risk mangemnet
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RISK MANAGEMENTPRESENTATION ON
CREDIT RISKAND
MARKET RISK
By
S.D.BARGIR, Joint Director, IIBF
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Risk may be defined as
exposure to uncertainty
favourable or unfavourable
outcomes
aims at mitigating the loss
managing risk rather than oneliminating it
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Risk management is a foursteps process
IdentifyingMeasuring ( quantifying)
Managingcontrolling, monitoring andreviewing
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Three generic categories ofrisk
Credit risk
Market risk
Operational risk
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Credit Risk
credit risk means default of the
borrower or deterioration of
borrowers credit quality.
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Market Risk
arising from movement in market prices
Interest Rate Risk,
Exchange Rate Risk,
Commodities Price risk
Equity Price Risk.
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Operational Risk
loss resulting from inadequate or failed
internal processes
People
systems or
external events.
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Credit Riskdefaults take various forms
Direct Lending:Loan amount
(Principal as well as interest) will notbe paid
Guarantees/ Letter of Credit
etc.Funds will not be forthcomingupon crystallization of liability
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Credit Riskdefaults take various forms
Treasury Products payment due from the
counter parties either stops or not
forthcoming Securities Trading Settlement will not be
effected Cross boarder exposure: free transfer of
currency is restricted or comes to an end.
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credit risk, consists of three
risks
Default risk
Exposure risk
Recovery risk
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Exposure risk uncertainty associated with future
amounts
credit lines- repayment schedule-exposure risk small
other lines of credit -OD, project financing
, guarantees etc- risk cannot be predictedaccurately
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Recovery risk:
recoveries in the event of default not
predictable
depend upon type of default availability of collaterals, third party
guarantees
circumstances surrounding the default.
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Expected Losses &Unexpected Losses
EL depends upon defaultprobability(PD), Loss given default
(LGD)& exposure at risk (EAD) EL = PD x LGD x EAD
Unexpected losses (UL) is the
uncertainty around EL and it isStandard deviation of EL.
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challenges faced by banksin r/o EL
aggregation of the risk-relatedinformation to assess the PD,
LGD and EAD
implementation of a risk ratingsystem that can correctly modelthese parameters which isstatistically valid.
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BASEL
Basel Committee on Banking supervision(BCBS) under the auspices of Bank forInternational Settlements (BIS)
Established in 1975 by group of 10countries
Belgium, Canada, France, Germany, Italy,
Japan, Luxembourg, the Netherlands,Spain, Sweden, Switzerland, the UnitedKingdom and the United States.
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Basel II-Implementation inIndia
with effect from March, 31,2007 by commercial banks.
90 commercial Banks in
India100 countries
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Basel II
capital requirements more risk sensitive
directly related to the credit rating ofeach counter-party instead of counter-party category
capital for credit and market risk but alsofor operational risk (OR)
where warranted for interest rate risks,credit concentration risks, liquidity risks
SME sector
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BASEL II RESTS ON THETHREE PILLARS,
Pillar I Minimum CapitalRequirements
Pillar 2 Supervisory Review Process Pillar 3 Market Discipline
each pillar is as important as the other one
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Pillar 1 Minimum Capital
Requirements
menu of approaches for computingcapital adequacy
freedom to choose the approach minimum, the Standardized Approach for
credit risk
Basic Indicator Approach for operationalrisk
standardised Approach or Internal RiskMeasurement Models approach formarket risk
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Various Approaches
Credit Risk Market Risk OperationalRisk
StandardizedApproach(SA) StandardizedApproach(SA) BasicIndicatorApproach
Basic-
Internal RiskBased(IRB)
Internal RiskMeasurementModel
Standardized
Approach(SA)
Advanced
IRB
The internalmeasurement
approach
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Pillar 2- SupervisoryReview
encourage to adopt better riskmanagement techniques
intervene to mandate a higher capitalrequirement
more inclusive besides CR,MR,OR creditconcentration risk Interest rate risk inbanking book, Liquidity risk, Businessrisk, Strategic risk and Reputation risk.
