mr ravi mohan
TRANSCRIPT
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Integrated Risk architecture:Implementation Issues
FICCI - IBA conference on Global Banking paradigm shifton October 5th 2005
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Challenges in Implementing IRM3
Components for implementing IRM
What is Integrated Risk Management
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Three key imperatives for Banks Management
Differing requirementsfrom variousstakeholders
Employees
Borrowers
Regulators
Credit Ratingagencies
Counterpartybanks
Depositors
InvestorsCapitalAdequacy
Growth
Profitabilit
y
IRM can assist in managing the three objectives proactively
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Maintenance of Regulatory/ EconomicCapital is crucial to business continuity
Economic Capital is the financial cushion that a bank uses to absorbunexpected losses. The purpose of economic capital is to provideconfidence to claim holders such as depositors, creditors and otherstakeholders.
The development of of sophisticated risk measurement tools offersbanks the capability to calculate economic capital.
The proposed New Basel Capital Accord is a major move towards
aligning regulatory capital to economic capital.
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Profitability Analysis Bank ABC
Investments offer thehighest contributionp.c.age on assets
Which segmentleads to highinterest earnings?
The credit function hasthe largest contributiontowards fixed expenses
Which creditsegmentcontributes thehighest?
What is the positionafter allocatingcosts?
Am I properlypricing for expectedLosses?
Profitability AnalysisCredit Investments Others
Average Assets 51840 35064 10597
Interest Income 7.9% 8.5% 1.5%
Interest Expenses 3.6% 3.6% 3.6%
Net Interest Margin 4.3% 4.9% -2.1%
Other Income 1.9% 1.3%
Less: Provisions 1.3% 0.0%Total Contribution 4.9% 6.3% -2.1%
Contribution (LKR Mn) 2548 2204 -226
Total Contribution 4526
Operating Expenses 3975
Share of Profit from subsidiaries 197
PBT 749
Tax 70PAT 679
What is the capital required for different business lines?
What is the return provided by different business lines on
capital invested? What is the expected impact of NPAs/ revaluation? Where
should we grow?
Are we generating enough internal capital to support growth?
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Risk Exposures Bank ABC
Assets
31/12/2003
Cash & Short Term Funds 1739
Balances with Central Banks 3305
T Bills and other eligible securities 5756
Placement with and loans to other banks 10987
Bills of Exchange 2493
Loans & Advances 44222
Lease Rentals receivable within one year 96
Lease Rentals receivable after One year 72
Dealing Securities 587
Equity & others 916Bonds 17664
Investment Securities 18580
Investment Properties 804
Investments in Subsidiaries & Associates 1667
Accrued Intt 1073
Cheques Purchased 2979
Other Assets 3331
Other Assets 7382
Group balances receivable 503
Property Plant & Equipment 1807Total Assets 100000
Liabilities
31/12/2003
Deposits from customers 77312
Deposits from Banks 188
Total Deposits 77500
Borrowings 10923
Group balances payable 397
Deferred Tax Liability 0
Tax Payable 26
Other Liabilities 4887
Subordinated Debentures 520
Total Liabilities 94253Shareholders Equity
Share Capital 1082
Permanent Reserve Fund 609
Reserves 4056
Total Equity 5747
Total Liabilities & Equity 100000
Market RiskCredit Risk Liquidity Risk
The bank runs asset liability mismatches due differing maturity profiles and lending and borrowing
rates for credit, investments, deposits and subordinated debentures.
Borrowing/ Lending/ Investing in Foreign Currency gives rise to foreign exchange risk
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How does this affect us?
