ANUPAMA K ANUPAMA K

JAYA NAIR JAYA NAIR

ANUPAMA SANUPAMA S

MANJUMANJU

JAYSHREEJAYSHREE

Risk Management Systems Risk Management Systems in Banksin Banks

Genesis, Significance and Genesis, Significance and ImplementationImplementation

CONTENTSCONTENTS

What is Risk?What is Risk?

Classification of RiskClassification of Risk

Objectives of Risk ManagementObjectives of Risk Management

Tools for Managing RiskTools for Managing Risk

Risk Management in PNBRisk Management in PNB

The potential loss an asset The potential loss an asset or a portfolio is likely to or a portfolio is likely to suffer due to a variety of suffer due to a variety of reasons.reasons.

Survival of the organizationSurvival of the organization

Efficiency in OperationsEfficiency in Operations

Uninterrupted OperationsUninterrupted Operations

Identifying and achieving acceptable level of Identifying and achieving acceptable level of riskrisk

Earning StabilityEarning Stability

Continued and sustained GrowthContinued and sustained Growth

RISKSRISKS

FINANCIAL RISK NON FINANCIAL RISK

CREDIT RISK MARKET RISK

TRANSACTION RISK

PORTFOLIO RISK

INTEREST RATE RISK

LIQUIDITY RISK

FOREX RISK

OPERATING RISK

SYSTEMATIC RISK

POLITICAL RISK

HUMAN RISK

TECHNOLOGY RISK

CREDIT RISKCREDIT RISK Risk that the counterparty will fail to perform or Risk that the counterparty will fail to perform or

meet the obligation on the agreed terms .meet the obligation on the agreed terms .

TYPES OF CREDIT RISKSTYPES OF CREDIT RISKSTransaction RiskTransaction RiskRisk relating to specific trade transactions, Risk relating to specific trade transactions, sectors or groups.sectors or groups.

Portfolio RiskPortfolio RiskRisk arising from lending to sectors non related Risk arising from lending to sectors non related to the core competencies of the Bank / to the core competencies of the Bank / concentrated credits to a particular sector / concentrated credits to a particular sector / lending to a few big borrowers.lending to a few big borrowers.

MARKET RISKMARKET RISKMarket risk is the risk to a bank’s financial condition that Market risk is the risk to a bank’s financial condition that could result from adverse movements in market price.could result from adverse movements in market price.

TYPES OF MARKET RISKTYPES OF MARKET RISK

Interest Rate RiskInterest Rate RiskRisk felt, when changes in the interest rate Risk felt, when changes in the interest rate structure put pressure on the net interest margin of structure put pressure on the net interest margin of the Bank.the Bank. Liquidity RiskLiquidity RiskRisk arising due to the potential for liabilities to Risk arising due to the potential for liabilities to drain from the Bank at a faster rate than assets. drain from the Bank at a faster rate than assets.

TYPES OF MARKET RISKTYPES OF MARKET RISK(continued)(continued)

FOREX RISKFOREX RISKThis risk can be classified into three types.This risk can be classified into three types.

Transaction RiskTransaction Risk is observed when movements in price of a is observed when movements in price of a currency upwards or downwards, result in a loss on a particular currency upwards or downwards, result in a loss on a particular transaction.transaction.Translation RiskTranslation Risk arises due to adverse exchange rate movements arises due to adverse exchange rate movements and change in the level of investments and borrowings in foreign and change in the level of investments and borrowings in foreign currency.currency.Country RiskCountry Risk.. The buyers are unable to meet the commitment due The buyers are unable to meet the commitment due to restrictions imposed on transfer of funds by the foreign govt. or to restrictions imposed on transfer of funds by the foreign govt. or regulators. regulators. When the transactions are with the foreign govt. the risk is called as When the transactions are with the foreign govt. the risk is called as Sovereign RiskSovereign Risk..

