Académique Documents
Professionnel Documents
Culture Documents
Credit
Risk
O-BalanceSheet Risk
Foreign
Exchange
Risk
The failure of a borrower or an issuer of bonds to meet his contracted cash outflow
obligations on a loan he has taken or a bond he has issued
The risk associated with assets and liabilities that are contingent (i.e. could result
in claims in the future) on the financial institution and hence reported outside its
balance sheet ( as off- balance sheet items).
The gains or losses that arises due to fluctuations in the foreign exchange rates
The potential adverse impact of factors that are exogenous to the firm, i.e., factors
outside the firm's control, largely a result of macroeconomic changes.
Market
Risk
Opera&onal
Risk
Liquidity
Risk
Solvency
Risk
The causes, consequences, measurement and management of each of these risks are dealt
with at great length in this course.
This document has been prepared by PC Narayan, Indian Institute of Management, Bangalore and is made available for use only with the course
FC201.2x titled Banking and Financial Markets: A Risk Management Parspective delivered in the online course format by IIM Bangalore. All rights
reserved. No part of this document may be reproduced, stored in a retrieval system or transmitted in any form or by any means electronic, mechanical,
photocopying, recording, or otherwisewithout the permission of the Indian Institute of Management Bangalore (fc201.support@iimb.ernet.in)
This document has been prepared by PC Narayan, Indian Institute of Management, Bangalore and is made available for use only with the course
FC201.2x titled Banking and Financial Markets: A Risk Management Parspective delivered in the online course format by IIM Bangalore. All rights
reserved. No part of this document may be reproduced, stored in a retrieval system or transmitted in any form or by any means electronic, mechanical,
photocopying, recording, or otherwisewithout the permission of the Indian Institute of Management Bangalore (fc201.support@iimb.ernet.in)
If a substantial number of its customers suddenly decide to withdraw a large part of their
deposits/investments from that institution
Due to a sudden and sharp impairement in the vlaue of its assets (or increase in its nonperforming assets, as they are popularly referred to in the world of banking & finance).
Financial institutions try to overcome the sudden liquidity crunch by one or more of the following
methods:
a) By drawing on its cash reserves
b) By borrowing in the short term money market or
c) By selling its holding in government securities and other liquid assets.
Important lessons in managing liquidity and solvency:
1. If a financial institution has ample cash reserve or has adequate liquid securities that can be
turned into cash quickly or has the credibility to borrow short-term in the money market, the
liquidity problem can be overcome quickly and will not have a serious impact on that institution
going forward.
2. If a financial institution maintains adequate capital (i.e. equity, retained earnings, etc.), it will
lessen the chance of bankruptcy/insolvency even when its assets are stressed i.e. increase in nonperforming assets that may have to be written off.
In summary, liquidity is managed through cash reserves and solvency is managed through capital
adequacy, both mandated by the regulator in every country.
Liquidity
Solvency
Cash Reserves
Capital Adequacy
This document has been prepared by PC Narayan, Indian Institute of Management, Bangalore and is made available for use only with the course
FC201.2x titled Banking and Financial Markets: A Risk Management Parspective delivered in the online course format by IIM Bangalore. All rights
reserved. No part of this document may be reproduced, stored in a retrieval system or transmitted in any form or by any means electronic, mechanical,
photocopying, recording, or otherwisewithout the permission of the Indian Institute of Management Bangalore (fc201.support@iimb.ernet.in)
This document has been prepared by PC Narayan, Indian Institute of Management, Bangalore and is made available for use only with the course
FC201.2x titled Banking and Financial Markets: A Risk Management Parspective delivered in the online course format by IIM Bangalore. All rights
reserved. No part of this document may be reproduced, stored in a retrieval system or transmitted in any form or by any means electronic, mechanical,
photocopying, recording, or otherwisewithout the permission of the Indian Institute of Management Bangalore (fc201.support@iimb.ernet.in)
All forms of demand liabilities such as balances in the current accounts and savings accounts.
Time liabilities such as fixed deposits, certificate of deposits, etc.
Net Inter Bank Liabilities (NIBL), which is borrowings from the banking system minus lending
to the banking system
Important points to remember while computing NDTL:
(1) Liabilities that are long term in nature, such as equity capital, retained earnings, provisions
for bad loans, etc. as well as contingent liabilities should not be included in the NDTL
computation
(2) If NIBL is negative (i.e. the loans to the banking system is greater than the borrowings from
the banking system), it should not be considered in the NDTL calculation
(3) The time period considered for the daily average NDTL computation is one fortnight,
commencing Friday through Thursday after next
The Reserve Bank of India (the banking regulator in India) mandates that all regulated bank in the
country maintain:
(a) Cash Reserve Ratio (CRR): X% of the banks average NDTL as cash reserves, either as physical
cash in its vaults or as balances in its current account with the Reserve Bank of India. X%
could vary and will be notified from time to time by the Reserve Bank of India but can never
be less than 3%
(b) Statutory Liquidity Ratio (SLR): An additional Y% of NDTL as investment in government
securities. This Y%, which is referred to as the Statutory Liquidity Reserve, could vary over
time and is currently at 20%
This document has been prepared by PC Narayan, Indian Institute of Management, Bangalore and is made available for use only with the course
FC201.2x titled Banking and Financial Markets: A Risk Management Parspective delivered in the online course format by IIM Bangalore. All rights
reserved. No part of this document may be reproduced, stored in a retrieval system or transmitted in any form or by any means electronic, mechanical,
photocopying, recording, or otherwisewithout the permission of the Indian Institute of Management Bangalore (fc201.support@iimb.ernet.in)
Reserve Bank of India, in its role as the monetary authority of the country, use CRR and/or SLR as a
tool to control money supply in the Indian financial system.
