RISK MANAGEMENT
PRESENTATION ON
CREDIT RISK
AND
MARKET RISK
By
S.D.BARGIR, Joint Director, IIBF
Risk may be defined as
exposure to uncertainty
favourable
or unfavourable
outcomes
aims at mitigating the loss
managing risk rather than on
eliminating it
Risk management is a four
steps process
Identifying
Measuring
( quantifying)
Managing
controlling,
reviewing
monitoring and
Three generic categories of
risk
Credit
risk
Market
risk
Operational
risk
Credit Risk
credit
risk means default of the
borrower or deterioration of
borrowers credit quality.
Market Risk
arising from movement in market prices
Interest Rate Risk,
Exchange Rate Risk,
Commodities Price risk
Equity Price Risk.
Operational Risk
loss resulting from inadequate or failed
internal processes
People
systems or
external events.
Credit Risk
defaults take various forms
Direct Lending:Loan amount
(Principal as well as interest) will not
be paid
Guarantees/ Letter of Credit
etc.Funds will not be forthcoming
upon crystallization of liability
Credit Risk
defaults take various forms
Treasury Products payment due from the
counter parties either stops or not
forthcoming
Securities Trading Settlement will not be
effected
Cross boarder exposure: free transfer of
currency is restricted or comes to an end.
credit risk, consists of three
risks
Default risk
Exposure risk
Recovery risk
Default risk
is the probability of an event of default
depends upon credit standing of the counter
party.
default probability cannot be measured directly.
guidance from historical statistics on large
sample over long period of time.
bank faces difficulty in obtaining accurate
historical data.
Exposure risk
uncertainty
associated
with
future
amounts
credit
linesrepayment
scheduleexposure risk small
other lines of credit -OD, project financing
, guarantees etc- risk cannot be predicted
accurately
Recovery risk:
recoveries in the event of default not
predictable
depend upon type of default
availability of collaterals, third party
guarantees
circumstances surrounding the default.
Expected Losses &
Unexpected Losses
EL
depends
upon
default
probability(PD), Loss given default
(LGD)& exposure at risk (EAD)
EL = PD x LGD x EAD
Unexpected
losses (UL) is the
uncertainty around EL and it is
Standard deviation of EL.
challenges faced by banks
in r/o EL
aggregation
of the risk-related
information to assess the PD,
LGD and EAD
implementation of a risk rating
system that can correctly model
these parameters which is
statistically valid.
BASEL
Basel Committee on Banking supervision
(BCBS) under the auspices of Bank for
International Settlements (BIS)
Established in 1975 by group of 10
countries
Belgium, Canada, France, Germany, Italy,
Japan, Luxembourg, the Netherlands,
Spain, Sweden, Switzerland, the United
Kingdom and the United States.
Basel II-Implementation in
India
with
effect from March, 31,
2007 by commercial banks.
90 commercial Banks in
India
100 countries
Basel II
capital requirements more risk sensitive
directly related to the credit rating of
each counter-party instead of counterparty category
capital for credit and market risk but also
for operational risk (OR)
where warranted for interest rate risks,
credit concentration risks, liquidity risks
SME sector
BASEL II RESTS ON THE
THREE PILLARS,
Pillar
I
Minimum
Capital
Requirements
Pillar 2 Supervisory Review Process
Pillar 3 Market Discipline
each pillar is as important as the other one
Pillar
Minimum
Requirements
Capital
menu of approaches for computing
capital adequacy
freedom to choose the approach
minimum, the Standardized Approach for
credit risk
Basic Indicator Approach for operational
risk
standardised Approach or Internal Risk
Measurement Models approach for
market risk
Various Approaches
Credit Risk
Market Risk
Standardized
Approach(SA)
Standardized Basic
Approach(SA)
Indicator
Approach
BasicInternal Risk
Based(IRB)
Internal Risk
Advanced
IRB
Measurement
Model
Operational
Risk
Standardized
Approach(SA)
The internal
measurement
approach
Pillar 2- Supervisory
Review
encourage to adopt better risk
management techniques
intervene to mandate a higher capital
requirement
more inclusive besides CR,MR,OR credit
concentration risk Interest rate risk in
banking book, Liquidity risk, Business
risk, Strategic risk and Reputation risk.
