CAIIB - RISK MANAGEMENT – MODULE B

1. CAIIB- RISK MANAGEMENT – MODULE B G.R.Rao, Faculty, IIBF

2. WHAT IS RISK • EVERY ACTION HAS A REACTION • IF REACTION IS FOR OUR BEENFIT; NO WORRY AND NO RISK • IF IT IS AGAINST OUR INTEREST ONLY WE ARE WORRIED AND THAT IS RISK • RISK IS THEREFORE POSSIBILITY OF A NEGATIVE RESULT FOR OUR ACTIONS • COULD BE DUE TO US OR BEYOND US

3. RISK Contd… • RISK IS SUPPOSED TO HAVE BEEN DERIVATIVE OF “RISICARE” WHICH MEANS “TO DARE” • DARING IS TO TAKE STEPS RECOGNISING THE POTENTIAL FOR LOSS • EXTENT OF THIS BEHAVIOUR IS “TAKER” SPECIFIC • MORE RISK IS TAKEN IN VIEW OF POTENTIAL FOR HIGHER YIELD

4. RISK Contd… • DUE TO RISK EITHER , PROFITS AND CAPITAL MAY GROW MULTIFOLD OR BUSINESS MAY BE WIPED OUT • NEVERTHLESS WE CANNOT BE RISK FREE/AVERSE BANKER LIKE A SHIP IN A PORT • BANKING IS THEREFORE RISK MANAGEMENT

5. RISK Contd… • RETURN IS THEREFORE RELATED TO RISK • RETURNS FROM BUSINESSES ARE TO BE ADJUSTED FOR RISKS FOR COMPARABILITY-THIS IS RAROC

6. BANKING BUSINESS • BUSINESS IS BROADLY DIVIDED INTO ON BALANCE SHEET AND OFF BALANCE SHEET ACTIVITIES. • ON BALANCE SHEET ACTIVITIES ARE BANKING BOOK (DEPOSITS & ADVANCES) AND TRADING BOOK(INVESTMENTS) • BANKING BOOK HAS NO MARKET RISK • RISKS COMMON TO BOTH BOOKS ARE CREDIT, OPERATIONAL

7. RISKS Contd.. • MAJOR RISKS ARE • CREDIT RISK • MARKET RISK • INTEREST RISK • LIQUIDITY RISK • PRICE RISK • OPERATIONAL RISK • STRATEGIC RISK • REPUTATION RISK

8. RFISK MANAGEMENT • IDENTIFICATION • MEASUREMENT • SENSITIVITY • VOLATILITY • DOWNSIDE POTENTIAL • PRICING COVERING • COST OF RESORUCES • COSTOF OPERATIONS • RISK PREMIUM • CAPITAL CHARGE • MONITORING AND CONTROL • MITIGATION • TRANSFERING

9. BASEL 1 & 2 • THREE PILLARS • TWO TYPES OF CAPITALS • DIFFERENT METHODS OF MEASUREMENT OF RWA

10. MARKET RISK • HAS A COMPONENT OF CREDIT RISK IN ADDITION TO PRICE, LIQUIDITY AND INTEREST RATE RISKS • LIQUIDITY RISK CAN ALSO BE DUE TO MARKETS • RISK IN INVESTMENTS IS MEASURED THRO’ BPV, MODIFIED DURATION, VaR AND YIELD AND PRICE VOLATILITIES

11. MONITORING & CONTROL AND MITIGATION • MONITORING • POLICY GUIDELINES FOR VARIOUS ACTIVITIES • CAPS FOR TRANSACTION SIZES, STOP LOSS LIMITS, GUIDLEINES ON PORTFOLIO SIZES BOTH TYPE AND INDUSTRY, EXPOUSRE NORMS • MITIGATION THROUGH DERIVATIVES

12. CREDIT RISK • CREDIT SELECTION, PRUDENTIAL LIMITS • CREDIT RATING • CREDIT PRICING • CREDIT MONITORING THROUGH RATING MIGRATION • LOAN REVIEW MECHANISM • CREDIT DERIVATIVES AND SECURITIES AND SECURITISATION

13. OPERATIONAL RISK • CAN BE CLASSIFIED BASED ON BOTH SOURCE, IMPACT AND EVENT • RISK MITIGATION CAN BE THORUGH AUDIT, VARIOUS REPORTS

14. OBJECTIVE QUESTIONS Q. RAROC STANDS FOR A. RISK ADJUSTED RETURN ON CAPITAL B. RISK ADJUSTED RETURN ON COST. C. RETURN ADJUSTED RISK ON CREDIT. D NONE OF ABOVE. Q.CREDIT DEFAULT SWAPS ARE A. ONE OF CREDIT DERIVATIVES. B. A KIND OF BANK GUARANTEE C. A KIND OF LINE OF CREDIT. D. STAND BY CREDIT.

15. OBJECTIVES Q. THE BETA FACTOR FOR CALCULATING OPERATIONAL RISK UNDER STANDARDIZED APPROACH FOR RETAIL BANKING IS A. 12% B.18% C.15% D. NONE OF ABOVE. Q. PROBABILITY OF OCCURRENCE =4; POTENTIAL FINANCIAL IMPACT =4; IMPACT OF INTERNAL CONTROL =0%   WHAT IS ESTIMATED LEVEL OF OPERATIONAL RISK? A. 3 B. 2 C. 0 D. 4

16. OBJECTIVE QUESTIONS • INORDER TO DEVELOP ACTIVE CREDIT RISK MANAGEMENT, BANK MUST HAVE 1.GOOD CREDIT RATING MODEL AND 2. CONDUCT MIGRATION STUDIES • both of the above are required • Only 1 is required • Only 2 is required • both are insufficient

17. A transaction where financial securities are issued against cash flows generated from a pool of assets is called • Credit default swap • Securitisation • Participation certificate • Credit linked notes

18. A bank expects fall in price of a security if it sells it in the market. What is the name of such risk? • Market risk • Operational risk • Asset liquidation risk • Market liquidity risk

19. Credit rating agencies fix interest rates on bonds and debentures issued by companies a. true b. False c. Cannot say d. Only RBI can fix rate

20. An 8 year 8% semi annual bond has a BPV of Rs 125.The yield on the bond has increased by 5 basis points. What is the profit or loss suffered in price due to increase in yield? • Rs 1000 profit • Rs 1000 loss • Rs 625 profit • Rs 625 loss

21. A decline in CRR will cause the yield curve to • Slope upward • Slope downward • Become flatter • Remain unchanaged

22. Given the rating migration of 100 a rated accounts in bank during a year as under, please answer the number of accounts who suffered rating migration. A++ A+ A B+ B C Default 1 1 75 12 3 5 3 a. 2 b. 23 c. 25 d. 21

23. ABC financial corporation has lent Rs 1500 crores, at an average contractual rate of 14%. Past experience indicates that the probability of repayment is 0.90 what would be the expected return rate of the corporation if the recovery rate of principal and interest is 0.95 Expt. rate = p * r + q [ (1 + r) R -1] Where p is probability of repayment q= 1-p r is contractual rate and R is recovery rate

24. THANK YOU AND WISHING YOU ALL SUCCESS IN EXAMINATION