RISK MANAGEMENT FOR COMMERCIAL BANKS & DFIs.

Risk Management for Commercial Banks & DFIs.
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INSTITUTE OF BUSINESS AND TECHNOLOGY RISK MANAGEMENT FOR COMMERCIAL BANKS & DFIs. Prepared By XXXXX Course Code : MKT-606
MBA (Banking and Finance) FACULTY OF MANAGEMENT AND SOCIAL SCIENCES FALL - 2010
_________________________________________________________________________________________________ Institute of Business and Technology 1
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CONTENTS
Page No. ACKNOWLEDGEMENT..... 3 ABSTRACT....4 CHAPTER NO: 1. INTRODUCTION
1.1 1.2 1.3 1.4 Introduction .. 6 Purpose of study ..7 Research objectives 8 Research methodology ...9
CHAPTER NO: 2. RISK MANAGEMENT

2.1 2.2 2.3 2.4 2.5 Defining Risk ................. 10 Risk Management ......... .11 Risk Management Framework ...12 Business Line Accountability ..14 Risk Evaluation / Measurement .14
CHAPTER NO: 3. CONTINGENCY PLANNING

3.1 3.2 3.3 3.4 3.5 3.6 3.7 3.8 3.9 Managing Credit Risk....16 Components of Credit Risk Management..17 Organization Structure .17 Systems and Procedures ....18 Credit origination ...19 Limit setting ....19 Credit Administration .. . 20 Measuring Credit Risk ...21 Credit Risk Monitoring & Control ..22
CHAPTER NO:4. MANAGING PROBLEM CREDITS

4.1 4.2 4.3 4.4 4.5 4.6 4.7 Managing Market Risk ..24 Interest Rate Risk ..26 Foreign Exchange Risk .26 Equity / commodity price Risk ..27 Element of Market Risk Management 27 Risk Management Committee ..27 Middle Office ...28
Institute of Business and Technology 2
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CHAPTER NO: 5. RISK MEASUREMENT

5.1 5.2 5.3 5.4 5.5 Repricing Gap Models ...31 Earning at Risk &Economic Value of Equity Models.33 Value at Risk ...34 Risk Monitoring . 34 Risk Controls .....34
CHAPTER NO :6 . RISK AUDIT

6.1 6.2 6.3 6.4 6.5 6.6 6.7 6.8 6.9 Risk limits ...37 Managing Liquidity Risk...38 Early Warning Indicators..39 Liquidity Risk Strategy and Policy .39 ALCO/ Investment Committee ...41 Contingency Funding Plan ..41 Cash Flow Projections... .42 Liquidity Ratios & Limits...43 Internal Controls ...44
CHAPTER NO: 7. RISK MONITORING AND CONTROL

7.1 7.2 7.3 7.4 7.5 7.6 7.7 Risk Management Plan46 Risk Register.46 Work Performance Information..47 Risk Reassessment ....47 Variance and Trend Analysis ....48 Technical Performance Measurement..49 Reserve Analysis..49
CHAPTER NO: 8. CONCLUSION AND RECOMMENDATIONS

8.1 8.2 Conclusion ...53 Recommendations .....54
BIBLOGRAPHY ..................................................................... 56
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ACKNOWLEDGEMENT
I would like to express my heartfelt gratitude towards all those people who have supported me for the fair compilation of this research report. Firstly, I would like to thank my teacher Dr. Noor Ahmed Memon, whose guidance and encouragement motivated me to undergo this grueling exercise, secondly all those people whose help and support made this work possible. I hope that this report rightly serves its purpose of providing an in domain knowledge for risk management analysis of Growing financial market of Pakistan. Where all efforts have been made to ensure objectivity and accuracy in the information provided, any errors whatsoever may kindly be excused. Thanks Imran Ahmed (BEM/969)
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INSTITUTE OF BUSINESS AND TECHNOLOGY

