1. RISK MANAGEMENT PRESENTATION ON CREDIT RISK MARKET RISK AND By
S.D.BARGIR, Joint Director, IIBF

2. Risk may be defined as “ exposure to uncertainty”
favourable or unfavourable outcomes
aims at mitigating the loss
managing risk rather than on eliminating it

3. Risk management is a four steps process
Identifying
Measuring ( quantifying)
Managing
controlling, monitoring and reviewing

4. Three generic categories of risk
Credit risk
Market risk
Operational risk

5. Credit Risk
credit risk means default of the borrower or deterioration of borrowers’ credit quality.

6. Market Risk arising from movement in market prices Interest Rate Risk,
Exchange Rate Risk,
Commodities Price risk
Equity Price Risk.

7. Operational Risk loss resulting from inadequate or failed
internal processes
People
systems or
external events.

8. Credit Risk defaults take various forms
Direct Lending:Loan amount (Principal as well as interest) will not be paid
Guarantees/ Letter of Credit etc.Funds will not be forthcoming upon crystallization of liability

9. Credit Risk defaults take various forms
Treasury Products payment due from the counter parties either stops or not forthcoming
Securities Trading Settlement will not be effected
Cross boarder exposure: free transfer of currency is restricted or comes to an end.

10. credit risk, consists of three risks
Default risk
Exposure risk
Recovery risk

11. Default risk is the probability of an event of default
depends upon credit standing of the counter party.
default probability cannot be measured directly.
guidance from historical statistics on large sample over long period of time.
bank faces difficulty in obtaining accurate historical data.

12. Exposure risk uncertainty associated with future amounts
credit lines- repayment schedule- exposure risk small
other lines of credit -OD, project financing , guarantees etc- risk cannot be predicted accurately

13. Recovery risk: recoveries in the event of default not predictable
depend upon type of default
availability of collaterals, third party guarantees
circumstances surrounding the default.

14. Expected Losses & Unexpected Losses
EL depends upon default probability(PD), Loss given default (LGD)& exposure at risk (EAD)
EL = PD x LGD x EAD
Unexpected losses (UL) is the uncertainty around EL and it is Standard deviation of EL.

15. challenges faced by banks in r/o EL
aggregation of the risk-related information to assess the PD, LGD and EAD
implementation of a risk rating system that can correctly model these parameters which is statistically valid.

16. BASEL
Basel Committee on Banking supervision (BCBS) under the auspices of Bank for International Settlements (BIS)
Established in 1975 by group of 10 countries
Belgium, Canada, France, Germany, Italy, Japan, Luxembourg, the Netherlands, Spain, Sweden, Switzerland, the United Kingdom and the United States.

17. Basel II-Implementation in India
with effect from March, 31, 2007 by commercial banks.
90 commercial Banks in India
100 countries

18. Basel II capital requirements more risk sensitive
directly related to the credit rating of each counter-party instead of counter-party category
capital for credit and market risk but also for operational risk (OR)
where warranted for interest rate risks, credit concentration risks, liquidity risks
SME sector

19. BASEL II RESTS ON THE THREE PILLARS,
Pillar I Minimum Capital Requirements
Pillar 2 Supervisory Review Process
Pillar 3 Market Discipline
each pillar is as important as the other one

20. Pillar 1 – Minimum Capital Requirements
menu of approaches for computing capital adequacy
freedom to choose the approach
minimum, the Standardized Approach for credit risk
Basic Indicator Approach for operational risk
standardised Approach or Internal Risk Measurement Models approach for market risk

21. Various Approaches Credit Risk Market Risk Operational Risk
Standardized Approach(SA)
Basic Indicator Approach
Basic-Internal Risk Based(IRB)
Internal Risk Measurement Model
Advanced IRB
The internal measurement approach

22. Pillar 2- Supervisory Review
encourage to adopt better risk management techniques
intervene to mandate a higher capital requirement
more inclusive –besides CR,MR,OR credit concentration risk Interest rate risk in banking book, Liquidity risk, Business risk, Strategic risk and Reputation risk.
Takes into account Business cycle effects too

23. RISK BASED SUPERVISION (RBS)
Business Risk Factors
Capital,
Credit Risk,
Market Risk,
Earnings risk,
Liquidity Risk,
Business Strategy and Environment Risk,
Operational Risk
Group Risk.
Control Risk Factors
Internal Controls Risk,
Organisation risk,
Management Risk
Compliance Risk.

