Description
This is a presentation highlights credit risk measurement and monitoring procedures.
Overview of Risks, Regulatory Issues & Guidelines for managing risks
Risk & Risk Management
What is risk? ? Risk relates to unexpected events ? Risk measures unexpected losses—loss in asset value or loss in earnings ? Risk management means taking risks within limits, not avoiding risks Objective: To optimize risk adjusted returns ? Risk management is a process that identifies, measures, monitors and control risks.
Risk Tree for Banks
Bank Risk Balance Sheet Risk Credit Risk Default Risk Market Risk Portfolio Risk Technology Risk Equity Currency Liquidity Interest Rate Risk Risk Risk Risk Other Risks: Liquidity Risk, Credit Concentration Risk, Reputational Risk, Residual Risk, Strategic Risk etc. Delivery Risk Operational Risk Legal Risk
Risk Profile of Banks
Risk Profile
Other Risks Op. Risk Liq. Risk Credit Risk
Mkt. Risk
Credit Risk
Credit risk is : ? a possibility that an obligor fails to meet his obligations in accordance with agreed terms (Default Risk).
? the volatility of losses, asset values or asset returns on credit portfolio (Portfolio Risk).
Building blocks of Credit Risk Management ? A) Policy and Strategy ? b) Organisational Structure ? c) Operations/ Systems
Policy and Strategy
? Credit Risk Policy approved by the Board. ? Document should include risk identification, risk measurement, risk grading/ aggregation techniques, reporting and risk control/ mitigation techniques, documentation, legal issues and management of problem loans. ? Define target markets, risk acceptance criteria, credit approval authority, credit origination/ maintenance procedures and guidelines for portfolio management. ? Policy guidelines to be implemented.
Organisational Structure
Board of Directors Risk Management Committee
Credit Risk Management Committee Credit Risk Management Department
Operations/ Systems
? Relationship management phase i.e. business development. ? Transaction management phase covers risk assessment, loan pricing, structuring the facilities, internal approvals, documentation, loan administration, on going monitoring and risk measurement. ? Portfolio management phase entails monitoring of the portfolio at a macro level and the management of problem loans.
Credit risk measurement and monitoring procedures
? Banks should establish ? Proactive credit risk management practices like annual / half yearly industry studies and individual obligor reviews, periodic visits of plant and business site, and at least quarterly management reviews of troubled exposures/weak credits.
Credit risk measurement and monitoring procedures
? System of checks and balances in place for extension of credit viz.: ? Separation of credit risk management from credit sanction ? Multiple credit approvers making financial sanction subject to approvals at various stages viz. credit ratings, risk approvals, credit approval grid, etc. ? The level of authority required to approve credit will increase as amounts and transaction risks increase and as risk ratings worsen. ? An independent audit and risk review function.
Credit risk measurement and monitoring procedures
? Every obligor and facility must be assigned a risk rating. ? Mechanism to price facilities depending on the risk grading of the customer, and to attribute accurately the associated risk weightings to the facilities. ? Consistent standards for the origination, documentation and maintenance for extensions of credit. ? Consistent approach towards early problem recognition, the classification of problem exposures, and remedial action.
Credit risk measurement and monitoring procedures
? Diversified portfolio of risk assets; system to conduct regular analysis of the portfolio and ensure ongoing control of risk concentrations. ? Credit risk limits - obligor limits and concentration limits by industry or geography. ? Boards should authorize efficient and effective credit approval processes for operating within the approval limits. ? To accurately, completely and in a timely fashion, report the comprehensive set of credit risk data into the ? independent risk system.
Credit risk measurement and monitoring procedures
? Systems and procedures for monitoring financial performance of customers and for controlling outstanding within limits. ? A conservative policy for provisioning in respect of nonperforming advances. ? Clear, well-documented scheme of delegation of powers for credit sanction. ? Banks must have a Management Information System (MIS), which should enable them to manage and measure the credit risk inherent in all on- and offbalance sheet activities.
