Professional Documents
Culture Documents
Presented by –
Address correspondence -
DRIEMS B- School,
Kairapari,Tangi.
Cuttack,754022.
Ph no – (0671) 2695061/062/063/064/065/066.
** Lecturer- Finance, DRIEMS Business School, Tangi, Cuttack- 754022, Orissa, Phone:
+91-0671- 2695061-65 Mobile: 09337026846 Email: sk.tripathy@sify.com
INTRODUCTION-
In spite of the credit crisis if we will open the passage of Indian banking history for
last few days we can get the idea regarding the improvement of Indian banking sector
comparison to other country .So for an emerging sector like banking sector risk is a threat as
well as opportunity .So the concept of risk management is a most important for each banking
organization. Although the concept of ERM has existed before long days still the
implementation part is ineffective. So just before going to know about its implementation lets
first discuss about its framework. Risk management is the identification, assessment, and
prioritization of risks followed by coordinated and economical application of resources to
minimize, monitor, and control the probability and/or impact of unfortunate events. Risks can
come from uncertainty in financial markets, project failures, legal liabilities, credit risk,
accidents, natural causes and disasters as well as deliberate attacks from an adversary.
IMPORTANCE OF RISK MANAGEMENT-
Risk Management is a comprehensive process adopted by banks that seeks to minimize the
adverse effects it is exposed to due to various factors-
economic
political
environmental
some of them inherent to the business , others unforeseen and unexpected
Objective of study-
The objective of the present study is to find out:
SETTING OBJECTIVES
COMMUNICATE &
IDENTIFY RISKS
MONITOR
TREAT RISKS
This framework discusses details about the steps involved in ERM. But the concept of
holistic risk management is narrower than ERM. Holistic risk management is the holistic
approach where all steps involved in ERM is not taken into consideration. That is why it is
called as holistic approach.
Steps involved in enterprise risk management-
1. Setting Objectives
The first step in the ERM process is the setting of objectives. Objectives are simply what an
entity strives to achieve. Objectives can be short-term, or long-term, or they can be
quantitative (numeric), or qualitative (non-numeric).
Objectives should be:
Specific: Objectives should be precisely defined.
Measurable: The method of measuring the objective should be defined.
Agreed to: All interested parties need to agree to the objectives.
Realistic and Attainable: Objectives must realistic and they must be attainable. If
they’re not, then they are superfluous.
Timely: Objectives should be specific as to when they are to be achieved.
Note: As we can see, objectives should be SMART.
A direct benefit of ERM is that it may reveal some objectives that are not clear or understood
by those responsible to achieving them. It’s recommended that time be taken in an effort to
clarify the objectives before moving on to the next step – identifying risks.
EXTERNAL SOURCES:
Comparison with other organizations.
Discussion with peers.
Benchmarking.
Risk consultants.
TOOLS, DIAGNOSTICS, and PROCESSES:
Checklists.
Flowcharts.
Scenario analysis.
Value chain analysis
Business process analysis.
Systems engineering.
Process mapping.
Treating and Controlling Risks
Once the risks have been assessed, management must then decide how it is going to manage
them. In the ERM process there should be a conscious decision about risk. There are different
actions that management can take for any given risk, including:
Transfer the risk to another party. This can be done through signing a long-term
contract with a supplier. You transfer the risk of future price increases.
Avoid the risk. This is generally the not most desirable thing to do, but in some cases,
it may be unavoidable.
Reduce the negative effect of the risk. This might include hedging, or some other
method.
Accept some or all of the consequences of the particular risk. You take on the risk
because you know that if you are successful, you will indeed be very successful.
In this stage, the risks with the greatest loss and the greatest probability of occurring are
handled first, and risks with lower probability of occurrence and lower loss are handled later.
In practice the process can be very difficult, and balancing between risks with a high
probability of occurrence but lower loss vs. a risk with high loss but lower probability of
occurrence can often be mishandled.
