Risk is inherent in any walk of life in general and in financial sectors in particular. Till recently, due to a regulated environment, banks could not afford to take risks. But of late, banks are exposed to same competition and hence are compelled to encounter various types of financial and non-financial risks. Risks and uncertainties form an integral part of banking which by nature entails taking risks. There are three main categories of risks; Credit Risk, Market Risk & Operational Risk. Main features of these risks as well as some other categories of risks such as Regulatory Risk and Environmental Risk. Various tools and techniques to manage Credit Risk, Market Risk and Operational Risk and its various components, are also discussed in detail. Another has also mentioned relevant points of Basel’s New Capital Accord’ and role of capital adequacy, Risk Aggregation & Capital Allocation and Risk Based Supervision (RBS), in managing risks in banking sector.

When we use the term “Risk”, we all mean financial risk or uncertainty of financial loss. If we consider risk in terms of probability of occurrence frequently, we measure risk on a scale, with certainty of occurrence at one end and certainty of non-occurrence at the other end. Risk is the greatest where the probability of occurrence or non-occurrence is equal. As per the Reserve Bank of India guidelines issued in Oct. 1999, there are three major types of risks encountered by the banks and these are Credit Risk, Market Risk & Operational Risk. In August 2001, a discussion paper on move towards Risk Based Supervision was published. Further after eliciting views of banks on the draft guidance note on Credit Risk Management and market risk management, the RBI has issued the final guidelines and advised some of the large PSU banks to implement so as to gauge the impact. A discussion paper on Country Risk was also released in May 02. Risk is the potentiality that both the expected and unexpected events may have an adverse impact on the bank’s capital or earnings. The expected loss is to be borne by the borrower and hence is taken care of by adequately pricing the products through risk premium and reserves created out of the earnings. It is the amount expected to be lost due to changes in credit quality resulting in default. Whereas, the unexpected loss on account of the individual exposure and the whole portfolio in entirely is to be borne by the bank itself and hence is to be taken care of by the capital. Thus, the expected losses are covered by reserves/provisions and the unexpected losses require capital allocation. Hence the need for sufficient Capital Adequacy Ratio is felt. Each type of risks is measured to determine both the expected and unexpected losses using VAR (Value at Risk) or worst-case type analytical model.

Credit Risk is the potential that a bank borrower/counter party fails to meet the obligations on agreed terms. There is always scope for the borrower to default from his commitments for one or the other reason resulting in crystallization of credit risk to the bank. These losses could take the form outright default or alternatively, losses from changes in portfolio value arising from actual or perceived deterioration in credit quality that is short of default. Credit risk is inherent to the business of lending funds to the operations linked closely to market risk variables. The objective of credit risk management is to minimize the risk and maximize bank’s risk adjusted rate of return by assuming and maintaining credit exposure within the acceptable parameters. Credit risk consists of primarily two components, Quantity of risk, which is nothing but the outstanding loan balance as on the date of default and the quality of risk, the severity of loss defined by both Probability of Default as reduced by the recoveries that could be made in the event of default. Thus credit risk is a combined outcome of Default Risk and Exposure Risk. The elements of Credit Risk are Portfolio risk comprising Concentration Risk as well as

Intrinsic Risk and Transaction Risk comprising migration/down gradation risk as well as Default Risk. At the transaction level, credit ratings are useful measures of evaluating credit risk that is prevalent across the entire organization where treasury and credit functions are handled. Portfolio analysis help in identifying concentration of credit risk, default/migration statistics, recovery data, etc. In general, Default is not an abrupt process to happen suddenly and past experience dictates that, more often than not, borrower’s credit worthiness and asset quality declines gradually, which is otherwise known as migration. Default is an extreme event of credit migration. Off balance sheet exposures such as foreign exchange forward can tracks, swaps options etc are classified in to three broad categories such as full Risk, Medium Risk and Low risk and then translated into risk Neighed assets through a conversion factor and summed up. The management of credit risk includes a) Measurement through credit rating/ scoring, b) Quantification through estimate of expected loan losses, c) Pricing on a scientific basis and d) Controlling through effective Loan Review Mechanism and Portfolio Management.

Tools of Credit Risk Management.
The instruments and tools, through which credit risk management is carried out, are detailed below:

1. Exposure Ceilings:
Prudential Limit is linked to Capital Funds – say 15% for individual borrower entity, 40% for a group with additional 10% for infrastructure projects undertaken by the group, Threshold limit is fixed at a level lower than Prudential Exposure; Substantial Exposure, which is the sum total of the exposures beyond threshold limit should not exceed 600% to 800% of the Capital Funds of the bank (i.e. six to eight times). 2. Review/Renewal: Multi-tier Credit Approving Authority, constitution wise delegation of powers, Higher delegated powers for better-rated customers; discriminatory time schedule for review/renewal, Hurdle rates and Bench marks for fresh exposures and periodicity for renewal based on risk rating, etc are formulated.

3. Risk Rating Model:
Set up comprehensive risk scoring system on a six to nine point scale. Clearly define rating thresholds and review the ratings periodically preferably at half yearly intervals. Rating migration is to be mapped to estimate the expected loss.

4. Risk based scientific pricing:
Link loan pricing to expected loss. High-risk category borrowers are to be priced high. Build historical data on default losses. Allocate capital to absorb the unexpected loss. Adopt the RAROC framework.

5. Portfolio Management:
The need for credit portfolio management emanates from the necessity to optimize the benefits associated with diversification and to reduce the potential adverse impact of concentration of exposures to a particular borrower, sector or industry. Stipulate quantitative ceiling on aggregate exposure on specific rating categories, distribution of borrowers in various industry, business group and conduct rapid portfolio reviews. The existing framework of tracking the non-performing loans around the balance sheet date does not signal the quality of the entire loan book. There should be a proper & regular on-going

Determine adequacy of loan loss provisions. — Reasonable estimation of the overall health status of an account captured under Portfolio approach as Contrasted to stand-alone or asset based credit management. review of risk rating. Ensure adherence to lending policies and procedures. The model may consist of minimum of six grades for performing and two grades for non-performing assets. — Instead of passive approach of originating the loan and holding it till maturity. — Concentration risks are measured in terms of additional portfolio risk arising on account of increased Exposure to a borrower/group or co-related borrowers. compliance status.e. The process of credit risk management needs analysis of uncertainty and analysis of the risks inherent in a credit proposal. As observed by RBI. Loan Review Mechanism: This should be done independent of credit operations. active approach of Credit portfolio management is adopted through securitization/credit derivatives. at the branch that has appraised the advance and where the main Operative limits are made available. monitor and control the overall exposure to high value Customers on real time basis to focus attention on vital few so that trivial many do not take much of Valuable time and efforts. it is not required to risk borrowers’ factory/office premises. However. It should target all loans above certain cut-off limit ensuring that at least 30% to 40% of the portfolio is subjected to LRM in a year so as to ensure that all major credit risks embedded in the balance sheet have been tracked. Credit Audit is conducted on site. — Pricing of credit risk on a scientific basis linking the loan price to the risk involved therein. 6. — The co-relation or co-variance between different sectors of portfolio measures the inter relationship Between assets. The focus of the credit audit needs to be broadened from account level to overall portfolio level. Therefore an lending decision should always be preceded by detailed analysis of risks and the outcome of analysis should be taken as a guide for the credit decision. .system for identification of credit weaknesses well in advance. at the branch that has appraised the advance and where the main operative limits are made available. pick up of warning signals and recommendation of corrective action with the objective of improving credit quality. Risk Rating Model Credit Audit is conducted on site. However. i. — Impact of a new loan asset on the portfolio can be assessed. Identify loans with credit weakness. Regular. it is not required to visit borrower’s factory/office premises. The benefits of diversification will be available so long as there is no perfect positive Correlation between the assets.e. As there is a significant co-relation between credit ratings and default frequencies. The predictable risk should be contained through proper strategy and the unpredictable ones have to be faced and overcome. It is also referred as Credit Audit covering review of sanction process. Taking a fresh exposure to the sector in which there already exists sizable exposure may simply increase the portfolio risk although specific unit level risk is negligible/minimal. Credit Risk is the major component of risk management system and this should receive special attention of the Top Management of the bank. — Disciplined way of looking at Credit Risk. The need for the adoption of the credit riskrating model is on account of the following aspects. — Need for Relationship Manager to capture. i. Initiate steps to preserve the desired portfolio quality and integrate portfolio reviews with credit decision-making process. This is done to bring about qualitative improvement in credit administration. The distribution of rating of assets should be such that not more than 30% of the advances are grouped under one rating. any derivation of probability from such historical data can be relied upon. otherwise impact on one would affect the other. proper & prompt reporting to Top Management should be ensured.

