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OVERVIEW:

• What is Risk
• Risk management
• Methods for treating risk
• Risk management process
Risk:
• Risk—Uncertainty arising from the possible occurrence of given
events.
• Risk - Pure—The risk involved in situations that present the
opportunity for loss but no opportunity for gain. Pure risks are
generally insurable, whereas speculative risks (which also present the
opportunity for gain) generally are not.
• Risk - Speculative—Uncertainty about an event under consideration
that could produce either a profit or a loss, such as a business venture
or a gambling transaction. A pure risk is generally insurable while
speculative risk is usually not.
• Event Risk—Risk of loss associated with fortuitous occurrences (e.g.,
fires, hurricanes, tortuous conduct). Event risk, which is synonymous
with pure risk, hazard risk, or insurance risk, presents no chance of
gain, only of loss. The perils covered by traditional property and
casualty insurance products are within the realm of event risk.
Risk Management:
• Risk management—The practice of
identifying and analyzing loss exposures
and taking steps to minimize the financial
impact of the risks they impose. Traditional
risk management, sometimes called
"insurance risk management," has focused
on "pure risks," but not business risks (i.e.,
those that may present the possibility of loss
or gain).
Methods for treating risk:
• Traditional risk management techniques for handling
event risks include:
– Risk Retention – Planned Acceptance of Losses by Deductibles,
Deliberate Non-Insurance, and Loss-Sensitive Plans Where Some,
But Not All, Risk Is Consciously Retained Rather Than
Transferred
– Contractual or Non-Insurance Risk Transfer – Shifting
Responsibility For First or Third Party Losses To Another Entity
– Risk Avoidance – Not Engaging In Activities That Create Risk
– Risk Control - Reduce The Possibility That a Loss Will Occur
and/or Reduce the Severity of Those That Do Occur.
– Insurance Transfer
Risk management process:
• Risk management process—A systematic approach to
treating risk: identification and analysis of exposures,
selection of appropriate risk management techniques to
handle exposures, implementation of chosen techniques,
and monitoring of the results.
• Risk tolerance—The willingness of an organization to
incur risk to gain future reward. In insurance, risk
tolerance may be evidenced by a willingness of the insured
to increase deductibles or self-insured retentions (SIRs).
• Retention capability—The mount of aggregate incurred
losses that an insured can retain in any one financial
reporting period without creating an adverse impact on
cash flow or earnings. Compare to Risk tolerance
Risk management process (cont.)
• Risk identification—The qualitative determination of risks that are
material, i.e., that potentially can impact the organization's
achievement of its financial and/or strategic objectives. This is often
done through structured interviews of key personnel by internal (e.g.,
internal audit) or external experts. In some cases, the organization's
business process maps are used to guide the risk assessment

• Determination of Appropriate Technique- Which method is most


suitable for the risk given risk tolerance and ability to retain risk.

• Hazard Compared to Risk – Hazard is a condition that increases the


probability of loss. Examples include poor housekeeping in a factory,
uneven surfaces on walkways, and inadequate lighting in a crime-
prone area.
IP Legal Risk Management
IP- The Basics:
• Types of IP
– Patents
– Trademarks
– Copyrights
Benefits/ Reasons to Protect IP:
• economic development
– foreign investment
– incentivizes creativity
– tax revenue vs. tax evasion
• protects public health and safety
• promotes rule of law
The WTO and TRIPs:
• General goals of TRIPs
• Updating international standards
– Establishing uniform international standards
– Provide for transparency
– Provide for dispute resolution
– National treatment
– Provide for IPR enforcement
Risk Management in Forex
Types of Risk in Forex
Credit Risk
Cause: failure of contract party Open Position Risk
Mitigation: fixing counterparty limit Cause-overbought/oversold
Mitigation: keeping position square.

