International Journal of Management and Social Sciences Research (IJMSSR) ISSN: 2319-4421 46

Volume 5, No. 2, February 2016

A Study of the Risk Management Practices of Banks in India

Tejas Hegde, MBA (Finance) Student, Department of Management and Commerce, Sri Sathya Sai Institute of Higher
Learning, India
Dr. Subramanian, S. Assistant Professor, Department of Management and Commerce,Sri Sathya Sai Institute of Higher
Learning, India

ABSTRACT is made between the practices of risk management

Banks are affected by various risks, the principal ones
being credit risk, interest rate risk, liquidity risk,
operational risk and exchange risk. Currently Basel II is
in force and Basel III is being adopted by the banks in a
phased manner. This transition calls for the analysis of
how Basel III is being implemented and what the banks
have in store for them in the future. This work studies the
current risk management practices of Indian banks and
their adherence to Basel norms.
Keywords
Risk management in banks, Basel III.
1. INTRODUCTION
Banking has been one of the most regulated industries in
the world. The most prominent aspect of the regulations in
banking are the rules that administer the bank capital. The
risk management process has become one of the key
business functions of banks as well as the other financial
institutions since the early 90s. The basic task of bank
management can be summarized as managing its risk. Risk
management is largely concerned with reducing the
potential of any external or internal event affecting the
functioning of the business in a detrimental manner. The
implementation of Basel III norms, in addition to
subjecting them to rigorous monitoring through
regulations, would noticeably augment banks‟ capital
requirement.
techniques of various banks viz. public sector, private
sector and foreign banks. It includes both the qualitative
and the quantitative data as provided by the respondents.
A questionnaire was administered to seven banks which
were:
Federal Bank, Standard Chartered Bank, HDFC Bank,
DCB Bank, Yes Bank, IDBI Bank, BMB (Bharatiya
Mahila Bank).
The questionnaire was given to the risk management
personnel i.e. Risk officers and managers, Chief Risk
Officer etc.
The questions here have been divided into four categories:
1. Risk management policy
2. Credit risk practices
3. Market risk practices
4. Operation risk practices
5. Analysis and Interpretation
4. ANALYSIS
The responses on the twenty two questions are discussed
in the following paragraphs.
1. Risk Management Practices
Q 1: Does the concept of Risk Management feature
strongly in your bank‟s corporate strategy or meetings?

2. OBJECTIVE OF THE STUDY

The objectives of the study are as follows: Yes

 To find out the adherence levels of the banks to the
Basel as well as RBI‟s norms.
 To understand in detail the various types of risk.
 To understand the risk management practices of the
banks in India.

0 2 4 6 8
3. METHODOLOGY OF THE STUDY

This study is based on primary data survey relating to the Fig.1: Risk Management Importance
risk management practices in Indian banks. A comparison

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International Journal of Management and Social Sciences Research (IJMSSR) ISSN: 2319-4421 47
Volume 5, No. 2, February 2016

100% of the respondents said that their bank was serious as the Basel norms are universally applicable across all
and committed to the factoring in of risk management banks.
concept in their corporate strategy and meetings. Risk
management has now become an essential feature in most
of the organizations, especially those related to the Q 4: How do you view Basel II/Basel III?
financial institutions and in banks, it has become one of
the most important departments.

Q 2: Please rate in the order of importance how the as a

following risks are managed in your bank (1 being least regulatory
significant and 5 most significant) constraint
as a 43%
Operational risk received an average importance rating of priority
4. constraint
Market risk received an average importance rating of 4. 57%
Interest rate risk received an average importance rating of
4.17.
Credit risk received an average importance rating of 4.67.
Liquidity risk received an average importance rating of as a regulatory constraint as a priority constraint
4.17.
Forex risk received an average importance rating of 3.67.
Fig.3: Basel II/III Views
It can be inferred that all the risks apart from Forex risk
(3.67) have received an importance rating of 4 or above
out of 5. Managing forex risk may not be so important a 43% of the respondents view Basel II/Basel III as a
factor for few banks. BIS has mandated that a bank must regulatory constraint and 57% view it as a priority
use FMIs (Financial Market Infrastructure) that provide constraint. It means that the banks are taking up the Basel
PVP (Payment-Versus-Payment) settlement to eliminate norms as important regulations not only due to therules of
the principal risk when resolving forex transactions. RBI, but also as they see it to be of benefit to them.

Q 3. Does your bank take into account the risk Q 5: Have you performed a cost benefit analysis for each
management practices of the competitors? approach proposed by Basel II?