The systematic risk emanates from General political environment. Certain level of reasonable over-provisioning as Best practice. associated with credit. labour strike. Given the past experience and assumptions about the future. Assessment of financial risks involves appraisal of the financial strength of a unit based on its performance and financial indicators like liquidity. turnover etc. It tries to estimate the asset value path of the firm over a time horizon. d.— Rating can be used for the anticipatory provisioning. credit risk models are intended to aid banks in quantifying. coverage. We can narrow the margin of uncertainty of a forecast if we have a fair understanding of the nature and level of uncertainty regarding the variable in question and availability of quality information at the time of assessment. It is based on insurance industry model of event risk. through its Expected Default Frequency (EDF) methodology derives the actua probability of default for each obligor based on functions of capital structure. . infrastructural changes etc. It separates defaulting borrower from non-defaulting borrower on the basis of certain financial ratios converted into simple index. profitability. It is necessary to study the movement of these indicators over a period of time as Also its comparison with industry averages wherever possible. b. c. aggregating and managing risk across geographical and product lines. leverage. gearing. Industry/Business risk consists of both systematic and unsystematic risks which are market driven. Some of the risk rating methodologies used widely is briefed below: a. The risk-rating model should capture various types of risks such as Industry/Business Risk. The default risk is the probability of the estimated asset value falling below a pre-specified default point. The key ingredient of credit risk is the risk of default that is measured by the probability that default occurs during a given period. changes in economic policies. fiscal policies of the government. Credit models are used to flag potential problems in the portfolio to facilitate early corrective action. the volatility of asset returns and the current asset value. The model is base on actuarial rates and unexpected losses from defaults. It calculates the asset value of a firm from the market value of its equity using an option pricing based approach that recognizes equity as a call option on the underlying asset of the firm. Probabilities are estimates of future happenings that are uncertain. new competitors who are quite specific to the activities in which the borrower is engaged. KMV. Credit Risk +. Credit Metrics focuses on estimating the volatility of asset values caused by variation in the quality of assets. A study carried out in the western corporate world reveals that 45% of the projects failed to take off simply because the personnel entrusted with the test were found to be highly wanting in qualitatively managing the project. Thus. Financial Risk and Management Risk. The expected loss/unexpected loss methodology forces banks to adopt new Internal Ratings Based approach to credit risk management as proposed in the Capital Accord II. is for measuring credit risk. The model tracks rating migration which is the probability that a borrower migrates from one risk rating to another risk rating. the credit risk model seeks to determine the present value of a given loan or fixed income security. It also seeks to determine the quantifiable risk that the promised cash flows will not be forthcoming. The unsystematic risk arises out of internal factors such as machinery break down. Altman’s Z score Model involves forecasting the probability of a company entering bankruptcy. a statistical method based on the insurance industry.

The cash flows are placed in different time buckets based on future likely behavior of assets. Time Risk & Call Risk. Time risk: It is the need to compensate for non receipt of expected inflows of funds. Scenario analysis and stress testing is yet another tool used to assess areas of potential problems in a given portfolio. It is the risk that the value of on-/off-balance sheet positions will be adversely affected by movements in equity and interest rate markets. currency exchange rates and commodity prices. i. Tolerance levels on mismatches should be fixed for various maturities depending upon the asset liability profile.e. Liquidity is the ability to efficiently accommodate deposit as also reduction in liabilities and to fund the loan growth and possible funding of the off-balance sheet claims. c. Market Risk Management provides a comprehensive and dynamic frame work for measuring. liquidity conditions etc that could have unfavorable effect on bank’s portfolio is a condition precedent for carrying out stress testing. Funding Risk: It is the need to replace net out flows due to unanticipated withdrawal/non. deposit mix. as well as the volatilities.MARKET RISK Market Risk may be defined as the possibility of loss to bank caused by the changes in the market variables. etc. nature of cash flow etc.Renewal of deposits. monitoring and managing liquidity. Bank should track the impact of pre-payment of loans & premature closure of deposits so as to realistically estimate the cash flow profile. Liquidity Risk Bank Deposits generally have a much shorter contractual maturity than loans and liquidity management needs to provide a cushion to cover anticipated deposit withdrawals. foreign exchange and equities. Market risk is the risk to the bank’s earnings and capital due to changes in the market level of interest rates or prices of securities. d) Risk exposure. foreign exchange and equity as well as commodity price risk of a bank that needs to be closely integrated with the bank’s business strategy. b) Cost. output of the test should be reviewed periodically as market risk management system should be responsive and sensitive to the happenings in the market. a. Call risk: It happens on account of crystallization of contingent liabilities and inability to undertake profitable business opportunities when desired. It Implies examination of all the assets and liabilities simultaneously on a continuous basis with a view to ensuring a proper balance between funds mobilization and their deployment with respect to their a) Maturity profiles. Identification of future changes in economic conditions like – economic/industry overturns. As the underlying assumption keep changing from time to time. b. . of those prices. market risk events. c) Yield. Performing assets turning into non performing assets. The Asset Liability Management (ALM) is a part of the overall risk management system in the banks. Liquidity risk consists of Funding Risk. interest rate. liabilities and off-balance sheet items.

Interest Rate Risk Interest Rate Risk is the potential negative impact on the Net Interest Income and it refers to the vulnerability of an institution’s financial condition to the movement in interest rates. d. Gap/Mismatch risk: It arises from holding assets and liabilities and off balance sheet items with different principal amounts. In order to manage interest rate risk. By reducing the size of the duration gap. The economic value perspective identifies risk arising from long-term interest rate gaps. The difference between the average duration for bank assets and the average duration for bank liabilities is known as the duration gap which assess the bank’s exposure to interest rate risk. This is measured by measuring the changes in the Net Interest Income (NII) equivalent to the difference between total interest income and total interest expense. Changes in interest rate affect earnings. There are different techniques such as . maturity dates & re-pricing dates thereby creating exposure to unexpected changes in the level of market interest rates. The degree of basis risk is fairly high in respect of banks that create composite assets out of composite liabilities. Reprice risk: When assets are sold before maturities. the objective of interest rate risk management is to maintain earnings. Management of interest rate risk aims at capturing the risks arising from the maturity and re-pricing mismatches and is measured both from the earnings and economic value perspective. Embedded option Risk: Option of pre-payment of loan and Fore closure of deposits before their stated maturities constitute embedded option risk. ability to absorb potential loss and to ensure the adequacy of the compensation received for the risk taken and effect risk return trade-off. banks should begin evaluating the vulnerability of their portfolios to the risk of fluctuations in market interest rates. Earnings perspective involves analyzing the impact of changes in interest rates on accrual or reported earnings in the near term. c. Economic Value perspective involves analyzing the expected cash in flows on assets minus expected cash out flows on liabilities plus the net cash flows on off-balance sheet items. One such measure is Duration of market value of a bank asset or liabilities to a percentage change in the market interest rate. value of assets. f. Hence. e. Basis Risk: It is the risk that the Interest rat of different Assets/liabilities and off balance items may change in different magnitude. improve the capability. b. Yield curve risk: Movement in yield curve and the impact of that on portfolio values and income. banks can minimize the interest rate risk. net interest position risk arises in case market interest rates adjust downwards. Net interest position risk: When banks have more earning assets than paying liabilities. The Asset Liability Committee (ALCO) of a bank uses the information contained in the duration gap analysis to guide and frame strategies. liability off-balance sheet items and cash flow. Reinvestment risk: Uncertainty with regard to interest rate at which the future cash flows could be reinvested. The various types of interest rate risks are detailed below: a.

Till then it is a random variable whose outcome has been estimated. Currency Risk is the possibility that exchange rate changes will alter the expected amount of principal and return of the lending or investment. bank should be able to adopt standardized method or internal models for providing explicit capital charge for market risk. It is a statistical measure of risk exposure and measures the worst expected loss over a given time interval under normal market conditions at a given confidence level of say 95% or 99%. The actual result will not be known until the event takes place. but only gets converted in to credit risk.I. the banking book consists of assets and liabilities contracted basically on account of relationship or for steady income and statutory obligations and are generally held till maturity/payment by counter party. As far as Trading Book is concerned. Thus. Even in case where spot or forward positions in individual currencies are balanced the maturity pattern of forward transactions may produce mismatches. either spot or forward or both in same foreign currency. There is also a settlement risk arising out of default of the counter party and out of time lag in settlement of one currency in one center and the settlement of another currency in another time zone. Banks broadly bifurcate the asset into Trading Book and Banking Book. Individual Gap Limits and Aggregate Gap Limits. The traditional Maturity Gap Analysis to measure the interest rate sensitivity. Duration Gap Analysis to measure interest rate sensitivity of capital. while price risk is the prime concern of banks in trading book. While trading book comprises of assets held primarily for generating profits on short term differences in prices/yields. II. It is the possibility that a country will be unable to service or repay debts to foreign lenders in time. The approach towards measurement and hedging interest rate risk varies with segmentation of bank’s balance sheet. Thus VAR is simply a distribution of probable outcome of future losses that may occur on a portfolio. IV. Country Risk This is the risk that arises due to cross border transactions that are growing dramatically in the recent years owing to economic liberalization and globalization. Simulation Value at Risk for measurement of interest rate risk. It comprises of Transfer Risk arising on . The Value at Risk (VAR) indicates the risk that the bank is exposed due to uncovered position of mismatch and these gap positions are to be valued on daily basis at the prevalent forward market rates announced by FEDAI for the remaining maturities. Banks are also exposed to interest rate risk. the earnings or changes in the economic value are the main focus in banking book. which arises from the maturity mismatch of foreign currency position. stop-loss limits. III. banks may try to cope with this specific risk on the lending side by shifting the risk associated with exchange rate fluctuations to the borrowers. By setting appropriates limits-open position and gaps. However the risk does not get extinguished. Value at Risk (VAR) is a method of assessing the market risk using standard statistical techniques. At times. Day Light as well as overnight limits for each currency. clear cut and well defined division of responsibilities between front. middle and back office the risk element in foreign exchange risk can be managed/monitored. Forex Risk Foreign exchange risk is the risk that a bank may suffer loss as a result of adverse exchange rate movement during a period in which it has an open position.

