Professional Documents
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RISK MANAGEMENT
RISK IN BANKING BUSINESS ? WHAT IS RISK ? RISK , CAPITAL AND RETURN.
VALUATION OF SECURITIES.
VALUATION OF INVESTMENT PORTOLIO OF BANKS WILL BE CLASIFIED AS UNDER : HTM: VALUALTION METHOD: Investments classified under HTM category need not be marked to market and will be carried at acquisition cost unless it more than the face value. In such case the premium is amortized over a period of remaining maturity.
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VALUATION OF SECURITIES
AFS : VALUATION METHOD : Individual scrip will be marked to market at the quarter end . The net depreciation under each classification should be recognized and fully provided for and any appreciation should be ignored. The book value of securities would not undergo any change after the revaluation. HTM. VALUATION METHOD : The individual scrips in the HTM category will be revalued at monthly interval and net appreciation or deprecation under each classification will be recognized in income account. The book value of the individual scrip will be changed with
Liquidity Risk.
Q Funding risk is : A. Un anticipated withdrawal/non renewal of deposit. B. Unable to provide funds to Head office of Bank. C. Inadequate funds. Q. The liquidity risk arising out of non receipt of expected in flow of funds due to accounts turning as NPA is known as a. Time Risk. b. Call Risk. c. Operational Risk. d. Funding risk. Q. The liquidity risk arising out of crystallization of liabilities and conversion of non fund based limits to fund based limits is known as : a. Call risk. b. Time risk. c. Operational risk. d. Market risk.
Interest Rate Risk. Gap or Mismatch risk. Yield curve risk. Basis Risk. Embedded option risk.
Market Risk
Forex Risk. Equity price risk. Interest rate risk. Mark to Market. CREDIT RISK: Counter Party risk. OPERATION RISK.
MANAGEMENT OF RISK
RISK IDENTIFICATION.: RISK MEASURMENT. Sensitivity, Volatility, Var. RISK PRICING. RISK MONITORING. RISK MITIGATION.
What is the Basel Committee? Established at the end of 1974 by Central Bank Governors of G10 to address cross-border banking issues Reports to G10 Governors/Heads of Supervision Members are senior bank supervisors from G10, Luxembourg and Spain Work undertaken through several working groups
Outreach to other countries Committee started as a closed shop Over time, has developed close ties with non-members Committee tries to address issues relevant for all jurisdictions worldwide Core Principles Liaison Group (16 non-Committee jurisdictionsincluding Indiaplus IMF, World Bank) Working Group on Capital Regional groups International Conference of Banking Supervisors (ICBS) Participation in work of the Secretariat Training, speeches, consultation
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The three Cs
From Basel I to Basel II 1988 Capital Accord established minimum capital requirements for banks Minimum ratio: Capital 8% Risk weighted assets
In 1998, Committee started revising the 1988 Accord: More risk sensitive More consistent with current best practice in banks risk management Numerator (definition of capital) remains unchanged
What are the basic aims of Basel II? To deliver a prudent amount of capital in relation to risk To provide the right incentives for sound risk management To maintain a reasonable level playing field Basel II is not intended to be neutral between different banks/different exposures
Market Discipline
Enhanced disclosure
Market
Credit
Risk of loss due to unexpected repricing of assets owned by the bank, caused by either Exchange rate fluctuation Interest rate fluctuations Market price of OUR investment FOCUS fluctuations TODAY Risk of loss due to unexpected borrower default Risk of loss due to a sudden reduction in operational margins, caused by either internal or external factors
Stocks
Operational
Business unit A
The three pillars All three pillars together are intended to achieve a level of capital commensurate with a banks overall risk profile
eas r c In
Standardized Approach
Banks use internal estimations of probability of default (PD) to calculate risk weights for exposure classes. Other risk components are standardized.
Advantages of capital
Provides safety and soundness Depositor protection Limits leveraging Cushion against unexpected losses Brings in discipline in risk taking
The Current Capital Accord Focused on credit risk but formula based Partially amended in 1996 to include market risk Operational risk not addressed Simple in its application Produced an easily comparable and verifiable measure of banks soundness
Talks of Credit Risk only Capital Charge for Credit Risk Does not mention separate Capital charge for Market and Operational Risk No mention about market Discipline No effort to quantify Market and Operational Risk
Talks of Credit, Market and Operational Risks Capital Charge dependant on Risk rating of assets Capital Charge to include risks arising out of Credit, Market and Operational risks. Not a broad brush approach Quantitative approach for calculation of Market and Operational risks as for Credit Risk.