24. Pillar 3- Market Discipline
disclosures to enhance market discipline
Monitoring by markets- other banks, customers, depositors, subordinated debt instrument holders, analysts & rating agencies
disclosure policy approved by Board
financial penalty, for non-compliance

25. INITIATIVES BY RBI
each bank has suitable risk management framework and the expected level of capital
introduced RBS In 23 banks on a pilot basis
encouraged all banks to operationalise CAAP
expanded the area of disclosures
encouraged some banks to migrate from SA to IRB approaches  

26. Standardised Approach Different categories of obligors
Corporates
Sovereign
Bank
Retail
Real Estate
Specialized Lending

27. Issues emerging out of Basel II
higher capital requirements
improved IT architectures
data issues
consolidation
capacity building
external ratings
use of national discretion
validating the concept of economic capital

28. Capital requirements for CORPORATES in Basel II
credit rating
AAA to AA
A+ to A-
BBB+ to BB-
Below BB-
Unrated
RW Basel I
100%
Capital-Basel I 8%
RW Basel II
20%
50%
150%
Capital-Basel II
1.6% 4%
12%

29. Capital requirements for SOVEREIGN in Basel II
AAA to AA
A+ to A-
BBB+ to BB-
BB to BB-
Below BB-
Unrated
100% 8%
20%
50%
150%
1.6% 4%
12%

30. Capital requirements for BANKS in Basel II
AAA to AA
A+ to A-
BBB+ to BB-
BB to BB-
Below BB-
Unrated
100% 8%
20%
50%
150%
1.6% 4%
12%

31. Capital requirements for BANKS in Basel II
AAA to AA
A+ to A-
BBB+ to BB-
BB to BB-
Below BB-
Unrated
100% 8%
20%
50%
150%
1.6% 4%
12%

32. Capital requirements for RETAIL in Basel II
INDIVIDUAL OR SMALL BUSINESS
DEFAULT
RW under Basel I
100%
RW under Basel II
75%
From 150% to 50%
Capital under Basel II 6%
4% to 12%

33. Capital requirements for REAL ESTATE in Basel II
RETAIL
RW BASEL I
RESIDENTIAL
50%
COMMERCIAL
100%
Capital under Basel I 4% 8%
RW under Basel II
35%
Capital under Basel II
2.7%

34. SPECIALISED LENDDING PROJECT FINANCE COMMODITIES,COM. REAL ESTATE
RW UNDER BASEL I
100%
CAPITAL Basel I 8%
RW UNDER BASEL II
CAPITAL BASEL II

35. Assessing exposure customer wise and facility wise
Probability of Default (PD) - the probability that a specific customer will default within the next 12 months.
Loss Given Default (LGD) - the percentage of each credit facility that will be lost if the customer defaults.
Exposure at Default (EAD) - the expected exposure for each credit facility in the event of a default.

36. MARKET RISK
Market risk takes the form of interest rate risk, exchange rate risk, commodity price risk and equity price risk , major risk presently faced by banks in India are interest rate ,exchange rate and liquidity risk.

37. MARKET RISK-CONTINUED
Basel-I focused only on credit risk excluding the market risk
Risk brought vide amendments in 1996
usually measured with a Value-at-Risk method and on daily basis
capital charge should be either the previous day’s VaR or three times the average of the daily VaR for the preceding 60 working days.

38. Stipulations of RBI
Assign additional risk weight of 2.5% on the entire investment portfolio
Assign risk weight of 100% on the open position limit on foreign exchange and gold
Build investment fluctuation reserve up to a minimum of 5% of the investment held in ‘Held for Trading’(HFT) and ‘available for sale’(AFS) category in their investment portfolio

39. Linking risk to capital- single metric
Risk measurement focuses on unexpected losses
Different business activities lead to various unexpected losses
These different risks must be measured individually and aggregated to a single risk metric, both by business line and across the bank as a whole

40. Overall risk should always be lower than overall economic capital
WINNING FORMULA
Overall risk should always be lower than overall economic capital

41. .