remained unaffected by market pressures.
The deregulation of the financial system in India has put in place a lot of operational freedom to
the financial institution and the pricing of a major portion of assets and liabilities has been left to
their commercial judgment. The earning of assets and the cost of liabilities are therefore closely
related to interest rate volatility. Thus, on account of deregulation of interest rate, interest rate
risk, a term totally unknown to the banking industry in India has suddenly becomes relevant. The
bank have already identified interest rate risk sa a drag on their profitability and have started
assessing the magnitude of interest rate risk embedded in their balance sheet.
Interest rate risk is the exposure of a banks financial condition to adverse movement in interest
rate. In other words, interest rate risk refers to potential impact on Net Interest Income or Net
interest margin or market Value of equity(MVE) caused by unexpected changes in interest rate.
SOURCES OF INTEREST RATE RISK
Military planner have a well-know saying :knowing the nature of the enemy is winning half the
battle. Similarly, understanding the nature of interest rate risk is critical for its successful
management. A proper analysis of the nature of interest rate risk helps in assessing its potential
financial impact and evaluating the right management techniques. The following are the seven
dimensions of the interest rate risk:
1. Gap or Mismatch or Reprising risk
2. Basis risk
3. Net Interest Position Risk
4. Yield curve risk
5. Embedded Option Risk
6. Price risk
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7. Reinvestment Risk

(1) GAPOR MISMATCH OR REPRICING RISK
A Gap or Mismatch risk arise from holding assets and liabilities with different principal amount,
maturity or reprising date, thereby creating exposure to unexpected changes in the level of
interest rate. The gap is the difference between the amount of assets and liabilities on which the
interest rate are reset or reprised during a given period. In other words, when assets and liabilities
fall due for repricing in different periods that can create a mismatch. Such a mismatch or gap
may lead to gain or loss depending upon how interest rate in the market tends to move.

(2) BASIS RISK
In a perfectly matched gap position, there is no timing difference between the repricing dates and
the magnitude of change in the deposit rates would be exactly matched by the magnitude of
change in the loan rate. However, interest rate of two different instruments will seldom change
by the same degree during a given period of time. The risk that the interest rate of the different
assets and liabililties may change in different magnitudes is called basis risk. The following table
shows how the basis risk occure:
GAPSTATEMENT OF N BANK
(INTEREST SENSITIVITY GAP POSITION -1-30 DAYS BUCKET)
REPRICING
LIABILITIES
AMOUNT(RS.IN
CRORES)
REPRICING
ASSETS
AMOUNT(RS.IN
CRORES)
Saving bank
50
Call money 50
Time Deposit
50
Cash Credit 40
Total
100
90
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NEGATIVE GAP 10