Total capital = Banks capital ratio Credit risk + Market risk + Operational risk (minimum 9%)
Total Capital Credit Risk Market Risk Operational Risk
Total capital = Tier 1 + Tier 2 Tier 1: Shareholders equity + disclosed reserves Tier 2: Supplementary capital (e.g. undisclosed reserves, provisions) The risk of loss arising from default by a creditor or counterparty The risk of losses in trading positions when prices move adversely The risk of loss resulting from inadequate or failed internal processes, people and systems or from external events
* The revisions affect the denominator of the capital ratio - with more sophisticated measures for credit risk, and introducing an explicit capital charge for operational risk
Framework
Internal ratings based (IRB) approach Foundation Advanced Goal: Should contain incentives for migration from standardized to IRB approach
IRB approach
Risk components PD, LGD, EAD,
Advanced approaches
Requires supervisors approval Increased emphasis on banks internal assessments Banks to meet certain standards Capital Management Policy Committee Process to review the quality of risk management & control systems Appropriateness of the capital level and composition to the nature and scale of banks activities
Operational Risk
Explicit charge on capital Basic Indicator approach 15% of gross income Gross income = net interest income plus net non interest income
GROSS INCOME
GROSS INCOME = NET PFORIT+ PROVISIONS+OPERATING EXPENSESPROFIT ON SALE OF INVSTEMENTINCOME FROM INSURANCE-EXTRA ORDINARY ITEM OF INCOME+ LOSS ON SALE OF INVESTMENT
Operational Risk
Standardised ApproachCapital charge is calculated as a simple summation of capital charges across 8 business lines
Business lines % of gross income 18 18 12 15 18 15 12 12 Corporate finance Trading & sales Retail Banking Commercial Banking Payment & Settlement Agency Services Asset Management Retail Brokerage
Pillar II
Principles:
(c) Supervisors should expect banks to operate above the minimum CAR and should have the ability to require banks to hold capital in excess of the minimum (d) Supervisors should intervene at an early stage to prevent capital from falling below required level and initiate rapid remedial action
Pillar II
Risk Based Supervision
Business risk and control risk
Pillar III
Sets out disclosure requirements and recommendations (core and supplementary) Required disclosures on capital, risk exposures, risk assessment (credit risk, market risk, Operational risk etc) and hence the capital adequacy. Allows market participants to assess key information about a banks risk profile and level of capitalisation
MARKET DISCIPLINE
a. Third Pillar to supplement first two pillars namely minimum capital requirement and supervisory review. b. The aim of this pillar is o encourage market discipline by developing a set of disclosure requirements which allows market participants to assess : Scope of application Capital Risk Exposures Risk assessment processes Ultimately Capital Adequacy
c. Such disclosures with common framework provides enhanced comparability. d. Achieving Appropriate Disclosure Market Discipline contributes to safe and sound banking. Non-disclosure attracts penalty including a financial penalty. No direct penalty of additional capital for nondisclosure but indirectly by way of lower risk weight under pillar-1 provided certain disclosures are made etc.
e. Interaction with accounting disclosures : Disclosure framework not to conflict with requirements under accounting standards. All banks should provide Pillar-III disclosures both qualitative and quantitative as on March end each year along with annual financial statements. Banks with capital funds of more than Rs.500 crores and their significant subsidiaries must disclosure on quarterly basis. - Tier 1 Capital - Total Capital - Total required capital - Total Capital adequacy ratios
g. Validation : No need of audit of disclosures as they are either consistent with audited financial statements or gone through internal assessment/control procedures and systems. h. Materially Information is regarded as material if its omission or misstatement could change or influence the assessment or decision of a user relying on that information for the purpose of making economic decision. - RBI will prescribe certain materiality threshold for certain limited disclosures to provide greater comparability among banks.
i.
Proprietory and Confidential Information Proprietory Information On products or Systems Confidential Information On customers RBI has prescribed in the form of various tables (1-11), a system of disclosures striking a balance between the need for meaningful disclosures and protection of proprietory and confidential information.
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General Disclosure Principle Each bank to have formal disclosure policy approved by Board. Approach for disclosures Internal control over disclosure process Process to assess appropriateness of its disclosures including validation and frequency
k. Scope of application Parent bank need not make disclosures of individual banks/entities except disclosure of Tier-I and total capital of each subsidiary bank. All Units to make Pillar-III disclosures.
Annual disclosures qualitative & quantitative Interim disclosures for banks with capital > 100 crore
Quantitative aspects in websites
Banks
to
have
formal
disclosure
Superior to the claims of investors in equity shares and Subordinated to the claims of all other creditors
A++
A+
B+
C+
Default
A++ A+ A B+ B C+
C
Thank You!