[CATEG
ORY
NAME]
Yes [CATEG [PERCEN
ORY TAGE]
NAME]
[PERCEN
TAGE]

0 2 4 6 8
Fig. 4: Cost-Benefit Analysis

A Cost-Benefit analysis is a methodology which helps in

Fig2: Risk management practices of competitors taken
into account
All the respondents take into account the risk management
practices of their competitors. The risk management
framework is developed not only by the internal members
based on the regulatory requirement, but is also shaped by
the competitors‟ practices and all are bound to be similar
estimating the strengths and weaknesses of the different
alternatives which are available, to carry out a transaction
or an activity for a business. In banks, the analysis is done
for every investment project to determine whether the
project helps to create more net benefits than any other
option. In the study conducted, there is a split of 57/43 i.e.
57% of the banks (four banks) have done a cost benefit
analysis and 43% (three banks) have not done it.

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International Journal of Management and Social Sciences Research (IJMSSR) ISSN: 2319-4421 48
Volume 5, No. 2, February 2016

Q 6: In managing liquidity risk do you prepare a 2. Credit Risk Practices

„Statement of short term dynamic liquidity‟ to manage Q 8: Upto what credit rating do you disburse unsecured
short term mismatches in inflows & outflows? loans to institutional borrowers?

8 7 6
5
7 5
6
5 4
4 3
2
3 2
2
1 1
0 0
Yes BBB Rating Others

Fig. 5: Preparation of Statement of short term dynamic

liquidity
All the banks prepare the „Statement of short term
dynamic liquidity‟ to check if any disparities occur in their
inflows and outflows. RBI has mandated the use of short
term liquidity statements as they provide a lead signal of
forthcoming liquidity problems. Banks are expected to
monitor their collective mismatches among all time
buckets with the help of internal prudential limits. The net
cumulative negative mismatches of the structural liquidity
statement (both domestic and overseas) during the
following day, 2-7 days, 8-14 days and 15-28 days bucket
should not exceed 5%, 10%, 15%, 20% of their
cumulative cash outflows respectively.
Fig. 7: Credit rating upto which unsecured loans to
institutional borrowers are disbursed
Four banks mentioned that „BBB‟ is the final rating upto
which they can disburse unsecured loans.
Two banks mentioned others, which included the
following- „As per internal rating‟ and „No specified
threshold, mostly investment grade.‟ RBI has issued a
master circular which consists of guidelines and
restrictions on loans and advances. It consists of
restrictions like Loans and advances against shares,
debentures and bonds; Advances against Certificate of
Deposit (CD), Fixed Deposits (FD) etc. among other
guidelines.

Q 7: Do you have a Contingency Funding Plan (CFP) for
addressing liquidity shortfalls in emergency situations?
Yes
0 2 4 6 8 Account (RFA) in an effort to minimize fraud risks, NPA
Fig.6: Contingency Funding Plan Existence
As the RBI has mandated the banks to have a CFP, all the
respondent banks are following this regulation. CFP helps
in addressing disturbances in liquidity which may affect
the bank‟s capacity to acquire funds at low cost whenever
required in times of stress.
Q 9: What are the red flags which were raised frequently
(either in credit, operation or market risk) in the last 12
months?
The responses received for this question were as follows:
3 banks had nothing major to report as a red flag, the other
banks mentioned these red flags- SMA position, Collateral
waivers, Sanctions related and Market and Industry
related, Concentration risk and Information security.
A Red Flag is an indicator of any potential problems that a
security might have. Thus it is an undesirable
characteristic that an analyst can identify. The RBI has
decided to introduce the concept of a Red Flagged
levels and fund diversion by corporates. Thus the Indian
banks are relatively stable in terms of the red flags raised.
Q 10: Who is authorized to alert if the VaR limits exceed?
All the banks use VaR to calculate the probable losses in
any given day and gave the following responses as to the
person who is authorized to alert if the VaR limits exceed:
Chief Risk Officer (CRO), Treasury, Country Chief Risk
Officer, and Executive Committee. VaR is defined as a

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International Journal of Management and Social Sciences Research (IJMSSR) ISSN: 2319-4421 49
Volume 5, No. 2, February 2016

market risk measure of the risk of loss on the portfolio
value.
Question 11: Do you have a Risk-Adjusted Return
framework while pricing assets or doing portfolio
analysis?
The responses received were: Cheque bounce by
borrower, Combination of various indicators viz. cheque
bounce by borrower, diversification of funds from short
term to long term, significant overexpansion, Special
Mention Account (SMA) etc. EWS help in identification
of areas where problems may exist.