The bank ha s now a negative gap of Rs.10 crore. In case the interest rate falls by 1%, the bank
will gain 10 lakhs per year assuming that the rise in interest will be uniformly applicable to all
the item of assets and liabilities. But in real world interest rate on assets and liabilities do not
change in proportions. Instead of falling in the magnitude, assume that when rate on call money
leading falls by 1%. The rate on cash credit falls by 0.7%, the rate on savings bank fall by 0.5%
and rate on time deposits fall by 0.4%. The undernoted calculation indicates that the banks Net
Interest Income would deteriorate rather than improve in terms of the assumption of gap
management.
1. CALLMONEY 50*1% =Rs.0.50 crore
2. CASH CREDIT 40*0.7% = Rs.0.28 crore
--------------------- (-) Rs. 0.78 crore
3. SAVINGS BANK 50*0.05% = Rs.0.28 crore
4. TIME DEPOSITS 50*0.04% = Rs.0.20 crore
--------------------- (+) Rs. 0.45 crore
----------------------
NET INTEREST POSTION INCOM (-) Rs.0.33 crore
-----------------------
Thus, the magnitude of change in the interest rate of various assets and liabilities as above seems
more consistent with real world than the equal changes in all the rate. In the case, when the
variation in interest rate causes the Net Interest Income to Expand, the bank has experienced a
favorable basis shift and if the interest rate movement cause the NET Interest Income to contract,
the basis has moved against the bank.
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(3) NET INTEREST POSITON RISK
The banks net interest position also exposes the bank to an additional interest rate risk. If a
bank has more assets on which it earns interest than its liabilities on which it pays interest,
interest rate risk arise when interest rate earned on assets changes while the cost of funding of the
liabilities remained at 0%. Thus, the bank with a positive net interest position will experience a
reduction in Net Interest Income as interest rate decline and expansions in Net Interest Income as
interest tare rise. A large positive net interest position account for most of the profit generated by
many financial institutions.
(4) EMBEDDED OPTION RISK
Large changes in the level of interest rate create another source of risk to bank profit
encouraging prepayment of loan and bonds(with put or call option) and/ or withdrawal of
deposits before their started maturity dates. In case where there is no penalty for prepayment of
loan, the borrowers have a natural tendency to pay off their loans when a decline in interest rate
occurs. In such cause, the bank will receive only a Lower Net Interest Income. Take the cause of
a bank disbursed a 90 days loan at rate of 10% which is funded through a 90 days terms deposits
at the rate of 8%. In case the rate of interest declines to 9% after 30 days and the borrower
prepays his loan immediately, the bank receives only 200 basis points Net Interest Income for 30
days rather the anticipated 90days. In the remaining 60 days of the 90 days term, the Net Interest
Income will be only 100basis point. When the interest rate rise, the Net Interest Income is
exposed to the same embedded option risk in the liability side of the balance sheet as well. if
there are no substantial penalties for premature withdrawal, the depositors will withdraw their
term deposits before the contacted maturities so that the funds can be redeposit in new deposit
accounts at a higher rate of interest. For example, if a 100 basis points rise in interest rate occurs
30 days after the deposit is fixed, the depositor would close the 90 days 8% deposit and open a
new 90 term deposit at 9%. This action of the depositor will cause the banks Net Interest
Income declined by 100 basis point during the last days of the original 90 days term.sa interest
rate rise and falls, the banks are exposed to some degree of risk as customers exercise the
embedded options inherent in their loan and deposit contacts. The faster and higher the
magnitude of changes in interest rate, the greater will be the embedded option risk to the banks
Net Interest Income.
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Most of the banks protect themselves from this risk by imposing penalties for prepayment of
loan and premature withdrawal of deposits. however, most banks have found customer resist
paying competitive strategy to attract additional business.
(5) YIELD CURVE RISK
As yield curve is a line on a graph plotting the yield of all maturities of a particular instrument.
As the economy moves through business cycle, the yield curve changes rather frequently. At the
intervention of reserve bank of India, the yield curve can be changed to the desired direction by
altering the yields on Government Stocks of different maturities. To illustrate how a change in
the shape of yield curve affect the banks Net Interest Income, let us assume that a bank uses 3
year floating rate fixed deposits for funding 3 year floating rate loans (the deposits and loans are
reprised at quarterly intervals). If the bank pays 100 basis point above the 8.50% 91 days
treasury Bills rate to fixed deposits and changes 300 basis point above the 364 days treasury Bills
rate of 9% on its loans, a Net Interest margin of 250 basis points is produced. If the yield curve
turns inverted during the next reprising date with the91 days treasury Bills rate increasing to10%
and 364 days treasury Bills rate remaining at 9% and spread relationship of deposits and loans to
treasury Bill remains constant,
PERIOD 91DAYS
TREASURY
BILLS
364DAYS
TREASURY
BILLS
TERM SPRED INTEREST
SPRED
BETWEEN
DEPOSITS
AND LOANS
APRIL1999
8.75%

