Organisation for Risk Management
Risk organisation consists of :
– The Board of Directors
– The Risk Management Committee of the bord
– The Committee of Senior level Executives
– The Risk Management Support Group
Risk identification
Risk identification involves identifying various risks associated with a transaction, the bank has take at transaction level and then assessing the impact on :the :portfolio and capital return. All transactions in a bank have , one or more of the major risk such as liquidity risk, interest rate risk, market risk, :credit or default risk and operational risk (see example Below).
Certain risks are contracted at transaction level (credit risk) and others happen and managed at the aggregated level such as liquidity risk or interest risk.
Risk Measurement
Measurement of risk is done with the objective of making an assessment about variations in earnings, market value, losses due to default etc because of the uncertainties associated with various risk elements.
The risk measurement may be based on (i) sensitivity (ii) volatility and (iii) downside potential.
(i) Sensitivity : Under this measurement, the deviation in the target variable (say the market value) is measured on the basis of variation in one variable component For example, measurement of the change in market value of a security (say Treasury Bills) as a result of change in interest rate say by 0.5%.
Sensitivity suffers from the drawback that it takes into account variation in only one variable and not all the variables at a time.
(ii) Volatility : The volatility reflects the stability or instability of any random variable. Volatility is the standard deviation (SD which is square root of the variance of the random variable) of the values of different variables. In volatility, it is possible to combine the sensitivity of target variables with the variation of the underlying parameters. Volatility captures upside and downside deviations.
(iii) Downside potential: Downside potential captures the possible loss and ignores the possible profit. Hence it is adverse deviation of a target variable. It has two components i.e. potential losses and probability of occurrence. The Value at Risk (VAR) is the downside risk measure.
Risk pricing
Risk pricing means, while fixing the price of a product, to take into account the risk. This cost of risk is in addition to the normal actual cost incurred on the transaction (may be in the form of infrastructure, employees cost etc). The pricing of a transaction must take into account the cost of risk to that transaction, which may be on two counts.
Hence the pricing of a product should take into accounts (a) cost of funds to be deployed (b) operating expenses (c) loss probability (d) capital cost.
Risk Monitoring and Control
Risk monitoring is essential to understand the change in risk profiles and taking corrective steps. For the purpose of risk control, the banks take following actions:
1 have an appropriate organizational structure
2 adopt a comprehensive risk measurement approach
3 set up a comprehensive risk rating system
4 adopt risk management policies consistent with the broader business strategy, capital strength, risk appetite of the bank
5 place limits on different types of exposures, including the inter-bank borrowings which include call funding purchased funds, core deposits to core assets, off balance sheet commitments, swapped funds etc.
6 take periodical review to ensure its integrity, accuracy and reasonableness.
7 Identification of risk concentration, large exposures etc.
Risk Mitigation
The objective of risk mitigation is to reduce the downward variation in net cash flows_ Risk mitigation stands for take steps to cover, reduce or eliminate the risk, whatever possible. In banking, the risk mitigation techniques and tools dill from case to case.
(a) Credit operation : To mitigate risk, traditionally, the loans are secured by collateral or third party guarantees margins are obtained_ In the present day context, prescription of exposure for individual borrowers, borrowing and industry exposure, capital market exposure etc., regular credit rating of borrowers etc. are the risk mitigants measures.
(b) Interest rate : To mitigate interest rate risk, banks enter in to interest rate swaps, forward rate agreements etc.
(c) Forex transactions : To mitigate forex risk banks used forward agreements, forex options or forex futures.
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