banks should reckon both fund and non-fund exposures from their domestic as well as foreign branches. The system should be able to identify the full dimensions of country risk as well as incorporate features that acknowledge the links between credit and market risks. a possibility that exchange rate change. As per the RBI guidance note on Country Risk Management published recently. is the risk of loss arising from inadequate or failed internal processes. Banks were also advised to set country exposure limits and monitor such exposure on weekly basis before eventually switching over to real tie monitoring.2004. the guidelines suggests that banks should use the country ratings of international rating agencies and broadly classify the country risk rating into six categories such as insignificant. However. has highlighted the potential losses on account of operational risk. OPERATIONAL RISK Always banks live with the risks arising out of human error. guarantees etc. Exponential growth in the use of technology and increase in global financial inter-linkages are the two primary changes that contributed to such risks. for products. i. With regard to inter-bank exposures. monitoring and controlling country risk. maturity etc. branches. but may not be paid or the buyer (importer) might have paid the money in advance but was not delivered the goods for one or the other reasons. people and systems or from external events. Sovereign Risk associated with lending to government of a sovereign nation or taking government guarantees. It advocates that bank should also take into account indirect country risk exposure. Political Risk when political environment or legislative process of country leads to government taking over the assets of the financial entity (like nationalization. RBI further suggests that banks should eventually put in place appropriate systems to move over to internal assessment of country risk within a prescribed period say by 31. though defined as any risk that is not categorized as market or credit risk. while identifying. Banks are expected to disclose the “Country Risk Management” policies in their Annual Report by way of notes. internal control and internal audit systems are used as the primary means.account of possibility of losses due to restrictions on external remittances. by which time the new capital accord would be implemented. very high & off-credit. Banks should use variety of internal and external sources as a means to measure country risk and should not rely solely on rating agencies or other external sources as their only tool for monitoring country risk. etc) and preventing discharge of liabilities in a manner that had been agreed to earlier. gross exposure minus collaterals. The exposures should be computed on a net basis. if necessary.e. Banks should not rely solely on rating agencies or other external sources as their only country riskmonitoring tool. Insurance cover is one of the important mitigators of operational risk. measuring. high. In the process there can be a situation in which seller (exporter) may deliver the goods. exposures to a domestic commercial borrower with large economic dependence on a certain country may be considered as subject to indirect country risk. Cross border risk arising on account of the borrower being a resident of a country other than the country where the cross border asset is booked. Netting may be considered for collaterals in/guarantees issued by countries in a lower risk category and may be permitted for bank’s dues payable to the respective countries. The recent happenings such as WTC tragedy. Operational risk. . Barings debacle etc.3. low. moderate. Currency Risk. if any. financial fraud and natural disasters. For example. Banks may set country exposure limits in relation to the bank’s regulatory capital (Tier I & II) with suitable sub limits. Risk education for familiarizing the complex operations at all levels of staff can also reduce operational risk. will alter the expected amount of principal and return on the lending or investment. In order to mitigate this. banks may be allowed to adopt a more conservative categorization of the countries.

However. fraud. etc. As banks deal with public funds and money. Thus. Securities Exchange Board of India (SEBI). This entails multiplicity of regulatory controls. etc. Bank should strive to promote a shared understanding of operational risk within the organization. reach customers. The Basel Committee on Banking Supervision (BCBS) is a committee of banking supervisory authorities of G-10 countries and has been developing standards and establishment of a framework for bank supervision towards strengthening financial stability throughout . Putting in place proper corporate governance practices by itself would serve as an effective risk management tool. scientific measurement of operational risk has not been evolved. they are exposed to the environmental risk resulting in loss in business share with consequential profit. This provides the platform for environmental change and exposes the bank to the environmental risk. Moreover. having already gone for public issue. particularly in the banking field. The key to management of operational risk lies in the bank’s ability to assess its process for vulnerability and establish controls as well as safeguards while providing for unanticipated worst-case scenarios. The very many regulators include Reserve Bank of India (RBI). Hence 20% charge on the Capital Funds is earmarked for operational risk and based on sub sequent data/feedback. Thus all the banks run the risk of multiple regulatory-risks which inhibits free growth of business as focus on compliance of too many regulations leave little energy and time for developing new business. Banks should learn the art of playing their business activities within the regulatory controls. they are subject to various regulations. it is natural that very few regulators operate and supervise them. more national and international players are operating the financial markets. ENVIRONMENTOL RISK As the years roll by and technological advancement take place. unless the banks improve their delivery channels. While measurement of operational risk and computing capital charges as envisaged in the Basel proposals are to be the ultimate goals. Over a period of time. it was reduced to 12%. So far. especially since operational risk is often intertwined with market or credit risk and it is difficult to isolate. performance failure. monitored and analyzed. Department of Company Affairs (DCA). as banks accept deposit from public obviously better governance is expected of them. Many Banks. what is to be done at present is start implementing the Basel proposal in a phased manner and carefully plan in that direction. And yet the root causes of all the financial scams and losses are the result of operational risk caused by breakdowns in internal control mechanism and staff lapses. Operational risk involves breakdown in internal controls and corporate governance leading to error. management of credit and market risks has evolved a more sophisticated fashion than operational risk. expectation of the customers change and Enlarge. innovate their products that are service oriented.Operational risk events are associated with weak links in internal control procedures. The incentive for banks to move the measurement chain is not just to reduce regulatory capital but more Importantly to provide assurance to the top management that the bank holds the required capital. as the former can be more easily measured. With the economic liberalization and globalization. REGULATORY RISK When owned funds alone are managed by an entity. compromise on the interest of the bank resulting in financial loss. have a greater responsibility and accountability. BASEL’S NEW CAPITAL ACCORD Bankers’ for International Settlement (BIS) meet at Basel situated at Switzerland to address the common Issues concerning bankers all over the world. The Companies Act. banks should ensure compliance of the applicable provisions of The Banking Regulation Act.

Combined forces of globalization and liberalization compelled the public sector banks. While Basel standards currently require banks to have a capital adequacy ratio of 8% with Tier I not less than 4%. As an improvement on the above. capitalization in banks was not given due importance as it was felt necessary for the reason that the ownership of the banks rested with the government. In banks asset creation is an event happening subsequent to the capital formation and deposit mobilization.5 times (implying for maximum Asset Creation Multiple of 12. That is to say. Asset Creation Multiple (ACM) may be examined/thought of for strict implementation. While getting support from a large body of shareholders is a difficult proposition when the bank’s performance is adverse. core principles for effective banking supervision in the form of minimum requirements to strengthen current supervisory regime. Therefore. hitherto shielded from the vagaries of market forces. the preposition should be for a given capital how much asset can be created? Hence. in lieu of capital adequacy ratio. stipulation of Maximum Asset Creation Multiple of 12. owner of PSU banks.5 time for the given capital of Rs 8) would be more meaningful. as all the capital was required to be reinvested in government securities yielding low interest.the world. would be more appropriate and rational. CAPITAL ADEQUACY Subsequent to nationalization of banks. Tier I capital is known as the core capital providing permanent and readily available support to the bank to meet the unexpected losses. At least in respect of the new banks (starting from zero). It has no maturity or repayment requirement. asset classification and provisioning. creating the required confidence in the mind of the public. capital adequacy ratio is adopted instead of asset creation multiple. However as the assets have been already created when the norms were introduced. In consultation with the supervisory authorities of a few non-G-10 countries including India. to be implemented by the financial year 2003-04. In doing so. the New Capital Accord was published in 2001. in ideal situation and taking a radical view. were mooted. to come to terms with the market realities where certain minimum capital adequacy has to be maintained in the face of stiff norms in respect of income recognition. It provides spectrum of approaches for the measurement of credit. and is expected to remain a permanent component of the core capital of the counter party. Tier I capital is not owed to anyone and is available to cover possible unexpected losses. Further. capital infusion did not result in any cash flow to the receiver. RBI has mandated the banks to maintain CAR of 9%. a smaller shareholder base constrains the ability of the bank to garner funds. The 1988 Capital Accord essentially provided only one option for measuring the appropriate capital in relation to the risk-weighted assets of the financial institution. the government was not acting as a prudent investor as return on such capital was never a consideration. It is clear that multi pronged approach would be required to meet the challenges of maintaining capital at adequate levels in the face of mounting risks in the banking sector. It focused on the total amount of bank capital so as to reduce the risk of bank solvency at the potential cost of bank’s failure for the depositors. instead of Minimum Capital Adequacy Ratio of 8 percent (implying holding of Rs 8 by way of capital for every Rs 100 risk weighted assets). . market and Operational risks to determine the capital required. In the recent past. the government provided capital in good measure mainly to weaker banks. stipulation of Asset Creation Multiple (ACM). The spread and nature of the ownership structure is Important as it impinges on the propensity to induct additional capital. The maintenance of capital adequacy is like aiming at a moving target as the composition of risk-weighted assets gets changed every minute on account of fluctuation in the risk profile of a bank. Receipt of capital was just a book entry with the only advantage of interest income from the securities.