10.07%

1.32%

3.32%
JUNE1999
9.24%

10.32%

1.08%

3.08%
AUGEST1999
9.46%

10.28%

0.82%

2.82%
MARCH2000
9.16%

9.93%

0.77%

2.77%
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FEBRUARY2002
6.25%

6.42%

0.17%

2.17%

The Net Interest margin will be reduce to 100 basis point. Thus, the banker should base only
the rate of a single instrument for pricing the assets and liabilities.
The following table shows yield curve risk involved, as the spread between the two maturities of
Treasury Bills narrowed:
(6)PRICE RISK
Price risk occurs when assets are sold before their stated maturity dates. In the financial market ,
bond price and bond yield are inversely related. For example, the price of 100 year 14%
Government of India Stock will receive only lower price than originally paid for when coupon of
stock of similarly maturity has gone up to 15% in the market.
(7)REINVESTMENT RISK
Uncertainty with regard to interest rate at which the future cash flowed can be reinvested is
called as reinvestment risk. Suppose, a bank has a zero coupon deposits of Rs.10000 and it
promises to double the amount within 7 years and user the funds for investing in a 7 year bond at
an annual coupon of 12%. This intermediation generates a Net Interest Income of Rs.2017. In
case, the interest rate falls to 5% after one years, the bank could reinvest the coupon cash flow
only at 5% against the anticipation of reinvesting the coupon a fixed rate of 12%. Due to this
reinvestment risk, the will not be able to repay the entire amount of deposits on maturity.
The bond pricing formula assumes that all coupon payment are reinvested at the bonds yield to
Maturity (YMT). If the interest rate increases over the life of a bond, coupons will be reinvested
at higher yields thereby increasing the reinvestment income. The increase in reinvestment
income will increase the realized yield of the bond. When the interest rate goes up, the bond
price decrease but the bonds realized compound yield will increase due to higher coupon
reinvestment income. On the other hand, when the interest rate declines the bond price increase
resulting in a capital gain but the realized compound yield decrease because of lower coupon
reinvestment income. Thus, price risk and reinvestment risk partially off-set one another.
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The sort term bonds have more reinvestment risk since proceeds of the bonds must be reinvested
more and more times. Alternatively, long term bonds have more price risk. In order to reduce
reinvestment risk, banks try to match the duration of their assets and liabilities and not their
maturities.
EFFCTS OF INTEREST RATE RISK
Interest rate risk is the risk where changes in market interest rate might adversely affect a banks
financial condition. The immediate impact of changes in interest rate is on the Net Interest
Income (NII). A long term impact of changes interest rate on the on the banks net worth since
the economic value of a banks assets, liabilities and off-balance sheet positions get affected due
to variation in market interest rate . The interest rate risk when viewed from these two
perspectives is known as `earning perspective, respectively.
DETAILS SHORT
TERMPERSPECTIVE
LONG TERM
PERSPECTIVE
TARGET VARIABLE Net Interest Income(NII) Market Value of equity
(MVE)
PERSPECTIVE Accounting Economic
TYPE OF MISMATCH Tactical Structural
FOCUS Profit/loss Balance Sheet Strength
ANALYTICAL
TECHNIQUES
a)Gap Analysis
b)Simulation of NII
c)Earnings at risk
a)Duration Gap Analysis
b)Simulation of MVE
c)Value at Risk Equity
(Source: Reserve Bank of Indias Guidance Note on market Risk Management)
MEASURING AND MANAGEMENT OF INTEREST RATE RISK
The management of interest Rate Risk should be one of the critical components of market risk
management in banks. The regulatory restriction in the past had greatly reduce many of the risk
in the banking system. Deregulation of interest rate has, however, exposed them to the adverse
impact of the interest rate risk. The Net Interest Income or interest margin of banks is dependent
on the movements of interest rate. Any mismatch in the cash flows(fixed assets and liabilities) or
reprising dates (floating assets or liabilities),expose banks Net Interest Income or Net Interest
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Page 49

Margin to variation. The earning of assets and the cost liabilities are now closely related to
market interest rate volatility.
Before risk can be managed, they must be indentified and quantified. Unless the quantum of risk
inherent in a banks balance sheet is measured, it is impossible to measure the degree of risk to
which the bank is exposed. It is also equally impossible to develop effective risk management
strategies/techniques without being able to understand the correct risk position of the bank.
There are many analytical techniques to measure and hedge/manage interest rate risk. The
most commonly used techniques are
1. Maturity Gap Analysis or Tradition Gap Analysis (to measure the interest rate sensitivity of
earning )
2. Duration Gap Analysis (to measure the interest rate sensitivity of capital)
3. Simulation
4. Value at Risk
While these method highlight different facets of interest rate risk, many banks use them in
combination, or use hybrid method that combine feature of all the techniques.