Takes into account Business cycle effectstoo
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RISK BASED SUPERVISION(RBS)
Business Risk Factors
1. Capital,
2. Credit Risk,
3. Market Risk,4. Earnings risk,
5. Liquidity Risk,
6. Business Strategy
and EnvironmentRisk,
7. Operational Risk
8. Group Risk.
Control Risk Factors
1. Internal ControlsRisk,
2. Organisation risk,
3. Management Risk
4. Compliance Risk.
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Pillar 3- MarketDiscipline
disclosures to enhance marketdiscipline
Monitoring by markets- other banks,customers, depositors, subordinateddebt instrument holders, analysts &rating agencies
disclosure policy approved by Board
financial penalty, for non-compliance
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Standardised Approach Different
categories of obligors
Corporates
Sovereign
Bank
Retail
Real Estate
Specialized Lending
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Issues emerging out ofBasel II
higher capital requirements
improved IT architectures
data issues
consolidation
capacity building
external ratings use of national discretion
validating the concept of economiccapital
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Capital requirements forCORPORATES in Basel II
creditrating
AAA toAA
A+ toA-
BBB+to BB-
BelowBB-
Unrated
RWBasel I
100% 100% 100% 100% 100%
Capital-Basel I
8% 8% 8% 8% 8%
RWBasel II
20% 50% 100% 150% 100%
Capital-Basel II
1.6% 4% 8% 12% 8%
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Capital requirements forSOVEREIGN in Basel II
AAA toAA
A+ toA-
BBB+to BB-
BB toBB-
BelowBB-
Unrated
100% 100% 100% 100% 100% 100%
8% 8% 8% 8% 8% 8%
0 20% 50% 100% 150% 100%
0 1.6% 4% 8% 12% 8%
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Capital requirements forBANKS in Basel II
AAA toAA
A+ toA-
BBB+to BB-
BB toBB-
BelowBB-
Unrated
100% 100% 100% 100% 100% 100%
8% 8% 8% 8% 8% 8%
20% 50% 100% 100% 150% 100%
1.6% 4% 8% 12% 8% 8%
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Capital requirements forBANKS in Basel II
AAA toAA
A+ toA-
BBB+to BB-
BB toBB-
BelowBB-
Unrated
100% 100% 100% 100% 100% 100%
8% 8% 8% 8% 8% 8%
20% 50% 100% 100% 150% 100%
1.6% 4% 8% 12% 8% 8%
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Capital requirements forRETAIL in Basel II
RETAIL INDIVIDUALOR SMALLBUSINESS
DEFAULT
RW underBasel I
100% 100%
RW underBasel II
75% From 150%to 50%
Capital underBasel II
6% 4% to 12%
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Capital requirements for REALESTATE in Basel II
RETAIL
RW BASEL I
RESIDENTIAL
50%
COMMERCIAL
100%
Capital underBasel I
4% 8%
RW under
Basel II
35% 100%
Capital underBasel II
2.7% 8%
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SPECIALISED LENDDING
PROJECT FINANCE
COMMODITIES,COM.
REAL ESTATERW UNDER BASEL I 100%
CAPITAL Basel I 8%
RW UNDER BASEL II 100%
CAPITAL BASEL II 8%
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Assessing exposure customer
wise and facility wise
Probability of Default (PD) - theprobability that a specific customer will
default within the next 12 months.
Loss Given Default (LGD) - thepercentage of each credit facility that will
be lost if the customer defaults. Exposure at Default (EAD) - the
expected exposure for each credit facilityin the event of a default.
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MARKET RISKMarket risk takes the form ofinterest rate risk, exchange
rate risk, commodity price riskand equity price risk , majorrisk presently faced by banks in
India are interest rate,exchange rate and liquidityrisk.
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MARKET RISK-CONTINUED
Basel-I focused only on credit riskexcluding the market risk
Risk brought vide amendments in 1996
usually measured with a Value-at-Riskmethod and on daily basis
capital charge should be either theprevious days VaR or three times theaverage of the daily VaR for thepreceding 60 working days.
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Stipulations of RBI
Assign additional risk weight of 2.5% onthe entire investment portfolio
Assign risk weight of 100% on the openposition limit on foreign exchange andgold
Build investment fluctuation reserve up
to a minimum of 5% of the investmentheld in Held for Trading(HFT) andavailablefor sale(AFS)category in theirinvestment portfolio
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Linking risk to capital-single metric
Risk measurement focuses on unexpectedlosses
Different business activities lead tovarious unexpected losses
These different risks must be measuredindividually and aggregated to a single
risk metric, both by business line andacross the bank as a whole
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WINNING FORMULA
Overall risk should always
be lower than overalleconomic capital
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.
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