Credit Risk Modeling
? Credit risk model would also seek to determine the (quantifiable) risk that the promised cash flows will not be forthcoming. ? The credit risk models are intended to aid banks in quantifying, aggregating and managing risk across geographical and product lines. The outputs of these models also play increasingly important roles in banks’ risk management and performance measurement processes, customer profitability analysis, risk-based pricing, active portfolio management and capital structure decisions. Credit risk modeling may result in better internal risk management and may have the potential to be used in the supervisory oversight of banking organisations.
Market Risk
? Market Risk may be defined as the possibility of loss to a bank caused by changes in the market variables. viz. ? Interest Rate ? Foreign Exchange rates ? Equity Price ? Commodity Price ? Thus, Market Risk is the risk to the bank’s earnings and capital due to changes in the market level of interest rates or prices of securities, foreign exchange and equities, as well as the volatilities of those changes.
Organizational Structure
? The Board of Directors ? The Risk Management Committee ? The Asset-Liability Management Committee (ALCO) ? The ALM support group/ Market Risk Group ? Mid-Office
Role of ALCO
? Product pricing for deposits and advances ? Deciding on desired maturity profile and mix of incremental assets and liabilities ? Articulating interest rate view of the bank and deciding on the future business strategy ? Reviewing and articulating funding policy ? Decide the transfer pricing policy of the bank ? Reviewing economic and political impact on the balance sheet
Why there is Interest Rate Risk?
? On account of Banks core business being financial intermediation and asset transformation. ? Due to periodical renewal of assets and liabilities. ? Due to mismatches between maturity/ repricing dates as well as maturity amounts between Assets and Liabilities ? Since depositors and borrowers can preclose their accounts
Types of Interest Rate Risk
? ? ? ? ? Gap or Mismatch Risk Basis Risk Yield Curve Risk Embedded Option Risk Price Risk - Bond prices and interest rates are inversely related ? Reinvestment Risk – Uncertainty to correctly predict the interest rates at which future cash flows will be invested. ? Revaluation Risk/Regulatory Risk - Occurs when revaluation of assets are to be done as per regulatory prescriptions
Measures of IRR
? Maturity Gap Analysis – to measure interest rate sensitivity of earnings or NII ? Duration Gap Analysis – to measure interest rate sensitivity of equity ? Simulation ? Value at Risk
IRR Management - Rising Interest Rate Scenario
? ? ? ? ? Reduce investment portfolio maturities Increase floating rate assets Increase short-term assets Increase long-term deposits/borrowings Sell fixed rate assets
IRR Management - Falling Interest Rate Scenario ? Increase maturities of investment portfolio ? Increase fixed rate loans ? Increase short-term deposits/borrowings (reduce maturity of liabilities) ? Increase floating rate deposits
Liquidity Risk
? Liquidity represents the ability of a bank to accommodate decrease in liabilities and fund in increase in assets as they become due. ? It is essential for all the banks to meet the expected and unexpected balance sheet fluctuations as also provide funds for asset growth. ? A banks inability to meet the required liquidity needs is called liquidity risk.
Impact of Liquidity Risk
? Liquidity risk can arise from either internal or external factors. ? A bank can raise liquidity either by increasing its liabilities or converting some of its assets. ? Excess liquidity- loss of returns or less profit. ? Inadequate liquidity - can be disastrous.