ABSTRACT SUBMITTED BY: DISCIPLINE: TITLE OF PROJECT REPORT: Imran Ahmed (BEM/969) MBA (Finance) Risk Management for Commercial Banks & DFI MONTH OF SUBMISSION: November 2009
NAME OF PROJECT SUPERVISOR: Dr. Noor Ahmed Memon
ABSTRACT
The increased interest of risk management in the financial market of Pakistan is evident from the increased risk in the market due to current economic conditions along with the increase in number of banks and DFIs. My research is distributed in two parts. The first part is the analysis of relationship of commercial banks and DFI attribute with the Equity market investment returns. Whereas the second part deals with the analysis of the impact of risk management operations. I will end my report by giving my conclusion and recommendations.
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CHAPTER 1: INTRODUCTION 1.1 Introduction 1.2 Purpose of study 1.3 Research objectives 1.4 Research methodology
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1. INTRODUTION
1.1 Introduction The past decade has seen dramatic losses in the banking industry. Firms that had been performing well suddenly announced large losses due to credit exposures that turned sour, interest rate positions taken, or derivative exposures that may or may not have been assumed to hedge balance sheet risk. In response to this, commercial banks have almost universally embarked upon an upgrading of their risk management and control systems. Coincidental to this activity, and in part because of our recognition of the industry's vulnerability to financial risk, through the past year, on-site visits were conducted to review and evaluate the risk management systems and the process of risk evaluation that is implemented in the local market. In the banking sector, system evaluation was conducted covering many commercial banks and DFI. These results were then presented to a much wider array of banking firms for reaction and verification. The purpose of the present paper is to outline the findings of this investigation. It reports the state of risk management techniques in the industry -- questions asked, questions answered and questions left unaddressed by respondents. This report can not recite a litany of the approaches used within the industry, Nor can it offer an evaluation of each and every approach. Rather, it reports the standard of practice and evaluates how and why it is conducted in the particular way chosen. But, even the best practice employed within the industry is not good enough in some areas. Accordingly, critiques also will be offered where appropriate. The paper concludes with a list of questions that are currently unanswered, or answered imprecisely in the current practice employed by this group of relatively sophisticated banks. Here, we discuss the problems which the industry finds most difficult to address, shortcomings of the current methodology
_______________________________________________________________________ _ used to analyze risk and the elements that are missing in the current procedures of risk management and risk control 1.2 Purpose of Study All decisions have an element of risk. Financial professionals must be able to anticipate and balance the risks vs. returns of any financial choice. The Risk Management interest area offers an understanding of risk management strategies to improve the performance of financial decisions. 1.3 Research Objectives Development and application of an integral model to incorporate technical, human and organizational factors in risk control and disaster response in order to give a transparent picture of what factors influence which risk scenarios and to quantify priorities where appropriate and possible. For this, extensive use has to be made of systematically acquired expert judgment for risk management. Following are the objectives of my study: To conduct In-depth analysis of risk management of financial market in Pakistan and strategy. To analyze the result of portfolio returns on the basis of strong risk management in financial market. To apply the strategy of Portfolio management through managing risk parameters. 1.4 Research Methodology The nature of this study is Quantitative and Descriptive. I have done the analysis of impact of fund attributes on the return of each individual Pakistani financial market. The data is obtained through both primary and secondary sources. The
_______________________________________________________________________ _ data for fund attributes is collected using quarterly and annual reports. In this study, the correlation is determined by using the Multi-variable regression model. In order to run the regression on different variables, E-Views software has been used. Put risk management strategy has been implemented in year 2008 against the actual returns of the Pakistani financial market in order to see the impact of manage risk in market volatility.
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CHAPTER 2: RISK MANAGEMENT 2.1 Defining Risk 2.2 Risk Management 2.3 Risk Management Framework 2.4 Integration of Risk 2.5 Business Line Accountability 2.6 Risk Evaluation / Measurement
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2. RISK MANAGEMENT
2.1 Defining Risk For the purpose of these guidelines financial risk in banking organization is Possibility that the outcome of an action or event could bring up adverse Impacts such outcomes could either result in a direct loss of earnings / capital or may result in imposition of constraints on banks ability to meet its business objectives. Such constraints pose a risk as these could hinder a bank's ability to Conduct its ongoing business or to take benefit of opportunities to enhance its Business. Regardless of the sophistication of the measures, banks often distinguish between expected and unexpected losses. Expected losses are those that the bank knows with reasonable certainty will occur (e.g., the expected default rate of corporate loan portfolio or credit card portfolio) and are typically reserved for in some manner. Unexpected losses are those associated with unforeseen events (e.g. losses experienced by banks in the aftermath of nuclear tests, losses due to a sudden down turn in economy or falling interest rates). Banks rely on their capital as a buffer to absorb such losses. Risks are usually defined by the adverse impact on profitability of several distinct sources of uncertainty. While the types and degree of risks an organization may be exposed to depend upon a number of factors such as its size, complexity business activities, volume etc, it is believed that generally the banks face Credit, Market, Liquidity, Operational, Compliance / legal / regulatory and reputation risks. Before overarching these risk categories, given below are some basics about risk Management and some guiding principles to manage risks in banking organization.
_______________________________________________________________________ _ 2.2 Risk Management It is a discipline at the core of every financial institution and encompasses all the activities that affect its risk profile. It involves identification, measurement, monitoring and controlling risks to ensure that a) The individuals who take or manage risks clearly understand it. b) The organizations risk exposure is within the limits established by Board of Directors. c) Risk taking Decisions are in line with the business strategy and objectives set by BOD. d) The expected payoffs compensate for the risks taken e) Risk taking decisions are explicit and clear. f) Sufficient capital as a buffer is available to take risk The acceptance and management of financial risk is inherent to the business of banking and banks roles as financial intermediaries. Risk management as commonly perceived does not mean minimizing risk; rather the goal of risk management is to optimize risk-reward trade-off. Notwithstanding the fact that banks are in the business of taking risk, it should be recognized that an institution need not engage in business in a manner that unnecessarily imposes risk upon it: nor it should absorb risk that can be transferred to other participants. Rather it should accept those risks that are uniquely part of the array of banks services. In every financial institution, risk management activities broadly take place simultaneously at following different hierarchy levels.. Strategic level: It encompasses risk management functions performed by senior management and BOD. For instance definition of risks, ascertaining institutions risk appetite, formulating strategy and policies for managing risks and establish adequate
_______________________________________________________________________ _ systems and controls to ensure that overall risk remain within acceptable level and the reward compensate for the risk taken. Macro Level It encompasses risk management within a business area or across business lines. Generally the risk management activities performed by middle management or units devoted to risk reviews fall into this category. Micro Level It involves On-the-line risk management where risks are actually created. This is the risk management activities performed by individuals who take risk on organizations behalf such as front office and loan origination functions. The risk management in those areas is confined to following operational procedures and guidelines set by management. 2.3 Risk Management framework. A risk management framework encompasses the scope of risks to be managed, the process/systems and procedures to manage risk and the roles and responsibilities of individuals involved in risk management. The framework should be comprehensive enough to capture all risks a bank is exposed to and have flexibility to accommodate any change in business activities. An effective risk management framework includes a) Clearly defined risk management policies and procedures covering risk identification, acceptance, measurement, monitoring, reporting and control. b) A well constituted organizational structure defining clearly roles and responsibilities of individuals involved in risk taking as well as managing it. c) Banks, in addition to risk management functions for various risk categories may institute a setup that supervises overall risk management at the bank.
_______________________________________________________________________ _ d) Such a setup could be in the form of a separate department or banks Risk Management Committee (RMC) could perform such function. The structure should be such that ensures effective monitoring and control over risks being taken. The individuals responsible for review function (Risk review, internal audit, compliance etc) should be independent from risk taking units and report directly to board or senior management who are also not involved in risk taking. e) There should be an effective management information system that ensures flow of information from operational level to top management and a system to address any exceptions observed. There should be an explicit procedure regarding measures to be taken to address such deviations. f) The framework should have a mechanism to ensure an ongoing review of systems, policies and procedures for risk management and procedure to adopt changes Integration of Risk Management Risks must not be viewed and assessed in isolation, not only because a single transaction might have a number of risks but also one type of risk can trigger other risks. Since interaction of various risks could result in diminution or increase in risk, the risk management process should recognize and reflect risk interactions in all business activities as appropriate. While assessing and managing risk the management should have an overall view of risks the A recent concept in this regard is Enterprise Risk Management (ERM) Institution is exposed to. This requires having a structure in place to look at risk interrelationships across the organization.
_______________________________________________________________________ _ 2.4 Business Line Accountability In every banking organization there are people who are dedicated to risk management activities, such as risk review, internal audit etc. It must not be construed that risk management is something to be performed by a few individuals or a department. Business lines are equally responsible for the risks they are taking. Because line personnel, more than anyone else, understand the risks of the business, such a lack of accountability can lead to problems. 2.5 Risk Evaluation/Measurement Until and unless risks are not assessed and measured it will not be possible to control risks. Further a true assessment of risk gives management a clear view of institutions standing and helps in deciding future action plan. To adequately capture institutions risk exposure, risk measurement should represent aggregate exposure of institution both risk type and business line and encompass short run as well as long run impact on institution. To the maximum possible extent institutions should establish systems / models that quantify their risk profile, however, in some risk categories such as operational risk, quantification is quite difficult and complex. Wherever it is not possible to quantify risks, qualitative measures should be adopted to capture those risks. Whilst quantitative measurement systems support effective decision-making, better measurement does not obviate the need for well-informed, qualitative judgment. Consequently the importance of staff having relevant knowledge and expertise cannot be undermined. Finally any risk measurement framework, especially those which employ quantitative techniques/model, is only as good as its underlying assumptions, the rigor and robustness of its analytical methodologies, the controls surrounding data inputs and its appropriate application Independent review.
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CHAPTER 3: CONTINGENCY PLANNING 3.1 Managing Credit Risk 3.2 Components of Credit Risk Management 3.3 Organization Structure 3.4 Systems and Procedures 3.5 Credit origination 3.6 Limit setting 3.7 Credit Administration 3.8 Measuring Credit Risk 3.9 Credit Risk Monitoring & Control
