Risk Management in the Context of

International Trade
Dr. D.S.Gangwar IAS
CVO
The State Trading Corporation of India
Outline of the Presentation
A. Introduction to Risk & Uncertainty
B. Mechanism of International Trade
C. Understanding Risks in International Trade
D. Risk Management
I. Risk Management at Transaction Level
II. Enterprise Risk Management
E. Examples of Risk management Systems in Indian
companies
F. Conclusion
A. Introduction to Risk & Uncertainty
Returns are speculative;
Risk is a reality.
 Global Financial Meltdown 2008-09
What went wrong?
 Proximate Reason:
Sub-prime housing mortgage crisis

Banking crisis

Financial crisis

Economic crisis
Global Financial Meltdown 2008-09
What Counts ?

Everything that can be counted

does not necessarily count;
Everything that counts cannot
necessarily be counted”
- Albert Einstein
Risk @ heart of business
Risk is a fact of business life. Taking and managing
risk is part of what companies must do to create
profits and shareholders value.
Entrepreneur = A person who organizes, operates,
and assumes the risk for a business venture.
Entrepreneurs choose a level of personal,
professional or financial risk to pursue opportunity.
The risk taking by business entrepreneurs is
fundamentally important for wealth creation in the
capitalistic society.
Meaning of Risk
Risk is the effect of uncertainty on objectives.
Risk is often described by :
an event,
a change in circumstances or
a consequence.
Dimensions of Risk
Risk = Probability X Impact X Time
Dimensions of Risk
Risk, Uncertainty and Unknowable
Bell Curve Vs Power-Law Distribution
B. Mechanism of International Trade
International Trade
Mechanism of Trade and Payments
Methods of trade and settlement of
trade accounts
 Advance Payment
 Cash on Delivery
 Letter of Credit (L/C)
L/C is issued by the buyer’s bank at the buyer’s request in
accordance with the payment terms of the underlying
contratct and is a guarantee of payment by that bank.
 Finance against the Bill of Exchange (B/E)
B/E is issued by the seller (drawer) and addressed to the
buyer (drawee) for payment
Widely used , convenient
Finance may be arranged against B/E for both the seller
and buyer
Types of Bills of Exchange
 Trade financing – Export Finance
 Pre-shipment finance is extended as working capital for purchase of
raw materials, processing, packing, transportation, warehousing etc., of
goods meant for exports.
 Export Packing Credit (EPC) : Rs. Finance for purchase of above
item/activity.
 Advance against Duty Drawback entitlements : Export credit for an
amount in excess of export order representing duty drawback receivable.
 Pre-shipment Credit in Foreign Currency (PCFC) : Foreign Currency
finance at international interest rates through Authorised Dealers.
 Post-shipment finance is extended after shipment to bridge the time lag
between the shipment of goods and the realization of proceeds. Types of
Post-shipment finance are :
  Short-term finance
 Long-term finance