6%. bank is required to calculate an expected loss value to ascertain the required capital to be allocated/assigned. if only to understand the risk return trade off that have been made. Aggregate risk exposure is estimated through Risk Adjusted Return on Capital (RAROC) and Earnings at Risk (EaR) method. to be chosen from under each of the risk are detailed below: Credit Risk Menu: 1) Standardized Approach: The bank allocates a risk weight to each assets as well as off balance sheet items and produces a sum of R W A values (RW of 100% may entail capital charge of 8% and RW of 20% may entail capital charge of 1. 2) Foundation Internal Rating Based Approach : Under this. bank rates the borrower and results are translated into estimates of a potential future loss amount which forms the basis of minimum capital requirement. Market Risk Menu: 1) Standardized Approach 2) Internal Models Approach Operational Risk Menu: 1) Basic Indicator Approach (Alpha) Hence. . for each combination of business line. 2) Standardized Approach (Beta) This approach specifies different indicators for different lines/units of business and the summation of different business lines such as Corporate Finance. In the New Capital Accord. Banks may adopt any of the approach suitable to them for arriving at the total risk weighted assets. it is critical that they are able to continuously monitor the exposures across the entire organization and aggregate the risks so than an integrated view is taken. 3) Internal Measurement Approach (Gamma) Based on the past internal loss data estimation. the method of calculation of Risk Weighted Assets has been modified to factor market risk and operational risk. RAROC is the first step towards examining the institution’s entire balance sheet on a mark to market basis. RISK AGGREGATION & CAPITAL ALLOCATION Capital Adequacy in relation to economic risk is a necessary condition for the long-term soundness of banks. As banks carry on the business on a wide area network basis. Former is used by bank with international presence and the RAROC process estimates the cost of Economic Capital & expected losses that may prevail in the worst-case scenario and then equates the capital cushion to be provided for the potential loss. the range of risk weights will be well diverse. etc to be done.) The risk weights are to be refined by reference to a rating provided by an external credit assessment institution that meets certain strict standards. Risk Weighted Asset etc. one indicator for operational risk is identified such as interest income. Various approaches. Retail Banking Asset Management. in addition to the Credit Risk that alone was reckoned in the 1988 Capital Accord. 3) Advanced Internal Rating Based Approach: In Advanced IRB approach. while the definition of Capital Fund remains the same.Minimum Capital Requirement The capital Adequacy Ratio is the percentage of bank’s Capital Funds in relation to the Risk Weighted Assets of the bank.

It is designed to ensure continuous monitoring and evaluation of risk profile of the institution through risk matrix. the internal auditor would not only offer remedial measures for current trouble-prone areas. This may optimize the utilization of the supervisory resources of the RBI so as to minimize the impact of a crises situation in the financial system. As against this. RISK BASED SUPERVISION (RBS) The Reserve Bank of India presently has its supervisory mechanism by way of on-site inspection and off-site monitoring on the basis of the audited balance sheet of a bank. beginning from the last quarter of the financial year 02-03. Risk based supervision approach is an attempt to overcome the deficiencies in the traditional point-intime. supervisors are expected to concentrate their efforts on ensuring that financial institutions use the process necessarily to identify measure and control risk exposure. but also anticipate problems to play an active role in protecting the bank from risk hazards. The RBS is expected to focus supervisory attention in accordance with the risk profile of the bank. the RBI has decided to put in place. The transaction based audit and supervision is getting shifted to risk focused audit. the regulatory capital is the actual Capital Funds held by the bank against the Risk Weighted Assets.The Economic Capital is the amount of the capital (besides the Regulatory Capital) that the firm has to put at risk so as to cover the potential loss under the extreme market conditions. By focusing on effective risk management. In order to enhance the supervisory mechanism. In other words. It is forward looking enabling the supervisors to differentiate between banks to focus attention on those having high-risk profile. transaction-validation and value based supervisory system. a system of Risk Based Supervision. it is the difference in mark-to-market value of assets over liabilities that the bank should aim at or target. The RBI has already structured the risk profile templates to enable the bank to Make a self-assessment of their risk profile. bank’s actual capital has to be allocated to individual business units on the basis of various types of risks. Under risk based supervision. This process can be continued till capital is allocated at transaction/customer level. . The implementation of risk based auditing would imply that greater emphasis is placed on the internal Auditor’s role for mitigating risks. After measuring the economic capital for the bank as a whole.

and EFT etc. Bakshi Jaishi Ram. Nationalisation of the fourteen major banks on 19th July. 1969 was a major step for the banking industry. The banks were expected to reach people in every nook and corner. Besides this PNB has video conferencing facility at 70 locations. Lala Lalchand. The Bank made steady progress right from its inception. Shri Lal Bahadur Shastri and Shrimati Indira Gandhi besides the account of the famous Jalianwala Bagh Committee. The Bhagwan Dass Bank Limited. Redundant and Scalable network designed in a four-tier full meshed network architecture wherein the branches /offices are connected to a Network Center (NC). PNB has setup Robust. Some smaller banks like. . Shri E. Lala Lajpat Rai. It withstood the crisis in banking industry of 1913 and the severe depression of the thirties. It has shown resilience to tide over many a crisis. As a result. It has 58 circle offices controlling these branches besides specialized service branches. PNB has the privilege of maintaining accounts of the illustrious national leaders like Mahatma Gandhi. PNB was one amongst these. PNB was founded in the year 1895 at Lahore (presently in Pakistan) as an off-shoot of the Swadeshi Movement. training establishment and Circle Inspectorates. With the passage of time the Bank grew to strength spreading its wings from one corner of the country to another. The Hindustan Commercial Bank Limited and The Nedungadi Bank were brought within its fold. Lala Dholan Dass. meet their needs. Bank has deployed Centralized Banking Solution (CBS) through FINACLE banking software procured from M/s Infosys Technologies in more than 4700 locations. It survived the most critical period in its history — the Partlition of 1947 — when it was uprooted from its major area of operations. The Bharat Bank Limited. The Lion of Punjab. Lala HarKishen Lal. It has been earnestly engaged in the task of national development. the first one with Indian capital — owned. It was the farsightedness of the management that the registered office of the Bank was shifted from Lahore to Delhi in June 1947 —even before the announcement of the Partition. Reliable. Removal of poverty and regional imbalances were accorded a high priority. In the process. It has also introduced Internet Banking Services and additional delivery channels like ATMs. Kiosks etc.C. Shri Kali Prosanna Roy. Among the inspired founders were Sardar Dayal Singh Majithia. The Indo-Commercial Bank Limited. and work for their economic upliftment. For running above applications. SWIFT and is also a member of Reserve Bank of India's various payment and settlement systems like RTGS. PNB has always responded enthusiastically to the nation's needs. PNB is a member of Indian Financial Network (INFINET). managed and operated by the Indians for the benefit of the Indians. Universal Bank of India. Shri Prabhu Dayal. banking was given a new direction and thrust. the bank has emerged as a major nationalized bank.PANJAB NATIONAL BANK INTRODUCTION OF PNB: Punjab National Bank (PNB) is one of the leading nationalized banks having its head office at New Delhi and has more than 4700 branches all over the country. Shri Jawahar Lal Nehru. With a common missionary zeal they set about establishing a national bank. SFMS. Jessawala. was actively associated with the management of the Bank in its formative years.

Investment policy. Capital Adequacy: The bank believes in the policy of total risk management. containing the direction and strategies for integrated management of the various risk exposures of the Bank. Credit Management & Risk policy. Reserves and Innovative Perpetual Bonds. These policies.DISCLOSURES UNDER THE NEW CAPITAL ADEQUACY FRAMEWORK (BASEL II GUIDELINES) FOR THE YEAR ENDED 31 March. Bank believes that risk management is one of the foremost responsibilities of top/senior management. exposure levels. ALM policy. interalia. Bank’s Tier I capital comprises of Equity Shares. Stress Testing Policy and Policy for Mapping Business Lines/Activities. . Bank has issued Innovative Perpetual Bonds (Tier 1 capital) and also other bonds eligible for inclusion in Tier 2 capital. contain various trigger levels. thrust areas etc. 2012: 1. Credit Risk Mitigation & Collateral Management Policy. Policy for internal capital adequacy assessment process (ICAAP). The Board of Directors decides the overall risk management policies and approves the Risk Management Philosophy & Policy. 2. Capital Structure. Operational Risk Management policy.