Takes into account Business cycle effects
too
RISK BASED SUPERVISION
(RBS)
Business Risk Factors
1. Capital,
2. Credit Risk,
3. Market Risk,
4. Earnings risk,
5. Liquidity Risk,
6. Business
Strategy
and
Environment
Risk,
7. Operational Risk
8. Group Risk.
Control Risk Factors
1. Internal
Controls
Risk,
2. Organisation risk,
3. Management Risk
4. Compliance Risk.
Pillar 3- Market
Discipline
disclosures to enhance market
discipline
Monitoring by markets- other banks,
customers, depositors, subordinated
debt instrument holders, analysts &
rating agencies
disclosure policy approved by Board
financial penalty, for non-compliance
INITIATIVES BY RBI
each bank has suitable risk management
framework and the expected level of
capital
introduced RBS In 23 banks on a pilot
basis
encouraged all banks to operationalise
CAAP
expanded the area of disclosures
encouraged some banks to migrate from
SA to IRB approaches
Standardised Approach Different
categories of obligors
Corporates
Sovereign
Bank
Retail
Real Estate
Specialized Lending
Issues emerging out of
Basel II
higher capital requirements
improved IT architectures
data issues
consolidation
capacity building
external ratings
use of national discretion
validating the concept of economic
capital
Capital
requirements
CORPORATES in Basel II
Unrated
credit
rating
AAA to A+
AA
A-
RW
100%
100%
100%
100%
100%
CapitalBasel I
8%
8%
8%
8%
8%
RW
20%
50%
100%
150%
100%
CapitalBasel II
1.6%
4%
8%
12%
8%
Basel I
Basel II
to BBB+ Below
to BB- BB-
for
Capital
requirements
SOVEREIGN in Basel II
AAA to A+
AA
A-
to BBB+ BB to
to BB- BB-
for
Below
BB-
Unrated
100%
100%
100%
100%
100%
100%
8%
8%
8%
8%
8%
8%
20%
50%
100%
150%
100%
1.6%
4%
8%
12%
8%
Capital
requirements
BANKS in Basel II
AAA to A+
AA
A-
to BBB+ BB to
to BB- BB-
for
Below
BB-
Unrated
100%
100%
100%
100%
100%
100%
8%
8%
8%
8%
8%
8%
20%
50%
100%
100%
150%
100%
1.6%
4%
8%
12%
8%
8%
Capital
requirements
BANKS in Basel II
AAA to A+
AA
A-
to BBB+ BB to
to BB- BB-
for
Below
BB-
Unrated
100%
100%
100%
100%
100%
100%
8%
8%
8%
8%
8%
8%
20%
50%
100%
100%
150%
100%
1.6%
4%
8%
12%
8%
8%
Capital
requirements
RETAIL in Basel II
RETAIL
RW under
Basel I
RW under
Basel II
for
INDIVIDUAL
OR SMALL
BUSINESS
100%
DEFAULT
75%
From 150%
to 50%
Capital under 6%
Basel II
100%
4% to 12%
Capital requirements for REAL
ESTATE in Basel II
RETAIL
RW BASEL I
RESIDENTIAL COMMERCIAL
50%
100%
Capital under 4%
Basel I
8%
RW under
Basel II
100%
35%
Capital under 2.7%
Basel II
8%
SPECIALISED LENDDING
PROJECT FINANCE
COMMODITIES,COM.
REAL ESTATE
RW UNDER BASEL I 100%
CAPITAL Basel I
8%
RW UNDER BASEL II 100%
CAPITAL BASEL II
8%
Assessing exposure customer
wise and facility wise
Probability of Default (PD) - the
probability that a specific customer will
default within the next 12 months.
Loss Given Default (LGD) - the
percentage of each credit facility that will
be lost if the customer defaults.
Exposure at Default (EAD) - the
expected exposure for each credit facility
in the event of a default.
MARKET RISK
Market risk takes the form of
interest rate risk, exchange
rate risk, commodity price risk
and equity price risk , major
risk presently faced by banks in
India
are
interest
rate
,exchange rate and liquidity
risk.
MARKET RISK-CONTINUED
Basel-I focused only on credit risk
excluding the market risk
Risk brought vide amendments in 1996
usually measured with a Value-at-Risk
method and on daily basis
capital charge should be either the
previous days VaR or three times the
average of the daily VaR for the
preceding 60 working days.
Stipulations of RBI
Assign additional risk weight of 2.5% on
the entire investment portfolio
Assign risk weight of 100% on the open
position limit on foreign exchange and
gold
Build investment fluctuation reserve up
to a minimum of 5% of the investment
held in Held for Trading(HFT) and
available for sale(AFS) category in their
investment portfolio
Linking risk to capitalsingle metric
Risk measurement focuses on unexpected
losses
Different business activities lead to
various unexpected losses
These different risks must be measured
individually and aggregated to a single
risk metric, both by business line and
across the bank as a whole
WINNING FORMULA
Overall risk should always
be lower than overall
economic capital