NON-FINANCIAL RISKSNON-FINANCIAL RISKSOperational RiskOperational Risk arises as a result of failure of arises as a result of failure of operating system in the bank due to certain reasons operating system in the bank due to certain reasons like fraudulent activities, natural disaster, human like fraudulent activities, natural disaster, human error, omission or sabotage etc.error, omission or sabotage etc.Systemic RiskSystemic Risk is seen when the failure of one is seen when the failure of one financial institution spreads as chain reaction to financial institution spreads as chain reaction to threaten the financial stability of the financial system threaten the financial stability of the financial system as a whole.as a whole.Political RiskPolitical Risk arises due to introduction of Service arises due to introduction of Service tax or increase in income tax, freezing the assets of tax or increase in income tax, freezing the assets of the bank by the legal authority etc.the bank by the legal authority etc.Human RiskHuman Risk Labour unrest, lack of motivation, Labour unrest, lack of motivation, inadequate skills, problems faced by the bank after inadequate skills, problems faced by the bank after implementation of VRS lead to Human Risk.implementation of VRS lead to Human Risk.Technology RiskTechnology Risk Obsolescence, mismatches, Obsolescence, mismatches, breakdowns, adoption of latest technology by breakdowns, adoption of latest technology by competitors, etc, come under technology riskcompetitors, etc, come under technology risk

MANAGEMENT OF CREDIT MANAGEMENT OF CREDIT RISKRISK

Measurement through Credit Rating / Measurement through Credit Rating / scoringscoring

Quantification through estimate of Quantification through estimate of expected loan lossesexpected loan losses

Pricing on a scientific basisPricing on a scientific basis

Controlling through Effective loan review Controlling through Effective loan review mechanism and portfolio managementmechanism and portfolio management

TOOLS OF CREDIT RISK TOOLS OF CREDIT RISK MANAGEMENTMANAGEMENT

EXPOSURE CEILINGSEXPOSURE CEILINGS : :Setting of prudential Setting of prudential norms related to the Bank’s exposure to a single borrower / norms related to the Bank’s exposure to a single borrower / group borrowers / sectorial borrowersgroup borrowers / sectorial borrowers

REVIEW / RENEWALREVIEW / RENEWAL : : This involves multi-tier This involves multi-tier credit approving authority, constitution wise delegation of credit approving authority, constitution wise delegation of powers, higher delegated powers for better rated powers, higher delegated powers for better rated borrowers, discriminatory time for credit review / renewal, borrowers, discriminatory time for credit review / renewal, hurdle rates / benchmarks for fresh exposures & periodicity hurdle rates / benchmarks for fresh exposures & periodicity for renewal based on risk rating.for renewal based on risk rating.

COMPREHENSIVE RISK RATING COMPREHENSIVE RISK RATING MODELSMODELS

RISK BASED SCIENTIFIC PRICINGRISK BASED SCIENTIFIC PRICING: : Linking Linking loan pricing to expected lossloan pricing to expected loss

PORTFOLIO MANAGEMENTPORTFOLIO MANAGEMENT : : Stipulate Stipulate quantitative ceiling on specific rating categories, quantitative ceiling on specific rating categories, distribution of borrowers in various industries / business distribution of borrowers in various industries / business groups , rapid portfolio reviews, on-going system for groups , rapid portfolio reviews, on-going system for identification of credit weaknesses well in advance, initiate identification of credit weaknesses well in advance, initiate steps to preserve the desired portfolio quality and integrate steps to preserve the desired portfolio quality and integrate portfolio reviews with credit decision making process.portfolio reviews with credit decision making process.

TOOLS OF CREDIT RISK TOOLS OF CREDIT RISK MANAGEMENTMANAGEMENT

LOAN REVIEW MECHANISMLOAN REVIEW MECHANISM : : This This should be done independent of credit should be done independent of credit operations & administration and cover all operations & administration and cover all the loans above certain cut-off limit the loans above certain cut-off limit ensuring that at least 30 – 40% of the ensuring that at least 30 – 40% of the portfolio is subjected to LRM in a year. portfolio is subjected to LRM in a year.

RISK MANAGEMENT IN PNBRISK MANAGEMENT IN PNB

New Capital Adequacy FrameworkNew Capital Adequacy Framework::

Bank has migrated to New Capital Adequacy Bank has migrated to New Capital Adequacy Framework, popularly known as BASEL II w.e.f. Framework, popularly known as BASEL II w.e.f. from March 2008. The approaches prescribed by from March 2008. The approaches prescribed by the 'Regulator', namely Standardised Approach the 'Regulator', namely Standardised Approach under Credit Risk and Basic Indicator Approach under Credit Risk and Basic Indicator Approach under Operational Risk have been under Operational Risk have been implemented.The Bank had adopted Standard implemented.The Bank had adopted Standard Duration Approach for Market Risk, since March Duration Approach for Market Risk, since March 2006. 2006.