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3. Contingency planning
Contingency planning
Activity undertaken to ensure that proper and immediate follow up steps will be taken by a management and employees in an emergency Its major objectives are to ensure (1) containment of damage or injury to, or loss of, personnel and property, and (2) continuity of the key operations of the organization. 3.1 Managing credit risk Credit risk arises from the potential that an obligor is either unwilling to perform on an obligation or its ability to perform such obligation is impaired resulting in economic loss to the bank In addition to direct accounting loss, credit risk should be viewed in the context of economic exposures. This encompasses opportunity costs, transaction costs and expenses associated with a non -performing asset over and above the accounting loss. Credit risk can be further sub-categorized on the basis of reasons of default. For instance the default could be due to country in which there is exposure or problems in settlement of a transaction. Credit risk not necessarily occurs in isolation. The same source that endangers credit risk for the institution may also expose it to other risk. For instance a bad portfolio may attract liquidity problem. Components of credit risk management The very first purpose of banks credit strategy is to determine the risk appetite of the bank. Once it is determined the bank could develop a plan to optimize return while keeping credit risk within predetermined limits. The banks credit risk
_______________________________________________________________________ _ 3.2 Components of Credit Risk Management It is essential that banks give due consideration to their target market while devising credit risk strategy. The credit procedures should aim to obtain an indepth understanding of the banks clients, their credentials & their businesses in order to fully know their customers. The strategy should provide continuity in approach and take into account cyclic aspect of countrys economy and the resulting shifts in composition and quality of overall credit portfolio. While the strategy would be reviewed periodically and amended, as deemed necessary, it should be viable in long term and through various economic cycles. In order to be effective these policies must be clear and communicated down the line. Further any significant deviation/exception to these policies must be communicated to the top management/board and corrective measures should be taken. It is the responsibility of senior management to ensure effective implementation of these policies.
3.3 Organizational Structure. To maintain banks overall credit risk exposure within the parameters set by the board of directors, the importance of a sound risk management structure is second to none. While the banks may choose different structures, it is important that such structure should be commensurate with institutions size, complexity and diversification of its activities. It must facilitate effective management oversight and proper execution of credit risk management and control processes. Each bank, depending upon its size, should constitute a Credit Risk Management Committee (CRMC), ideally comprising of head of credit risk management Department, credit department and treasury. This committee reporting to banks risk management committee should be empowered to oversee credit risk taking activities and overall credi t risk management function.
_______________________________________________________________________ _ The CRMC should be mainly responsible for The implementation of the credit risk policy / strategy approved by the Board. Monitor credit risk on a bank-wide basis and ensure compliance with limits approved by the Board. Recommend to the Board, for its approval, clear policies on standards for presentation of credit proposals, financial covenants, rating standards and benchmarks. Decide delegation of credit approving powers, prudential limits on large credit exposures, standards for loan collateral, portfolio management, loan review mechanism, risk concentrations, risk monitoring and evaluation, pricing of loans, provisioning, regulatory/legal compliance, etc. 3.4 Systems and Procedures Further, to maintain credit discipline and to enunciate credit risk management and control process there should be a separate function independent of loan origination function. Credit policy formulation, credit limit setting, monitoring of credit exceptions / exposures and review /monitoring of documentation are functions that should be performed independently of the loan origination function. For small banks where it might not be feasible to establish such structural hierarchy, there should be adequate compensating measures to maintain credit discipline introduce adequate checks and balances and standards to address potential conflicts of interest. Ideally, the banks should institute a Credit Risk Management Department (CRMD). Typical functions of CRMD include: To follow a holistic approach in management of risks inherent in banks portfolio and ensure the risks remain within the boundaries established by the Board or Credit Risk Management Committee. The department also ensures that business lines comply with risk parameters and prudential limits established by the Board or CRMC. Establish systems and procedures relating to risk identification, Management Information System, monitoring of loan / investment portfolio quality and early
_______________________________________________________________________ _ warning. The department would work out remedial measure when deficiencies/problems are identified. Managing credit risk The Department should undertake portfolio evaluations and conduct comprehensive studies on the environment to test the resilience of the loan portfolio. Notwithstanding the need for a separate or independent oversight, the front office or loan origination function should be cognizant of credit risk, and maintain high level of credit discipline and standards in pursuit of business opportunities 3.4 Credit Origination Banks must operate within a sound and well-defined criteria for new credits as well as the expansion of existing credits. Credits should be extended within the target markets and lending strategy of the institution. Before allowing a credit facility, the bank must make an assessment of risk profile of the customer/transaction. This may include a) Credit assessment of the borrowers industry, and macro economic factors. b) The purpose of credit and source of repayment. c) The track record / repayment history of borrower. d) Assess/evaluate the repayment capacity of the borrower. e) The Proposed terms and conditions and covenants. f) Adequacy and enforceability of collaterals. g) Approval from appropriate authority 3.5 Limit setting An important element of credit risk management is to establish exposure limits for single obligors and group of connected obligors. Institutions are expected to develop their own limit structure while remaining within the exposure limits set by State Bank of Pakistan. The size of the limits should be based on the credit
_______________________________________________________________________ _ strength of the obligor, genuine requirement of credit, economic conditions and the institutions risk tolerance. Appropriate limits should be set for respective products and activities. Institutions may establish limits for a specific industry, economic sector or geographic regions to avoid concentration risk. 3.6 Credit Administration Ongoing administration of the credit portfolio is an essential part of the credit process. Credit administration function is basically a back office activity that support and control extension and maintenance of credit. A typical credit administration unit performs following functions:
Documentation
It is the responsibility of credit administration to ensure completeness of documentation (loan agreements, guarantees, transfer of title of collaterals etc) in accordance with approved terms and conditions. Outstanding documents should be tracked and followed up to ensure execution and receipt.
Credit Disbursement
The credit administration function should ensure that the loan application has proper approval before entering facility limits into computer systems. Disbursement should be effected only after completion of covenants, and receipt of collateral holdings. In case of exceptions necessary approval should be obtained from competent authorities.
Credit monitoring
After the loan is approved and draw down allowed, the loan should be continuously watched over These include keeping track of borrowers compliance with credit terms, identifying early signs of irregularity, conducting periodic valuation of collateral and monitoring timely repayments.
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Loan Repayment
The obligors should be communicated ahead of time as and when the principal/markup installment becomes due. Any exceptions such as non-payment or late payment should be tagged and communicated to the management. Proper records and updates should also be made after receipt.
Maintenance of Credit Files
Institutions should devise procedural guidelines and standards for maintenance of credit files. The credit files not only include all correspondence with the borrower but should also contain sufficient information necessary to assess financial health of the borrower and its repayment performance. It need not mention that information should be filed in organized way so that external / internal auditors or SBP inspector could review it easily.
Collateral and Security Documents
Institutions should ensure that all security documents are kept in a fireproof safe under dual control. Registers for documents should be maintained to keep track of their movement. 3.8 Measuring Credit Risk The measurement of credit risk is of vital importance in credit risk management. A number of qualitative and quantitative techniques to measure risk inherent in credit portfolio are evolving. To start with, banks should establish a credit riskrating framework across all type of credit activities. Among other things, the rating framework may, incorporate: The rating process in relation to credit approval and review ratings are generally assigned /reaffirmed at the time of origination of a loan or its renewal /enhancement. The analysis supporting the ratings is inseparable from that required for credit appraisal. In addition the rating and loan analysis process while being separate are intertwined. The process of assigning a rating and its
