©2005 KESDEE Inc. All rights reserved. 1 Presented By S. L. (Sam) Srinivasulu, Ph.D President, KESDEE Inc. PO Box , San Diego, CA , USA. Tel: , Fax: Website: Global Best Practices in Risk and Treasury Management Organized by Indian Banks’ Association (IBA) in association with Canara Bank Date : September 26,2005 Venue: Mumbai, India

©2005 KESDEE Inc. All rights reserved. 2 An interactive web-based version of the presentation is available in our e-Learning and Reference Solutions Each of you will be provided with User ID’s and Passwords to access the following for a period of one week; Entire suite of e-Learning & Reference Solutions eCoaches (eFRM Coach and ePRM Coach) You will also be able to access the Job Aids / Performance Support Tools Please provide your ID’s to send the access codes 2 ©2005 KESDEE Inc. All rights reserved. 2 Global Best Practices in Risk and Treasury Management

©2005 KESDEE Inc. All rights reserved. 3 The U.S. Federal Reserve Board, Washington D.C., USA A 5 YEAR PROJECT…. The programs were;  Based on actual case studies  Dealt with all aspects of a financial institution’s management including products, Risk Management and Best Practices Key Output – Database of Global Best Practices in Risk Management The experience and knowledge from these programs served as a catalyst for the establishment of KESDEE Inc. KESDEE - the Genesis ©2005 KESDEE Inc. All rights reserved. 3

4 Presentation topic covers the following:  A Framework for Analysis of Best Practices in Risk Management  How Best Practices are arrived at ? - Global Database of Disclosures, Benchmarking Data, Case Studies; - Focus group discussions and interviews  Survey Results of Best Practices  A Plan of Action: How to Implement Best Practices? Global Best Practices in Risk and Treasury Management

©2005 KESDEE Inc. All rights reserved. 5 Global Best Practices in Risk and Treasury Management How Best Practices are arrived at ?  Empirical Analysis Disclosures Benchmarking Data  Case Studies  Comparative Analysis  Focus Group Discussions with groups of Key Decision Makers  Questionnaires - Fax  In-person - Interviews with CEO’s / Senior Executives  Annual Updates

©2005 KESDEE Inc. All rights reserved. 6  Asset Liability Management  Trading Risk  Derivatives  Credit Risk  Liquidity Risk Funding Trading  Contingency Funding Plan  Operational Risk Global Best Practices in: Global Best Practices in Risk and Treasury Management

©2005 KESDEE Inc. All rights reserved. 7 Global Best Practices in:  Corporate Treasury Management  Risk Management Governance Organisation Disclosures  Policy Statements  Analytics  Performance Measurement  Various functions / Business Lines Global Best Practices in Risk and Treasury Management

©2005 KESDEE Inc. All rights reserved. 8 Global Best Practices in Risk and Treasury Management A comprehensive framework – 9 part framework

©2005 KESDEE Inc. All rights reserved. 9 Global Best Practices in Risk and Treasury Management “ The strength of the chain is the strength of the weakest link in the chain. “

©2005 KESDEE Inc. All rights reserved. 10 Global Best Practices in Risk and Treasury Management Integrated, not Fragmented Approach (Asset, Liability, Off-Balance Sheet Items)

©2005 KESDEE Inc. All rights reserved. 11 Global Best Practices in Risk and Treasury Management Best practice institutions take a proactive, not a reactive approach to Risk Management as part of Balance Sheet Management The function is integrated with other business strategies. CASE EXAMPLES

©2005 KESDEE Inc. All rights reserved. 12 Global Best Practices in Risk and Treasury Management Risk Approach

©2005 KESDEE Inc. All rights reserved. 13 Global Best Practices in Risk and Treasury Management Best Practices Institutions view Risk Management not from the perspective of compliance or control but from the perspective of value creation.

©2005 KESDEE Inc. All rights reserved. 14 Global Best Practices in Risk and Treasury Management Best practice institutions have a clear articulation of the amount of risk to be taken. They are quantified, pre-specified, and measurable.

©2005 KESDEE Inc. All rights reserved. 15 Global Best Practices in Risk and Treasury Management Best practice institutions control both the volatility of Net Interest Income (NII), a short-term objective, and Economic Value of Portfolio Equity (EVPE), a long-term objective. A change in the EVPE is a leading indicator of the quality of the future income statement.

©2005 KESDEE Inc. All rights reserved. 16 Global Best Practices in Risk and Treasury Management Best practice institutions manage risk, not eliminate them. The watchwords are: Risk by choice, not by chance Exposure by choice, not by chance Clean bet, not confused bet Bet with your head, not over your head

©2005 KESDEE Inc. All rights reserved. 17 Global Best Practices in Risk and Treasury Management Integration of Credit and Market Risk Best practice institutions ensure that there is integration between credit risk management and market risk management.

©2005 KESDEE Inc. All rights reserved. 18 Global Best Practices in Risk and Treasury Management Integration of Credit and Market Risk Money Vs. Financial “ Value Chain " Risk Management Advisory Services Structured Products

©2005 KESDEE Inc. All rights reserved. 19 Global Best Practices in Risk and Treasury Management Strategic Process Best practice institutions have Risk Management function acting as a catalyst for the formulation of strategies. They ensure that there is a fit between different strategies. They include: On-Balance Sheet Business Strategies On-Balance Sheet Investment/Funding Strategies Off-Balance Sheet Strategies

©2005 KESDEE Inc. All rights reserved. 20 Global Best Practices in Risk and Treasury Management Risk Management Infrastructure Best practice institutions have a balance sheet management process that encompasses on-balance sheet, off-balance sheet, and behind the balance sheet (quality of Risk Management infrastructure) items.