Sources of Liquidity Risk
Uncertainty of: • Depositors behaviour • Demand for credit • Environment in the Financial Market • Major developments - Domestic or international
Types of Liquidity risks
? Funding Risk Need to replace net outflows due unanticipated withdrawal/non-renewal deposits ? Time Risk Need to compensate for non-receipt expected inflows of funds- NPAs ? Call Risk Due to crystallisation of contingent liabilities needs of new business to of
of
&
Measurement of Liquidity
Stock approach - Employing ratios
? Volatile Liability Dependence Ratio Volatile Liabilities minus Temporary Investments to Earning Assets net of Temporary investments Shows the extent to which bank’s reliance on volatile funds to support LT assets ? Growth in Core Deposits to growth in assets Higher the ratio the better ? Purchased Funds to Total Assets ? Loan Losses to Net Loans
Measurement of Liquidity ? Cash flow approach:
? Preparing a structural liquidity by taking into a/c b/s on particular date and place in maturity ladder according to time buckets ? Identify the liquidity needs - to evolve methods to meet it. ? Negative gaps in individual time buckets indicate the need. The need could be controlled by ? prudential limits ? as also by regulating the basis of business structure/financial flexibility of banks ? Regulatory Limit on outflows in first four time buckets
Prudential limits for managing liquidity
? ? ? ? ? ? ? Cap on inter-bank borrowings & Call money Outside funds vis-a-vis liquid assets Core Deposits vis-à-vis Core Assets Duration of liabilities and investment portfolio Need to monitor high value deposits Maximum Cumulative Outflows Track Commitments given to corporates and banks to limit off-balance sheet exposure ? Monitor Swapped Funds Ratio- i.e, extent of Indian Rupees raised out of foreign currency sources
Contingency plans for Liquidity management
? Banks to prepare & submit annual contingency plans to ALCO for approval. ? Contingency plans -liquidity stress tests - reveal the impact on B/S in adverse liquidity conditions. ? Contingency Plans to include : Normal conditions Bank specific conditions Market specific crises
Foreign Exchange Risk
? Maybe defined as the risk that a bank may suffer losses as a result of adverse exchange rate movements during a period in which it has an open position, either spot or forward, or a combination of the two, in an individual foreign currency. ? Banks are also exposed to interest rate risk, which arises from the maturity mismatching of foreign currency positions.
Managing Foreign Exchange Risk
? Open position limits Daylight limit and the Overnight limit. ? The daylight limit is substantially higher for two reasons, (a) It is easier to manage exchange risk when the market is open and the bank is actively present in the market and (b) the bank needs a higher limit to accommodate client flows during business hours. Overnight position, being subject to more uncertainty and therefore being more risky should be much lower.
Foreign Exchange Risk
Risk inherent to running open foreign Exchange position. ? Banks are also exposed to interest rate risk arising from maturity mismatching of foreign currency positions. ? Banks also face the risk of default of the counter-parties or settlement risk. ? Forex transactions with counter-parties from another country also triggers sovereign or country risk.
Forex Risk Management & Measures
? Setting up appropriate limits- open position and gaps. ? Clear-cut and well-defined division of responsibility between front, middle and back offices. ? VaR approach to measure risk associated with exposures should also be adopted.
Tools and Techniques for managing forex risk ? Hedging forex risk by derivatives like forwards, futures, options. ? Measurement of forex VaR.
Equity Price Risk, Commodity Price Risk ? Equity Price Risk: Probability of loss due to changes in the equity price. Measurement ? Commodity Price Risk: Probability of loss associated with the dealing of a commodity.
Operational Risk
? Risk of loss resulting from inadequate or failed internal processes, people and systems or from external events. ? Basel Committee has identified the following types of operational risk events as having potential to result in substantial losses.
? ? ? ? ? ? ? Internal fraud External fraud Employment practices and workplace safety Clients, products and business practices Damages to physical assets Business disruption & system failures Execution, delivery and process management
Operational Risk
? Outsourcing results in banks being exposed to operational risk and other risks like Strategic Risk, Reputation Risk, Compliance Risk, Legal Risk, Exit Strategy Risk, Counterparty Risk, Country Risk, Contractual Risk, Access Risk, Concentration and Systemic Risk.
? As IT has become widely and deeply interconnected and involved with business operations, IT Risk has grown into prominence. Within Operational Risk Management, IT Risk Management is emerging as separate practice because of unique role played by IT in today’s organizations.
Assessment of Operational Risk
? Self Risk Assessment ? Risk Mapping ? Key Risk Indicators
Measuring Operational Risk
? Measuring operational risk requires identification of the underlying operational risk factors. ? No uniform approach for measurement of operational risk in the banking system. ? Existing methods are experimental. ? Some of the international banks have made considerable progress in developing advanced techniques for allocating capital with regard to operational risk. ? Measuring operational risk involves estimating the probability of an operational loss event and the potential size of the loss. This requires collection of huge data on Loss events and operational losses as well as near miss Operational losses. ? Indian banks are in the process of developing scientific methods for quantifying operational risk.