_______________________________________________________________________ _ approval / confirmation goes along with the initiation of a credit proposal and its approval. Generally loan origination function (whether a relationship The credit risk exposure involves both the probability of Default (PD) and loss in the event of default or loss given default (LGD). The former is specific to borrower while the later corresponds to the facility. The product of PD and LGD is the expected loss. Point in time means to grade a borrower according to its current condition while through the cycle approach grades a borrower under stress conditions 3.9 Credit Risk Monitoring and control As part of portfolio monitoring, institutions should generate reports on credit exposure by risk grade. Adequate trend and migration analysis should also be conducted to identify any deterioration in credit quality. Institutions may establish limits for risk grades to highlight concentration in particular rating bands. It is important that the consistency and accuracy of ratings is examined periodically by a function such as an independent credit review group
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CHAPTER NO:4. MANAGING PROBLEM CREDITS 4.1 Managing Market Risk 4.2 Interest Rate Risk 4.3 Foreign Exchange Risk 4.4 Equity / commodity price Risk 4.5 Element of Market Risk Management 4.6 Risk Management Committee 4.7 Middle Office
_______________________________________________________________________ _ 4. MANAGING PROBLEM CREDITS Having identified 'green' and 'red' risks you now need to look at what your response will be to each of the red risks. There are a number of fairly standard definitions of response types that can be summed up as follows: Even from those very basic examples we can see that, in all cases, the risk response costs money. This stage of the process can be quite iterative because until you know how you are going to respond to a risk you can't be sure what it will cost you in terms of time or money. For example you may decide 'Losing a programmer won't lose us as much time as we thought. We don't need to take three months to recruit another because we can use a recruitment agency with a pool of programmers on their books if we are prepared to pay their 20% finders fee.' Risk response actions don't only occur when a risk happens - some of the above responses are preventative measures that are taken as soon as you identify the risk. At this point you may revisit your Risk Log to assess the status of a risk once the preventative or mitigating actions are complete. This is sometimes known as Residual Risk. 4.1 Managing Market Risk Risk is a personal experience, because it is subjective, it is individuals who suffer the consequences of risk. Although we may speak of companies taking risk, in actuality, companies are merely conduits for risk. Ultimately, all risks which flow through an organization accrue to individualsstockholders, creditors, employees, customers, board members, etc. Business activities entail a variety of risks. For convenience, we distinguish between different categories of risk: market risk, credit risk, liquidity risk, etc. Although such categorization is convenient, it is only informal. Usage and definitions vary. Boundaries between categories are blurred. A loss due to
_______________________________________________________________________ _ widening credit spreads may reasonably be called a market loss or a credit loss, so market risk and credit risk overlap. Liquidity risk compounds other risks, such as market risk and credit risk. It cannot be divorced from the risks it compounds. An important but somewhat ambiguous distinguish is that between market risk and business risk. Market risk is exposure to the uncertain market value of a portfolio. A trader holds a portfolio of commodity forwards. he knows what its market value is today, but he is uncertain as to its market value a week from today. he faces market risk. Business risk is exposure to uncertainty in economic value that cannot be marked-to-market. The distinction between market risk and business risk parallels the distinction between mark-to-market accounting and book-value accounting. Suppose a New England electricity wholesaler is long a forward contract for on-peak electricity delivered over the next 3 months. There is an active forward market for such electricity, so the contract can be marked to market daily. Daily profits and losses on the contract reflect market risk. Suppose the firm also owns a power plant with an expected useful life of 30 years. Power plants change hands infrequently, and electricity forward curves don't exist out to 30 years. The plant cannot be marked to market on a regular basis. In the absence of market values, market risk is not a meaningful notion. Uncertainty in the economic value of the power plant represents business risk. The distinction between market risk and business risk is ambiguous because there is a vast "gray zone" between the two. There are many instruments for which markets exist, but the markets are illiquid. Mark-to-market values are not usually available, but mark-to-model values provide a more-or-less accurate reflection of fair value. Do these instruments pose business risk or market risk? The decision is important because firms employ fundamentally different techniques for managing the two risks.
_______________________________________________________________________ _ 4.2 Interest Rate Risk Business risk is managed with a long-term focus. Techniques include the careful development of business plans and appropriate management oversight. bookvalue accounting is generally used, so the issue of day-to-day performance is not material. The focus is on achieving a good return on investment over an extended horizon. Market risk is managed with a short-term focus. Long-term losses are avoided by avoiding losses from one day to the next. On a tactical level, traders and portfolio managers employ a variety of risk metrics duration and convexity, the Greeks, beta, etc.to assess their exposures. These allow them to identify and reduce any exposures they might consider excessive. On a more strategic level, organizations manage market risk by applying risk limits to traders' or portfolio managers' activities. Increasingly, value-at-risk is being used to define and monitor these limits. Some organizations also apply stress testing to their portfolios. Liquidity risk is financial risk due to uncertain liquidity. An institution might lose liquidity if its credit rating falls, it experiences sudden unexpected cash outflows, or some other event causes counterparties to avoid trading with or lending to the institution. A firm is also exposed to liquidity risk if markets on which it depends are subject to loss of liquidity. 4.3 Foreign Exchange Risk Liquidity risk tends to compound other risks. If a trading organization has a position in an illiquid asset, its limited ability to liquidate that position at short notice will compound its market risk. Suppose a firm has offsetting cash flows with two different counterparties on a given day. If the counterparty that owes it a payment defaults, the firm will have to raise cash from other sources to make its payment. Should it be unable to do so, it too we default. Here, liquidity risk is compounding credit risk.
_______________________________________________________________________ _ 4.4 Equity / Commodity Price Risk Obviously, a position can be hedged against market risk but still entail liquidity risk. This is true in the above credit risk examplethe two payments are offsetting, so they entail credit risk but not market risk. 4.5 Element of Market Risk Management Accordingly, liquidity risk has to be managed in addition to market, credit and other risks. Because of its tendency to compound other risks, it is difficult or impossible to isolate liquidity risk. In all but the most simple of circumstances, comprehensive metrics of liquidity risk don't exist. Certain techniques of assetliability management can be applied to assessing liquidity risk. A simple test for liquidity risk is to look at future net cash flows on a day-by-day basis. Any day that has a sizeable negative net cash flow is of concern. Such an analysis can be supplemented with stress testing. Look at net cash flows on a day-to-day basis assuming that an important counterparty defaults. 4.6 Risk Management Committee Bank of International Settlements (BIS) through Basel Accords has stipulated risk management practices required for banks. The concept of risk and risk management provides an understanding of various types of risks faced by banks and financial institutions and ways to control such risks. The major goals of financial sector policies are to maintain financial stability and also enhance access to financial services. These two goals are mostly mutually reinforcing. Through the financial stability goal, policymakers aim at protecting savers, investors and other economic agents from economic disruptions, which help in ensuring access to financial services, including unprivileged sections of society
_______________________________________________________________________ _ 4.7 Middle Office Defined as the change in a bank's portfolio value due to interest rate fluctuations. Taking on IRR is a key part of what banks do; but taking on excessive IRR could threaten a bank's earnings and its capital base, raising concerns for bank supervisors. In practice, IRR management systems have been developed to measure and control such risk exposures, both in the trading book (i.e., assets that are relatively liquid and regularly traded) and in the banking book (i.e., assets, such as loans, that are much less actively traded). IRR can be roughly decomposed into four categories: reprising risk, yield curve risk, basis risk, and optionally ( Basel Committee on Banking Supervision (BCBS) 2003.) Reprising risk refers to fluctuations in interest rate levels that have differing impacts on bank assets and liabilities; for example, a portfolio of long-term, fixedrate loans funded with short-term deposits (i.e., a case of duration mismatch) could significantly decrease in value when rates increase, since the loan payments are fixed (and funding costs have increased). Yield curve risk refers to changes in portfolio values caused by unanticipated shifts in the slope and shape of the yield curve; for example, short-term rates might rise faster than long-term rates, clearly affecting the profitability of funding long-term loans with short-term deposits. Basis risk refers to the imperfect correlation between index rates across different interest rate markets for similar maturities; for example, a bank funding loans whose payments are based on U.S. Treasury rates with deposits based on Libor rates is exposed to the risk of unexpected changes in the spread between these index rates. The economic value approach takes a broader perspective on IRR management by focusing on how interest rate changes affect total expected net cash flows from all of a bank's operations. Thus, this approach examines expected cash flows from assets minus expected payments on liabilities plus the expected net cash flows from off-balance-sheet positions, such as fees charged for borrower credit lines. This approach is more challenging to conduct since, at a minimum, it
_______________________________________________________________________ _ requires collecting and aggregating more data; at the same time, it provides greater insight into a bank's aggregate IRR exposure. In addition to such aggregate IRR management approaches, banks use more focused IRR measurement techniques for derivatives and other instruments with especially complex risk profiles, such as mortgage-backed securities. While the aggregate approaches typically involve making judgmental adjustments to interest rates and tracking their impact across the bank, the focused techniques explicitly use mathematical models of interest rate dynamics for various index rates and their yield curves. For example, many possible future interest rate paths are generated and used to examine the potential effects of interest rate changes on portfolio values, investment returns, and cash flows from different assets. Since the models can examine the components of interest rate risk separately, risk managers use them to gauge and control their portfolios' exposures to a broader range of interest rate fluctuations. In theory, the more sophisticated IRR management techniques could be applied to the bank as a whole. Important developments in this direction have been made, but several important challenges still remain, especially in aggregating IRR exposures across business lines. A key advantage of these mathematical IRR management techniques is that they provide a consistent framework for analyzing a wide variety of possible interest rate scenarios.
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CHAPTER NO: 5. RISK MEASUREMENT