Account will be treated out of order. Credit risk: General disclosures Any amount due to the bank under any credit facility is overdue if it is not paid on the due date fixed by the bank. an impaired asset is a loan or an advance where: (i) Interest and/or installment of principal remains overdue for a period of more than 90 days in respect of a term loan. if: . 3.The outstanding balance remains continuously in excess of the limit/drawing power. but there are no credits continuously for 90 days as on the date of balance sheet or credits are not enough to cover the interest debited during the same period (iii) In case of bills purchased & discounted. (ii) The account remains out of order in respect of an overdraft/cash credit for a period of more than 90 days.In cases where the outstanding balance in the principal operating account is less than the sanctioned limit/drawing power. . The committee has the overall responsibility of risk management functions and oversees the function of Credit Risk Management Committee (CRMC). The meeting of RMC is held at least once in a quarter. The bank recognizes that the management of risk is integral to the effective and efficient management of the organization. Asset Liability Committee (ALCO) and Operational Risk Management Committee (ORMC). the bill remains overdue for a period of more than 90 days . Further.The bank has constituted a Board level subcommittee namely Risk Management Committee.

The risk rating system is drawn up in a structured manner. Bank is undertaking periodic validation exercise of its rating models and also conducting migration and default rate analysis to test robustness of its rating models. to cater to the requirement for the reliable and accurate historical data base and to implement the sophisticated risk management solutions/ techniques and the tools for estimating risk components {PD (Probability of Default). The pools are created based on homogeneity. Bank is in the process of implementing enterprise-wide data warehouse (EDW) project. Credit approving authority. to monitor the default rates. credit risk rating system. bank has put in place a tool called Preventive Monitoring System (PMS) for detection of early warning signals with a view to prevent/minimize the loan losses. Small & Medium Enterprise (SME) and Retail advances are subjected to Scoring models which support “Accept/ Reject” decisions based on the scores obtained. All SME and Retail loan applications are necessarily to be evaluated under score card system. Credit Risk Management Credit Risk Management Committee (CRMC) headed by CMD is the top-level functional committee for Credit risk. LGD (loss Given Default). incorporating different factors such as borrower’s specific characteristics. approval of any other action necessary to comply with requirements set forth in Credit Risk Management Policy/ RBI guidelines or otherwise required for managing credit risk. risk based pricing and loan review mechanisms are the tools used by the bank for credit risk management. The committee considers and takes decisions necessary to manage and control credit risk within overall quantitative prudential limit set up by Board. prudential exposure limits. industry exposure limits. fine-tuning required in various models based on feedbacks or change in market scenario. Risk rating system is being applied to the loan accounts with total limits above Rs. . Recognizing the need of technology platform in data handling and analytics for risk management. which are regularly tested for their predictive ability as per best practices. policy document is an embodiment of the Bank’s approach to understand measure and manage the credit risk and aims at ensuring sustained growth of healthy loan portfolio while dispensing the credit and managing the risk. For monitoring the health of borrowable accounts at regular intervals. Credit risk is measured through sophisticated models. The bank plans to cover each borrowable account to be evaluated under risk rating/ score framework. All these tools have been defined in the Credit Management & Risk Policy of the bank. Bank has developed comprehensive risk rating system that serves as a single point indicator of diverse risk factors of counterparty and for taking credit decisions in a consistent manner. Additionally. At the macro level. the bank has placed rating/ scoring systems at central server network. The committee is entrusted with the job of approval of policies on standards for presentation of credit proposal. the pool/segment rating methodology is applied to the retails/small loan portfolio. Scoring model Farm sector has been developed and implementation process is under progress. EAD (Exposure at Default)} and quantification of the risks in the individual exposures to assess risk contribution by individual accounts in total portfolio and identifying buckets of risk concentrations.(iv) The installment or principal or interest thereon remains overdue for two crop seasons for short duration and the installment of principal or interest thereon remains overdue for one crop season for long duration crops. Default rates are assigned to identify pool/segment to monitor the trends of historical defaults.50 lacs. industry specific characteristics etc. All these models can be assessed by the users ‘on line’ through any office of the bank.

yet the bank shall continue its journey towards adopting Internal Rating Based Approaches. All loan proposals falling under the powers of GM & above at HO/ Field General Manager and Circle Head at field are routed through Credit Committee. Though the bank has implemented the Standardized Approach of credit risk. Credit Department and one representative from an area not connected with credit. doubtful or loss asset. the committee consists of one representative each from risk management department.As an integral part of Risk Management System. This helps bring about qualitative improvements in credit administration. To ensure transparency and to give wider coverage. A separate Division known as Credit Audit & Review Division has been formed to ensure LRM implementation. In order to provide a robust risk management structure. and policies perspectives. As such. bank has put in place a well-defined Loan Review Mechanism (LRM). reporting and risk control systems /mitigation techniques. in accordance with the directions or guidelines relating to asset classification issued by RBI . The rating category wise portfolio of loan assets is reviewed on quarterly basis to analyze mix of quality of assets etc. The proposals are deliberated in the Credit Committee from business objectives. risk management objectives. documentation practice and the system for management of problem loans NPA (NON PERFORMING ASSET)  Non Performing Asset means a loan or an account of borrower. The policy of the bank embodies in itself the areas of risk identification. risk measurement. risk grading techniques. current practices and future strategies. which has been classified by a bank or financial institution as sub-standard. The risk rating and vetting process are done independent of credit appraisal function to ensure its integrity and independency. goals to be achieved. the credit policy deals with short term implementation as well as long term approach to credit risk management. the Credit Management and Risk policy of the bank aims to provide a basic framework for implementation of sound credit risk management system in the bank. The credit risk ratings are vetted/ confirmed by an independent authority. It deals with various areas of credit risk.

Doubtful Assets: All those assets which are considered as non-performing for period of more than 12 months are called as Doubtful Assets. Non-performing assets are problematic for financial institutions since they depend on interest payments for income. Sub-Standard Assets: All those assets (loans and advances) which are considered as nonperforming for a period of 12 months are called as Sub-Standard assets. Asset Classification for NPAs  Standard Assets: A standard asset is a performing asset. Such assets carry a normal risk and are not NPA in the real sense. Loss Assets: All those assets which cannot be recovered are called as Loss Assets.  Once the borrower has failed to make interest or principal payments for 90 days the loan is considered to be a non-performing asset. no special provisions are required for Standard Assets.    . So. Standard assets generate continuous income and repayments as and when they fall due.

units of mutual funds etc. irrevocable and unconditional. VaR limit. However. As such. The collaterals used by the Bank as risk mitigants (for capital calculation under standardized approach) comprise of the financial collaterals (i. monitoring and managing systemic risk. credit risk. explicit. Limits for exposures to counter-parties.4. stop loss limits. Guarantees.). Market Risk in Trading Book: RBI prescribed Standardized Measurement Method (duration based) for computation of capital charge for market risk has been adopted by Bank./postal securities. which is under implementation. interalia. . the bank is not making use of the on-balance sheet netting in its capital calculation process. For the Market Risk Management of the bank. Bank has prescribed entry level barriers. which do not have any issue in realization. Individual gap limit. now Bank is preparing for the Internal Model Approach (Advanced Approach on Market risk) based on Value at Risk (VaR) model. Aggregate Gap limit. industry segments and countries are monitored. Duration limits and Risk Tolerance limit for trading book investments. exposure limits. it incorporates policy prescriptions for measuring. Besides regulatory limits. bank deposits. The capital requirements for market risk are as under: Market Risk & Liquidity Risk: The investment policy covering various aspects of market risk attempts to assess and minimize risks inherent in treasury operations through various risk management tools. Daylight limit. Inter-Bank dealing and investment limits etc. gold jewellery. A detailed process of calculation of correct valuation and application of haircut thereon has been put in place by developing suitable software. Majority of financial collaterals held by the Bank is by way of own deposits and government securities.e. The risks under Forex operations are monitored and controlled through Stop Loss Limits. which are direct. govt. are taken into consideration by Bank for calculating capital requirement. Value at Risk (VaR) limit. covers policies and processes for various collaterals including financial collaterals and netting of on and off balance sheet exposure. market risk. there is no risk concentration on account of nature of collaterals. Use of such guarantees for capital calculation purposes is strictly as per RBI guidelines on the subject. the bank has put in place internal limits and ensures adherence thereof on continuous basis for managing market risk in trading book of the bank and its business operations.    5. Broadly. operational risk and liquidity risk in treasury operations. Bank is keeping constant track on Migration of credit ratings of investment portfolio. Mid-Office with separate Desks for Treasury & Asset Liability Management (ALM) has been established. Overnight limit. Credit Risk Mitigation: disclosures for standardized approaches: Qualitative disclosures:  Bank has put in place Board approved ‘Credit Risk Mitigation and Collateral Management Policy’ which. life policies. Being fully compliant with Standardized Measurement Method as per RBI guidelines.