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CHAPTER:-11
CASE STUDY
State Bank of India, London, United Kingdom
case study- 1

The Client
STATE BANK OF INDIA (SBI) is the largest bank in India with over 180 years of banking
experience. Today, State Bank of India ranks among the top 25 commercial banks in Asia with
assets exceeding US$60 billion. SBI operates worldwide through an extensive network of over
9000 offices including 50 overseas offices in 48 countries. The Bank has won the Technology
Award 2005, from the Banker, London. Until recently, SBI UK operation has been using the
Misys-Equation banking application for its operations. This application runs on the IBM AS400
platform. Since 2001, IIL Risk Management has provided various IT related services to the
Bank.
The Problem
SBI, UKs Treasury operations use the Reuters 3000 dealing system. Dealers negotiate and
confirm various deals every day involving money market and forex trades. These deals were
posted manually into the banking application. Manual posting carried with it the risk of error
prone entries, missed out deals, lack of suitable and timely checks & verification and inability to
ascertain accurately counter party dealing limits. The Bank required straight through
processing from Reuters dealing server to the Misys-Equation platform to minimize operational
risk. With an eye on future proofing the investment in the system it also desired that the solution
be platform independent and therefore be based on java programming and be integrated with
the Meridian middleware provided by Misys. In addition, they required counter party limits and
exposures to be displayed back to the dealer on a separate screen by intelligently using the
information from dealer initiated Reuter conversations with the counter party. Investigation of
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Page 51

available products in the market place found that they contained many functionalities already
catered for by the Reuter system and were not cost effective and used obsolete technologies.
The Solution
IIL Risk Management (IIL) developed for the bank a unique and cost effective solution to
automate the entire process from capturing deals from Reuter dealing 3000 server to posting into
the core banking application.

The solution integrates various technologies such as Microsoft Windows 2000 server, Access
database, IBM MQ series, Misys Meridian middleware and IBM AS/400.

The process can be categorized as follows:

Electronic capture of deals via Reuter Ticket Output Feed (TOF).
Deal data processing with data validation and writing to database.
Deal data mapping, formatting and posting to Misys Equation using Meridian Middleware/IBM
MQ Series.
Secure and user-friendly interface to monitor flow of deal data, correct any exceptions and
review status of posting into Misys Equation.
Intelligent use of Reuters Current Interest Feed (CIF) to retrieve counter- party dealing limits
and actual exposures from the Equation banking system and displaying the same back to the
dealers.

All the above modules work closely with each other in terms of connectivity, request and
response along with reliable audit trails.
The Benefits
The implemented solution reduced SBI, UK Treasury Departments workload considerably
virtually eliminating the need for human intervention. Operational efficiency was greatly
improved. Timely display of counter party dealing limits at both Group and Individual level and
actual exposures enabled the dealers to know the exact position at any given time. This was an
RISK MANGEMENT IN BANK
Page 52

important technology based support for the Banks efforts to minimize operational risk from
manual interventions.
Case Study - 2
Bank of Baroda, London, United Kingdom
bank fo

The Client
BANK OF BARODA has significant International presence with a network of 57 Offices in 19
countries including 38 branches of the bank and 17 branches of its seven subsidiaries besides 2
representative offices in Malaysia and China and a network of more than 2700 branches in India.
In the U.K, since the 1990s the bank has been using the Misys-Equation core banking
application to support its activities at its London Main Office and other branches. This
application runs on the IBM AS400 Operating platform. IIL Risk Management has been
providing various IT related services to the bank.
The Problem
Bank of Baroda U.K conducts it's clearing through NatWest/Royal Bank of Scotland. The bank
(main office and branches) receives all clearing information such as cheques, giro credits and
direct debits from NatWest on a daily basis as printed statements along with the related
instruments. The process involves classifying each payment and posting the resultant
transactions into Misys Equation core banking product manually. Checks have to be made in
respect of stopped cheque, blocked account, inactive account, closed account and incorrect
accounts. Moreover, the account numbers held at NatWest do not exactly match with that in the
Misys-Equation database. Manual entries were error prone requiring additional verification. This
process therefore, called for considerable effort and use of human resources contributed to
operational risk.
The Solution
IIL Risk Management has provided a solution to automate the entire process end to end with the
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Page 53

necessary validations at every level of the data pass through. The objective being the reduction of
manual effort to a minimum and improvement in the accuracy of posted transactions and
operational efficiency.