5.1 5.2 5.3 5.4 5.5 Repricing Gap Models EaR & Economic Value of Equity Models Value at Risk Risk Monitoring Risk Controls
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CHAPTER: 5. RISK MEASUREMENT

Accurate and timely measurement of market risk is necessary for proper risk management and control. Market risk factors that affect the value of traded portfolios and the income stream or value of non -traded portfolio and other business activities should be identified and quantified using data that can be directly observed in markets or implied from observation or history. While there is a wide range of risk measurement techniques ranging from static measurement techniques (Gap analysis) to highly sophisticated dynamic modeling (Monte Carlo Simulation), the banks may employ any technique depending upon the nature size and complexity of the business and most important the availability and integrity of data. Banks may adopt multiple risk measurement methodologies to capture market risk in various business activities; however management should have an integrated view of overall market risk across products and business lines. The measurement system ideally should a) Assess all material risk factors associated with a bank's assets, liabilities, and Off Balance sheet positions. b) Utilize generally accepted financial concepts and risk measurement techniques. c) Have well documented assumptions and parameters. It is important that the assumptions underlying the system are clearly understood by risk managers and top management. 5.1 Repricing Gap Models At the most basic level banks may use repricing gap schedules to measure their interest rate risk. A gap report is a static model wherein interest sensitive assets (ISA), Interest Sensitive liabilities (ISL) and off-balance sheet items are stratified into various time bands according to their maturity (if fixed rate) or time remaining to their next re -pricing (if floating rate). The size of the gap for a given time band - that is, assets minus liabilities plus OBS exposures that re-price or mature within that time band gives an indication of the bank's re-pricing risk exposure. If
_______________________________________________________________________ _ ISA of a bank exceed ISL in a certain time band, the bank is said to have a positive GAP for that particular period and vice versa. An interest sensitive gap ratio is also a good indicator of banks interest rate risk exposure. Relative IS GAP = IS GAP /Banks Total Asset Also an ISA to ISL ratio of bank for particular time band could be a useful estimation of a banks position. Interest Sensitive Ratio = ISA/ISL Measuring Risk to Net Interest Income (NII) Gap schedules can provide an estimate of changes in banks net interest income given changes in interest rates. The gap for particular time band could be multiplied by a hypothetical change in interest rate to obtain an approximate change in net interest income. The formula to translate gaps into the amount of net interest income at risk, measuring exposure over several periods, is: (Periodic gap) x (change in rate) x (time over which the periodic gap is in effect) = change in NII While such GAP measurement apparently seem perfect, practically there are some problems such as interest paid on liabilities of a bank which are generally short term tend to move quickly compared with that being earned on assets many of which are relatively longer term. This problem can be minimized by assigning weights to various ISA and ISL that take into account the tendency of the bank interest rates to vary in speed and magnitude relative to each other and with the up and down business cycle.
Measure of risk to Economic Value
The stratification of Assets and liabilities into various time bands in a gap analyses can also be extended to measure change in economic value of banks assets due to change in interest rates. This can be accomplished by applying sensitivity weights to each time band. Typically, such weights are based on
_______________________________________________________________________ _ estimates of the duration of the assets and liabilities that fall into each time-band, where duration is a measure of the percent change in the economic value of a position that will occur given a small change in the level of interest rates. Duration-based weights can be used in combination with a maturity/ re-pricing schedule to provide a rough approximation of the change in a bank's economic value that could occur given a particular set of changes in market interest rates. 5.2 Earnings at Risk and Economic Value of Equity Models Many bank, especially those using complex financial instruments or otherwise having complex risk profiles, employ more sophisticated interest rate risk measurement systems than those used on simple maturity/re-pricing schedules. These simulation techniques attempt to overcome the limitation of Duration is the weighted average term to maturity of a securitys cash flow. For instance a Rs100 5 year 8% (semi Annual) coupon bond having yield of 8% will have a duration of 4.217 years. This could be derived by following formula Duration = t1 x PVCF 1 + t2 x PVCF2 ---------tn x PVCFn K x Price Where PVCF = present value of cash flow n= Total number of payments . K = Number of payments per annum Duration however works for small change in interest rate due to convexity of yield curve. The estimation can be improved by introducing convexity measure of a bond. Static gap schedules and typically involve detailed assessments of the potential effects of changes in interest rates on earnings or economic value by simulating the future path of interest rates and their impact on cash flows. In static simulations, the cash flows arising solely from the bank's current on- and offbalance sheet positions are assessed. In a dynamic simulation approach, the
_______________________________________________________________________ _ simulation builds in more detailed assumptions about the future course of interest rates and expected changes in a bank's business activity over that time. These more sophisticated techniques allow for dynamic interaction of payments streams and interest rates, and better capture the effect of embedded or explicit options. 5.3 Value at Risk Value at Risk (VAR) is generally accepted and widely used tool for measuring market risk inherent in trading portfolios. It follows the concept that reasonable expectation of loss can be deduced by evaluating market rates, prices observed volatility and correlation. VAR summarizes the predicted maximum loss (or worst loss) over a target horizon within a given confidence level. The well-known proprietary models that use VAR approaches are JP Morgans Risk metrics, Bankers trust Risk Adjusted Return on Capital, and Chases Value at risk. Generally there are three ways of computing VAR Parametric method or Variance covariance approach Historical Simulation 5.4 Risk Monitoring Risk monitoring processes are established to evaluate the performance of banks risk strategies/policies and procedures in achieving overall goals. Whether the monitoring function is performed by middle-office or it is a part of banks internal audit it is important that the monitoring function should be independent of units taking risk and report directly to the top management/board. 5.5 Risk Control. Banks internal control structure ensures the effectiveness of process relating to market risk management. Establishing and maintaining an effective system of controls including the enforcement of official lines of authority and appropriate segregation of duties, is one of the managements most important responsibilities. Persons responsible for risk monitoring and control procedures
_______________________________________________________________________ _ should be independent of the functions they review. Key elements of internal control process include internal audit and review and an effective risk limit structure.
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CHAPTER NO:6. RISK AUDIT