Integrated Risk Management / Enterprise-wide Risk Management (ERM)
? An enterprise can manage risks in one of the following two ways: ? One risk at a time on a largely compartmentalized and decentralized basis (Silo Approach); or ? All risks viewed together within a coordinated and strategic framework; ? Managing risks by silos does not work because risks are highly interdependent and cannot be segmented and manages solely by independent units. A segmented approach does not provide senior management and the Board with aggregated risk reporting.
ERM
? ERM creates value through its effects on companies at both macro (enterprise-wide) level and micro level (business-unit level). ? Macro level: Creates value by enabling senior management to quantify and manage the risk-return tradeoff that faces the entire enterprise. Helps the enterprise to maintain access to the capital markets and other resources necessary to implement its strategy and business plan. ? Micro level: ERM becomes a way of life for managers and employees at all levels.
ERM- Objective
? A well-designed ERM system ensures that ? all material risks are “owned” and ? risk-return tradeoffs carefully evaluated by operating managers and employees throughout the enterprise.
? What management can accomplish through ERM is? not to minimize or eliminate, ? but rather to limit, the probability of distress to a level that management and the board agrees is likely to maximizes firm value. ? Management’s job is to optimize the firm’s risk portfolio by trading off the probability of large shortfalls and the associated costs with the expected gains from taking risks.
ERM- Conceptual Framework
? Management begins by determining the firm’s risk appetite, a key part of which is choosing the probability of financial distress that is expected to maximize firm value. (When credit ratings are used as the primary indicator of financial risk, the firm determines an optimal or target rating based on its risk appetite and the cost of reducing its probability of financial distress.) ? Given the firm’s target rating, management estimates the amount of capital it requires to support the risk of its operations. ? Management determines the optimal combination of capital and risk that is expected to yield its target rating.
Thank You
doc_916671684.ppt
This is a presentation highlights credit risk measurement and monitoring procedures.
Overview of Risks, Regulatory Issues & Guidelines for managing risks
Risk & Risk Management
What is risk? ? Risk relates to unexpected events ? Risk measures unexpected losses—loss in asset value or loss in earnings ? Risk management means taking risks within limits, not avoiding risks Objective: To optimize risk adjusted returns ? Risk management is a process that identifies, measures, monitors and control risks.
Risk Tree for Banks
Bank Risk Balance Sheet Risk Credit Risk Default Risk Market Risk Portfolio Risk Technology Risk Equity Currency Liquidity Interest Rate Risk Risk Risk Risk Other Risks: Liquidity Risk, Credit Concentration Risk, Reputational Risk, Residual Risk, Strategic Risk etc. Delivery Risk Operational Risk Legal Risk
Risk Profile of Banks
Risk Profile
Other Risks Op. Risk Liq. Risk Credit Risk
Mkt. Risk
Credit Risk
Credit risk is : ? a possibility that an obligor fails to meet his obligations in accordance with agreed terms (Default Risk).
? the volatility of losses, asset values or asset returns on credit portfolio (Portfolio Risk).
Building blocks of Credit Risk Management ? A) Policy and Strategy ? b) Organisational Structure ? c) Operations/ Systems
Policy and Strategy
? Credit Risk Policy approved by the Board. ? Document should include risk identification, risk measurement, risk grading/ aggregation techniques, reporting and risk control/ mitigation techniques, documentation, legal issues and management of problem loans. ? Define target markets, risk acceptance criteria, credit approval authority, credit origination/ maintenance procedures and guidelines for portfolio management. ? Policy guidelines to be implemented.
Organisational Structure
Board of Directors Risk Management Committee
Credit Risk Management Committee Credit Risk Management Department
Operations/ Systems
? Relationship management phase i.e. business development. ? Transaction management phase covers risk assessment, loan pricing, structuring the facilities, internal approvals, documentation, loan administration, on going monitoring and risk measurement. ? Portfolio management phase entails monitoring of the portfolio at a macro level and the management of problem loans.