RBI
Money
Supply
CRR
or
SLR
Central Bank
Commercial Banks
RBI
Money
Supply
CRR
or
Money supply can be reduced
by increasing the percentage of
Cash Reserve Ratio and/or
Statutory Liquidity Ratio to be
maintained by the banks.
SLR
Central Bank
Commercial Banks
This document has been prepared by PC Narayan, Indian Institute of Management, Bangalore and is made available for use only with the course
FC201.2x titled Banking and Financial Markets: A Risk Management Parspective delivered in the online course format by IIM Bangalore. All rights
reserved. No part of this document may be reproduced, stored in a retrieval system or transmitted in any form or by any means electronic, mechanical,
photocopying, recording, or otherwisewithout the permission of the Indian Institute of Management Bangalore (fc201.support@iimb.ernet.in)
Step func5on
Cash
Reserves
Demand deposits
(Transac5on
accounts)
10%
3%
0%
$10 M to $50 M
Greater than
$50 M
Up to $10 M
The demand balances due from other banks and cash items under collection are subtracted from the
transaction account balances to determine the net transaction account balance on which the cash
reserve is to be computed.
Computing the cash reserve to be maintained is governed by two time periods: Reserve computation
period covers a two week period, always starting on a Tuesday and ending on the Monday after next
Reserve maintenance period consists of fourteen consecutive days, always starting on a Thursday
and ending on the Wednesday after next, with a lag of seventeen days after the end of a reserve
computation period (or thirty days
from the start of a reserve
Cash Reserves: Computa4on
computation period).
Reserve
Computa4on
Period
Reserve
Maintenance
Period
This document has been prepared by PC Narayan, Indian Institute of Management, Bangalore and is made available for use only with the course
FC201.2x titled Banking and Financial Markets: A Risk Management Parspective delivered in the online course format by IIM Bangalore. All rights
reserved. No part of this document may be reproduced, stored in a retrieval system or transmitted in any form or by any means electronic, mechanical,
photocopying, recording, or otherwisewithout the permission of the Indian Institute of Management Bangalore (fc201.support@iimb.ernet.in)
Managing Solvency
Solvency is managed using a well-defined method called Capital Adequacy Ratio (CAR) also known
as Capital to Risk Assets Ratio (CRAR). It measures a bank's capital as a percentage of its risk
weighted assets.
There are two operating phrases here:
Capital: That involves classifying the Banks Capital as Tier-I Capital and Tier-II Capital
Risk-Weighted Assets: Recomputing the assets on the bank's balance sheet based on the
degree of risk associated with each class of assets.
Capital Adequacy Ratio = Tier-I Capital + Tier-II Capital
Risk Weighted Assets
Basel Committee on Banking Supervision (BCBS) set up by the Bank of International Settlements
(BIS) has recommended capital adequacy ratio of minimum 8% or higher, to be maintained by
regulated banks in all countries (commonly referred to as BASEL-I guidelines). Based on the BASEL-I
guidelines, the Banking Regulator in each country issues directives on Capital Adequacy that banks
under its jurisdiction will be required to comply with. Such directives should be (at least) same as or
more rigorous than the Basel I guidelines.