6.1 6.2 6.3 6.4 6.5 6.6 6.7 6.8 6.9 Risk limits Managing Liquidity Risk Early Warning Indicators Liquidity Risk Strategy and Policy ALCO/ Investment Committee Contingency Funding Plan Cash Flow Projections Liquidity Ratios & Limits Internal Controls
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CHAPTER: 6. RISK AUDIT

Banks need to review and validate each step of market risk measurement process. This review function can be performed by a number of units in the organization including internal audit/control department or ALCO support staff. In small banks, external auditors or consultants can perform the function. The audit or review should take into account. a) The appropriateness of banks risk measurement system given the nature, scope and complexity of banks activities b) The accuracy or integrity of data being used in risk models. c) The reasonableness of scenarios and assumptions d) The validity of risk measurement calculations. 6.1 Risk limits As stated earlier it is the board that has to determine banks overall risk appetite and exposure limit in relation to its market risk strategy. Based on these tolerances the senior management should establish appropriate risk limits. Risk limits for business units, should be compatible with the institutions strategies, risk management systems and risk tolerance. The limits should be approved and periodically reviewed by the Board of Directors and/or senior management, with changes in market Conditions or resources prompting a reassessment of limits. Institutions need to ensure consistency between the different types of limits.
a) Gap Limits
The gap limits expressed in terms of interest sensitive ratio for a given time band aims at managing potential exposure to a banks earnings / capital due to changes in interest rates. Setting such limits is useful way to limit the volume of a banks repricing exposures and is an adequate and effective method of communicating the risk profile of the bank to senior management. Such gap limits can be set on a net notional basis (net of asset / liability amounts for both on and off balance sheet items) or a duration-weighted basis, in each
_______________________________________________________________________ _ time band. (Duration is the weighted average term to maturity of a securitys cash flow. 6.2 Managing Liquidity Risk Liquidity risk is the potential for loss to an institution arising from either its inability to meet its obligations or to fund increases in assets as they fall due without incurring unacceptable cost or losses. Liquidity risk is considered a major risk for banks. It arises when the cushion provided by the liquid assets are not sufficient enough to meet its obligation. In such a situation banks often meet their liquidity requirements from market. However conditions of funding through market depend upon liquidity in the market and borrowing institutions liquidity. Accordingly an institution short of liquidity may have to undertake transaction at heavy cost resulting in a loss of earning or in worst case scenario the liquidity risk could result in bankruptcy of the institution if it is unable to undertake transaction even at current market prices. Banks with large off-balance sheet exposures or the banks, which rely heavily on large corporate deposit, have relatively high level of liquidity risk. Further the banks experiencing a rapid growth in assets should have major concern for liquidity. Liquidity risk may not be seen in isolation, because financial risk are not mutually exclusive and liquidity risk often triggered by consequence of these other financial risks such as credit risk, market risk etc. For instance, a bank increasing its credit risk through asset concentration etc may be increasing its liquidity risk as well. Similarly a large loan default or changes in interest rate can adversely impact a banks liquidity position. Further if management misjudges the impact on liquidity of entering into a new business or product line, the banks strategic risk would increase.
_______________________________________________________________________ _ 6.3 Early Warning indicators of liquidity risk. An incipient liquidity problem may initially reveal in the bank's financial monitoring system as a downward trend with potential long-term consequences for earnings or capital. Given below are some early warning indicators that not necessarily always lead to liquidity problem for a bank; however these have potential to ignite such a problem. Consequently management needs to watch carefully such indicators and exercise further scrutiny/analysis wherever it deems appropriate. Examples of such internal indicators are: a) A negative trend or significantly increased risk in any area or product line. b) Concentrations in either assets or liabilities. c) Deterioration in quality of credit portfolio. d) A decline in earnings performance or projections. e) Rapid asset growth funded by volatile large deposit. f) A large size of off-balance sheet exposure. g) Deteriorating third party evaluation about the bank 6.4 Liquidity Risk Strategy The liquidity risk strategy defined by board should enunciate specific policies on Particular aspects of liquidity risk management, such as: a. Composition of Assets and Liabilities . The strategy should outline the mix of assets and liabilities to maintain liquidity. Liquidity risk management and asset/liability management should be integrated to avoid steep costs associated with having to rapidly reconfigure the asset liability profile from maximum profitability to increased liquidity. b. Diversification and Stability of Liabilities . A funding concentration exists when a single decision or a single factor has the potential to result in a significant and sudden withdrawal of funds. Since such a situation could lead to an increased risk, the Board of Directors and senior management should specify guidance relating to funding sources and ensure that the bank have a diversified sources of funding day-to-day liquidity
_______________________________________________________________________ _ requirements. An institution would be more resilient to tight market liquidity conditions if its liabilities were derived from more stable sources. To comprehensively analyze the stability of liabilities/funding sources the bank need to identify: Liabilities that would stay with the institution under any circumstances; Liabilities that run-off gradually if problems arise; and That run-off immediately at the first sign of problems. c. Access to Inter-bank Market . The inter-bank market can be important source of liquidity. However, the strategies should take into account the fact that in crisis situations access to inter bank market could be difficult as well as costly.
Contingency plan for handling liquidity crises
To be effective the liquidity policy must be communicated down the line throughout in the organization. It is important that the Board and senior management/ALCO review these policies at least annually and when there are any material changes in the institutions current and prospective liquidity risk profile. Such changes could stem from internal circumstances (e.g. changes in business focus) or external circumstances (e.g. changes in economic conditions). Reviews provide the opportunity to fine tune the institutions liquidity policies in light of the institutions liquidity management experience and development of its business. Any significant or frequent exception to the policy is an important barometer to gauge its effectiveness and any potential impact on banks liquidity risk profile. Institutions should establish appropriate procedures and processes to implement their liquidity policies. The procedural manual should explicitly narrate the necessary operational steps and processes to execute the relevant
_______________________________________________________________________ _ Liquidity risk controls. The manual should be periodically reviewed and updated to take into account new activities, changes in risk management approaches and systems. 6.5 ALCO/Investment Committee The responsibility for managing the overall liquidity of the bank should be delegated to a specific, identified group within the bank. This might be in the form of an Asset Liability Committee (ALCO) comprised of senior management, the treasury function or the risk management department. However, usually the liquidity risk management is performed by an ALCO. Ideally, the ALCO should comprise of senior management from each key area of the institution that assumes and/or manages liquidity risk. It is important that these members have clear authority over the units responsible for executing liquidity-related transactions so that ALCO directives reach these line units unimpeded. The ALCO should meet monthly, if not on a more frequent basis. Generally responsibilities of ALCO include developing and maintaining appropriate risk management policies and procedures, MIS reporting, limits, and oversight programs. ALCO usually delegates day-to-day operating responsibilities to the bank's treasury department. However, ALCO should establish specific procedures and limits governing treasury operations before making such delegation. 6.6 Contingency Funding Plans In order to develop a comprehensive liquidity risk management framework, institutions should have way out plans for stress scenarios. Such a plan commonly known as Contingency Funding Plan (CFP) is a set of policies and procedures that serves as a blue print for a bank to meet its funding needs in a timely manner and at a reasonable cost. A CFP is a projection of future cash flows and funding sources of a bank under market scenarios including aggressive asset growth or rapid liability erosion. To be effective it is important that a CFP should represent managements best estimate of balance sheet
_______________________________________________________________________ _ changes that may result from a liquidity or credit event. A CFP can provide a useful framework for managing liquidity risk both short term and in the long term. Further it helps ensure that a financial institution can prudently and efficiently manage routine and extraordinary fluctuations in liquidity. The scope of the CFP is discussed in more detail below. Use of CFP for Routine Liquidity Management For day-to-day liquidity risk management integration of liquidity scenario will ensure that the bank is best prepared to respond to an unexpected problem. In this sense, a CFP is an extension of ongoing liquidity management and formalizes the objectives of liquidity management by ensuring: a) A reasonable amount of liquid assets are maintained. b) Measurement and projection of funding requirements during various scenarios. c) Management of access to funding sources.
Use of CFP for Emergency and Distress Environments
Not necessarily a liquidity crisis shows up gradually. In case of a sudden liquidity stress it is important for a bank to seem organized, candid, and efficient to meet its obligations to the stakeholders. Since such a situation requires a spontaneous action, banks that already have plans to deal with such situation could address the liquidity problem more efficiently and effectively. A CFP can help ensure that bank management and key staffs are ready to respond to such situations. Bank liquidity is very sensitive to negative trends in credit, capital, or reputation. Deterioration in the company's financial condition (reflected in items such as asset quality indicators, earnings, or capital), management composition, or other relevant issues may result in reduced access to funding. 6.7 Cash Flow Projections At the basic level banks may utilize flow measures to determine their cash position. A cash flow projection estimates a banks inflows and outflows and thus net deficit or surplus (GAP) over a time horizon. The contingency funding plan
_______________________________________________________________________ _ discussed previously is one example of a cash flow projection. Not to be confused with the re-pricing gap report that measures interest rate risk, a behavioral gap report takes into account banks funding requirement arising out of distinct sources on different time frames. A maturity ladder is a useful device to compare cash inflows and outflows both on a day-to-day basis and over a series of specified time periods. The number of time frames in such maturity ladder is of significant importance and up to some extent depends upon nature of banks liability or sources of funds. Banks, which rely on short term funding, will concentrate primarily on managing liquidity on very short term Whereas, other banks might actively manage their net funding requirement over a slightly longer period. In the short term, banks flow of funds could be estimated more accurately and also such estimates are of more importance as these provide an indication of actions to be taken immediately. Further, such an analysis for distant periods will maximize the opportunity for the bank to manage the GAP well in advance before it crystallizes. Consequently banks should use short time frames to measure near term exposures and longer time frames thereafter. It is suggested that banks calculate daily GAP for next one or two weeks, monthly Gap for next six month or a year and quarterly thereafter. While making an estimate of cash flows, following aspect needs attention 6.8 Liquidity Ratios and Limits Banks may use a variety of ratios to quantify liquidity. These ratios can also be used to create limits for liquidity management. However, such ratios would be meaningless unless used regularly and interpreted taking into account qualitative factors. Ratios should always be used in conjunction with more qualitative information about borrowing capacity, such as the likelihood of increased requests for early withdrawals, decreases in credit lines, decreases in transaction size, or shortening of term funds available to the bank. To the extent that any asset-liability management decisions are based on financial ratios, a bank's asset-liability managers should understand how a ratio is constructed, the range
_______________________________________________________________________ _ of alternative information that can be placed in the numerator or denominator, and the scope of conclusions that can be drawn from ratios. Because ratio components as calculated by banks are sometimes inconsistent, ratio-based comparisons of institutions or even comparisons of periods at a single institution can be misleading. 6.9 Internal Controls In order to have effective implementation of policies and procedures, banks should institute review process that should ensure the compliance of various procedures and limits prescribed by senior management. Persons independent of the funding areas should perform such reviews regularly. T he bigger and more complex the bank, the more thorough should be the review. Reviewers should verify the level of liquidity risk and managements compliance with limits and operating procedures. Any exception to that should be reported immediately to senior management / board and necessary actions should be taken.
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CHAPTER:7. RISK MONITORING AND CONTROL 7.1 7.2 7.3 7.4 7.5 7.6 7.7 Risk Management Plan Risk Register Work Performance Information Risk Reassessment Variance and Trend Analysis Technical Performance Measurement Reserve Analysis
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7. RISK MONITORING AND CONTROL

