Managing Risks in banks and FI's

1. Managing Risks in Banks and
Financial Institutions

2. Risk = (Probability of an event) x (Losses per event)
Probability or threat of a damage, injury, liability, loss (present/ future) caused by external or
internal vulnerabilities, and which may be neutralized through pre-mediated action.
 In short, it is anything that deviates our Bank from its Goals and Objectives.
Uncertainty presents both risk and opportunity and the success in banking business largely
depends on a calculated risk taking and effective risk management.
Risks are omnipresent in all kinds of business, but in banking the owners do not usually
manage or run their business, which gives rise to a risk; in a sense that is unique only to the
banking industry.
The guidelines for managing core risks also have been developed by giving heed to this unique
risk element in most cases.
Risk : Meaning & Implication

3. • Risk management is the process of avoiding unacceptable
losses
• An unacceptable loss is one you did not plan for
• Risk Management does not mean risk avoidance
• Risk management is therefore the process of extracting
optimum reward from an acceptable risk exposure whilst
minimising cost
What is Risk
Management?
Risk Management

4. Basel II Requirement

5. +
• Credit Risk
• Asset Liability Management Risk
• Foreign Exchange Risk
• Internal Control & Compliance Risk
• Money Laundering Risk
• IT Risk
Core Risks
• Operational Risk
• Market Risk
• Liquidity Risk
• Reputational Risk
• Insurance Risk
• Sustainability Risk
Additional Risks
Risks in Banking

6. • Three Types:
-Market Risk
-Credit Risk
-Operational Risk
Types of Financial Risk

7. Sl. No. Particulars of Risks Capital Requirement
(Tk. Crore)
1 Credit Risk 752.04
2 Market Risk 53.09
3 Operational Risk 90.45
A) Minimum Capital Requirement under Pillar I 895.58
1 Residual Risk 15.06
2 Evaluation of Core Risk Management 0.00
3 Credit Concentration Risk 22.39
4 Interest Rate Risk in the Banking Book 92.35
5 Liquidity Risk 0.00
6 Reputation Risk 19.25
7 Settlement Risk 4.48
8 Strategic Risk 40.19
9 Environmental & Climate Change Risk 0.00
10 Other material risks
C) Total Capital Requirement (A+B) for the year 2010 1,089.30

8. Market Risk
Market risk is the risk that the value of a portfolio, either an investment portfolio or a trading
portfolio, will decrease due to the change in value of the market risk factors. The four
standard market risk factors are stock prices, interest rates, foreign exchange rates, and
commodity prices. The associated market risks are:
Equity risk, the risk that stock prices and/or the implied volatility will change.
Interest rate risk, the risk that interest rates and/or the implied volatility will change.
Currency risk, the risk that foreign exchange rates and/or the implied volatility will change.
Commodity risk, the risk that commodity prices (e.g. corn, copper, crude oil) and/or implied
volatility will change
Importance-Three Reasons:
- Popularity of securitization process
- Progressive growth of financial derivatives market
- More widespread adoption of new accounting standards which provide for mark
to market accounting

9. Currency Risk
Currency Risk
A form of risk that arises from the change in price of one currency
against another. Whenever investors or companies have assets or
business operations across national borders, they face currency risk if
their positions are not hedged.
For example, if you are a U.S. investor and you have stocks in
Canada, the return that you will realize is affected by both the change
in the price of the stocks and the change in the value of the Canadian
dollar against the U.S. dollar. So, if you realize a 15% return in your
Canadian stocks but the Canadian dollar depreciates 15% against the
U.S. dollar, this will amount to no gain at all.

10. Interest Rate Risk
The risk that an investment's value will change due to a change in the
absolute level of interest rates, in the spread between two rates, in the shape
of the yield curve or in any other interest rate relationship. Such changes
usually affect securities inversely and can be reduced by diversifying
(investing in fixed-income securities with different durations) or hedging (e.g.
through an interest rate swap).
 When the maturity on an asset is longer than that of a liability, the bank is
exposed to refinancing risk
 When the opposite is true, the bank is exposed to reinvestment risk
 Thus, interest rate risk in its broadest sense can be defined as the risk that
changes in market interest rates impact the profitability and economic value of
the bank
 An indirect effect of IRR is a situation where the interest rate change can
have an impact on the volumes negotiated by a bank

11. Equity Risk
Equity risk is the risk that one's investments will depreciate because of stock
market dynamics causing one to lose money.
The measure of risk used in the equity markets is typically the standard
deviation of a security's price over a number of periods. The standard
deviation will delineate the normal fluctuations one can expect in that
particular security above and below the mean, or average. However, since
most investors would not consider fluctuations above the average return as
"risk", some economists prefer other means of measuring it.

12. Commodity Risk
Commodity Price Risk
Commodity price risk occurs when there is potential for changes in the price of a commodity that must be
purchased or sold. Commodity price risk affects consumers and end-users such as manufacturers,
governments, processors, and wholesalers. If commodity prices rise, the cost of commodity purchases
increases, reducing profit from transactions.
Price risk is generally the greatest risk affecting the livelihood of commodity producers and should be
managed accordingly. Commodity prices may be set by local buyers and sellers in the domestic currency in
order to facilitate local customer business. However, when transactions are conducted in the domestic
currency for a commodity that is normally traded in another currency, such as U.S. dollars, the exchange rate
will be a component of the total price for the commodity, and the currency exposure continues to be a
consideration.
Commodity Quantity Risk
Organizations have exposure to quantity risk through the demand for commodity assets. Although quantity is
closely tied to price, quantity risk remains a risk with commodities since supply and demand are critical with
physical commodities.
For example, if a farmer expects demand for product to be high and plans the season accordingly, there is a risk
that the quantity the market demands will be less than has been produced. Demand may be less for a number of
reasons, all of which are out of the control of the farmer. If so, the farmer may suffer a loss by being unable to sell
all the product, even if prices do not change dramatically. This might be managed using a fixed price contract
covering a minimum quantity of commodity as a hedge.

13. • Credit Risk is the probability of not coming
the money on time due to non paument of
the borrower
• If borrower does not pay on time the
principal and/or interest, and the loss
lenders incur is called credit loss
Credit Risk Management

14. Operational Risk (As per Basle II)
Operational Risk is the risk of loss resulting from
inadequate or failed internal processes, people,
systems or from external events.
• Risk: The possibility of suffering harm or loss. Eg. The chance of
nonpayment of a debt.
• Loss: May be direct or indirect. Direct losses are the costs
required to repair or fix problems immediately associated with an
event. Indirect losses are costs not immediately associated with
an event but are impacted by the event, cost of preventing future
losses.
• Inadequate or failed internal processes, people and systems:
Any problem that may not have arisen with better planning,
resources or systems (i.e. could have been avoided)
• External events: That which is not controllable within the Bank
(i.e. could not have been avoided)

15. Limitations
• Lack of effective information systems  information disruption
• No regulations or policies  delay report of defaults  delay problems
solving
• No self-assessment policy or survey of training need
Operational Risk

16. Potential Benefits of Effective Risk Management
Reduction in
management
time spent
“fire-fighting”
• Increased
likelihood
of change
initiatives
being
achieved.
Potential
Benefits
More focus
internally on
doing the right
things properly.
Lower cost
of capital.Better basis for
strategy setting.
Competitive
advantage.
Fewer sudden
shocks and
unwelcome
surprises.
Better able to
take advantage
of new business
opportunities.
Higher
share
price