3. MARKET RISK PRACTICES

[CATEGO Q 14: Is your organization using derivatives to hedge the
RY market risk?
NAME]
[CATEGO [PERCEN
RY TAGE]
NAME]
[PERCEN 7 6
TAGE] 6
5
4
Fig. 8: Existence of Risk-Adjusted Return framework 3
2 1
57% of the banks (four banks) look at the macro 1
parameters in an economy and then at the micro level i.e. 0
the institution/individual at which it is lending. 43%
Yes No
(three) start from the micro perspective and then go on to
look at the macro level. Fig. 10: Use of derivatives
Q 12: Your credit policy is driven by- Micro to Macro or
Six banks replied in the affirmative whereas one bank
Macro to Micro?
(Bharatiya Mahila Bank (BMB) was not using derivatives
to hedge market risk. Derivatives as a product is used to
hedge the risks and used by mainly the stock brokers and
speculators among others. But the biggest traders and
[CATEGO counterparties of derivatives are banks. Banks use it for
RY hedging risks and generating cheap money. It has not yet
NAME] caught up in India as much as the banks do in the West;
[CATEGO [PERCEN the reasons being due to the following risks involved:
RY TAGE] Default by counter party which results in financial loss to
other party.
NAME]
The risk of change in the price of the underlying and thus
[PERCEN
that of the derivative (Price risk or market risk)
TAGE] The risk of default by counter party resulting in liquidity
risk.
Legal risk which is especially in OTC (Over The Counter)
Fig. 9: Drive of credit policy instruments.

57% of the banks (four banks) look at the macro
parameters in an economy and then at the micro level i.e.
the institution/individual at which it is lending. 43%
(three) start from the micro perspective and then go on to
look at the macro level.
Question 15: Do you apply stress tests to check the
minimum level of capital to be maintained in case of
adverse price movements?

Q 13: What type of Early Warning Systems (EWS) are

used frequently in your bank?

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International Journal of Management and Social Sciences Research (IJMSSR) ISSN: 2319-4421 50
Volume 5, No. 2, February 2016

banks prepare a daily report of the market risk. If not

daily, at least a weekly report is a must. Thus five banks
that responded prepare the market risk report at least once
in a week. BMB reported it monthly and for HDFC Bank
No it was not applicable.

Q 17. Does your bank perform backtesting to check

trading strategies?
Yes
6
5
0 2 4 6 8
4
Fig. 11: Application of stress tests 3

Six banks use stress tests and one bank doesn‟t use it. It is
observed that the one of the banks which do not use
derivatives to manage risk is the one which is not applying
stress tests. Though they are not inter-related, it suggests
the occurrence of a pattern. The bank which does not use
stress test in this case is Bharatiya Mahila Bank (BMB).
Stress testing is an essential part of the market risk
management framework which considers both historical
market events and forward looking scenarios. Stress
testing along with sensitivity analysis is used to evaluate
the bank‟s ability to sustain operations during times of
extreme but possible events. These provide understanding
into the potential effect of significant adverse events on
the earnings, capital position and risk profile of the bank
and how it can be mitigated. In all banks there is a group
which generates and monitors the information of the
various possible scenarios that may have an adverse effect
on the bank.
2
1
0
Yes No
Fig. 13: Application of backtesting process
Banks that use the internal model based approach to
measure market risk routinely compare the daily profits
and losses with model generated risk measures to measure
the quality and accuracy of their risk measurement
systems. This process is also known as „backtesting‟. As
shown in the next question, different banks execute
different types of backtesting evaluations. Five banks
perform the backtesting process, two banks don‟t perform
the backtesting process.

Q 16. How often is the Market risk report received by the Q 18. Do you perform backtests using both Hypothetical
trading staff? and Actual Trading Outcomes?

[PERCEN
TAGE]
No
[PERCEN [PERCEN
TAGE] TAGE]

Yes

[PERCEN
TAGE] 0 1 2 3 4 5 6
Fig. 12: Market risk frequency
Fig. 14: Backtesting using both types

As the market is highly dynamic and the rates keep on Five banks perform backtests with both hypothetical &
changing regularly, the bank must keep a constant track of actual trading outcomes. While two banks don‟t use any of
the market fluctuations. This is usually done using the these as they don‟t perform backtests.
VaR framework. It is thus a very good practice if the