RISK MANAGEMENT IN RISK MANAGEMENT IN PNB(contd)PNB(contd)

Bank has already placed credit risk rating models Bank has already placed credit risk rating models on central server based system ‘PNB TRAC’, on central server based system ‘PNB TRAC’, which provides a scientific method for assessing which provides a scientific method for assessing credit risk rating of a client. The Bank has credit risk rating of a client. The Bank has developed and placed on central server score developed and placed on central server score based rating model ‘PNB SCORE’ in respect of based rating model ‘PNB SCORE’ in respect of retail loans and traders up to total limits of Rs 50 retail loans and traders up to total limits of Rs 50 lacs. “Accept/Reject” decisions are also based on lacs. “Accept/Reject” decisions are also based on the score obtained. Scoring models for remaining the score obtained. Scoring models for remaining sectors like SME segments have been developed sectors like SME segments have been developed and are under testing stage.and are under testing stage.

Bank is also developing framework for estimating LGD Bank is also developing framework for estimating LGD (Loss Given Default) and EAD ( Exposure at Default) (Loss Given Default) and EAD ( Exposure at Default) and also framework for identifying concentration risk. A and also framework for identifying concentration risk. A data warehouse is being established for effective data data warehouse is being established for effective data management and use of application tools for management and use of application tools for quantification of risks.quantification of risks.

For the Market risk bank has a Mid-Office with separate For the Market risk bank has a Mid-Office with separate desks for Treasury & Asset Liability Management (ALM). desks for Treasury & Asset Liability Management (ALM). Asset Liability Management Committee (ALCO) is Asset Liability Management Committee (ALCO) is primarily responsible for establishing the market Risk primarily responsible for establishing the market Risk Management, asset liability management of the bank, Management, asset liability management of the bank, implementing the risk management of the bank. The implementing the risk management of the bank. The policies for hedging and mitigating risk are discussed in policies for hedging and mitigating risk are discussed in ALCO.ALCO.

A separate independent Division known as A separate independent Division known as Credit Audit & Review Division has been Credit Audit & Review Division has been formed to ensure LRM implementation. LRM formed to ensure LRM implementation. LRM examines compliance with extant sanction examines compliance with extant sanction and post-sanction process/procedures laid and post-sanction process/procedures laid down by the Bank from time to time. down by the Bank from time to time.

Preventive Monitoring System (PMS): It is a Preventive Monitoring System (PMS): It is a tool used by bank for detection of early tool used by bank for detection of early warning signals with a view to warning signals with a view to prevent/minimize the loan losses.prevent/minimize the loan losses.

Liquidity Risk of bank is assessed through gap Liquidity Risk of bank is assessed through gap analysis for maturity mismatch based on residual analysis for maturity mismatch based on residual maturity in different time buckets & management maturity in different time buckets & management of same is done through prudential limits fixed of same is done through prudential limits fixed thereon.thereon.Bank is also monitoring the liquidity through Bank is also monitoring the liquidity through various stock options.various stock options.The Bank is proactively using duration gap and The Bank is proactively using duration gap and interest rate forecasting to minimize impact of interest rate forecasting to minimize impact of interest rate changes.interest rate changes.Advance techniques such as Stress testing, Advance techniques such as Stress testing, simulation, sensitivity analysis etc, are conducted simulation, sensitivity analysis etc, are conducted at regular intervals to draw contingency funding at regular intervals to draw contingency funding plan under different liquidity scenarios.plan under different liquidity scenarios.

CONCLUSIONCONCLUSION

In the Banking industry where risk is the In the Banking industry where risk is the norm , rather than the exception, we have norm , rather than the exception, we have to adopt many measures like reducing to adopt many measures like reducing exposure in high risk areas, emphasising exposure in high risk areas, emphasising more on the promising industries, optimising more on the promising industries, optimising the return by striking a balance between the the return by striking a balance between the risk and the return on the assets. Our motto risk and the return on the assets. Our motto should be effective management of risks should be effective management of risks towards ensuring quality credit portfolio. towards ensuring quality credit portfolio.

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