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BFM MODULE-B
Chapt
er8:RI
SKANDBASI
CRISK
MANAGEMENTFRAMEWORK(PART-I
V)
Whatwewi
llst
udy?
*
RiskMoni
tor
ingandCont
rol
*
RiskMi
ti
gat
ion
Ri
skMoni
tor
ingandCont
rol
:
Thekeydr i
veri
nmanagi
ngabusinessisseeki
ng
enhancementinri
sk-
adj
ust
ed r
eturn on capi
tal
(RAROC).
Therefor
etheapproachtor
iskmanagementcannot
beinisol
ati
onorinstandal
onemode.
The appr oach torisk managementcenters on
faci
li
tati
ng implementat
ion ofri
sk and busi
ness
poli
ciessimult
aneouslyi
naconsist
entmanner.
Modernbestpr
acti
cesconsistofsett
ingr
iskl
imi
ts
based on economic measur es of ri
sk whi
le
ensur
ingthebestri
skadjustedretur
n,keepi
ngin
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v
iewt
hecapi
talt
hathasbeeni
nvest
edi
nbusi
ness.
Iti
saquest i
onoft aki
ngabal
ancedvi
ew onri
sks
andr et
urnsandthattoowi
thi
ntheconst
rai
ntsof
avai
labl
ecapit
al.
I
nor
dert
oachi
evetheabov
eobj
ect
ives,banksput
i
npl
acet
hef
oll
owi
ng:
1.
Anor
gani
zat
ionalst
ruct
ure
2.
Compr
ehensi
ver
iskmeasur
ementappr
oach.
3.Ri
sk management Pol i
cies adopt ed at the
corporat
el ev
el,which are consist
entwi tht he
broader busi
ness str
ategi
es,capi t
al st rength,
managementexperti
seandr i
skappetite.
4.
Guidel
inesandot
herpar
amet
ersusedt
ogov
ern
ri
sk
I
sthi
senoughf
orr
iskmanagement
?
I
ti snotenought oputinpl
aceast r
uct
ureforthe
purpose.I
tisequallyi
mportantt
oensurethatthe
organi
zati
on functi
ons i
n a mannerithas been
pl
anned.
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Feedback:Af eedbackoft
heact
ualfunct
ioni
ngi
s,
ther
efore,
necessaryfort
hepur
poseofcontrol
.
Moni
tor
ingofFeedback:
Inaddi t
iont othat
,thef eedbackrecei
vedont he
actualper for
mance requires monit
ori
ng al
so to
ensuret hatthedi v
ergencebet ween t
heplanned
perfor
manceandt heactualperfor
manceiskeptat
thelevelthati
sacceptabl
e.
Tokeepriskataccept
abl
elev
elbankr
equi
rest
he
f
oll
owing:
1.Str
ongManagementInf
ormati
onSystem(MI
S)f
or
report
ing,
moni
tor
ingandcontr
oll
ingr
isk.
2.Wel
llai
doutpr ocedur
es,eff
ect
ivecont
roland
compr
ehensi
ver
iskreport
ingf
ramework.
3.Separ
ate risk management f ramework
i
ndependentofoperat
ionaldepar
tmentswithcl
ear
deli
neati
onofr
esponsi
bili
tyformanagementofr
isk.
4.
Per
iodi
calr
evi
ewandev
aluat
ion.
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Rol
eofBoar
dofDi
rect
ors:
Thebanksboar dofdirector
shasar esponsibil
it
yt o
ensuret hatmanagementest abli
shesasy stem f or
assessing v ar
ious r
isks,dev el
ops a sy stem t o
rel
ater i
sktot hebankscapitall
evel,
andest abli
shed
amet hodf ormonitor
ingcompl i
ancewi thinternal
poli
cies.
Bank'
sint
ernalcont
rolst
ruct
ure:
Thebanksint
ernalcont
rolst
ruct
urei
sessent
ialt
o
thepr
ocess.
Ef
fecti
ve cont
rol of the process incl
udes an
i
ndependentrevi
ew and,wher e appropr
iat
e,the
i
nvolv
ementofint
ernalorext
ernalaudi
ts.
Boar
dcommi
tt
eeonRi
skManagement
:
The boar
d shouldr egularl
yv er
ify whether i
t'
s
syst
em ofint
ernalcontrolsisadequatetoensure
well
-or
der
edandprudentconductotbusiness.
Thi
si s nor
mall
ycarr
ied outt
hrough a separ
ate
boar
dcommi tt
eeonRi
skManagement.
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Ri
skMi
ti
gat
ion:
Sincerisksar i
sefrom uncer
taintiesassociatedwith
the ri
sk element s,ri
sk reduction is achieved by
adopti
ng st rategi
es t
hatel i
mi nate orr educe the
uncertaint
iesassociat
edwi thther i
skelement s.
Thi
siscal
ledRi
skMi
ti
gat
ion.
Exampl
eofat
radi
ngbusi
ness:
Cashi
nfl
ow:Fr
om sal
eofgoods
Mango Ear
li
er Today Tomor
row
Vol
ume 80Kg 100Kg 50Kg
Uni
tPr
ice 12Rs/
Kg 20Rs/
Kg 10Rs/
Kg
I
nfl
ow 960Rs 2000Rs 500Rs

