MARKET RISK

AKHIL UCHIL

MARKET RISK

Old wisdom dictates that one should avoid putting all eggs in
the same basket.

Diversification does not reduce risk below a minimum level.

The minimum level of risk which is attributable to factors which

are external to portfolio is MARKET or SYSTEMATIC RISK.

The component of risk which can be reduced by diversification

is NON SYSTEMATIC RISK.

What is Market Risk ?

The possibility of loss to a Bank caused

by changes in market variables.

Risk to the Banks 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

MARKET RISK - Types

1. Liquidity Risk
2. Interest rate Risk
3. Forex Risk
4. Equity price Risk
5. Commodity price Risk

WHAT IS LIQUIDITY?

Ability to fund increases in assets & meet

payment obligations on due date efficiently &
economically.

WHAT IS LIQUIDITY RISK?

Potential inability to meet the Banks

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.

Liquidity Risk Why to

Manage?
1.

Demonstrates
confidence.

safety

of

Bank

&

provides

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.

Liquidity Risk - Dimensions

1. Funding Risk

2. Time Risk.

3. Call Risk.

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.

Cap on Inter bank borrowings.

Purchased funds vis--vis core assets.

Core deposits vis--vis Core assets.

Duration of liabilities & Investment portfolio
Cumulative mismatches across all time
bands.
Commitment ratio tracking commitments
given

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.

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 Banks NII or NIM to
variations

INTEREST RATE RISKS- TYPES

1. Mismatch or Gap Risk.
2. Embedded Option Risk.
3. Reinvestment Risk.
4. Price Risk.

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

Interest Rate Risk Management

1. Floating rate Deposits.

2. Fixed rate Lending.

3. Derivative products like FRAs

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.

TYPES OF FOREX RISK

Open or Mismatch positions.
2. Price Risk.
4. Credit Risk.
5. Country Risk.
6. Operating Risk.
7. Legal Risk.
1.

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.

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

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.

COMMODITY PRICE RISK

Banks have very little exposure

commodities in their trading book.

to

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.