Interest Rate Risk in the Banking Book (IRRBB): The interest rate risk is managed through gap analysis and duration gap analysis.Net Gaps) Table 1: Interest rate sensitivity . hedge deals are undertaken. procedures. Duration gap analysis is being carried out at quarterly intervals to assess the interest rate risk of both banking book and trading book. ALCO is also entrusted with the job of fixing Base rate and pricing of advances & deposit products and suggesting revision of BPLR to Board.net gaps . practices/policies and risk management prudential limits are adhered to. simulation. sensitivity analysis etc. The tools used are: Earning Approach – (Interest rate sensitivity Statement. Net Interest Margin (NIM).Asset Liability Management Committee (ALCO) is primarily responsible for establishing the market risk management and asset liability management of the bank. best risk management practices followed globally and ensuring that internal parameters. Behavioral studies are being done for assessing and apportioning volatile and nonvolatile portion of various non-maturity products of both assets and liabilities. minimum ROA & minimum duration gap for the bank. implementing risk management guidelines issued by regulator. Liquidity risk of the bank is assessed through gap analysis for maturity mismatch based on residual maturity in different time buckets as well as various liquidity ratios and management of the same is done within the prudential limits fixed thereon. Prudential limits have been fixed for impact on Net Interest Income (NII). procedures thereof. are used on regular intervals to draw the contingency funding plan under different liquidity scenarios. The policies for hedging and/or mitigating risk and strategies & processes for monitoring the continuing effectiveness of hedges/mitigates are discussed in ALCO and based on views taken by /mandates of ALCO. Advance techniques such as Stress testing.

Business Units(BU) or Support Units(SU) . Second line of defense represented by independent Corporate Operational Risk Management Function (CORF) being Operational Risk Management Department(ORMD) as envisaged under Basel guidelines . Third lines of defense represented by Inspection & Audit Division/Management Audit Division(IAD/MARD) which is a challenge function to the first two lines of defense Operational Risk Management Committee (ORMC) headed by CMD with both the EDS and key divisional heads as members is the Executive level committee to oversee the entire operational risk management of the bank. The floating rate advances are assumed to be reprised in 29 days to 3 months.The reprising assumptions on assets and liabilities are taken as per RBI guidelines. the first line of defense represented by Various HO Divisions which are Control Units(CU). . Earning at Risk: Impact of 0.5 % change upward/downward in interest rate on NII/NIM Operational Risk: The bank adopts three lines of defense for management of operational risk.

. Manmohan Singh.437 crores and a net profit of 4. Life Insurance Corporation of India (LIC). 2012. General Insurance Corporation Ltd. then the Honorable Finance Minister.08%. Axis Bank (UTI Bank) opened its registered office in Ahmedabad and corporate office in Mumbai in December 1993. 413. National Insurance Company Ltd. as on 31st March. 2012. The Bank. The Oriental Insurance Corporation and United India Insurance Company UTI-I holds a special position in the Indian capital markets and has promoted many leading financial institutions in the country.242 crores. after the Government of India allowed new private banks to be established. The New India Assurance Company.20 crores with the public holding (other than promoters and GDRs) at 54. As on the year ended 31 March. It had begun operations in 1994. The first branch was inaugurated in April 1994 in Ahmedabad by Dr..AXIS BANK INTRODUCTION OF AXIS BANK: Axis Bank Limited is an Indian financial services firm headquartered in Mumbai. Axis Bank had operating revenue of 13. is capitalized to the extent of Rest.. Maharashtra. The Bank was promoted jointly by the Administrator of the Specified Undertaking of the Unit Trust of India (UTI-I).

While computing the consolidated Bank’s Capital to Risk-weighted Assets Ratio (CRAR).000. Some of the Tier-1 bonds have a step-up clause on interest payment ranging up to 100 bps.00 crores comprising 500.each. 2012 the Bank has issued. statutory reserves.952 numbers of shares of `10/. The GDRs issued by the Bank are listed on the London Stock Exchange (LSE). which was incorporated on 3 December. Capital Structure: Summary As per RBI’s capital adequacy norms capital funds are classified into Tier-1 and Tier-2 capital. subscribed and paid-up equity capital of `413. The interest on Upper Tier-2 bonds is payable either annually or semiannually. constituting 413.203. The Lower Tier-2 bonds have an original maturity between 5 to 10 years. 1993. Tier-1 bonds are non-cumulative and perpetual in nature with a call option after 10 years. The subsidiaries of the Bank are not required to maintain any regulatory capital. Some of the Upper Tier-2 debt instruments have a step-up clause on interest payment ranging up to 100 bps.20 crores. upper Tier-2 instruments and subordinate debt instruments eligible for inclusion in Tier-2 capital.000 equity shares of `10/each. the Bank has also allotted equity shares to employees under its Employee Stock Option Plan. the Bank’s investment in the equity capital of the wholly-owned subsidiaries is deducted. other disclosed free reserves. Axis Bank has issued debt instruments that form a part of Tier-1 and Tier-2 capital. 2012: 1. 2.DISCLOSURES UNDER THE NEW CAPITAL ADEQUACY FRAMEWORK (BASEL II GUIDELINES) FOR THE YEAR ENDED 31 March. 1956 and other applicable laws and regulations govern the rights and obligations of the equity share capital of the Bank. The Tier-2 capital consists of general provision and loss reserves. 50% from Tier 1 Capital and 50% from Tier 2 Capital. The provisions of the Companies Act. The Bank’s shares are listed on the National Stock Exchange and the Bombay Stock Exchange. capital reserves and innovative perpetual debt instruments eligible for inclusion in Tier-1 capital that complies with the requirement specified by RBI. The Bank is the controlling entity for all group entities that include its six wholly owned subsidiaries. The Upper Tier-2 bonds have an original maturity of 15 years with a call option after 10 years. Tier-1 capital of the Bank consists of equity capital.During the year. The interest on lower Tier-2 capital instruments is payable either semi-annually or annually. Debt Capital Instruments The Bank has raised capital through Innovative Perpetual Debt Instrument (IPDI) eligible as Tier 1 Capital and Tier 2 Capital in the form of Upper Tier 2 and Subordinated bonds (unsecured redeemable non-convertible debentures. . Equity Capital The Bank has authorized share capital of `500. The terms and conditions that are applicable for these instruments comply with the stipulated regulatory requirements. Interest on Tier-1 bonds is payable either annually or semi-annually. SCOPE OF APPLICATION: Axis Bank Limited (the ‘Bank’) is a commercial bank. As on 31 March.

. capital charge for credit and market risk for the financial year ended 31 March.0%. 2012. As per Basel II guidelines. CAPITAL ADEQUACY: Axis Bank is subject to the capital adequacy guidelines stipulated by RBI. In terms of RBI guidelines for implementation of Basel II.0%. For the year ended 31 March.3.0%. the Bank is required to maintain a minimum ratio of total capital to risk weighted assets (CRAR) of 9. at least half of which is required to be Tier 1 Capital. which are based on the framework of the Basel Committee on Banking Supervision. As per the capital adequacy guidelines under Basel I. Axis Bank is required to maintain a minimum CRAR of 9. with minimum Tier 1 Capital ratio of 6. the minimum capital required to be maintained by Axis Bank as per Basel II guidelines is higher than that required at 80% of the capital requirements under Basel I guidelines. 2012 will be required to be maintained at the higher levels implied by Basel II or 80% of the minimum capital requirement computed as per the Basel I framework.