Credit risk measurement and monitoring procedures
? Banks should establish ? Proactive credit risk management practices like annual / half yearly industry studies and individual obligor reviews, periodic visits of plant and business site, and at least quarterly management reviews of troubled exposures/weak credits.
Credit risk measurement and monitoring procedures
? System of checks and balances in place for extension of credit viz.: ? Separation of credit risk management from credit sanction ? Multiple credit approvers making financial sanction subject to approvals at various stages viz. credit ratings, risk approvals, credit approval grid, etc. ? The level of authority required to approve credit will increase as amounts and transaction risks increase and as risk ratings worsen. ? An independent audit and risk review function.
Credit risk measurement and monitoring procedures
? Every obligor and facility must be assigned a risk rating. ? Mechanism to price facilities depending on the risk grading of the customer, and to attribute accurately the associated risk weightings to the facilities. ? Consistent standards for the origination, documentation and maintenance for extensions of credit. ? Consistent approach towards early problem recognition, the classification of problem exposures, and remedial action.
Credit risk measurement and monitoring procedures
? Diversified portfolio of risk assets; system to conduct regular analysis of the portfolio and ensure ongoing control of risk concentrations. ? Credit risk limits - obligor limits and concentration limits by industry or geography. ? Boards should authorize efficient and effective credit approval processes for operating within the approval limits. ? To accurately, completely and in a timely fashion, report the comprehensive set of credit risk data into the ? independent risk system.
Credit risk measurement and monitoring procedures
? Systems and procedures for monitoring financial performance of customers and for controlling outstanding within limits. ? A conservative policy for provisioning in respect of nonperforming advances. ? Clear, well-documented scheme of delegation of powers for credit sanction. ? Banks must have a Management Information System (MIS), which should enable them to manage and measure the credit risk inherent in all on- and offbalance sheet activities.
Credit Risk Modeling
? Credit risk model would also seek to determine the (quantifiable) risk that the promised cash flows will not be forthcoming. ? The credit risk models are intended to aid banks in quantifying, aggregating and managing risk across geographical and product lines. The outputs of these models also play increasingly important roles in banks’ risk management and performance measurement processes, customer profitability analysis, risk-based pricing, active portfolio management and capital structure decisions. Credit risk modeling may result in better internal risk management and may have the potential to be used in the supervisory oversight of banking organisations.
Market Risk
? Market Risk may be defined as the possibility of loss to a bank caused by changes in the market variables. viz. ? Interest Rate ? Foreign Exchange rates ? Equity Price ? Commodity Price ? Thus, Market Risk is the risk to the bank’s earnings and capital due to changes in the market level of interest rates or prices of securities, foreign exchange and equities, as well as the volatilities of those changes.
Organizational Structure
? The Board of Directors ? The Risk Management Committee ? The Asset-Liability Management Committee (ALCO) ? The ALM support group/ Market Risk Group ? Mid-Office
Role of ALCO
? Product pricing for deposits and advances ? Deciding on desired maturity profile and mix of incremental assets and liabilities ? Articulating interest rate view of the bank and deciding on the future business strategy ? Reviewing and articulating funding policy ? Decide the transfer pricing policy of the bank ? Reviewing economic and political impact on the balance sheet
Why there is Interest Rate Risk?
