7_1-Market%20Risk.pdf

7/28/2019 7_1-Market%20Risk.pdf

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Market Risk


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Definition

Possibility of loss due to changes in the market factors

Market risk affects the banks earnings

Market risk reduces the capital position of banks

Volatility of market values

Affects banks ability to meet its obligations


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Bank for International Settlements (BIS)

Adverse change in value of balance sheet positions

on balance sheet positions

Off balance sheet positions

Movements in

Equity market

Interest rate market

Currency exchange rate

Commodity prices


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Focus of Market Risk

Liquidity risk

Market risk

Interest rate risk

Foreign exchange risk

Commodity price risk

Equity price risk


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Organizational Structure of Market Risk

Board of Directors

Risk Management Committee

Asset Liability Management Committee

Market Risk Group


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Structure of the Market Risk Group in Banks

Board of

Directors

Risk

Management

Committee

Asset Liability

Management

Committee

Market Risk

Group


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Board of Directors

Overall responsibility for market risk

Risk Management Policy of the bank

Setting of limits for

Liquidity

Interest rate

Foreign exchange rate

Commodity trade

Equity trade


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Risk Management Committee

Board level sub committee

Chief executive officer

Head of credit

Head of market

Head of operations

Strategy for integrating bank risk

Responsible for

Guidelines for market risk measurement

Compliance with market price risk policy Review of market risk limits, triggers, stop-loss positions

Effectiveness of market risk system

Quality of staff


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Asset Liability Management Committee

Responsible for adherence of limits, targets, stop-loss orders

Product prices for deposits and advances

Decision on maturity profile of assets and liabilities of the

bank

Forecast interest rate views of the bank

Decision on business strategies

Review funding policy

Decide the transfer pricing policy

Review economic and political impact on balance sheet


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Market Risk Group

Responsible for analyzing risk

Responsible for monitoring risk

Responsible for reporting risk profiles to ALM Committee

Preparation of forecasts

Simulation models


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Value-at-Risk Concept of Market Risk

Potential gain or loss

In a position

In a portfolio

Associated with a price movement

Measured as a probability

In relation to a time horizon


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Value-at-Risk Requirement

Instantaneous price shock for a specified holding

period

One tailed confidence interval of 99%

Historical observation of at least one year

Adjustments in terms of correlation

Within risk factors

Across risk factors


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Capital Requirement for Market Risk

Tier 1 capital

Shareholders equity

Retained earnings

Tier 2 capital

Supplementary capital

Tier 3 capital Short term subordinated debt (Tertiary capital held

by banks to meet part of market risk undisclosed

reserves and general loss reserves)


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Requirements for Consideration of Tier 3 Capital

Initial maturity of at least two years

Limited to 250% ofbanks Tier 1 capital that is allocated

to support market risk

Tier 2 capital could be substituted for Tier 3 up to 250%

Tier 3 capital subject to lock-in provisions


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Difficulties in Implementing Market Risk Capital

Adequacy Requirements

Market price movements are not normally distributed

Wide dispersion

Fat tails

Extreme events

Event risk is difficult to account for

Exceptional market scenarios

Difficult to account for intra-day trading risks

Historical representations may not repeat and market

risk may be due to factors not encountered earlier

7_1-Market%20Risk.pdf

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