Computa+on of CAR
The Composi+on of Capital
Compu+ng Tier -1 Capital & Tier - II Capital
The Composi+on of Assets
Compu+ng the Risk Weight for each of
those Assets
This document has been prepared by PC Narayan, Indian Institute of Management, Bangalore and is made available for use only with the course
FC201.2x titled Banking and Financial Markets: A Risk Management Parspective delivered in the online course format by IIM Bangalore. All rights
reserved. No part of this document may be reproduced, stored in a retrieval system or transmitted in any form or by any means electronic, mechanical,
photocopying, recording, or otherwisewithout the permission of the Indian Institute of Management Bangalore (fc201.support@iimb.ernet.in)
2 Caveats
1. Total Tier- II Capital cannot exceed 100% of Tier - I Capital
2. Subordinated Debt cannot exceed 50% of Tier - I Capital
Composi'on of Assets
Perpetual Instruments:
Perpetual
Preference Capital
Capital raised
through Perpetual
Debt
Perpetual Debt
Perpetual Cumula've
Preference Shares
Tier I
Capital
Issued by Banks
Other Securi'es
(such as Bonds) that
are issued with
specic maturity
date and are Long-
term in nature
Tier II
Capital
This document has been prepared by PC Narayan, Indian Institute of Management, Bangalore and is made available for use only with the course
FC201.2x titled Banking and Financial Markets: A Risk Management Parspective delivered in the online course format by IIM Bangalore. All rights
reserved. No part of this document may be reproduced, stored in a retrieval system or transmitted in any form or by any means electronic, mechanical,
photocopying, recording, or otherwisewithout the permission of the Indian Institute of Management Bangalore (fc201.support@iimb.ernet.in)
This document has been prepared by PC Narayan, Indian Institute of Management, Bangalore and is made available for use only with the course
FC201.2x titled Banking and Financial Markets: A Risk Management Parspective delivered in the online course format by IIM Bangalore. All rights
reserved. No part of this document may be reproduced, stored in a retrieval system or transmitted in any form or by any means electronic, mechanical,
photocopying, recording, or otherwisewithout the permission of the Indian Institute of Management Bangalore (fc201.support@iimb.ernet.in)
10
This document has been prepared by PC Narayan, Indian Institute of Management, Bangalore and is made available for use only with the course
FC201.2x titled Banking and Financial Markets: A Risk Management Parspective delivered in the online course format by IIM Bangalore. All rights
reserved. No part of this document may be reproduced, stored in a retrieval system or transmitted in any form or by any means electronic, mechanical,
photocopying, recording, or otherwisewithout the permission of the Indian Institute of Management Bangalore (fc201.support@iimb.ernet.in)
11
Fundamental Approach
Technical Approach
On the liability
side of the balance
sheet, focus on
source of funds
Vola=le Funds
Carefully analyze
cash inows and
ou?lows; source
funds ahead of need
Vulnerable Funds
(BIS)
Maturity
Ladder
Model
Stable Funds
This document has been prepared by PC Narayan, Indian Institute of Management, Bangalore and is made available for use only with the course
FC201.2x titled Banking and Financial Markets: A Risk Management Parspective delivered in the online course format by IIM Bangalore. All rights
reserved. No part of this document may be reproduced, stored in a retrieval system or transmitted in any form or by any means electronic, mechanical,
photocopying, recording, or otherwisewithout the permission of the Indian Institute of Management Bangalore (fc201.support@iimb.ernet.in)
12
Operational Risk
Operational risk is the risk of direct or indirect losses resulting from inadequate or failed internal
processes, people, and systems or from external events. Another name for operational risk is catchall risk (In Football parlance, operations risk is also referred to as the goal-keeper risk).
Operational risks are pervasive, complex and dynamic as well as embedded virtually in all the
business processes of any financial institution, since they can be triggered by both exogenous and
endogenous factors.
A broad category of endogenous contributors to operational risk include:
ENDOGENOUS FACTORS
Internal Fraud
Failure of Informa+onal
Technology and Business
Disrup+ons
Failures in Execu+on,
Delivery and Process
Management
This document has been prepared by PC Narayan, Indian Institute of Management, Bangalore and is made available for use only with the course
FC201.2x titled Banking and Financial Markets: A Risk Management Parspective delivered in the online course format by IIM Bangalore. All rights
reserved. No part of this document may be reproduced, stored in a retrieval system or transmitted in any form or by any means electronic, mechanical,
photocopying, recording, or otherwisewithout the permission of the Indian Institute of Management Bangalore (fc201.support@iimb.ernet.in)
13
EXOGENOUS FACTORS
Acts of forgery by the ins0tu0ons customers
External Fraud
Damage to
Physical Assets
Categorization of Operational Risks
All financial institutions around the world encounter operational risk events that can be categorized,
based on sound empirical analysis, into the following four quadrantsA, B, C, D.
High
Financial
Impact
Low
Low
High
Frequency/Probability
As you can see from the
quadrant diagram, X-axis
denotes the frequency or
probability of the risk events,
and the Y-axis denotes the
financial impact of such
operational risk events.
This document has been prepared by PC Narayan, Indian Institute of Management, Bangalore and is made available for use only with the course
FC201.2x titled Banking and Financial Markets: A Risk Management Parspective delivered in the online course format by IIM Bangalore. All rights
reserved. No part of this document may be reproduced, stored in a retrieval system or transmitted in any form or by any means electronic, mechanical,
photocopying, recording, or otherwisewithout the permission of the Indian Institute of Management Bangalore (fc201.support@iimb.ernet.in)
14
Mitigating Operational Risks
Financial institutions, on their part, have taken several proactive measures to protect themselves
against losses from operational risk events. These include:
At the initiative of the Central Bank in several countries, financial institutions have started sharing
and learning from their mutual experience and collectively found ways to mitigate operational risk
events and minimize losses when such events occur.
This document has been prepared by PC Narayan, Indian Institute of Management, Bangalore and is made available for use only with the course
FC201.2x titled Banking and Financial Markets: A Risk Management Parspective delivered in the online course format by IIM Bangalore. All rights
reserved. No part of this document may be reproduced, stored in a retrieval system or transmitted in any form or by any means electronic, mechanical,
photocopying, recording, or otherwisewithout the permission of the Indian Institute of Management Bangalore (fc201.support@iimb.ernet.in)
15