Indian Banking System

Risk Management Structure / Framework in Banks

A major issue in establishing an appropriate risk management organization structure is choosing between a centralized and decentralized structure. The global trend is towards centralizing risk management with integrated treasury management function to benefit from information on aggregate exposure, natural netting of exposures, economies of scale and easier reporting to top management.

The primary responsibility of understanding the risks run by the bank and ensuring that the risks are appropriately managed should clearly be vested with the Board of Directors. The Board should set risk limits by assessing the bank’s risk and risk-bearing capacity.

At organizational level, overall risk management should be assigned to an independent Risk Management Committee or Executive Committee of the top Executives that reports directly to the Board of Directors.… Read the rest

Abey Francis

Maturity Gap Analysis and Duration Gap Analysis

Maturity Gap Analysis

The simplest analytical techniques for calculation of IRR exposure begins with maturity Gap analysis that distributes interest rate sensitive assets, liabilities and off-balance sheet positions into a certain number of pre-defined time-bands according to their maturity (fixed rate) or time remaining for their next repricing (floating rate). Those assets and liabilities lacking definite repricing intervals (savings bank, cash credit, overdraft, loans, export finance, refinance from RBI etc.) or actual maturities vary from contractual maturities (embedded option in bonds with put/call options, loans, cash credit/overdraft, time deposits, etc.) are assigned time-bands according to the judgement, empirical studies and past experience of banks.… Read the rest

Abey Francis

Interest Rate Risk in Banking

The management of interest rate risk should be one of the critical components of market risk management in banks. The regulatory restrictions in the past had greatly reduced many of the risks in the banking system. Deregulation of interest rates has, however, exposed them to the adverse impacts of interest rate risk.

Interest rate risk in banking is the potential negative impact on the Net interest income and it refers to the vulnerability of an institutions financial condition to the movement in interest rates. Changes in interest rate affect earnings, value of assets, liability, off-balance sheet items and cash flow. Hence, the objective of interest rate risk management is to maintain earnings, improve the capability, ability to absorb potential loss and to ensure the adequacy of the compensation received for the risk taken and effect risk return trade-off.… Read the rest

Abey Francis

Liquidity Risk in Banking

Liquidity planning is an important facet of risk management framework in banks. Liquidity is the ability to efficiently accommodate deposit and other liability decreases, as well as, fund loan portfolio growth and the possible funding of off-balance sheet claims. A bank has adequate liquidity when sufficient funds can be raised, either by increasing liabilities or converting assets, promptly and at a reasonable cost. It encompass the potential sale of liquid assets and borrowings from money, capital and Forex markets. Thus, liquidity should be considered as a defense mechanism from losses on fire sale of assets.

Liquidity risk in banking is the potential inability of a bank to meet its payment obligations in a timely and cost effective manner.… Read the rest

Abey Francis

Operational Risks in Banks

“Operational Risk is defined as the risk of direct or indirect loss resulting from inadequate or failed internal processes, people and system or from external events.”

Generally, operational risk is defined as any risk, which is not categorized as market or credit risk, or the risk of loss arising from various types of human or technical error. It is also synonymous with settlement or payments risk and business interruption, administrative and legal risks. Operational risk has some form of link between credit and market risks. An operational problem with a business transaction could trigger a credit or market risk.

Indeed, so significant has operational risk become that the Bank for International Settlement (BIS) has proposed that, as of 2006, banks should be made to carry a Capital cushion against losses from this risk.… Read the rest

Abey Francis

Market Risk Management in Indian Banks

Traditionally, credit risk management was the primary challenge for banks. With progressive deregulation, market risk arising adverse changes in market variables, such as interest rate, foreign exchange rate, equity price and commodity price has become relatively more important. Even a small change in market variables causes substantial changes in income and economic value of banks.

Market Risk may be defined as the possibility of loss to a bank caused by the changes in the market variables. It is the risk that the value of on/off-balance sheet positions will be adversely affected by movements in equity and interest rate markets, currency exchange rates and commodity prices.… Read the rest

Abey Francis