? On account of Banks core business being financial intermediation and asset transformation. ? Due to periodical renewal of assets and liabilities. ? Due to mismatches between maturity/ repricing dates as well as maturity amounts between Assets and Liabilities ? Since depositors and borrowers can preclose their accounts
Types of Interest Rate Risk
? ? ? ? ? Gap or Mismatch Risk Basis Risk Yield Curve Risk Embedded Option Risk Price Risk - Bond prices and interest rates are inversely related ? Reinvestment Risk – Uncertainty to correctly predict the interest rates at which future cash flows will be invested. ? Revaluation Risk/Regulatory Risk - Occurs when revaluation of assets are to be done as per regulatory prescriptions
Measures of IRR
? Maturity Gap Analysis – to measure interest rate sensitivity of earnings or NII ? Duration Gap Analysis – to measure interest rate sensitivity of equity ? Simulation ? Value at Risk
IRR Management - Rising Interest Rate Scenario
? ? ? ? ? Reduce investment portfolio maturities Increase floating rate assets Increase short-term assets Increase long-term deposits/borrowings Sell fixed rate assets
IRR Management - Falling Interest Rate Scenario ? Increase maturities of investment portfolio ? Increase fixed rate loans ? Increase short-term deposits/borrowings (reduce maturity of liabilities) ? Increase floating rate deposits
Liquidity Risk
? Liquidity represents the ability of a bank to accommodate decrease in liabilities and fund in increase in assets as they become due. ? It is essential for all the banks to meet the expected and unexpected balance sheet fluctuations as also provide funds for asset growth. ? A banks inability to meet the required liquidity needs is called liquidity risk.
Impact of Liquidity Risk
? Liquidity risk can arise from either internal or external factors. ? A bank can raise liquidity either by increasing its liabilities or converting some of its assets. ? Excess liquidity- loss of returns or less profit. ? Inadequate liquidity - can be disastrous.
Sources of Liquidity Risk
Uncertainty of: • Depositors behaviour • Demand for credit • Environment in the Financial Market • Major developments - Domestic or international
Types of Liquidity risks
? Funding Risk Need to replace net outflows due unanticipated withdrawal/non-renewal deposits ? Time Risk Need to compensate for non-receipt expected inflows of funds- NPAs ? Call Risk Due to crystallisation of contingent liabilities needs of new business to of
of
&
Measurement of Liquidity
Stock approach - Employing ratios
? Volatile Liability Dependence Ratio Volatile Liabilities minus Temporary Investments to Earning Assets net of Temporary investments Shows the extent to which bank’s reliance on volatile funds to support LT assets ? Growth in Core Deposits to growth in assets Higher the ratio the better ? Purchased Funds to Total Assets ? Loan Losses to Net Loans
Measurement of Liquidity ? Cash flow approach:
? Preparing a structural liquidity by taking into a/c b/s on particular date and place in maturity ladder according to time buckets ? Identify the liquidity needs - to evolve methods to meet it. ? Negative gaps in individual time buckets indicate the need. The need could be controlled by ? prudential limits ? as also by regulating the basis of business structure/financial flexibility of banks ? Regulatory Limit on outflows in first four time buckets
Prudential limits for managing liquidity
? ? ? ? ? ? ? Cap on inter-bank borrowings & Call money Outside funds vis-a-vis liquid assets Core Deposits vis-à-vis Core Assets Duration of liabilities and investment portfolio Need to monitor high value deposits Maximum Cumulative Outflows Track Commitments given to corporates and banks to limit off-balance sheet exposure ? Monitor Swapped Funds Ratio- i.e, extent of Indian Rupees raised out of foreign currency sources
Contingency plans for Liquidity management
? Banks to prepare & submit annual contingency plans to ALCO for approval. ? Contingency plans -liquidity stress tests - reveal the impact on B/S in adverse liquidity conditions. ? Contingency Plans to include : Normal conditions Bank specific conditions Market specific crises
Foreign Exchange Risk
? Maybe defined as the risk that a bank may suffer losses as a result of adverse exchange rate movements during a period in which it has an open position, either spot or forward, or a combination of the two, in an individual foreign currency. ? Banks are also exposed to interest rate risk, which arises from the maturity mismatching of foreign currency positions.
Managing Foreign Exchange Risk
? Open position limits Daylight limit and the Overnight limit. ? The daylight limit is substantially higher for two reasons, (a) It is easier to manage exchange risk when the market is open and the bank is actively present in the market and (b) the bank needs a higher limit to accommodate client flows during business hours. Overnight position, being subject to more uncertainty and therefore being more risky should be much lower.