The implemented solution integrates with electronic receipt of Agency Credit Clearing data from
NatWest based on APACS (Association of Payment Clearing Services) standards 27 and 29,
which define the specification of files exchanged between banks and their customers. Both
Microsoft and IBM technologies are used with suitable data transfer methodology to IBM
AS/400.

An MS Windows based front-end provides a user-friendly interface to process downloaded data
from NatWest, carry out necessary checks to ensure data integrity and to transfer the data to
AS/400.

IBM AS/400 operations menu guides the user to process the transferred data, categorizing the
transactions as 'OK' to post and 'Exceptions' based on established business validation rules and to
tally the credit/Debit totals with those from NatWest. The automatic mapping function enables
correction of incorrect account numbers. All the Branches including the Main Office have access
to menu options to view and correct the exceptions. A specially written automatic posting
program handles the posting of accounting entries into Misys-Equation.
The Benefits
Implementation of the automated clearing system increased the speed of processing, drastically
reduced manual errors, eliminated delays in posting customer accounting entries and kept up-to-
date individual customer accounts. The solution is centrally managed from the Head Office and
use of the AS/400 platform on which the banking application runs, allows branches to handle
their part of the data effectively while not worrying about uploading and managing their branch
specific clearing data


RISK MANGEMENT IN BANK
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CHAPTER:-12
CONCLUSION
The objective of risk management is not to prohibit or prevent risk taking, but to ensure
that the risks are consciously taken with full knowledge, clear purpose and understanding so that
it can be measured and mitigated. The purpose of managing risk is to prevent an institution from
suffering unacceptable loss causing an institution to fail or materially damage its competitive
position.
Functions of risk management should actually be bank specific dictated by the size and
quality of balance sheet, complexity of functions, technical/professional manpower and the status
of MIS in place in that bank. There may not be one-size-fits-all risk management module for all
the banks to be made applicable uniformity.
As in the international practice, a committee approach may be adopted to manage various
risks. Risk Management Committee, Credit Policy Committee, Asset Liability Management
Committee, etc., are such committee that handles the risk management aspects.
The effectiveness of risk management depends on efficient Management Information
System, computerization and net working of the branch activities. An objective and reliable data
base has to be built up for which bank has to analyse its own past performance data relating to
loan defaults, trading losses, operational losses, etc., and come out with bench ,marks so as to
prepare themselves for the future risk management activities.
A large project involves certain risks, and that is true of banking projects. The Risk
Management is an emerging area that aims to address the problem of identifying and managing
the risks associated with the banking industry. The Risk Management helps banks in preventing
problems even before they occur. In managing the risks, the Board of Directors and Senior
Management will have to play an effective role by formulating clear and comprehensive policies.


RISK MANGEMENT IN BANK
Page 55

The Risk Management System, which integrates:-
Prudent risk limits,
Sound risk management procedures and information systems,
Continuous risk monitoring and frequent reporting is said to be efficient one. The keen
interest taken by the Reserve Bank of India in this context needs to be appreciated and
supported at all levels.

Most of the risks arise as a result of mismatch of assets and liabilities. If the Assets of a
bank exactly matched its liabilities of identical maturity, interest rate conditions, and currency,
then liquidity risk, interest rate risk, and currency risk could have been avoided. However, in
practice it is near impossible to have such a perfectly matched balance sheet. A banker therefore
has, to keep different types of risk within acceptable limits. It requires the ability to forecast
future changes in the environment and formulate suitable action plans to protect the net worth of
the organization from the impact of these risks.
It is by no means an easy task. If he is proved wrong in his judgment, the process of risk
management may go haywire. Few would disagree with the statement that being a banker is like
being a country hound dog. If you stand still, you get kicked. If you run, they throw rocks at
you.








RISK MANGEMENT IN BANK
Page 56


Bibliography:
1. Credit risk model
2. Basel accords
3.risk management
Weblography:
1. www.amezon.com
2. www.thunderbird.edu
3. www.garo.org

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