The overseas policies are drawn based on the risk perceptions of these economies and the Bank’s risk appetite. Various senior management committees operate within the broad policy framework as illustrated below. comprehensive processes and internal control mechanism. Objectives and Policies The Bank’s risk management processes are guided by well-defined policies appropriate for various risk categories. the Risk Management Committee and the Audit Committee of the Board. RISK MANAGEMENT: OBJECTIVES AND ORGANIZATION STRUCTURE The wide variety of businesses undertaken by the Bank requires it to identify. operational risk and asset-liability both for the domestic as well as overseas operations. The Department has three separate teams for . The key components of the Bank’s risk management rely on the risk governance architecture. independent risk oversight and periodic monitoring through the sub-committees of the Board of Directors. market risk. The Bank has put in place policies relating to management of credit risk. The Bank’s risk governance architecture focuses attention on key areas of risk such as credit. The Board sets the overall risk appetite and philosophy for the Bank. control. market and operational risk and quantification of these risks wherever possible for effective and continuous monitoring. measure. review various aspects of risk arising from the businesses of the Bank.4. The Bank has formulated a comprehensive Stress Testing policy to measure impact of adverse stress scenarios on the adequacy of capital. monitor and report risks effectively. The Committee of Directors. 56 Structure and Organization: The Risk Department reports to the Executive Director and CFO and the Risk Management Committee of the Board oversees the functioning of the Department. which are subcommittees of the Board.

financial companies. 5. which have an adverse impact on the financial performance of the Bank. SME. which are defined quantitatively and qualitatively through strategic businesses plan as well as the Corporate Credit Policy. Retail credit to individuals and small business is managed through definition of product criteria. key processes and reporting framework. ii. • The Bank has developed rating tools specific to market segments such as large and mid corporate. Review frequency These methods have been adopted by the Bank.Credit Risk. • • Credit Rating System: • The foundation of credit risk management rests on the internal rating system. The Bank is exposed to credit risk through lending and capital market activities Credit Risk Management Policy: • • It lays down the roles and responsibilities. risk appetite. appropriate credit filters and subsequent portfolio monitoring. Delegation of powers. Statistical application and behavioral scorecards have been developed for all major retail portfolios. Each internal rating grade corresponds to a distinct probability of default over one year. • • • • . Go/No-Go score cards are used for various SME schematic products and retail agri schemes. Corporate credit is managed through risk vetting of individual exposures at origination and through periodic review after sanctioning. The Board of Directors establishes the parameters for risk appetite. i. iii. Market Risk and Operational Risk and the head of each team reports to the Chief Risk Officer. Rating linked single borrower exposure norms. CREDIT RISK: Credit risk covers the inability of a borrower or counter-party to honor commitments under an agreement and any such failures. The credit rating tool uses a combination of quantitative inputs and qualitative inputs to arrive at a ‘point-in-time’ view of the risk profile of counterparty. microfinance companies and project finance to objectively underlying risk associated with such exposures.

The Bank has put in place the following • • • • • • • • hierarchical committee structure for credit sanction and review: Retail Agriculture Credit Committee (RACC) Central Agriculture Business Credit Committee (CABCC) Regional Credit Committee (RCC) Central Office Credit Committee (COCC) Committee of Executives (COE) Senior Management Committee (SMC) Committee of Directors (COD). are monitored and reviewed periodically against the approved limits. compliance of sanction terms and conditions and effectiveness of loan administration. Remedial action is initiated promptly to minimize the potential loss to the Bank. The acceptability of credit exposure is primarily based on the sustainability and adequacy of borrower’s normal business operations and not based solely on the availability of security. once approved. a sub-committee of the Board. compliance with internal policies of the Bank and with the regulatory framework. ii. • • . iii. Input related risks. All management level sanctioning committees require mandatory presence of a representative from Risk Department for quorum. Customers with emerging credit problems are identified early and classified accordingly. Industries are classified into various categories based on factors such as Demand-supply. Concentration Risk: • The Bank manages concentration risk by means of appropriate structural limits and borrowerwise limits based on creditworthiness.Credit Sanction and related processes: • • • The guiding principles behind the credit sanction process are us under. ‘Know your Customer’ is a leading principle for all activities. Review and Monitoring:    All credit exposures. Borrowers with lower credit rating are subject to more frequent reviews. Concentration of unsecured loans to total loans and advances. Residual maturity concentration of loans and advances. Delegation of sanctioning powers is based on the size and rating of the exposures. Government policy stance towards the sector and financial strength of the sector in general. Credit concentration in the Banks’ portfolios is monitored for the following: Large Exposures to Individual Clients or Group: The Bank has individual borrower-wise exposure ceilings based on the internal rating of the borrower as well as group-wise borrowing limits which are continuously tracked and monitored. Geographic concentration on sensitive sectors. Non-Performing Assets: Advances are classified into performing and non-performing advances (NPAs) NPAs are further classified into sub-standard. • • • • • i. doubtful and loss assets. Credit audit involves independent review of credit risk assessment. Concentration by Industry: Industry analysis plays an important part in assessing the concentration risk within the loan portfolio.

If such impairment is detected. the carrying amount is reduced to its recoverable amount.• An asset. The reduction is treated as an impairment loss and is recognized in the profit and loss account . the account remains “out-of-order’’ for a period of more than 90 days in respect of an Overdraft or Cash Credit (OD/CC)  The bill remains overdue for a period of more than 90 days in case of bills purchased and discounted  A loan granted for short duration crops will be treated as an NPA if the installments of principal or interest thereon remain overdue for two crop seasons. the Bank ascertains if there is any impairment in its assets. An NPA is a loan or an advance where:  Interest and/or installment of principal remains overdue for a period of more than 90 days  In respect of a term loan. and  A loan granted for long duration crops will be treated as an NPA if the installments of principal or interest thereon remain overdue for one crop season. becomes non-performing when it ceases to generate income for the Bank. If the recoverable amount of the asset or the cash-generating unit to which the asset belongs is less than its carrying amount. Impairment: • • At each balance sheet date. including a leased asset. the Bank estimates the recoverable amount of the asset.

In most cases. . CREDIT RISK MITIGATION: • • • • • The Bank uses various collaterals both financial as well as non-financial. The Bank has in place a collateral management policy. Gain on securitisation is recognized over the period of the underlying securities issued by the SPV. All risks in the securitised portfolio are transferred to a Special Purpose Vehicle (SPV). The Bank has not sponsored any special purpose vehicle which is required to be consolidated in the consolidated financial statements as per accounting norms. appropriate provision/disclosure is made at the time of sale in accordance with AS 29 ‘Provisions. The main non-financial collaterals include land and building. The Bank has a valuation policy that covers processes for collateral valuation. The Bank also provides credit enhancement in the form of cash collaterals and/or by subordination of cash flows to Senior PTC holders. The guarantees include guarantees given by corporate. which underlines the eligibility requirements for credit risk mitigants (CRM) for capital computation as per Basel II guidelines. During FY 2012 no fresh investments in securitised instruments had been made. The main financial collaterals include bank deposits. • Valuation of securitised exposures is carried out in accordance with FIMMDA/RBI guidelines. In respect of credit enhancements provided or recourse obligations (projected delinquencies. future servicing etc. the Bank continues to service the loans transferred to the assignee/SPV. plant and machinery. residential and commercial mortgages. post securitisation. which provides 100% protection to the Bank from default. The securitisation of assets generally being undertaken by the Bank is on the basis of “True Sale”. 7. contingent liabilities and contingent assets’. Bank may also invest in securitised instruments which offer attractive risk adjusted returns. Loss on securitisation is immediately debited to profit and loss account. bank and personal guarantees.6. The Bank enters into purchase/sale of corporate and retail loans through direct assignment/SPV.) accepted by the Bank. The Bank revalues various financial collaterals at varied frequency depending on the type of collateral. optimization of usage of capital and churning of the assets as part of risk management strategy. NSC/KVP/LIP and gold. The Bank however does not follow the originate to distribute model and pipeline and warehousing risk is not material to the Bank. guarantees and credit insurance as credit risk mitigants. SECURITISATION: The primary objectives for undertaking securitisation activity by the Bank are enhancing liquidity. except where the Bank provides sub-ordination of cash flows to Senior Pass-Through Certificate (PTC) holders by retaining the junior tranche of the securitised pool.

at least. however. foreign exchange rates and equities.e. position limits. investment and asset and liability portfolios. Management Information System (MIS) for timely market risk reporting to senior management functionaries. back tests and scenario analysis. marked-to-market (MTM). The model assumes that the risk factor changes observed in the past are a good estimate of those likely to occur in the future and is. option Greeks). Non-statistical measures like position limits. market conditions and trading strategies. as well as the volatilities of those changes. risk limits are reviewed. The VaR is computed on a daily basis for the trading portfolio and reported to the senior management of the Bank. MARKET RISK IN TRADING BOOK: Market risk is the risk of loss to the Bank’s earnings and capital due to changes in the market level of interest rates. if deemed necessary. For market risk management the bank has:       Well laid down policies and guidelines which are aligned to the regulatory norms and based on experiences gained over the years. which are undertaken for customers as well as on a proprietary basis.     . The Bank typically uses 250 days of historical data or one year of relative changes in historical rates and prices. 2012. duration. The method. All transfers of assets under securitisation were affected on true sale basis. The Bank uses the ratings assigned by various external credit rating agencies viz. the Bank has not securitised any asset.• The Bank follows the standardized approach prescribed by the RBI for the securitisation activities. However in the financial year ended 31 March. PVBP. As a discreet market risk management measure. The bank adopts a comprehensive approach to market risk management for its trading. The Bank is in the process of building its capabilities to migrate to advance approach i. annually or more frequently. • 8. relevant market analysis. Statistical measures like Value at Risk (VaR). Mechanism for periodic review of the market risk management policies. limited by the relevance of the historical data used. does not make any assumption about the nature or type of the loss distribution. gaps and sensitivities (mark-tomarket. to align the limits with the Bank’s risk appetite. supplemented by stress tests. price of securities. CRISIL. Internal Models Approach for assessment of market risk capital. Market risk identification through elaborate mapping of the Bank’s main businesses for various market risks. All the above mentioned risks are based on a number of criteria including regulatory guidelines. The bank calculates the VaR on the basis of the historical data. There are some risks limits like: Position Limits Stop –loss Limits Alarm Limits Gaps & Sensitivities. Fitch and CARE for its securitisation exposures. ICRA. business strategy. therefore. management experience and the Bank’s risk apetitite. newer processes are being introduced and employee skills are being improved. system capabilities are being strengthened. For this purpose. The Bank is exposed to market risk through its investment activities and also trading activities. The VaR models for different portfolios are back-tested at regular intervals and the results are used to maintain and improve the efficacy of the model.