• Liquidity Risk:- – Every bank has the need for a certain amount of liquidity in order
to meet short term liability payments. e.g. - net outflows due to unanticipated
withdrawals/non-renewal Compensate for non-receipt of expected inflows of funds &
Crystallization of contingent liability. Liquidity risk will include the risk from positions in
foreign currency denominated assets and liabilities. Potentially large and uneven flows of
funds, in different currencies, will expose the banks to greater fluctuations in their liquidity
position and complicate their asset-liability management as banks can find it difficult to fund
an increase in assets or accommodate decreases in liabilities at a reasonable price and in a
timely fashion.
• Interest rate risk
Interest rate risk can be defined as exposure of bank's net interest income to adverse
movements in interest rates. A bank's balance sheet consists mainly of rupee assets and
liabilities. Any movement in domestic interest rate is the main source of interest rate risk.
Over the last few years the treasury departments of banks have been responsible for a
substantial part of profits made by banks. Between July 1997 and Oct 2003, as interest rates
fell, the yield on 10-year government bonds (a barometer for domestic interest rates) fell,
from 13 per cent to 4.9 per cent. With yields falling the banks made huge profits on their
bond portfolios.
Now as yields go up (with the rise in inflation, bond yields go up and bond prices fall as the
debt market starts factoring a possible interest rate hike), the banks will have to set aside
funds to mark to market their investment.
This will make it difficult to show huge profits from treasury operations. This concern
becomes much stronger because a substantial percentage of bank deposits remain invested in
government bonds.
Banking in the recent years had been reduced to a trading operation in government securities.
Recent months have shown a rise in the bond yields has led to the profit from treasury
operations falling. The latest quarterly reports of banks clearly show several banks making
losses on their treasury operations. If the rise in yields continues the banks might end up
posting huge losses on their trading books. Given these facts, banks will have to look at
alternative sources of investment.
The best indicator of the health of the banking industry in a country is its level of NPAs.
Given this fact, Indian banks seem to be better placed than they were in the past. A few banks
have even managed to reduce their net NPAs to less than one percent (before the merger of
Global Trust Bank into Oriental Bank of Commerce, OBC was a zero NPA bank). But as the
bond yields start to rise the chances are the net NPAs will also start to go up. This will
happen because the banks have been making huge provisions against the money they made
on their bond portfolios in a scenario where bond yields were falling.
Reduced NPAs generally gives the impression that banks have strengthened their credit
appraisal processes over the years. This does not seem to be the case. With increasing bond
yields, treasury income will come down and if the banks wish to make large provisions, the
money will have to come from their interest income, and this in turn, shall bring down the
profitability of banks.
The entry of new generation private sector banks has changed the entire scenario. Earlier the
household savings went into banks and the banks then lent out money to corporate. Now they
need to sell banking. The retail segment, which was earlier ignored, is now the most
important of the lot, with the banks jumping over one another to give out loans. The
consumer has never been so lucky with so many banks offering so many products to choose
from. With supply far exceeding demand it has been a race to the bottom, with the banks
undercutting one another. A lot of foreign banks have already burnt their fingers in the retail
game and have now decided to get out of a few retail segments completely.
The nimble footed new generation private sector banks have taken a lead on this front and the
public sector banks are trying to play catch up.
The PSBs have been losing business to the private sector banks in this segment. PSBs need to
figure out the means to generate profitable business from this segment in the days to come.
In the recent past there has been a lot of talk about Indian Banks lacking in scale and size.
The State Bank of India is the only bank from India to make it to the list of Top 100 banks,
globally. Most of the PSBs are either looking to pick up a smaller bank or waiting to be
picked up by a larger bank.
The central government also seems to be game about the issue and is seen to be encouraging
PSBs to merge or acquire other banks. Global evidence seems to suggest that even though
there is great enthusiasm when companies merge or get acquired, majority of the
mergers/acquisitions do not really work.
