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1. MARKET RISK
Dr.T.V.RAO – FACULTY
RISK MANAGEMENT

2. MARKET RISK
• Old wisdom dictates that one should avoid putting all eggs inOld wisdom dictates that one should avoid putting all eggs in
the same basket.the same basket.
• Diversification does not reduce risk below a minimum level.Diversification does not reduce risk below a minimum level.
• The minimum level of risk which is attributable to factors whichThe minimum level of risk which is attributable to factors which
are external to portfolio is MARKET or SYSTEMATIC RISK.are external to portfolio is MARKET or SYSTEMATIC RISK.
• The component of risk which can be reduced by diversificationThe component of risk which can be reduced by diversification
is NON SYSTEMATIC RISK.is NON SYSTEMATIC RISK.

3. What is Market Risk ?
• The possibility of loss to a Bank caused by
changes in market variables.
• Risk to the Bank’s Earnings & Capital due to
changes in the market level of Interest rates
or prices of Securities, Foreign Exchange,
Commodities & Equities as well as volatilities
in the prices

4. MARKET RISK - Types
1. Liquidity Risk
2. Interest rate Risk
3. Forex Risk
4. Equity price Risk
5. Commodity price Risk

5. WHAT IS LIQUIDITY?
• Ability to fund increases in assets & meet
payment obligations on due date efficiently
& economically.

6. WHAT IS LIQUIDITY RISK?
• “ Potential inability to meet the Bank’s
liabilities on the due date.”
• Arises due to :
• 1. Inability to generate cash to cope with
decline in deposits or increase in assets.
• 2. Mismatches in maturity pattern of
assets & liabilities.

7. Liquidity Risk – Why to Manage?
1. Demonstrates safety of Bank & provides confidence.
2. Necessary to nurture relationship.
3. Avoid unprofitable sale of assets.
4. Lowers the default risk premium.
5 Reduces the need to resort to borrowings from the
Central Bank.

8. Liquidity Risk - Dimensions
• 1. Funding Risk
• 2. Time Risk.
• 3. Call Risk.

9. Liquidity Risk – how to manage?
• Have an effective Liquidity management policy.
• Should speak out: Funding Strategies, Liquidity
planning under alternative scenario, Prudential
limits, Liquidity reporting & reviewing.
• Tracking of cash flow mismatches. Track the
impact of prepayment of loans & pre mature
closure of deposits.

10. Cap on Inter bank borrowings.
Purchased funds vis-à-vis core assets.
 Core deposits vis-à-vis Core assets.
 Duration of liabilities & Investment portfolio
 Cumulative mismatches across all time
bands.
 Commitment ratio – tracking commitments
given

11. Monitoring high value deposits.
 Seasonal pattern of deposits/loans.
 Potential liquidity needs for meeting
new loan demands, un-availed credit
limits, potential deposit losses,
investment obligations, statutory
obligations etc.
 Contingency funding plans.

12. INTEREST RATE RISK
• Deregulation of interest rates has exposed the
Banks to adverse impact of Interest rate risk.
• Risk that value of Assets & Liabilities as also Net
Interest Income get affected due to movements in
interest rates.
• Mismatch in cash flows or re-pricing dates of
assets & liabilities expose Bank’s NII or NIM to
variations

13. INTEREST RATE RISKS- TYPES
1. Mismatch or Gap Risk.
2. Embedded Option Risk.
3. Reinvestment Risk.
4. Price Risk.

14. Rigidities on Interest Rate Risk
• Most liabilities are on Fixed rate basis while
assets are on the floating rate basis.
• There is no definite interest rate re-pricing date
for floating rate.
• Banks have to strengthen the MIS & Computer
processing capabilities for accurate measurement
of IRR

15. Interest Rate Risk - Management
1. Floating rate Deposits.
2. Fixed rate Lending.
3. Derivative products like FRAs

16. FOREIGN EXCHANGE RISK
• Risk that Bank may suffer loss as result of
adverse exchange rate movements during
the period in which it has open position.
• Risk arises whenever business has
income/expenditure, asset/liability in a
currency other than balance sheet
currency.

17. TYPES OF FOREX RISK
1. Open or Mismatch positions.
2. Price Risk.
4. Credit Risk.
5. Country Risk.
6. Operating Risk.
7. Legal Risk.

18. FOREX RISK MANAGEMENT
1. Set appropriate limit for open
position/gaps.
2. Clear cut & well defined division of
responsibility between front, middle & back
office.
3. Use of hedging tools like forwards, futures
& options.

19. EQUITY PRICE RISK
• Changes in Equity prices can result losses
to the bank holding Equity portfolio.
• Banks are not allowed to sell the securities
with out holding the same.
• Banks are free to acquire
Shares/Debs/Units of equity oriented
mutual funds subject to ceiling of 5% of the
total domestic credit

20. Equity Price Risk - Management
1. Build up adequate exposure to equity market
2. Formulate transparent policy & procedure for
investment in shares.
3. Formation of Investment committee.
4. Review of Investment portfolio – on going basis.
5. Fixing prudential exposure limits.

21. COMMODITY PRICE RISK
Banks have very little exposure to
commodities in their trading book.
Price rise/movement in commodities is more
complex & volatile.
Banks in developed countries use
derivatives to hedge commodity price risk.
Banks in India have to acquire the skills to
manage as & when they get exposed to
commodity price risk.