Risk management:

Major risks identified in banking business:

1) Liquidity Risk 2) Interest Rate Risk 3) Credit Risk 4) Market Risk
Operational Risk

5)

Guidelines to banks for managing these risks:

RBI / ALM Guidelines: Liquidity Risk, Interest Rate Risk
RBI/Basel II Guidelines: Credit Risk, Market Risk, & Operational Risk.
1) Liquidity Risk: Risk to inability of a bank to meet its contractual
obligations due to mismatch in inflows/ out flows from assets and
liabilities.
2) Interest Rate Risk: Risk due to adverse movements in interest rates
impacting profitability.
3) Credit Risk: Risk on account of possible default by the borrower/
counter party in meeting commitments.
4) Market Risk: Risk of adverse deviations due to marking to market
value of the trading portfolio due to market movements.
5) Operational Risk: Risk of loss due to inadequate or failed internal
process, people, systems or external factors. Examples of such events
are internal, external frauds, negligence, data loss etc.
6) Exchange Risk: Risk on account of adverse fluctuation in forex rates.
7) Settlement Risk( Herstatt Risk): Risk of counterparty default after
the deal is put through and before the settlement. Also known as
Hersttat Risk due to the famous Herstatt Bank incidence where many
American banks suffered due to default by Herstatt Bank, Germany
which was put under liquidation without notice before it could settle
the deals it had agreed upon.
Risk management Basel II RBI Guidelines:
1988

1996
2004

Basel I accord put in place

by G 8 Countries
to avoid situations like the
Herstatt Bank incident.
Basel I modified

Addressed Minimum Capital adequacy

and credit Risk. Capital charge for
Credit

Market
Risk
to
be
identified,
Quantified and capital charge provided
for.
Three Pillars of Basel II Banks to provide Capital Charge for
norms defined:
Operational Risk also.
Minimum
Capital,
Supervisory process. Market

disclosures.
RBI
Time Frame
Guide Indian banks with overseas
Lines Presence and foreign banks
in India to migrate to
Basel II by 31/03/2008.
All other banks except RRBs,
UCB by 31/03/2008.

Basel Norms
Pillar I: Minimum capital Adequacy
Basel II Norm 8%, RBI 9%
Pillar II: Supervisory Process
RBI Supervises through On-site & Off
site methods.
Pillar III: Market disclosures.

Capital charge / Capital Calculations:

1) Credit Risk: Indian banks have to adopt standardized method for
calculations as per Basel/ RBI Guidelines. Here, risk weights are
assigned as per RBI guidelines/Approved external rating agencies and
9% of the RWA is arrived at as the Minimum Capital Requirement for
credit risk.
2) Market Risk: Indian banks have to adopt standardized (Duration)
method as per RBI guidelines Capital Charge arrived at using Duration
method and capital requirement arrived at by multiplying the capital
charge by 12.5
3) Operational Risk: Indian banks have to adopt Basic indicator approach
as per RBI Guidelines Capital Charge arrived at Basic indicator method
of applying 15% (alpha) on the average gross income of past three
positive years. Once capital charge is arrived, capital requirement is
arrived by multiplying capital charge by 12.5
4) Minimum Capital Requirement = Capital for Credit Risk + (Capital
Charge for Market Risk x 12.5) + (Capital charge for Operational Risk x
12.5)