Credit Risk: Simple credit products(loans normally backed by
collateral, few products)
Market Risk: Simple market riskproducts (dealing in g-sec/ limitedcorporate bond market/ limited FX
market)
Operational Risk: Not a majorconcern
Increasing Complexity & Size
Current Environment Future Environment
Credit Risk: Credit Derivatives
Project Finance
Market Risk: Multiple currencies Investments in securities across
countries Investments in corporate bonds
Swaps/ Options otherderivatives
Operational Risk: Increasingly important with
complex systems andprocesses, operations across
time zones and markets
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RAROC - Base for Integrated Risk Management
RAROC
22%
Risk-adjustedNet income
1750
Risk-adjusted
After tax income
1.75%
Average
Lending assets
100,000
Total capital
8000
Risk-adjusted
Net income
2.20%
Net Tax
0.45%
Total capital
8.0 %
Risk-adjusted
income
5.60 %
Costs
3.40 %
Credit Risk Capital
4.40 %
Market Risk Capital
1.60 %
Operational Risk Capital 2.00 %
Income
6.10 %
Expected
Loss 0.50 %
RAROC could be carried out for the bank as a
whole or a business segment.
RAROC allows a bank to take a comprehensiverisk view and forms the base for IRM
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Integrated Risk Management in a Bank
What is Integrated Risk Management?
Measure, monitor and manageall therisksacross the bank.
Bank wideintegrated riskmanagement infrastructurein terms ofpeople, policies and systems
Common and consistent riskmeasurement and quantification
methodologiesacross all riskcategories
Aggregation of risks andestimation ofeconomic capitalto assist in risk/return decision making
Compliance
Integrated
Risk
Manageme
nt
Organisation
Structure
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Perceived advantages of IRM
Facilitates strategic value creation
Key to regulatory compliance
Mechanism for efficient allocation of economic capital
Enables bank to maximise returns Lower capital costs
Better decision making due to scenario analysis
Risk adjusted pricing
Loss reduction due to understanding of correlations
Elimination of unwanted exposures
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Challenges in Implementing IRM3
Components for implementing IRM
What is Integrated Risk Management
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IRM Implementation Important Facets
IT Infrastructure
Risk Communication and Control
Centralised
risk function
(analytics and
management)
New product
assessment
Quantification
Aggregation
Risk-adjusted
performance
measurement
Controls on
Risk takers
Risk reportingRisk
Policy
Policy Risk Models PerformanceMeasurment
MIS
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Challenges in Implementing IRM3
Components for implementing IRM
What is Integrated Risk Management
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IRM Challenges identification of gaps inexisting risk management practices
Organisation Structure
Risk Management Policies
Management Information Systems
Information Technology Systems
Top Management Oversight
Risk Analytics
Processes and Systems
Reviewing and improving existing
Credit Risk
Market Risk
Operational Risk
Basel II
ALM
Business Risk
Reputation Risk
Beyond Basel II
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IRM Challenges - measurement of risks
Credit Risk
Probability of Default
Loss Given Default
Exposure at Default
Market Risk
Trading Book (VaR)
Interest Rate Risk on Banking Book
Operational Risk (evolving)
Requires collection of data over time, development of measurement
models, back testing of models
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IRM Challenges Risk Aggregation
Correlations among risk silos
OVERALL ECONOMIC CAPITAL
RISKCATEGORY
RISK SILOCREDIT RISK
Cor
pora
teI
Corp
o
rateII
RetailP
ool
CorrelationsAcross
Companies
OPERATIONALRISK
Busin
ess
Line1
Busin
essLin
e2
Correlationsacross
Businesses
MARKET RISKCAPITAL
Intere
stR
a
teRisk
ForeignEx
ch
an
geRisk
Comm
odi
tyRisk
Correlationsacross
Asset classes
Equity
Risk
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IRM Challenges - modelling of correlationsacross risk categories & risk silos
Modelling correlations requires data and is not easy
Fat tails in credit risk create problems
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IRM Challenges - Improving IT systems
Internal risk scoring models for credit Portfolio Management Models
Models for estimating VaR for Market risk
Operational Risk databases
Asset Liability Management System
Data warehouse having interfaces for Analytical
Modelling
Reporting
Options for developing Risk Management Systems In-house
Off-the-shelf
Sizeable investments in IT infrastructure required for implementing Basel II
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Thank you
CRISIL Investment & Risk Management ServicesCRISIL [email protected]
Ph.no: 91 22 56537371
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