 At the post shipment stage, the Bank basically finances against Shipping
documents and Duty drawback entitlements
Trade financing – Import Finance
 Bank Finance: Banks provide Fund Based and Non Fund based
limits to Importer’s to meet their import requirement in form of CC
/ LC / BG limit.
 Trade Credits This is extended directly by the overseas
supplier/bank/financial institution for maturity of less than three
years. These are of two types :
 Suppliers’ credit : relates to credit for imports into India
extended by the overseas supplier.
 Buyer’s credit : refers to loans for payment of imports into India
arranged by the importer from a bank or financial institution
outside India for maturity or less than three years.
 External Commercial Borrowings (ECBs) are commercial loans
(in the form of bank loans, buyers’ credit, suppliers’ credit,
securitized instruments (e.g. floating rate notes and fixed rate
bonds) availed from non-resident lenders with minimum average
maturity of 3 years. ECB can be accessed under two routes, viz. (i)
automatic Route and (ii) Approval Route.
Indian Legal Framework for International Trade
 Foreign Trade (Development & Regulation) Act 1992: The
Government of India announces Foreign Trade Policy after every five years
under the Act.
 Foreign Trade (EXIM) Policy :
 EXIM policy aims at developing export potential, improving export
performance, encouraging foreign trade and creating favourable balance of
payments position.
 The EXIM Policy is updated every year on the 31st of March and the
modifications, improvements and new schemes becomes effective from 1st
April of every year.
 Foreign Exchange Management Act 1999
 The Prevention of Money Laundering Act 2002
 Conservation of Foreign Exchange and Prevention of
Smuggling Activities Act (1974)
 SEBI : Clause 49 © of listing agreement –Risk
Management Framework
C. Understanding Risks in
International Trade
 International Trade is the riskiest!
 If doing business is risky, trading is riskier, and international trading is
the riskiest!
In trading you buy at a certain price and sell at an uncertain price,
therefore operate at a risk.
In international trade you neither goods nor cash have in your physical
control !
 Sellers’ concerns:
 How will I be paid?
 When will I be paid?
 How can the risk of non-payment be minimised?
 Buyers’ concerns:
 How the goods/services will be delivered?
 When will be delivered?
 Will these be of agreed quality/quantity?
 Without price escalation
International Trade Risks
Country Risks
Financial Risks
Counterparty Risk
Funding Risk
Interest Rate Risk
Currency Risk
Crimes & Fraud Risks
Risk in Commercial Letters of Credit
Operations
Document risk
Procedure risk
Risk in transferable L/C
Risk in back-to-back L/C
Disputes over discrepancies and wrongful dishonour
Estoppel and waiver
Risk for confirming bank
Fraudulent L/C and fraud rules
International Trade Frauds
Scuttling, deviation, arson, cargo theft, charter
party & insurance frauds
Prime bank instruments, syndicated crimes,
franchisee crimes
Merchant banking frauds
Corruption
D. Risk Management
 Importance of Studying Risk Management
 Risk Management is “A systematic way of protecting the concern’s
resources and income against losses so that the aims of the business can
be achieved without interruption”.
 Prior to the industrial revolution decisions could be made easily using
heuristics or “gut level feel” based on past experience. The consequences
of failure were concentrated in small locations.
 Today the stakes are higher; the decision making is more complex, and
consequences more severe, global, and fundamental.
 The credit crisis revealed that lack of understanding of risks, and their
combined and correlated ramifications has far-reaching consequences
worldwide.
 Critical to the modern management of risk is the realization that all risks
should be treated in a holistic, global, and integrated manner, as opposed
to having individual divisions within a firm treating the risk separately.
 Enterprise-wide risk management was named one of the top ten
breakthrough ideas in business by the Harvard Business Review in 2004.
Risk Management
“The first step in the risk management
process is to acknowledge the reality of
risk. Denial is a common tactic that
substitutes deliberate ignorance for
thoughtful planning.”
-Charles Tremper
Risk Management at Transaction Level
 Preventive measures:
"Risk comes from not knowing what you're doing." ~ Warren Buffet
 Know your Customer well:
 The nature and history of the customer's business, including any recent change in
the ownership and management of the company, major trading partners and its
trading pattern.
 proven track record of repayment.
 It would be useful to visit the borrower's office or factory to ensure that business and
production are normal.
 Avoid entering into L/C transactions with abnormal terms, e.g. in cases where the
nature or volume of goods is unusual, the usance period of bills is unreasonably long,
and documents required for payment are exceptionally simple so that false
documents could be created easily.
 Drawing up the Contract documents as per negotiated terms
 Ensure the authenticity of L/Cs and the shipping documents.
 Confirm the authenticity of the L/C with the issuing bank.
 For L/Cs of substantial amount or in case of doubt, shipping documents should be
authenticated before negotiation.
 As far as possible spot checks should be arranged on suppliers and inspection
certificates should be obtained from independent surveyors.
 Managing the Risks of International
Trade
Customer Risk:
Assessment of the credit worthiness of your customer:
 the identity of your customer. Do they exist as a legally established
business in the country of import? Are you dealing with someone who
has the authority to bind your customer;
 the usual period of credit offered in your customer's country;
 the credit limit you are prepared to offer your customer;
 the trading history of your customer. Are they a prompt payer? Have
there been any changes to their normal payment patterns?
 are your exports compatible with your customer's normal business
profile?
 can your customer pay the bill?
 insolvency.
 You can obtain the information needed to carry out these checks either
yourself or through a reputable credit agency or credit insurer.
 Credit Risk:
 Perhaps the first question you should ask is 'Can I afford to
give my customers credit?' To decide how much credit you
are prepared to advance you must consider :
 the amount of credit outstanding in your trading accounts, both
overseas and domestic;
 what do you know about your customer and what is the maximum
amount of credit you should NOT exceed;
 can you carry any financial shortfall? What will be the impact on
your business if your customer delays payment or does not pay at
all?
 how will you finance the credit period you offer? This means do you
have sufficient money to allow you to offer credit terms in export
sales contracts as part of your business cycle.
 Risks in international trade and mitigation methods
Risk Economic (commercial) Exchange rate Transportation Political risks
category risks related to the risk risk
trading partner
Examples Importer is not willing Floating Damaged or War
or unable to pay exchange rates: Loss of goods Embargo
Importer does not variations in Restrictions
accept merchandise. exchange rates. Revolt
Exporter does not Fixed exchange Civil war
deliver on time or rates: risk of Prohibition on
products agreed. devaluation. foreign
exchange
transfer
Currency
declared
non-convertible
Methods to Private insurance or Bank provides Private Export credit
migrate public export credit hedging insurance agencies or
risks agencies; facilities; private insurance
Letter of credit; Public
Bank guarantees. exchange risk
insurance.
Enterprise Risk Management
 Differences between ERM and
Traditional Risk Management
Traditional Risk Management ERM

