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TYPES OF RISKS, RISK MITIGATION AND RISK MANAGEMENT SOLUTIONS
TYPES OF RISKS Credit Risk Market Risk Liquidity Risk Interest Rate Risk Gap or Mismatch Risk Basis Risk Embedded Option Risk Yield Curve Risk Price Risk Reinvestment Risk Net Interest Position Risk Foreign Exchange Risk Operational Risk Regulatory Risk .
.CREDIT RISK Credit Risk – Arises due to inability of the borrower to repay.
MARKET RISK Market Risk – Arises due to adverse changes in the market. Call Risk – Arises when contingent liabilities are crystallized resulting in banks being unable to utilize them in profitable opportunities. . Funding Risk – Arises when there is a need to replace cash outflows owing to unanticipated withdrawals. Time Risk – Arises owing to non-receipt of cash inflows. and include Liquidity Risk – Arises due to inability to efficiently accommodate deposits. using short term deposits to fund long term purposes.
Interest rates of different assets with different principal amounts and maturity period change in different magnitudes.Assets are sold before maturity.Different assets will cause non parallel and frequent movements in the yield curve when economy moves through business cycle. call/put options.Significant changes in market rates will cause preclosure. (inverse relation between bond value and yield) . which affects the Net Interest Margins and the market value of equity.MARKET RISK (CONTINUED) Interest Rate Risk – It arises due to impact of interest rates. credit demand. Yield Curve Risk . Price Risk . duration will create exposure to unexpected changes in market rates. premature withdrawals.Different assets in terms of maturity. Gap or Mismatch Risk . Basis Risk . Embedded Option Risk .
MARKET RISK (CONTINUED) Interest Rate Risk Reinvestment Risk – Uncertainty in interest rates at which future cash flows can be reinvested. changes in time zones (‘Herstatt’ Risk) . counter party default. the NIM will decline. Foreign Exchange Risk – Risks owing to adverse changes in the currency exchange rates. Net Interest Position Risk – When market interest rates decline. limitations on cross border remittances. Mismatch in cash flows will impact NIM.
REGULATORY RISK Operational Risk . Regulatory Risk .Risk of loss arising from various types of human or technical error.OPERATIONAL RISK. . issues in settlement or payments.Risk of changes in operations due to regulatory interferences. business interruption. administrative and legal issues.
Review/Renewal – Multi Tier credit approving authority. . Maintain an effective credit portfolio. Risk Rating Model – Create a risk scoring system and rate risks on a scale. RAROC Framework can be used. Independent loan review mechanism should be adopted.RISK MANAGEMENT Credit Risk Exposure Ceilings – 15% for individuals and 40% for a group with additional 10% for infra projects taken by the group. Risk based Scientific Pricing – High risk category loans should be priced at higher interest rates. Identify thresholds and review periodically.
It is given by the formula (revenue – expenses – expected loss + income from capital) RAROC = ---------------------------------------------------------------------------------capital where. Expected loss = average anticipated losses over the time period observed.. Bankers can compare returns on credits extended with varying risk levels over a time period.RISK MANAGEMENT – ‘RAROC’ FRAMEWORK Risk Adjusted Return On Capital gives insights into decision making with respect to extending credit. .
The model tracks rating migration which is the probability that a borrower migrates from one risk rating to another risk rating. Expected Default Frequency – deriving the actual probability of default by borrowers by measuring the asset value of the firm from the market value of its equity.using a multifactor approach to stimulate the distribution of default probabilities. probability of risk is higher. . McKinsey’s Credit Portfolio View . Credit Metrics .RISK MANAGEMENT – RISK RATING MODELS Altman’s Z Score . as well as migration probabilities conditioned on the value of macro-economic factors. When estimated asset value falls below a pre-specified default point.forecasting the probability of a company entering bankruptcy.estimating the volatility of asset values caused by variation in the quality of assets. It separates defaulting borrower from non-defaulting borrower on the basis of certain financial ratios converted into simple index.
A good portfolio will survive the stress testing. Liquidity Risk – Asset Liability Management (ALM) should be deployed to ensure a proper balance between funds mobilization and deployment. interest rate. Identify future changes in economic and market conditions and identify the impact of the unfavorable changes on the banks portfolio. monitoring and controlling liquidity. Tolerance level should be set according to the mismatch.RISK MANAGEMENT (CONTINUED) Market Risk Create a framework for measuring. foreign exchange risk and integrate the same with the bank’s strategy. Perform scenario analysis and stress testing. .
lower the interest rate risk. Lower the loss. Lower the duration gap. ‘VaR’ Model – Measures the impact of market risk and measures the worst expected loss at a given instance with a confidence level of 99%. lower the impact of market risk.RISK MANAGEMENT (CONTINUED) Interest Rate Risk – Measure the volatility of the portfolio as a result of fluctuations of the interest rates. Gap Analysis Duration Gap Analysis – Duration (Ʃ t * Wt ) gap is the measure of difference between duration of assets and liabilities. .
RISK MANAGEMENT (CONTINUED) Operational Risk Internal Controls and Internal Audit Insurance Risk education to familiarize complex operations .
RISK MANAGEMENT SOLUTIONS RISK IDENTIFICATION RISK MEASUREMENT RISK MITIGATION EXTERNAL DATA RISK DATA REPOSITORY CREDIT RISK ACTIONS BANK MIS DATA MARKET RISK OPERATIONAL RISK CRM DATA •Capital Allocation •Credit Review •Operating Efficiency •Hedging .
Ensuring that risk management remains independent of business. Setting risk objectives and ensuring alignment to corporate objectives. . Identifying risk areas and defining boundaries of risk management.RISK MANAGEMENT SOLUTIONS Wipro – Enterprise Risk Management (ERM) for banks Establishing company-wide risk framework (view. definitions. assumptions). Identifying and selecting strategy for risk mitigation. Creating risk profile for each risk area.
Operational and IT Risk Manage access to critical applications. Automate policy based user roles and access rights. Risk insight and control in real time.RISK MANAGEMENT SOLUTIONS IBM – Integrated Risk Management Solution Financial Risk Set up of centrally managed repository of financial risk data. Risk scenarios that can be applied and tested. Manage workflows. Using compliance framework to stay updated with regulations . Ensuring safety of depositors funds with compliance. Enforce process standards and controls. Governance and Compliance Identifying market conduct breaches.
Accelerate enterprise wide risk management. Achieve superior operational efficiency through effective governance. data and system management models Improve Risk analytics and Risk model validation and testing. Provide enhanced reporting services with investigative reporting features . Reduce operational risk by managing bankruptcies using collection and recovery framework.RISK MANAGEMENT SOLUTIONS Infosys – Risk Management Solution Implement Regulatory Risk programs within time and budget.
Providing a set of tools. methodologies.RISK MANAGEMENT SOLUTIONS TCS – Risk Management BASEL II Providing extensive support to the risk management activities by consulting. product implementation and modelling. Operational Risk and Pillar II facilitating a seamless integration. Improved data quality and data integration. data management. thereby facilitating decisions based on accurate and holistic data. . ready to deploy assets to accelerate Basel II implementation. Providing a holistic and robust implementation framework across Credit.
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