Risk monitoring and control is the process of identifying, analyzing, and planning for newly discovered risks and managing identified risks. Throughout the process, the risk owners track identified risks, reveal new risks, implement risk response plans, and gage the risk response plans effectiveness. The key point is throughout this phase constant monitoring and due diligence is key to the success. The inputs to Risk Monitoring and Control are: 7.1 Risk Management Plan The Risk Management Plan is details how to approach and manage project risk. The plan describes the how and when for monitoring risks. Additionally the Risk Management Plan provides guidance around budgeting and timing for riskrelated activities, thresholds, reporting formats, and tracking. 7.2 Risk Register The Risk Register contains the comprehensive risk listing for the project. Within this listing the key inputs into risk monitoring and control are the bought into, agreed to, realistic, and formal risk responses, the symptoms and warning signs of risk, residual and secondary risks, time and cost contingency reserves, and a watch list of low-priority risks.
Approved Change Requests
Approved change requests are the necessary adjustments to work methods, contracts, project scope, and project schedule. Changes can impact existing risk and give rise to new risk. Approved change requests are need to be reviews from the perspective of whether they will affect risk ratings and responses of existing risks, and or if new risks are a result.
_______________________________________________________________________ _ 7.3 Work Performance Information Work performance information is the status of the scheduled activities being performed to accomplish the project work. When comparing the scheduled activities to the baseline, it is easy to determine whether contingency plans need to be put into place to bring the project back in line with the baseline budget and schedule. By reviewing work performance information, one can identify if trigger events have occurred, if new risk are appearing on the radar, or if identified risks are dropping from the radar.
Performance Reports
Performance reports paint a picture of the project's performance with respect to cost, scope, schedule, resources, quality, and risk. Comparing actual performance against baseline plans may unveil risks which may cause problems in the future. Performance reports use bar charts, S-curves, tables, and histograms, to organize and summarize information such as earned value analysis and project work progress.
All of these inputs help the banks and DFI manager to monitoring risks and assure a successful risk management. Once the Bank or DFI has gathered together all of the inputs, it is time to engage in risk monitoring and controlling. The best practices for risk management are: 7.4 Risk Reassessment It is normally addressed at the status meetings. Throughout the project, the risk picture fluctuates: New risks arise, identified risks change, and some risks may simply disappear. To assure team members remain aware of changes in the risk picture, risks are reassessed on a regularly scheduled basis. Reassessing risks enables risk owners and the project manager to evaluate whether risk probability, impact, or urgency ratings are changing; new risks are coming into play; old risks
_______________________________________________________________________ _ have disappeared; and if risk responses remain adequate. If a risk's probability, impact, or urgency ratings change, or if new risks are identified, the institution may initiate iterations of risk identification or analysis to determine the risk's effects on the process or deals.
Status Meetings
Status meetings provide a forum for team members to share their experiences and inform other team members of their progress and plans. A discussion of risk should be an agenda item at every status meeting. Open collaborative discussions allows risk owners to bring to light risks which are triggering events, whether and how well the planned responses are working, and where help might be needed. Most people find it difficult to talk about risk. However, communication will become easier with practice. To assure this is the case, the Institution must encourage open discussion with no room for negative repercussions for discussing negative events.
Risk Audits
Risk audits examine and document the effectiveness of planned risk responses and their impacts on the schedule and budget. Risk audits may be scheduled activities, documented in the Project Management Plan, or they can be triggered when thresholds are exceeded. Risk audits are often performed by risk auditors, who have specialized expertise in risk assessment and auditing techniques. To ensure objectivity, risk auditors are usually not members of the project team. Some companies even bring in outside firms to perform audits. 7.5 Variance and Trend Analysis Variance analysis examines the difference between the planned and the actual budget or schedule in order to identify unacceptable risks to the schedule, budget, quality, or scope of the project. Earned value analysis is a type of variance analysis. Trend analysis involves observing project performance over
_______________________________________________________________________ _ time to determine if performance is getting better or worse using a mathematical model to forecast future performance based on past results. 7.6 Technical Performance Measurement (TPM) Technical performance measurement identifies deficiencies in meeting system requirements, provide early warning of technical problems, and monitor technical risks. The success of TPM depends upon identifying the correct key performance parameters (KPPs) at the outset of the project. KPPs are factors that measure something of importance to the project and are time/cost critical. Each KPP is linked to the work breakdown structure (WBS), and a time/cost baseline may be established for it. The project manager monitors the performance of KPPs over time and identifies variances from the plan. Variances point to risks in the project's schedule, budget, or scope. 7.7 Reserve Analysis - Reserve analysis makes a comparison of the contingency reserves to the remaining amount of risk to ascertain if there is enough reserve in the pool. Contingency reserves are buffers of time, funds, or resources set aside to handle risks that arise as a project moves forward. These risks can be anticipated, such as the risks on the Risk Register. They can be unanticipated, such as events that "come out of left field." Contingency reserves are depleted over time, as risks trigger and reserves are spent to handle them. With constraints as above monitoring the level of reserves to assure the level remains adequate to cover remaining project risk, is a necessary task. Outputs of the Risk Monitoring and Control process are produced continually, fed into a variety of other processes. In addition, outputs of the process are used to update project and organizational documents for the benefit of future project managers. The outputs of Risk Monitoring and Control are:
Updates to the Risk Register
An updated Risk Register has the outcomes from risk
assessments, audits, and risk reviews. In addition it is updated with the resulting
_______________________________________________________________________ _ outcome of the project risk and risk response. Was it a good response, did the response have the desired affect? The updated Risk Register is a key part of the historical record of risk management for the project and will be added to the historical archives.
Updates to Organizational Process Assets
Organizational process assets should be documented in light of the risk management processes to be used in future projects. Documents as the probability and impact matrix, risk databases, and lessons-learned information, as well as all of the project files are archived for the benefit of future project managers.
Updates to the Project Management Plan
Updates to the Project Management Plan occur if any approved changes have an impact on the risk management process. In addition, these authorized changes incur risks which are documented in the Risk Register.
Recommend Corrective Actions
Recommended corrective actions consist of two types: contingency plans and workaround plans. A contingency plan is a provision in the Project Management Plan that specifies how a risk will be handled if that risk occurs. The plan may be linked with money or time reserves that can be used to implement the plan. A workaround plan is a response to a negative risk that was passively accepted or not previously identified.
Recommend Preventative Actions
Recommended preventative actions assure the project follows the guidelines of the project management plan.
_______________________________________________________________________ _
Requested Changes
Requested Changes are any identified changes to the project management plan. Change requests are completed and submitted to the Integrated Change Control process. All requested changes must are documented, and that approvals at the right management levels are sought and obtained.
_______________________________________________________________________ _
CHAPTER NO: 8. CONCLUSION AND RECOMMENDATIONS 8.1 Conclusion 8.2 Recommendations
_______________________________________________________________________ _
8. CONCLUSION AND RECOMMENDATIONS