Foreign Exchange Risk
Risk inherent to running open foreign Exchange position. ? Banks are also exposed to interest rate risk arising from maturity mismatching of foreign currency positions. ? Banks also face the risk of default of the counter-parties or settlement risk. ? Forex transactions with counter-parties from another country also triggers sovereign or country risk.
Forex Risk Management & Measures
? Setting up appropriate limits- open position and gaps. ? Clear-cut and well-defined division of responsibility between front, middle and back offices. ? VaR approach to measure risk associated with exposures should also be adopted.
Tools and Techniques for managing forex risk ? Hedging forex risk by derivatives like forwards, futures, options. ? Measurement of forex VaR.
Equity Price Risk, Commodity Price Risk ? Equity Price Risk: Probability of loss due to changes in the equity price. Measurement ? Commodity Price Risk: Probability of loss associated with the dealing of a commodity.
Operational Risk
? Risk of loss resulting from inadequate or failed internal processes, people and systems or from external events. ? Basel Committee has identified the following types of operational risk events as having potential to result in substantial losses.
? ? ? ? ? ? ? Internal fraud External fraud Employment practices and workplace safety Clients, products and business practices Damages to physical assets Business disruption & system failures Execution, delivery and process management
Operational Risk
? Outsourcing results in banks being exposed to operational risk and other risks like Strategic Risk, Reputation Risk, Compliance Risk, Legal Risk, Exit Strategy Risk, Counterparty Risk, Country Risk, Contractual Risk, Access Risk, Concentration and Systemic Risk.
? As IT has become widely and deeply interconnected and involved with business operations, IT Risk has grown into prominence. Within Operational Risk Management, IT Risk Management is emerging as separate practice because of unique role played by IT in today’s organizations.
Assessment of Operational Risk
? Self Risk Assessment ? Risk Mapping ? Key Risk Indicators
Measuring Operational Risk
? Measuring operational risk requires identification of the underlying operational risk factors. ? No uniform approach for measurement of operational risk in the banking system. ? Existing methods are experimental. ? Some of the international banks have made considerable progress in developing advanced techniques for allocating capital with regard to operational risk. ? Measuring operational risk involves estimating the probability of an operational loss event and the potential size of the loss. This requires collection of huge data on Loss events and operational losses as well as near miss Operational losses. ? Indian banks are in the process of developing scientific methods for quantifying operational risk.
Integrated Risk Management / Enterprise-wide Risk Management (ERM)
? An enterprise can manage risks in one of the following two ways: ? One risk at a time on a largely compartmentalized and decentralized basis (Silo Approach); or ? All risks viewed together within a coordinated and strategic framework; ? Managing risks by silos does not work because risks are highly interdependent and cannot be segmented and manages solely by independent units. A segmented approach does not provide senior management and the Board with aggregated risk reporting.
ERM
? ERM creates value through its effects on companies at both macro (enterprise-wide) level and micro level (business-unit level). ? Macro level: Creates value by enabling senior management to quantify and manage the risk-return tradeoff that faces the entire enterprise. Helps the enterprise to maintain access to the capital markets and other resources necessary to implement its strategy and business plan. ? Micro level: ERM becomes a way of life for managers and employees at all levels.
ERM- Objective
? A well-designed ERM system ensures that ? all material risks are “owned” and ? risk-return tradeoffs carefully evaluated by operating managers and employees throughout the enterprise.
? What management can accomplish through ERM is? not to minimize or eliminate, ? but rather to limit, the probability of distress to a level that management and the board agrees is likely to maximizes firm value. ? Management’s job is to optimize the firm’s risk portfolio by trading off the probability of large shortfalls and the associated costs with the expected gains from taking risks.
ERM- Conceptual Framework
? Management begins by determining the firm’s risk appetite, a key part of which is choosing the probability of financial distress that is expected to maximize firm value. (When credit ratings are used as the primary indicator of financial risk, the firm determines an optimal or target rating based on its risk appetite and the cost of reducing its probability of financial distress.) ? Given the firm’s target rating, management estimates the amount of capital it requires to support the risk of its operations. ? Management determines the optimal combination of capital and risk that is expected to yield its target rating.
Thank You
doc_916671684.ppt