Risk in Banking Business

CAIIB

Bank Financial Management

Module B

Risk Management
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 Risk in Banking Business

Banking Business lines may be grouped broadly in 3 major

heads:

1. The Banking Book

2. The Trading Portfolio

3. Off-Balance Sheet Exposures.

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 Risk in Banking Business

1. The Banking Book:

The Banking Book includes all advances, deposits and

borrowings which is commercial and retail banking business.

All assets and liabilities in banking book have following

characteristics:

1.They are normally held until maturity

2. Accrual system of accounting is applied.

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 Risk in Banking Business
Risks in Banking Book are mainly 4 types:

1. Liquidity Risk: All assets and liabilities in the banking book

are held until Maturity, maturity mismatch between assets and
liabilities result in excess or shortage of liquidity, which is called
liquidity Risk.

2. Interest Rate Risk: When Interest rate changes take place during
the period is called interest rate Risk.

3. Credit Risk/Default Risk: Assets side banking book

generates credit risk arising from defaults in payment of principal
and/or interest by borrowers is called Credit Risk or Default Risk

4. Operational Risk : Risks arise due to human failures of

Omission or commission, deficiencies in information system and
system failure, internel process or external event all are called
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 Risk in Banking Business

2. The Trading Book:

The trading book inculeds all the assets which are marketable
like fixed income securities, foreign exchange holdings,
commodities etc.

Trading book is subject to adverse movement in market price

Until they are liquidated. it is called Market Risk.

Here market risk is also including liquidity risk, default risk or

credit risk and operational risk.

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 Risk in Banking Business

3. Off- Balance Sheet Exposures:

Off-Balance sheet exposure are contingent in nature which

included guarantees, letter of credit etc.

All these off-balnce sheet exposures also included liquidity risk,

interest rate risk, market risk, default or credit risk and operational
risk.

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 Risk in Banking Business
1. Liquidity Risk included:

a. Funding Risk (Difference between Loans and deposits).

It is the need to replace net out flows due to unanticipated
withdrawal/nonrenewal of deposit

b. Time Risk (Maturity period of Loan and deposits are different)

It is the need to compensate for nonreceipt of expected inflows of
Funds on time, i.e. performing assets turning into non-performing
assets.

c. Call Risk (When bank has profitable business but there is

contingent liabilities can be arises.) It happens on account of
crystalisation of contingent liabilities and Inability to undertake
profitable business opportunities when desired.
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 Risk in Banking Business

Interest Rate Risk includes:

a. Gap or Mismatch Risk: It arises from holding assets and liabi

lities and off balance sheet items with different principal amoun
ts, maturity dates & re-pricing dates thereby creating exposure
to unexpected changes in the level of market interest rates.

b. Basis Risk: It is the risk that the Interest rate of different Asse
ts/liabilities and off balance items may change in different mag
nitude. The degree of basis risk is fairly high in respect of bank
s that create composite assets out of composite liabilities.

c. Yield Curve Risk: Movement in yield curve and the impact of

that on portfolio values and income.
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 Risk in Banking Business

d. Embedded Option Risk: Option of pre-payment of loan and

Pre-mature of deposits before their stated maturities constitute
embedded option risk

e. Reinvestment Risk: Uncertainty with regard to interest rate at

which the future cash flows could be reinvested.

f. Net Interest position Risk: When banks have more earning a

ssets than paying liabilities, net interest position risk arises in c
ase market interest rates adjust downwards.

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 Risk in Banking Business

3. Market Risk:

a. Forex Risk : Foreign exchange risk is the risk that a bank may suf
fer loss as a result of adverse exchange rate movement during a p
eriod in which it has an open position, either spot or forward or bot
h in same foreign currency.

b. Market liqudity Risk : Market liquidity risk arises when a bank is u

nable to conclude a large transaction in a particular instrument nea
r the current market price.

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 Risk in Banking Business

4. Default or credit Risk

a. Counterparty Risk : The Counterparty risk is generally viewed

as a transaction financial risk associated with trading rather tha
n standard credit risk.

b. Country Risk: This is the risk that arises due to cross border t
ransactions that are growing dramatically in the recent years o
wing to economic liberalization and globalization. It is the possi
bility that a country will be unable to service or repay debts to f
oreign lenders in time.

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 Risk in Banking Business

5. Operational Risk

a. Transaction Risk: Always banks live with the risks arisin

g out of human error, financial fraud and natural disasters.

b. Compliance Risk : Compliance risk is the risk of legal or

regulatory sanction, financial loss or reputation loss that a
bank may suffer as a result of its failure to comply with an
y applicable law. It is also called integrity risk.

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 Risk in Banking Business

6. Other Risk

a. Strategic Risk: Strategic risk is the risk arising from adverse b

usiness decisions, improper implementation of decisions or lac
k of responsiveness to industry changes.

b.Reputation Risk: Reputation risk is the risk arising from negati

ve public opinion. This risk may exposed the institution to leti
gation, financial loss or a decline in customer base.

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Risk in Banking Business

Thank You

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