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RISK MANAGEMENT IN

BANKSBy

Shyam Ji Mehrotra

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Overview

ofBank Financial Management

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Wind of change

Competition is opening opportunity as wellthreats

To raise capital time and again to meet

CRAR norms - Now Basel IIIVarious risk in banking business

Credit risk

Market risk covering liquidity risk, interest raterisk, forex-risk

Operational risk

Complexity of risk

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Bank Financial ManagementObjectives

Optimize shareholders wealth

Stabilize and Increase net interest margin(NIM)

Improve ROA as well as ROE

Improve market share (Top line)

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Bank Financial Management

FinancialManagement

Bank FinancialManagement

Working capital

decision

Liquidity and interest rate

management decisionsCapital budgetingdecisions

Credit and costmanagement decisions

Financing decisions Funding decisions

Dividend distributionmanagement decisions

Capital accountmanagement decisions

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Five critical Management variables

Variables Nature

I Liquidity Management

II Interest rate risk management

III Capital account management

IV Cost (Productivity ) Management

V Credit risk management

All Profitability management

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CAMEL MODEL

C Cost management and credit riskmanagement

A The A in asset and liability managementrefers to liquidity management

M Managerial expertise (or hump of thecamel) in dealing with all five criticalfinancial management variablessimultaneously

E Equity or capital account management

L The L in asset and liability management

refers to Interest Rate risk management

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Financial Risk

Definition of risk likely loss given an event

Identify various type of risk Credit risk

Market risk

Operational risk

Measure risk quantify the likely loss because of exposure

Integrated risk management system

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Credit risk

Defined as the potential that a bankborrower or counterparty will fail to meetits obligations in accordance with agreed

terms

Either failing to repay the loan or serviceas per loan agreement

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Credit risk-examples

Direct lending- repayment is not made

Non fund- funds not forthcoming oncrystallization of LC/BG

Series of payment due from bonds are notforthcoming on due dates

Security trading- settlement not

forthcoming Cross border exposure- currency

movement not taking place

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Market risk

Losses in on and off balance sheet itemsarising from movement in market prices

Main market risks are

Interest rate risks

Exchange rate risks

Commodity price risks

Equity price risks

Liquidity risks

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Interest rate risk

Mismatch or Gap risk

Basis risk

Embedded option risk

Reinvestment risk

Price risk

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Operational Risk

Direct or indirect loss due to failedinternal process or people or system orfrom external events

Include legal risk as well

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Risk mitigationIntegrated risk management process

Identify risk

Set objectives relative to risk Measure and monitor risk

Communicate risk tolerance

Control risk