Risk as individual hazards Risk viewed in context of business

strategy

Risk identification & assessment Risk portfolio development

Focus on discrete risks Focus on critical risks

Risk mitigation Risk optimization

Risk limits Risk strategy

Risks with no owners Defined risk responsibilities

Haphazard risk quantification Monitoring & measurement of risks

“Risk is not my responsibility” “Risk is everyone’s responsibility”

Phases of Risk management
Components of a Risk Management
System (7 Rs)
Recognition or Identification of risks : description in a template e.g. Risk
Register or Table in a MIS
Ranking or Evaluation of Risks (Risk Classification System): Risk ranking
can be quantitative, semi-quantitative or qualitative in terms of
 the likelihood of occurrence and
 the possible consequences or impact.
Responding to Risks (4Ts)
 tolerate
 treat
 transfer
 terminate
Resourcing controls
Reaction planning
Reporting and monitoring risk performance
Reviewing the risk management framework
Structure and Elements of
Enterprise Risk management:
 The Risk Management Process
 Risk management is the process of anticipating and analyzing risks and coming up with effective and
efficient ways of managing as well as eradicating them.
 Risk Identification: The first step involves identifying risks. Certain risks could be quite obvious whereas
a few others may need a certain amount of anticipation
 Risk Analysis: Once all the risks have been identified, it is time to analyze and scrutinize each one of
them. Risk analysis should be done both qualitatively as well as quantitatively. Determine how big a
threat each risk is, what could be its consequence, its impact, etc. Each risk will have a likelihood factor
i.e., a probability factor. On the basis of its impact and its likelihood factor, you can prioritize different
risks as serious, moderate, mild, etc. Use a color coding system for easy graphical analysis. Once you have
all this data laid out in front of you, you will be in a position to rank individual risks.
 Risk Evaluation: This basically involves comparing the identified and analyzed risks with your individual
goals or your company's preset goals and objectives. You can then choose to grade risks and decide the
future course of action to be taken based on how severely the risk is likely to impact your goals, objectives
and targets.
 Risk Treatment and Contingency Plan: The next step involves preparing a risk treatment and
contingency plan. It is vital from the perspective of enterprise risk management. What will you do if the
risk materializes? Can you do something to overcome the risk? Can you take some measures to lessen its
impact? You should think about all these questions and come up with a risk treatment and contingency
plan for the same. It should include ways in which to control as well as overcome the risk conditions.
 Risk Monitoring: it is something that should happen on a continuous basis at all stages of the risk
management process. Have a RMMM (Risk Mitigation, Monitoring and Management) plan in place for the
same. At the same time, there should be proper communication between the different departments
involved in the risk management process. Communication is vital because it can affect the entire process
both negatively as well as positively.
Tools & Techniques for Enterprise Risk
Management
Risk Assessment Matrix
4 ways for dealing with risk
Risk Response Plan
Dashboard for Monitoring Operational Risks
Financial Risk Management
 Letter of Credit
 Bank Guarantee
 Natural Hedge
 Diversification : Don’t put all your eggs in one basket.
 Forex cover
 Derivatives: Futures & Options
 Swaps : Credit Default Swap
 Commodity Hedging
 Insurance cover
 Interest Rate Futures
E. Examples of Risk management
Systems in Indian companies
 Derivative use for Hedging FX Risk in Indian Firms
Company Instruments Nature of exposure