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International Journal of Management and Social Sciences Research (IJMSSR)
Volume 5, No. 2, February 2016
It is most suitable to use a definition of daily trading
outcome that allows for an „uncontaminated‟ test. To
develop this standard, banks must perform backtests using
the hypothetical trading outcomes. Backtesting using
actual daily profits and losses is also useful as it can
uncover any trading volatility even if care was taken to
calculate the values accurately. For these reasons, BIS
committee exhorts the banks to develop the competence to
perform backtests using both hypothetical and actual
trading outcomes.
4. OPERATION RISK PRACTICES
Q 19. Which of the following Basel II Approaches for the
calculation of operation risk is adopted by your bank?
[PERCEN
TAGE]
[PERCEN
TAGE]
Fig. 15: Operational risk calculation approach
All the Indian banks except one use the Basic Indicator
Approach (BIA) to measure the capital charge for
operational risk, as seen from the responses. Only one
foreign bank i.e. Standard Chartered and one Indian bank,
Yes bank, use the AdvancedMeasurement Approach
(AMA). The BIA does not require any prior supervisory
approval from the RBI. However the adoption of an AMA
requires supervisory approval as it allows banks to use
internal models to calculate their capital requirements. It
also involves the implementation of a rigorous risk
management framework. For these reasons, banks find it
easier to adapt the BIA.
Q 20. In the table given below, how does your bank
recognize people exposures as an important part of
operational risk? (1 being least significant and 5 being
most significant)
Incompetence
Negligence
Human Error
Low Morale
Fraudulent Activities by employees
Lack of training
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ISSN: 2319-4421 51
Almost all the people exposures are recognized as
important by all the banks i.e. they have received a
significance rating of 4 or 5 out of 5. Only low morale,
incompetence, negligence and product complexity have
received a rating of 1, 2, 2, 2 respectively. Thus all banks
are having a good operational risk protection with respect
to people exposures.
Q 21. In the table given below, to what degree does your
bank recognize process exposures as an important part
of operational risk? (1 being the least significant and 5
being the most significant)
Errors in methods
Execution Errors
Documentation Errors
Product Complexity
Security Risk
The outlier in this case is DCB bank and Yes bank. Both
rates product complexity as not very significant at 2 out of
5. All other processes receive a higher rating implying that
they are an important part of operational risk.
Q 22. Do you feel that KRIs (Key Risk Indicators) help in
managing the risks effectively?
[CATEGO
RY
NAME]
[PERCENT
AGE]
[CATEGO
RY
NAME]
[PERCENT
AGE]
Fig. 16: Effectiveness of KRIs
Five out of the six banks rate KRIs as effective and one
bank (Standard Chartered) rates it as very effective in
managing risks. KRIs are used to monitor the main drivers
of exposure linked with key risks. KRIs are chosen for
each business line along with the overall bank level for
each substantial operational risk. KRIs are and KPIs along
with escalation triggers are used to warn when risk levels
approach or cross the limits and help in mitigation plans.
Thus they are subject to regular examination and
augmentation.
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Volume 5, No. 2, February 2016

5. OVERALL ANALYSIS AND [6] Sikdar, Pallab, and Munish Makkad, “Shift form
CONCLUSION Basel II to Basel III-A reporting perspective on
Indian banking sector”,2011.
The survey revealed that, 43% of the Banks still think that
Basel II/Basel III is a regulatory constraint, which means
that they would have been better off if the regulations
were not in place.

Operation risk and forex risk is not given much

importance by a few banks. Operation risk is very
important and if not paid attention, it might escalate to a
bigger problem and might even lead to the liquidation of
the bank. Banks still have not adopted the Advanced
Measurement Approach (AMA) in calculating operational
risk capital charge. To become more advanced and self-
sufficient in determining the capital charge, banks must
use the AMA.

The banks in India appear to have robust risk management

practices. But the banks must not become complacent as
the business environment is highly dynamic and constantly
changing. The bankers as well as the regulators must take
complete cognizance of the risk management culture. As
seen in the above pages, RBI has regulations which are
even higher than the Basel III requirements for some
essential capital requirements. The banks in India are
already adopting the regulations of Basel III. RBI has also
ensured that the banks adopt the Basel III norms within
March 2019 and it is thus implementing the requirements
in a phased manner so that the banks are not affected
adversely. The main challenge that lies ahead of Indian
banks is to adopt the Basel III norms without any harm to
their own growth and development activities It becomes
all the more important as India is a growing economy and
credit requirements are increasing. Basel III thus should
not come in the way of this growth and developmental
activities of the banks.

REFERENCES

[1] Gopinath, Shyamala,Changing paradigms in risk

management. Deputy Governor, Mumbai RBI,
2006.
[2] Jayadev, M., “Basel III Implementation: Issues and
challenges for Indian Banks.” IIMB Management
Review, 2013.
[3] Sinha, Pankaj, Varundeep Singh, and Vineeth
Gothi. “Evaluation of riskiness of Indian Banks and
probability of book value insolvency.” 2009.
[4] Padmalatha Suresh and Justin Paul,Management of
banking and financial services(India, Pearson,
2015).
[5] Subramoniam, K.,“Basel III Framework on
Liquidity Standards: The Challenges Before the
Indian Banks on Liquidity Risk Management.” The
IUP Journal of Bank Management, 2015.

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