©2005 KESDEE Inc. All rights reserved. 21 Global Best Practices in Risk and Treasury Management Risk Management Infrastructure (Contd..) Best practice institutions have the following elements that constitute a sound risk management system: 1. Active board and senior management oversight 2. Adequate policies, procedures and limits 3. Adequate risk measurement, monitoring and management information systems 4. Comprehensive internal controls

©2005 KESDEE Inc. All rights reserved. 22 Global Best Practices in Risk and Treasury Management Best practice institutions ensure that all the employees read from the same script and sing from the same sheet of music. Every employee of the institution, is sensitized to the issues of Risk Management. All need to march to the same beat of the drum

©2005 KESDEE Inc. All rights reserved. 23 Global Best Practices in Risk and Treasury Management Policy Statement Best practice institutions have a well-articulated policy statement generally approved by the Board of Directors. The policy statement is customized and is not a "cookie cutter" ; they believe that "one size does not fit all"

©2005 KESDEE Inc. All rights reserved. 24 Global Best Practices in Risk and Treasury Management Policy Statement (Contd..) It is articulated to be relevant to the business portfolio mix and their strategic objectives. Rather than have an all-encompassing compendium, they develop the policy statement as a unique "road map" and not as a "world atlas"

©2005 KESDEE Inc. All rights reserved. 25 Global Best Practices in Risk and Treasury Management Policy Statement (Contd…) The policy statement provides a clear direction to the Risk Management function The policy statement is clear, concise, relevant, and timely

©2005 KESDEE Inc. All rights reserved. 26 Global Best Practices in Risk and Treasury Management Derivatives Best practice institutions view derivatives as a double- edged sword - they are not an end but a potential means to accomplishing a strategic objective.

©2005 KESDEE Inc. All rights reserved. 27 Global Best Practices in Risk and Treasury Management Derivatives (Contd…) Major high profile derivative disasters have one major lesson: Derivatives were used not in the context of or in the pursuit of business objectives. So, the lesson is do not put 'cart before the horse'. First, the objectives have to be formulated and then an evaluation is to be made whether derivatives have a role, if any, in accomplishing those objectives.

©2005 KESDEE Inc. All rights reserved. 28 Global Best Practices in Risk and Treasury Management Derivative Strategies Best practice institutions follow simple, easy-to- understand derivatives strategies for their Risk Management; in particular, they avoid exotic products/leveraged structures. The watchword is “ Keep It Simple, Smart ".

©2005 KESDEE Inc. All rights reserved. 29 Global Best Practices in Risk and Treasury Management Analytical Framework Best practice institutions use an eclectic mix of analytical techniques such as gap analysis, simulation, duration, and value at risk depending on the structure of the balance sheet and target variable being measured. No single technique is regarded as better than the others by best practice institutions. They view these techniques as complementary diagnostic tools.

©2005 KESDEE Inc. All rights reserved. 30 Global Best Practices in Risk and Treasury Management Information Reporting Framework Best practice institutions share Risk Management information among employees at right frequency and at the right level of detail. They ensure that the amount/type of information received is appropriate/necessary for the recipients' task. An appropriate balance between information overload and the dearth of information is maintained.

©2005 KESDEE Inc. All rights reserved. 31 Global Best Practices in Risk and Treasury Management Performance Measurement Framework A Case example on:  Hedge/Arbitrage/Speculation  Risk Based Framework

©2005 KESDEE Inc. All rights reserved. 32 Global Best Practices in Risk and Treasury Management Control Framework Best Practice institutions ensure that the Risk Management limits are articulated to place a "ring fence" around operating managers rather than tying their hands with rigid limits. They strive for a judicious balance between "tight controls" and "loose controls".

©2005 KESDEE Inc. All rights reserved. 33 Global Best Practices in Risk and Treasury Management Best Practices institutions primary emphasis is on Strategies for Exposure Reduction and not on techniques for Noise Reduction Examples of noise reduction: Purpose Examples of exposure reduction: Purpose

©2005 KESDEE Inc. All rights reserved. 34 Global Best Practices in Risk and Treasury Management Risk Management and Treasury Management closely linked to business portfolios Corporate Example Financial Institution Example

©2005 KESDEE Inc. All rights reserved. 35 Global Best Practices in Risk and Treasury Management  KNOW WHAT YOU DO NOT KNOW: BACK TESTING  THINK THE UNTHINKABLE: STRESS TESTING

©2005 KESDEE Inc. All rights reserved. 36 Global Best Practices in Risk and Treasury Management How to Implement Global Best Practices ? A Plan of Action: 3-Step Approach

©2005 KESDEE Inc. All rights reserved. 37 Question & Answers ©2005 KESDEE Inc. All rights reserved. 37

©2005 KESDEE Inc. All rights reserved. 38 Thank you ©2005 KESDEE Inc. All rights reserved. 38