So in the zeal to merge with or acquire another bank the PSBs should not let their common
sense take a back seat. Before a merger is carried out cultural issues should be looked into. A
bank based primarily out of North India might want to acquire a bank based primarily out of
South India to increase its geographical presence but their cultures might be very different.
So the integration process might become very difficult. Technological compatibility is
another issue that needs to be looked into in details before any merger or acquisition is
carried out.
The banks must not just merge because everybody around them is merging. As Keynes wrote,
"Worldly wisdom teaches us that it's better for reputation to fail conventionally than succeed
unconventionally". Banks should avoid falling into this trap.
1. They spelled out the target markets, risk acceptance / avoidance levels, risk tolerance
limits, preferred levels of diversification and concentration, credit risk measurement,
monitoring and controlling mechanisms in a precise manner.
2. Prepared a comprehensive credit rating / scoring models being applied in the spheres
of retail and non-retail portfolios of the bank.
In this stage, the risks with the greatest loss and the greatest probability of occurring are
handled first, and risks with lower probability of occurrence and lower loss are handled later.
In practice the process can be very difficult, and balancing between risks with a high
probability of occurrence but lower loss vs. a risk with high loss but lower probability of
occurrence can often be mishandled.
Step 5:
The last but not the least step is to communicate it to all departments also to monitor it to
know the effectiveness of the ERM process. Otherwise we can alter the step of total process
according to our need. This is the final stage of the ERM process. In this final stage,
management has the responsibility to review and make necessary changes in order to mitigate
potential risks that can hinder the achievement of objectives. The goal of ERM is not to
become risk adverse, but to develop and implement a system whereby risk-related
information is able to flow downward, across, and up the company.
In regards to monitoring, activities should periodically reassess risk and the effectiveness of
controls to manage risk.
Presently most Indian banks do not possess the data required for the calculation of their
LGDs. Also the personnel skills, the IT infrastructure and MIS at the banks need to be
upgraded substantially if the banks want to migrate to the IRB Approach.
Findings-
Best practices that companies can use as a reference when implementing ERM. Engage
senior management and board of directors that set “the tone from the top” and provide
organizational support and resources. Independent ERM functions under the leadership of
chief risk officer (CRO), who reports directly to the CEO with a dotted line to the board.
Established ERM framework that incorporates all of the company’s key risks: strategic risk,
business risk, operational risk, market risk, and credit risk. A risk-aware culture fostered by a
common language, training, and education, as well as risk-adjusted measures of success and
incentives. Written policies with specific risk limits and business boundaries, which
collectively represent the risk appetite of the company. An ERM dashboard technology and
reporting capability that integrates key quantitative risk metrics and qualitative risk
assessments. Robust risk analytics to measure risk concentrations and interdependencies,
such as scenario and simulation models. Integration of ERM in strategic planning, business
processes, and performance measurement. Optimization of the company’s risk-adjusted
profitability via risk-based product pricing, capital management, and risk-transfer strategies.
In summary, “ERM is essential in today’s business environment, as an holistic approach
where companies are required to disclose risk factors in the financial reports and the board of
directors regularly questions top management about the company’s risk.”1
1
.
Conclusion -
Enterprise risk management can be a powerful management tool, but its successful
implementation will require, education and training of managers at all levels of the
organization, including the board. But, there are limitations to ERM. Like any program,
human judgment is still required, and human judgment in regards to risks can be faulty; thus
leading to errors or mistakes.
A major weakness to the ERM system is that two or more people can collude together, or
management can override ERM decisions. Thus, even with the best of ERM systems, “these
limitations preclude a board and management from having absolute assurance as to the
achievement of the company’s objectives.”
Bibliography
Articles/newspaper-
1. “A new world of Risks, Best review of life/health insurance” January 2000,page 3,4.
References-
Websites-
1. www.rbi.org
2. www.yahooanswer.com
3. www.albert.com
4. www.google.com
5. www.wikipedia.com