Reliance •Options Earnings in all businesses are linked to USD. The

Industries Contracts key input, crude oil is purchased in USD. All export
•Forward revenues are in foreign currency and local prices
Contracts are based on import parity prices as well.
•Currency Swaps
Maruti Forward Import/Royalty payable in Yen and Exports
Udyog Contracts Receivables in dollars.
Currency Swaps Interest rate and forex risk.
Infosys Forward Revenues denominated in foreign currencies.
Contracts
Options Contracts
Dr. Reddy’s Forward Foreign currency earnings through export, currency
Labs Contracts requirements for settlement of liability for import
Options Contracts of goods.
Mahindra Forward Trade payables in Yen and Euro and export
and Contracts receivables in dollars.
Mahindra Currency Swaps Interest rate and foreign exchange risk.
 Case Study : Risk Management @Bank of Baroda
Risk Management Architecture:
Managing various types of financial risks is an
integral part of the banking business.
Bank of Baroda has a robust and integrated Risk
Management system to ensure that the risks
assumed by it are within the defined risk appetites
and are adequately compensated.
The Risk Management Architecture comprises:
 Risk Management Structure,
Risk Management Polices and
Risk Management Implementation and Monitoring
Systems.
 2.Risk Management Structure @ Bank of Baroda
 The overall responsibility of setting the Bank’s risk appetite and
effective risk management rests with the Board and apex level
management of the Bank.
 The Bank has a full fledged Risk Management Department headed
by a General Manager and consisting of a team of qualified, trained
and experienced employees.
 Asset Liability Management Committee (ALCO):
 the management of Market Risk and Balance Sheet Management.
 managing deposit rates, lending rates, spreads, transfer pricing, etc in
line with the guidelines of Reserve Bank of India.
 plans out strategies to meet asst-liability mismatches.
 Credit Policy Committee (CPC):
 formulate and implement various enterprise-wide credit risk strategies
including lending policies
 monitor Bank’s credit risk management functions on a regular basis.
 Operational Risk Management Committee (ORMC):
 has the responsibility of mitigation of operational risk by creation and
maintenance of an explicit operational risk management process.
3. Risk Management Policies @Bank of Baroda

