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BANKING

RISKS

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BANKING RISKS

•C AMEL

• A• M• E• L

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CAMEL

• Capital

Adequacy

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CAMEL

•Asset Quality

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CAMEL

• Management

Quality

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CAMEL

•Earnings Efficiency

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CAMEL•Liquidity

Risk

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CAMEL RISKS

• Capital Adequacy

• Asset Quality• Management• Earnings• Liquidity

Assets Liability Management

It is a dynamic process of Planning, Organizing & Controlling of Assets & Liabilities- their volumes, mixes, maturities, yields and costs in order to maintain liquidity and NII.

Significance of ALM

• Volatility• Product Innovations & Complexities• Regulatory Environment• Management Recognition

Purpose & Objective of ALMAn effective Asset Liability Management Technique aims to manage the volume, mix, maturity, rate sensitivity, quality and liquidity of assets and liabilities as a whole so as to attain a predetermined acceptable risk/reward ration.It is aimed to stabilize short-term profits, long-term earnings and long-term substance of the bank. The parameters for stabilizing ALM system are:

1. Net Interest Income (NII)2. Net Interest Margin (NIM)3. Economic Equity Ratio

Liquidity Management

Bank’s liquidity management is the process of generating funds to meet contractual or relationship obligations at reasonable prices at all times.New loan demands, existing commitments, and deposit withdrawals are the basic contractual or relationship obligations that a bank must meet.

Adequacy of liquidity position for a bank

Analysis of following factors throw light on a bank’s adequacy of liquidity position:

a. Historical Funding requirementb. Current liquidity positionc. Anticipated future funding needsd. Sources of fundse. Options for reducing funding needsf. Present and anticipated asset qualityg. Present and future earning capacity andh. Present and planned capital position

Funding Avenues

To satisfy funding needs, a bank must perform one or a combination of the following:

a. Dispose off liquid assetsb. Increase short term borrowingsc. Decrease holding of less liquid assetsd. Increase liability of a term naturee. Increase Capital funds

Types of Liquidity Risk

• Liquidity Exposure can stem from both internally and externally.

• External liquidity risks can be geographic, systemic or instrument specific.

• Internal liquidity risk relates largely to perceptions of an institution in its various markets: local, regional, national or international

Other categories of liquidity risk• Funding Risk

- Need to replace net outflows due to unanticipated withdrawals/non-

renewal• Time Risk

- Need to compensate for non-receipt of expected inflows of funds

• Call Risk- Crystallization of contingent liability

ADDRESSING THE MISMATCHES

• Mismatches can be positive or negative

• Positive Mismatch: M.A.>M.L. and Negative Mismatch M.L.>M.A.

• In case of +ve mismatch, excess liquidity can be deployed in money market instruments, creating new assets & investment swaps etc.

• For –ve mismatch,it can be financed from market borrowings (Call/Term), Bills rediscounting, Repos & deployment of foreign currency converted into rupee.

STRATEGY• To meet the mismatch in any maturity

bucket, the bank has to look into taking deposit and invest it suitably so as to mature in time bucket with negative mismatch.

SUCCESS OF ALM IN BANKS :PRE - CONDITIONS

1. Awareness for ALM in the Bank staff at all levels–supportive Management & dedicated Teams.

2. Method of reporting data from Branches/ other Departments. (Strong MIS).

3. Computerization-Full computerization, networking.

4. Insight into the banking operations, economic forecasting, computerization, investment, credit.

5. Linking up ALM to future Risk Management Strategies.

Interest Rate Risk Management

• Interest Rate risk is the exposure of a bank’s financial conditions to adverse movements of interest rates.

• Though this is normal part of banking business, excessive interest rate risk can pose a significant threat to a bank’s earnings and capital base.

• Changes in interest rates also affect the underlying value of the bank’s assets, liabilities and off-balance-sheet item.

Interest Rate Risk

• Interest rate risk refers to volatility in Net Interest Income (NII) or variations in Net Interest Margin(NIM).

• Therefore, an effective risk management process that maintains interest rate risk within prudent levels is essential to safety and soundness of the bank.

Sources of Interest Rate Risk

• Interest rate risk mainly arises from:– Gap Risk– Basis Risk– Net Interest Position Risk– Embedded Option Risk– Yield Curve Risk– Price Risk– Reinvestment Risk