8.1 CONCLUSIONS Risk management is the most important sector of the banking industry with the key success by attending directly the needs of the end Commercial banks and DFI is having glorious future in coming years. Risk management in financial sector as a whole is facing a lot of competition ever since financial sector reforms were started in the country. Walk-in business is a thing of past and banks are now on their toes to capture business. Banks and DFI therefore, are now competing for increasing competition and availability of day by day growing financial products and current modernization era financial market business going more risky area. There is a need for constant innovation in Risk management area banking. This requires product development and differentiation, micro-planning, marketing, prudent pricing, customization, technological up gradation, home / electronic / mobile banking, effective risk management and asset liability management techniques. While Risk management covered products offers phenomenal opportunities for growth, the challenges are equally discouraging. How far the financial market is able to lead growth of banking industry in future would depend upon the comprehensive risk management and capacity building of banks to meet the challenges and make use of opportunities profitably. However, the kind of technology used and the efficiency of operations would provide the much needed competitive edge for success risk management business. Furthermore, in all these customer interest is of chief importance. The banking sector in Pakistan is representing this and I do hope they would continue to succeed in this traded path.
_______________________________________________________________________ _ 8.2 Recommendations Current Situation and Issue Risk management is most essential part of any sort of operation in commercial banks and DFI. It is also depend the policy of institution to work on strong and comprehensive risk management which will be effective tool to secure and develop organizational growth and helpful for professional way of working without harmful effects
Current Situation and Issue Description
Assessment of facilities for standard physical losses (Equity and Debt) and potential occupational hazards is handled routinely by institutional Environmental. The program of neither risk analysis nor a fully-dedicated position for loss control and loss prevention at any institution. Responsibilities for risk management are spread among a variety of departments. Thus, pre-loss process review and loss prevention implementation is rare. Such strategies are generally handled on a post-incident, department-only basis.
Rationale for Change
Institutions typically respond to property and liability losses in a reactive mode. The work group believes it is essential to move to a proactive stance in preventing losses. In addition, this reactive stance may well be the result of the fact that no institution has a fully dedicated position to analyze losses, decide upon methods of prevention, and coordinate implementation of loss prevention measures. As the position of risk coordinator is currently configured at the institutions, only a small percentage of the total FTE is all risk activities. These activities are confined to information gathering and dissemination of that information to RMD. RMD then makes all the decisions regarding resolution of the claim. In general, Risk Coordinators process the claim rather than manage it. In contrast, workers compensation coordinators spend a majority of their time performing claims management activities. They generally have an extensive background in workers compensation and the associated loss control practices.
_______________________________________________________________________ _ Use of these practices allows them to impact the outcome of the claim and better control the associated costs. Working in cooperation with SAIF Corporation adjusters, they provide input and help design the best cost control strategy for each claim.
Key Concerns Regarding the Development of a Comprehensive Risk Program
The key concern with developing a comprehensive risk program across the System is the potential for initial increased resource costs. The challenge of implementing a new program is to demonstrate that the benefits of the program will outweigh the costs. Another concern with implementing a risk management program is whether incremental resources will possess the proper expertise. For a risk management program to work effectively, the risk manager position at each institution would ideally have professional experience. Without the proper experience and training (i.e. if the risk manager position was staffed at a clerical level), the benefits gained by implementing a risk management program would be considerably less
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_______________________________________________________________________ _ 9. Graham, John R. et al (Dec., 1999), Tax Incentives to Hedge, The Journal of Finance, Vol. 54, No. 6, 2241 2262, Blackwell Publishing for the American. 10. Gruber, Martin J. (Jul., 1996), Another Puzzle: The Growth in Actively Managed Risk Management, The Journal of Finance, Vol. 51, No. 3, 783 810, Papers and Proceedings of the Fifty-Sixth Annual Meeting of the American Finance Association, San Francisco, California, January 5 7, 1996, Blackwell Publishing for the American Finance Association. 11. ICI Investment Company Institute. 2008 Investment Company Fact book 48 th edition. Retrieved on February 12 2009 from website: www.icifactbook.org 12. Jensen, Michael C. (Mar., 1967), The Performance Of risk management In The Period 1945-1964, The Journal of Finance, Vol. 23, No. 2, 389 416, Harvard Business School, Blackwell Publishing for the American Finance Association. 13.Khan, Ahmed. (July 2008), Asset Management Industry, The research report: IGI Securities, NBFC Pakistan. 14. Knopf, John D. et al (Apr., 2002), The Volatility and Price Sensitivities of Managerial Stock Option Portfolios and Corporate Hedging, The Journal of Finance, Vol. 57, No. 2, 801 813, Blackwell Publishing for the American. 15. Leland, Hayne E. (May., 1980), Who Should Buy Portfolio Insurance?, The Journal of Finance, Vol. 35, No. 2, 581 594, Papers and Proceedings Thirty Eighth Annual Meeting of the American Finance Association, Atlanta, Georgia, December 28 30, 1979, Blackwell Publishing for the American Finance Association. 16. Risk management Association of Pakistan. Assets Under Management: Retrieved on February 9, 2009. from website

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