ANUPAMA K

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Risk Management Systems in Banks Genesis,
Significance and Implementation

• ANUPAMA K
• JAYA NAIR
• ANUPAMA S
• MANJU
• JAYSHREE

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CONTENTS

• What is Risk?
• Classification of Risk
• Objectives of Risk Management
• Tools for Managing Risk
• Risk Management in PNB

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RISK

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

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OBJECTIVES OF RISK MANAGEMENT

• Survival of the organization
• Efficiency in Operations
• Uninterrupted Operations
• Identifying and achieving acceptable level of
  risk
• Earning Stability
• Continued and sustained Growth

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CLASSIFICATION OF RISKS

• RISKS

FINANCIAL RISK
NON FINANCIAL RISK
OPERATING RISK
CREDIT RISK
MARKET RISK
SYSTEMATIC RISK
POLITICAL RISK
TRANSACTION RISK
INTEREST RATE RISK
HUMAN RISK
PORTFOLIO RISK
LIQUIDITY RISK
TECHNOLOGY RISK
FOREX RISK
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CREDIT RISK Risk that the counterparty will fail
to perform or meet the obligation on the agreed
terms .

• TYPES OF CREDIT RISKS
• Transaction Risk
• Risk relating to specific trade transactions,
  sectors or groups.
• Portfolio Risk
• Risk arising from lending to sectors non
  related to the core competencies of the Bank /
  concentrated credits to a particular sector /
  lending to a few big borrowers.

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MARKET RISKMarket risk is the risk to a banks
financial condition that could result from
adverse movements in market price.

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

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TYPES OF MARKET RISK (continued)

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

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NON-FINANCIAL RISKS

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

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MANAGEMENT OF CREDIT RISK

• Measurement through Credit Rating / scoring
• Quantification through estimate of expected loan
  losses
• Pricing on a scientific basis
• Controlling through Effective loan review
  mechanism and portfolio management

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TOOLS OF CREDIT RISK MANAGEMENT

• EXPOSURE CEILINGS Setting of prudential norms
  related to the Banks exposure to a single
  borrower / group borrowers / sectorial borrowers
• REVIEW / RENEWAL This involves multi-tier
  credit approving authority, constitution wise
  delegation of powers, higher delegated powers for
  better rated borrowers, discriminatory time for
  credit review / renewal, hurdle rates /
  benchmarks for fresh exposures periodicity for
  renewal based on risk rating.

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• COMPREHENSIVE RISK RATING MODELS
• RISK BASED SCIENTIFIC PRICING Linking loan
  pricing to expected loss
• PORTFOLIO MANAGEMENT Stipulate quantitative
  ceiling on specific rating categories,
  distribution of borrowers in various industries /
  business groups , rapid portfolio reviews,
  on-going system for identification of credit
  weaknesses well in advance, initiate steps to
  preserve the desired portfolio quality and
  integrate portfolio reviews with credit decision
  making process.

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TOOLS OF CREDIT RISK MANAGEMENT

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

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RISK MANAGEMENT IN PNB

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

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RISK MANAGEMENT IN PNB(contd)

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

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• Bank is also developing framework for estimating
  LGD (Loss Given Default) and EAD ( Exposure at
  Default) and also framework for identifying
  concentration risk. A data warehouse is being
  established for effective data management and use
  of application tools for quantification of risks.
• For the Market risk bank has a Mid-Office with
  separate desks for Treasury Asset Liability
  Management (ALM). Asset Liability Management
  Committee (ALCO) is primarily responsible for
  establishing the market Risk Management, asset
  liability management of the bank, implementing
  the risk management of the bank. The policies for
  hedging and mitigating risk are discussed in
  ALCO.

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• A separate independent Division known as Credit
  Audit Review Division has been formed to ensure
  LRM implementation. LRM examines compliance with
  extant sanction and post-sanction
  process/procedures laid down by the Bank from
  time to time.
• Preventive Monitoring System (PMS) It is a tool
  used by bank for detection of early warning
  signals with a view to prevent/minimize the loan
  losses.

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

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CONCLUSION

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

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Hope you have enjoyed our presentation.

• Thank you