Risk Management

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 Risk Management mindset
• Risk management has to be integrated
with business practices .
• Risk analysis should be part of any new
business initiative.
• A fine balance is required between
flexibility and consistency
• Risk management is effective when
Managers and employees are attuned to
risk .It cannot be imposed.
 Risk management and MIS
• Risk management has to be made as the
result of Management Information System
• Written manuals ,code of conduct and
ethics , value system are required to deal
with risks effectively.
• Financial controls, operational controls
effective treasury management practices
are examples
 Managing credit risk
• Identify “ Prime customers “ as part of
segmenting the lending market.
• Note that repayment capacity and convenient
interest structuring are prime considerations of
effective credit monitoring
• While analyzing repayment capacity, the
industry risk has to be assessed.
• Financial statement analysis and cash flow
projections help in credit appraisal
 Interest structuring
• Borrower’s purpose is to be kept in mind
while disbursing the credit flows
• Lender’s asset liability management
criteria has to be matched with borrower’s
requirements
• Appropriate legal documentation and
contract with the borrower is necessary to
protect the lender’s rights in case of
default.
 Risk factors of the borrower
• Industry risks of the borrower
• Cost structure of the borrower industry
• Growth stage of the borrower industry
• Business cycles of the borrower industry
• Overall profitability
• Market /competition structure
• Supply chain of vendors & dependence on
buyers
 Risk factors of the borrower
• Product substitution threats
• Regulatory/licensing environment
• Social and environmental risks of the
borrower industry
• Use of child labor, pollution control ,fire
hazards are some of the risk concerns
 Factors in Credit appraisal
• Industry overview
• Operation and financing aspects
• Cost structure
• Pricing strategy
• Operating leverage
• Financial leverage
• Risk/reward trade off
• Comparison with industry benchmarks
 Portfolio level factors
• Risk ratings of various debt instruments
• Default probability at various levels of
rating
• Recovery rate
• Industry exposure
• Overdue accounts /Non performing assets
• Appropriate interest /repayment revisions
 Collaterals and Margins
• Fixed assets as collateral
• Initial margin money
• “Mark to market” margin depending on
market fluctuations
• Additional margins in situations of
payment crisis /stock market crashes /melt
downs
 Limits /Ceilings
• Sector /industry exposures
• Earnings at risk limits
• Liquidity limits
• Market risk limits
• Maturities
• Profit and loss limits
• Position limits
 Risk diversification
• Diversification is reduction of market risk
by investing in many unrelated securities.
“Do not put all your eggs in one basket !“
• Systematic (non-diversifiable ) risk is
universal within the economy like business
cycles, war, inflation, natural calamities etc
• Unsystematic risk (diversifiable )is firm
specific and is due to financial/
fundamental factors and can be controlled
 Netting
• Netting means off-setting payables and
receivables arising under various contracts
and net settlement of the payable or
receivable ;helps in reducing settlement
risks
• Used in bilateral/multilateral transactions
between trading institutions &
counterparties
 BEST PRACTICES REPORT
• Introduced by representatives of
G-30(public –private sector corporates
&academicians)
• Senior management role
• Marking to market (reduces intra-day
fluctuations)
• Mid-market valuations
• Identifying revenue sources
• Market risk measurement
• Stress simulations
 Best practices Report
• Investing &funding forecasts
• Third party /independent market
assessment
• Practices by end-users
• Measuring credit exposure and
aggregating
• Clear authority for credit management
• Master agreements (Model agreement)
 Best practices report
• Credit enhancements through special
purpose vehicles (SPV)
• Promoting enforceability through mutual
consulting sessions
• Professional expertise
• Efficient data systems
• Standard accounting practices
• Standard disclosures
 Best practices report
• Suitable netting procedures to encourage capital
adequacy /provisioning
• Legal and regulatory uncertainties
• Tax treatment
• Time schedule from end of the year
• Scope of application
• Neither IMF nor the World Bank will interfere to
implement the risk management guidelines
which are consistent with BASEL framework.
 Scope of Application
• Applicable on a consolidated basis to
internationally active banks
• Would be applicable to holding company
or parent banking institution
• 3 year transitional period to apply for sub –
consolidation and new fund infusions
• Protection of Depositors interests is
primary obligation of the bank.
 Scope of application.
• To capture all elements of the crisis
through consolidation and netting
transactions of all banking and other
relevant financial activities within the group
• In case of consolidation of less than wholly
owned financial entities, supervisors will
adjust the amount of minority interests and
exposures which would be included in the
capital infusions
 Scope of application
• All of the loans underlying the $2.1 trillion of
mortgages cannot be allowed to go bust or
bankrupt.
• A cushion of over $ 1 trillion has to be created
over a period of time to ease the pain.
• THE PROBLEM IS SEVERE –MARKET IS
SEIZED WITH COMPLETE UNCERTAINTY and
LOSS OF CONFIDENCE IN COUNTERPARTY
–CONDITIONS UNDER WHICH
A FINANCIAL MARKET HAS COME TO
GRINDING HALT.
 SCOPE OF APPLICATION
• Thomas Gresham has said that bad
money drives out the good
• Greed is the basic human instinct of all
bad crises.
• Credit Default Swap (CDS) market has
grown to $ 53 trillion on the international
level because of the sub prime crisis and
the recent crisis.
 Scope of Application
• The US Government will have to pick up a
part of additional debt.
• Some debt would be picked up when
securities market recover
• Many investors would try to recover or
protect through hedging against inflation
Countries and companies against weak
currencies
 Scope of Application
• Of course, many companies would find it
increasingly difficult to get easy credit on
convenient terms in international financial
markets
• Restrictions on Foreign Institutional
Investors would be eased through relief
measures and inflow of foreign capital
• These would lead to stability eventually