Cash outf l
ow :From Pur
chase ofgoods and
tr
ansportcostet
c.
 Joi
nCAI
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Mango Ear
li
er Today Tomor
row
Vol
ume 100Kg 100Kg 100Kg
Uni
tPr
ice 12Rs/
Kg 8Rs/
Kg 20Rs/
Kg
Tr
anspor
t 200Rs 100Rs 500Rs
Admi
nist
rat
ive 600Rs 500Rs 800Rs
Out
fl
ow 2000Rs 1400Rs 2300Rs

Businessmanmayl i
ket o enterinto asaleand
purchase contr
act
.Si nce a sale contr
actwould
specif
y v olume and r educe t he pr i
ce the
uncertai
nti
esassoci
atedwi t
hpur chasepri
ce.
Onemayal sohav econt
ractwit
ht r
ansportser
v i
ces
provi
derandeliminater
isksi
nhi str
adingbusiness
toal arge extentprovi
ded hi
s contractcounter
part
ieskeeptheircommitment.
Itmaybenotedthati
ntheprocesshewouldbring
i
n anotherri
sk el
ement,namelythe uncer
tai
nty
associ
ated wit
h the abil
it
y of the cont r
act
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count
erpar
tyt
okeephi
scommi
tment
.
Itmayalsobenot edthatwhi
leent
eri
ngi nt
ovari
ous
contract
st hetr
aderwouldal
sofor
eclosehisopti
on
tot ake advant
age ofanyr i
se i
n sales pr
ice or
reducti
oninpurchasepri
ce.
Inot
herwords,upsi
depot
ent
ialofpr
ofi
tswoul
d
al
sogetr
educed.
Whileriskmi t
igati
on str
ategi
es hel
pi nreduci
ng
adverse i
mpacton t he busi
ness (
probabi
li
ty of
gett
inglosses)
,itl
imit
supsidepotent
ialaswel
l,i
.e.
,
chances ofget ti
ng superprofitwould al
so be
l
imited.
Never
thel
ess,oneachi
evesstabi
li
tyi
nhi
snetcash
fl
owandrisksstandr
educed.
Ri
skMi
ti
gat
ioni
nBanki
ng:
Inbanki
ng,wecomeacrossav ari
etyoffinanci
al
i
nstr
umentsandnumberoft
echniquesthatcanbe
usedtomit
igat
eri
sks.
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Thetechni
quest
omi
ti
gat
edi
ff
erentt
ypesofr
isk
aredi
ff
erent
.
Mi
ti
gat
ionofCr
edi
tRi
sk:
Formi ti
gatingcreditriskbankshav ebeenusing
tr
aditi
onaltechniques,suchascoll
ater
ali
zati
onsby
fi
rstpri
orit
yclaimswi t
hcashorsecurit
iesorl
anded
propert
ies,t
hirdpartyguarant
ees,
etc.
Mi
ti
gat
ionofI
nter
estr
ater
isk:
Formit
igat
ingint
erestrat
er i
skbanksusei
nter
est
rat
eswaps,for
wardrateagreement
s.
Mi
ti
gat
ionofFor
exRi
sk:
Similar
ly,f
ormi t
igati
ngforexrisksbanksusefor
ex
forward contr
acts,forexoptionsorf utur
es.Ri
sk
mitigat
ion measur es aim t o reduce downsi
de
vari
abil
ityinnetcashf owbutt hesemeasuresal
so
reducetheupsidepot ent
ialsi
mul t
aneousl
y.
I
n fact
,r i
sk mi t
igat
ion measur
es r
educe t
he
v
ari
abil
it
yinnetcashfl
ow.
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Count
erPar
tyRi
sk:
In addi t
ion, r i
sk mi t
igat
ion would i nv
olv
e
count
erpartyandi twi
llal
waysbeassociat
ionwit
h
count
er-partyr
isk.
Mi
ti
gat
ionofcount
erpar
tyr
isk:
Itmay al so be st
ated heret hatmar ket
s have
respondedtothecounter-
partyr
iskbyest abl
ishi
ng
"Exchanges'suchasst ockexchange,commodi t
y
exchanges,fut
uresandoptionsexchanges.
Such'Exchanges'takeupt
herol
eofcount
erpar
ty
andhaveestabli
shedrul
esf
orr
iskmi
nimi
zat
ion.
Asar esul
t,whenweent erint oacont r
actwi
th
exchange as count erparty, count
erpart
y ri
sk
remains butiti
sr educedv erysubst
anti
all
ysi
nce
exchangeactasthecentralcounter
part
y.

Joi
nCAI
IBWI
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