Overtrading Risk Cash Balance Risk (in nostro account)


Cause: speculative large deals Cause – communication delay
Mitigation: limit on transactions Mitigation – Limit of Nostro accoount

Maturity Mismatches Risk/gap risk


Cause: mismatch in maturity period of sale and purchase
Mitigation :Maturity limit, Gap limit
Exchange Exposure
FOREIGN EXCHANGE
EXPOSURE

ECONOMIC/
TRANSACTION EXPOSURE TRANSLATIONAL EXPOSURE
OPERATING EXPOSURE

INCORPORATING
CONVERSION OF
FOREIGN ASSET,LAIB, EFFECT OF FLUCTAUTION
FOREIGN CURRENCY
INCOME ON CASH FLOWS
INTO DOMESTIC
TO PARENT COMPANY
Exchange Risk: Transaction Exposure
Mitigate:
Cause: Import-Export industries,
By Hedging -covering risk
Arises Due to fluctuation Receivables-Payables
Forward contract , Option,
Exposure Netting, Lead-
Lags

Exchange Risk: Transaction Exposure

Cause: Accounting Mitigate:


Arises Consolidation of exposure – book
financials of Subsidiary value,
Risk: asset- Liability ↑/↓ historic data
Exchange Risk: Economic Exposure

Cause:
Unexpected changes in Exchange Mitigate:
rate,Impact on cash inflows and Market selection
outflows
Pricing
Product

RBI Guidelines includes

Functional Segregation
System in place
Limiting Risk
Timely Reporting
Control on Nostro/vostro accounts
Internal Audit/System Audit
BANKING
Capital Adequacy Ratio
A bank's capital, or equity, is the margin by which creditors are covered if the bank had to liquidate assets.

The following are the current minimum capital adequacy ratios:


Tier one capital to total risk weighted credit must not be less than 4%.
Total capital (tier one plus tier two less certain deductions) to total risk weighted credit exposures must not be less than
8%.

Assets Amount Risk weight Risk weighted Assets

Cash and equivalents $40m 0 0

Government securities $80m 0 0

Interbank loans $100m 0.2 $20m

Mortgage loans $200m 0.5 $100m

Ordinary loans $300m 1.0 $300m

Standby letters of credit $80m 1.0 $80m

Total Risk weighted Assets $500m


Tier I capital 4% $20m
Total Capital 8% $40m
Managing Risks in outsourcing of
Financial services by Banks
• Strategic Risk
• Reputation Risk
• Compliance Risk
• Operational Risk
• Legal Risk
• Exit Strategy Risk
• Counter Party Risk
• Country Risk
• Contractual Risk
Operational Risk
 Operational Risk Classification
 Cause Based
 Effect Based
 Event Based

 Operational Risk Mitigation


 Strategy
 Organizational Structure
 Policies and Procedures
 Integrated Risk Limits
 Integrated Risk Reporting
 Integrated Systems
Asset Liability Mismatch

1)Liquidity Risk
Particulars 1-14 15-28 29 days 3 6 1-year – 3 yrs – >5 Total
days days 3 months- months- 3 years 5yrs years
months 6 1 year
months

Inflows 1000 2500 1200 3000 5000 5000 6000 10000 33700
( Maturing Assets)

Outflows 1500 4000 3000 8000 7600 9000 500 100 33700
( Maturing
Liabilities)
Gap (-) 500 (-) 1500 (-)1800 (-) 5000 (-)2600 (-) 4000 5500 900
(Inflows-Outflows)

Gap as % to outflows -33% -38% -60% -63% -34% -44% 1100% 9900%

Limit By RBI -20% -20% Banks are Expected to place internal limits as prescribed by the Board
Interest Rate Risk
Particulars 0-6M
Interest Rate
6M-1Y
Risk
>1Y Total
Assets 100 1000 5000 6100
Liabilities 2000 1000 2500 5500
Gap -1900 0 2500 600

Direction Interest Position of gaps Impact on NII


rate
Increasing Positive Positive
Decreasing Positive Negative
Increasing Negative Negative
Decreasing Negative Positive
Credit Risk
Securitization

Credit Derivatives

Market Risk
Market Risk Mitigation Strategies

 Strategies Using Sensitivity Measures


A 5 year bond with 6% semi-annual @ market yield of 8% has a price of 92,
which rises to 92.10 at a yield of 7.95. If another bond rises to .20 with 5 basis
point Average is BPV is 15

 Strategies Using Correlation Measures


A portfolio has long on stock A and Short in Stock Futures. If the Stock moves
up by Rs 10 the Stock future would also go up but not exactly 10 say by 9

 Strategies Using Market Instruments


Financial Instrument Such as options provide us with method to hedge market
risk