measurement tools and monitoring and reporting mechanism using effective use of IT systems for availability of quality data. Country Risk: In order to monitor the country exposure the Bank uses seven-category classification i. stop-loss limits and duration limits have been set up for different categories within a portfolio. The Bank has also put in place the “Suitability & Appropriateness Policy” and Loan Equivalent Risk (LER) Policy to evaluate counterparty risk arising out of all customer derivatives contracts. Exposure to a country includes all credit-related lending. dynamic liquidity statements and scenario analysis. It has got two dimensions: 1) Risk of being unable to fund portfolio of assets at appropriate maturity and rates (liability dimension) 2) The risk of being unable to liquidate an asset in a timely manner at a reasonable price (asset dimension). investment obligations. current or future obligations on the due date. high. for a short-term period of three months. low.Concentration Risk: Concentration risk is a banking term denoting the overall spread of a bank's outstanding accounts over the number or variety of debtors to whom the bank has lent money. Counterparty risk as a risk to both parties and should be considered when evaluating a contract. Similarly. moderate. past transaction experiences and market conditions.e. Separate Counterparty rating models are used for commercial banks. These objectives are ensured by setting up policies. ratio analysis. The liquidity positions of overseas branches are managed in line with the Bank’s internal policies and host country regulations. The Bank’s ALM policy defines the tolerance limits for its structural liquidity position. The goal of Liquidity Risk Management is to meet all commitments on the due date and funding new investment opportunities. etc. The liquidity profile of the Bank is analyzed on a static basis by tracking all cash inflows and outflows in the maturity ladder based on the expected occurrence of cash flows. Counterparty Risk: The risk to each party of a contract that the counterparty will not live up to its contractual obligations. (ECGC) and ratings of international rating agency Dun & Bradstreet. business need. whether cross border or . foreign banks and cooperative banks for determining maximum permissible limit for counterparties. The Bank undertakes behavioral analysis of the non maturity products viz. In order to remove concentration risk the Bank has allocated the internal risk limits wherever applicable. trading and investment activities. For example. very high. This risk is calculated using a "concentration ratio" which explains what percentage of the outstanding accounts each bank loan represents. insignificant. savings and current deposits and cash credit/overdraft accounts on a periodic basis. to ascertain the volatility of residual balances in those accounts. restricted and off-credit followed by the Export Credit Guarantee Corporation Ltd. operational level committees. It is often described as the “default risk”. For Counterparty Risk management the Bank has a Counterparty Risk management policy incorporating well laid-down guidelines. The counterparty exposure limits are reviewed at periodic intervals based on financials of the counterparties. processes and measures. the Aggregate Gap Limit is allocated to various currencies and maturities as Individual Gap Limits to monitor concentrations. The Bank manages its liquidity on a static as well as dynamic basis using various tools such as gap analysis. Liquidity Risk: Liquidity risk arises from a bank’s inability to meet its short term. Such positions are also reviewed centrally by the Bank’s ALCO along with domestic positions. The concentration of large deposits is monitored on a periodic basis. The liquidity profile of the Bank is also estimated on a dynamic basis by considering the growth in deposits and loans.

and over a period would enable the Bank to adopt sophisticated approaches for the computation of capital for operational risk. Clients under the scheme are not being offered any guaranteed/assured returns. 2012 Amount of Capital required (` in crores) Interest rate risk Equity position risk Foreign exchange risk (including gold) OPERATIONAL RISK: Strategies and Processes 1. assessed. The Bank has further enhanced its capability for effective management of operational risk with the implementation of a software solution (OR Monitor) which creates a database on loss events experienced by the different business lines of the Bank. The portfolio manager will not be responsible or liable for any loss resulting from the operation of the scheme. Capital Requirement for Market Risk . controlled/mitigated and reported in a structured manner certain Operational Risk Management framework ( ORM). people or systems. The Bank has set up exposure limits for each risk category which are monitored at regular intervals. ORM policy.. identify areas which show manifestation of weak controls through Risk & Control Self Assessment (RCSA) and Key Risk Indicator (KRI) modules. roles and responsibilities of ORM function have been approved by the Bank.Position as on 31 March. Dubai and Colombo. Software Evaluation Committee and IT Security Committee in order to manage Operational Risk efficiently. The Bank formed several internal committees viz. or from external events. General risk factors:      Investments in securities are subject to market risks and portfolio manager will not in any manner whatsoever assure or guarantee that the objectives of the scheme will be achieved. Risk Department issues “Rating Watch” from time to time. key risk indicator framework. Operational Risk Management Committee (ORMC). In order to ensure that operational risk within the Bank is properly identified. Change Management Committee (CMC). Outsourcing Committee.55 131. The Portfolio may be affected by settlement periods and transfer procedures. The Asset Liability Management and all the risk exposures for the overseas operations are monitored centrally at the Central Office. The trading volumes in the Securities of companies in which the Scheme invests inherently restrict the liquidity of the Scheme’s investments. operational risk loss data collection methodology.588.31 Operational Risk is that risk which comes out of the inadequate or failed internal processes. .43 29. Hong Kong.locally funded. As a proactive measure of Country Risk Management. Product Management Committee (PMC). monitored. Risk Management Framework for Overseas Operations: The Bank has separate Risk Management policies for its overseas branches which are based on the host country regulator’s guidelines aligned with the practices followed for the Indian operations. The overseas branches are at Singapore. risk & control self-assessment framework.

changes to government policies and regulations with regard to industry and exports may have direct or indirect impact on the investments. Some of the risks by way of illustration include default or non performance of a third party. company’s refusal to register a Security due to legal stay or otherwise or disputes raised by third parties. The value of investment will appreciate/depreciate if the interest rates fall/rise. investment strategy and asset allocation. The cost of the hedge can be higher than adverse impact of market movements. Non-Diversification risk: This risk arises when the Portfolio is not sufficiently diversified by investing in a wide variety of instruments. economic performance etc. Transfer risk may arise due to the process involved in registering the shares physical and demat. take over and mergers of mutual funds. The Client also bears the risk of its recover through legal process. and consequently the growth of the Portfolio. the Portfolio Manager makes no assurance of any guaranteed returns on the Portfolio. foreclosure of Schemes or plans. In addition. Mutual Fund Risk: This risk arises from investing in units of mutual funds. Macro-economic risks: Overall economic slowdown. acts of war. The Client stands the risk of total loss of value of an asset. relatively small number of scripts accounting for a large proportion of trading volume. Efficiency of a derivatives market depends on the developments of a liquid and efficient market for underlying securities and also on the suitable and acceptable benchmarks. environmental or political problems. acts of nature. which forms parts of the Portfolio. change in government policies could affect performance of the investment in mutual fund units. which could be expensive. Non-Discretionary Investment Advisory Service is subject to risk arising out of nondiversification. or sovereign action. Investors should be aware of this and only invest in equity or equity related products if their investment horizon is long enough to support these important price movements.               The Non-Discretionary Investment Advisory Service is subject to risk arising from the investment objective. pricing. even in short periods of time. Risk factors inherent to equities and debt securities are also applicable to investments in mutual fund units. An exposure to derivatives can also limit the profits from a genuine investment transaction. Acts of state. which may accordingly increase or decrease the rate of return thereon. Fixed income investments are subject to the risk of interest rate fluctuations. Derivative risks: The derivatives will entail a counter party risk to the extent of amount that can become due from the party. in the Portfolio Manager’s name. Credit Risk: Debt Securities are subject to the risk of the issuer’s inability to meet the principal and interest payment on the obligations and may also be subject to the price volatility due to such factors as interest sensitivity. Past performance of the Portfolio Manager does not guarantee the future performance of the same. market perception. accounting and safekeeping or record keeping of securities. or the credit worthiness of the issuer and general market risk. market closure. The Client stands a risk of loss due to lack of adequate external systems for transferring. inflation. Equity and Equity related Risks: Equity instruments carry both company specific and market risks and hence no assurance of returns can be made for these investments. unanticipated corporate performance. civil disturbance. while price risk may arise on account of availability of share price from stock exchanges during the day and at the close of the day. events like change in name of the Fund Manager of the Scheme. Consequently. The value of the Portfolio may increase or decrease depending upon various market forces affecting the capital markets such as de-listing of Securities. . Price/Volatility Risk: Equity Markets can show large fluctuations in price. which depend on various factors such as government borrowing. Interest Rate Risk: Clients intending to avail securities linked to interest are aware that such securities is associated with movements in interest rate.

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