Risk Management Policies

The Bank has Board approved following policies to measure,
manage and mitigate various risks that the Bank is exposed to:
 Asset Liability Management and Group Risk Policy
 Domestic Loan Policy
 Mid Office Policy
 Off Balance Sheet Exposure Policy (domestic),
 Business Continuity Planning Policy,
 Pillar III Disclosure Policy,
 Stress Test Policy and Stress Test Framework,
 Operational Risk Management Policy,
 Internal Capital Adequacy Assessment Process (ICAAP),
 Credit Risk Mitigation and Collateral Management Policy
 4.Risk Management Implementation and Monitoring
System in Bank of Baroda
The main risk exposures that the Bank faces are Liquidity Risk, Credit Risk,
Market Risk and Operational Risk.
(1) Liquidity Risk : the risk that the Bank either does not have the financial resources
available to meet all its obligations and commitments as they fall due or it has to
access these resources at excessive cost.
 The Bank’s ALCO - overall responsibility of monitoring liquidity risk of the Bank.
 The liquidity risk is measured by flow approach on a daily basis through Structural
Liquidity Gap reports and on a dynamic basis by Dynamic Gap reports on fortnightly
basis for the next three months.
 Under Stock Approach, the Bank has established a series of caps on activities such
as daily call lending, daily call borrowings, net short term borrowings and net credit
to customer deposit ratio and prime asset ratio, etc.
 The Asset Liability Management (ALM) Cell, reviews the liquidity position on a daily
basis to ensure that the negative liquidity gap does not exceed the tolerance limit in
the respective time buckets.
 Management of liquidity by prudent diversification of the deposit base, control on
the level of bulk deposit, and ready access to wholesale funds under normal market
conditions.
 5.Risk Management in Bank of Baroda
(2) Credit Risk : the risk that the counterparty to a financial transaction will fail to
discharge an obligation resulting in a financial loss to the Bank.
 Credit risk management processes involve identification, measurement, monitoring
and control of credit exposures.
 Various policies such as Domestic Loan Policy, Investment Policy, Off-Balance Sheet
Exposure Policy, etc, wherein the Bank has specified various prudential caps for
credit risk exposures.
 The Bank also conducts industry studies to assess the risk prevalent in industries
where the Bank has sizable exposure and also for identification of sunrise
industries.
 The Bank uses a robust credit rating model to measure credit risk for majority of
the business loans (non personal loans). The rating model has the capacity to
estimate probability of default (PD), Loss Given Default (LGD) and unexpected
losses in a specific loan asset.
 Apart from assessing credit risk at the counterparty level, the Bank has
appropriate processes and systems to assess credit risk at portfolio level. The
Bank undertakes portfolio reviews at regular intervals to improve the quality of the
portfolio or to mitigate the adverse impact of concentration of exposures to certain
borrowers, sectors or industries.
 6.Risk Management @Bank of Baroda
(3)Market Risk: implies possibility of loss arising out of adverse price movements of
financial instruments .
 Market Risks : interest rate risk, foreign exchange risk, liquidity, or funding risk,
and price risk on trading portfolios.
 The Bank has clearly articulated policies to control and monitor its treasury functions.
 The Interest rate risk is measured through interest rate sensitivity gap reports and
Earning at Risk.
 The Bank calculates duration, modified duration, Value at Risk for its investment
portfolio consisting of fixed income securities, equities and forex positions on monthly
basis. The Bank monitors the short-term Interest rate risk by NII (Net Interest Income)
perspective and long-term interest rate risk by EVE (Economic Value of Equity)
perspective.
 The stress testing of fixed interest investment portfolio through sensitivity analysis and
equities through scenario analysis is regularly conducted.
(4) Operational Risk : the risk of loss on account of inadequate or failed internal process,
people and systems or external factors.
 The Operational Risk Management Committee (ORMC) has the responsibility of
monitoring the operational risk of the Bank. The Bank monitors operational risk by
reviewing whether its internal systems and procedures are duly complied with.
 Case Study : ERM @Infosys
The Enterprise Risk Management (ERM) at Infosys
encompasses practices relating to identification,
assessment, monitoring and mitigation of various risks
to the business.
ERM at Infosys seeks to minimize adverse impact on
our business objectives and enhance stakeholder value.
Risk management practices seek to sustain and
enhance long-term competitive advantage of the
Company.
Risk management is integral to the business model,
described as ‘Predictable, Sustainable, Profitable and
De-risked’ (PSPD) model.
2.Risk Management Framework @ Infosys
 3. Key Risk Management Practices at Infosys
 Risk identification and assessment :
 Risk survey of executives is conducted before the annual strategy exercise.
 business risk environment scanning and focused discussions in RC and RMC.
 Risk register
 internal audit findings
 Risk measurement, mitigation and monitoring :
 For top risks, dashboards are created that track external and internal indicators
relevant for risks, so as to indicate the risk level.
 The trend line assessment of top risks, analysis of exposure and potential impact
are carried out.
 Mitigation plans are finalized, owners are identified and progress of mitigation
actions are monitored and reviewed.
 Risk Reporting :
 Top risks report outlining the risk level, trend line, exposure, potential impact and
status of mitigation actions is discussed in RC and RMC on a periodic basis.
 Entity level risks such as project risks, account level risks are reported to and
discussed at appropriate levels of the organization.
 Integration with strategy and business planning : Identified risks are used
as one of the key inputs for the development of strategy and business plan.
F. Conclusions
Misplaced apprehensions about ERM:
Would it not put the brakes on risk-taking zeal?
Having risk under control gives a company agility and
flexibility.
It is like driving car: You can only go fast if you know
you have good brakes!
 Take-away lessons
Companies, exposed to thousands of natural and
unnatural shocks, give a portrait of a quivering mass of
vulnerabilities.
Tomorrow’s leaders in business need to understand risks
to make successful decisions.
The management of risk is, essentially, the strategy for
surviving and thriving in a volatile, uncertain, complex,
and ambiguous world.
ERM takes a portfolio approach towards risk. It
recognises the varieties and interdependence of
organisational vulnerabilities.
Hedge , don’t speculate.
Risk has both downside as well as upside:
Manage the downside, Upside will take care of itself!
Benefits of an effective ERM System

 Better informed strategic decisions,

 Successful delivery of change
 Increased operational efficiency.
 Reduced cost of capital,
 More accurate financial reporting,
 Competitive advantage,
 Improved perception of the organisation,
 Better marketplace presence
 Regulatory compliance
 Assurance to stakeholders
 Benefits from the “Upside of Risks”
 …lest you get risk scared !

“Twenty years from now you will be more

disappointed by the things that you didn't do
than by the ones you did do. So throw off the
bowlines. Sail away from the safe harbor.
Catch the trade winds in your sails. Explore.
Dream. Discover.”
-Mark Twain
Expect the Unexpected !

Be risk aware, not risk averse.

Take calculated risks:
If you win, you will be happy;
If you lose, you will be wise.
If You wish to Discover more…
Recommended Readings
Thank You