RISK MANAGEMENT IN BANKS

By Shyam Ji Mehrotra

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Overview of Bank Financial Management

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Wind of change
Competition is opening opportunity as well threats To raise capital time and again to meet CRAR norms - Now Basel III Various risk in banking business

Credit risk Market risk covering liquidity risk, interest rate risk, forex-risk Operational risk

Complexity of risk
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Bank Financial Management Objectives

Optimize shareholders wealth

Stabilize and Increase net interest margin (NIM) Improve ROA as well as ROE Improve market share (Top line)
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Bank Financial Management

Financial Management
Working capital decision Capital budgeting decisions Financing decisions

Bank Financial Management

Liquidity and interest rate management decisions Credit and cost management decisions Funding decisions

Dividend distribution Capital account management decisions management decisions

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Five critical Management variables

Variables I II Nature Liquidity Management Interest rate risk management

III
IV V

Capital account management

Cost (Productivity ) Management Credit risk management

All
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Profitability management
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CAMEL MODEL
C

A
M

E
L
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Cost management and credit risk management The A in asset and liability management refers to liquidity management Managerial expertise (or hump of the camel) in dealing with all five critical financial management variables simultaneously Equity or capital account management The L in asset and liability management refers to Interest Rate risk management
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Financial Risk

Definition of risk
likely loss given an event

Identify various type of risk

Credit risk Market risk Operational risk

Measure risk
quantify the likely loss because of exposure

Integrated risk management system

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Credit risk
Defined as the potential that a bank borrower or counterparty will fail to meet its obligations in accordance with agreed terms Either failing to repay the loan or service as per loan agreement

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Credit risk-examples
Direct lending- repayment is not made Non fund- funds not forthcoming on crystallization of LC/BG Series of payment due from bonds are not forthcoming on due dates Security trading- settlement not forthcoming Cross border exposure- currency movement not taking place

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Market risk
Losses in on and off balance sheet items arising from movement in market prices Main market risks are

Interest rate risks Exchange rate risks Commodity price risks Equity price risks Liquidity risks
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Interest rate risk

Mismatch or Gap risk Basis risk Embedded option risk Reinvestment risk Price risk

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Operational Risk
Direct or indirect loss due to failed internal process or people or system or from external events Include legal risk as well

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Integrated risk management process

Identify risk Set objectives relative to risk Measure and monitor risk Communicate risk tolerance Control risk

Risk mitigation

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