Mr Ravi Mohan

8/2/2019 Mr Ravi Mohan

1/19

Integrated Risk architecture:Implementation Issues

FICCI - IBA conference on Global Banking paradigm shifton October 5th 2005


2/19

2

1

2

Challenges in Implementing IRM3

Components for implementing IRM

What is Integrated Risk Management


3/19

3

Three key imperatives for Banks Management

Differing requirementsfrom variousstakeholders

Employees

Borrowers

Regulators

Credit Ratingagencies

Counterpartybanks

Depositors

InvestorsCapitalAdequacy

Growth

Profitabilit

y

IRM can assist in managing the three objectives proactively


4/19

4

Maintenance of Regulatory/ EconomicCapital is crucial to business continuity

Economic Capital is the financial cushion that a bank uses to absorbunexpected losses. The purpose of economic capital is to provideconfidence to claim holders such as depositors, creditors and otherstakeholders.

The development of of sophisticated risk measurement tools offersbanks the capability to calculate economic capital.

The proposed New Basel Capital Accord is a major move towards

aligning regulatory capital to economic capital.


5/19

5

Profitability Analysis Bank ABC

Investments offer thehighest contributionp.c.age on assets

Which segmentleads to highinterest earnings?

The credit function hasthe largest contributiontowards fixed expenses

Which creditsegmentcontributes thehighest?

What is the positionafter allocatingcosts?

Am I properlypricing for expectedLosses?

Profitability AnalysisCredit Investments Others

Average Assets 51840 35064 10597

Interest Income 7.9% 8.5% 1.5%

Interest Expenses 3.6% 3.6% 3.6%

Net Interest Margin 4.3% 4.9% -2.1%

Other Income 1.9% 1.3%

Less: Provisions 1.3% 0.0%Total Contribution 4.9% 6.3% -2.1%

Contribution (LKR Mn) 2548 2204 -226

Total Contribution 4526

Operating Expenses 3975

Share of Profit from subsidiaries 197

PBT 749

Tax 70PAT 679

What is the capital required for different business lines?

What is the return provided by different business lines on

capital invested? What is the expected impact of NPAs/ revaluation? Where

should we grow?

Are we generating enough internal capital to support growth?


6/19

6

Risk Exposures Bank ABC

Assets

31/12/2003

Cash & Short Term Funds 1739

Balances with Central Banks 3305

T Bills and other eligible securities 5756

Placement with and loans to other banks 10987

Bills of Exchange 2493

Loans & Advances 44222

Lease Rentals receivable within one year 96

Lease Rentals receivable after One year 72

Dealing Securities 587

Equity & others 916Bonds 17664

Investment Securities 18580

Investment Properties 804

Investments in Subsidiaries & Associates 1667

Accrued Intt 1073

Cheques Purchased 2979

Other Assets 3331

Other Assets 7382

Group balances receivable 503

Property Plant & Equipment 1807Total Assets 100000

Liabilities

31/12/2003

Deposits from customers 77312

Deposits from Banks 188

Total Deposits 77500

Borrowings 10923

Group balances payable 397

Deferred Tax Liability 0

Tax Payable 26

Other Liabilities 4887

Subordinated Debentures 520

Total Liabilities 94253Shareholders Equity

Share Capital 1082

Permanent Reserve Fund 609

Reserves 4056

Total Equity 5747

Total Liabilities & Equity 100000

Market RiskCredit Risk Liquidity Risk

The bank runs asset liability mismatches due differing maturity profiles and lending and borrowing

rates for credit, investments, deposits and subordinated debentures.

Borrowing/ Lending/ Investing in Foreign Currency gives rise to foreign exchange risk


7/19

7

How does this affect us?

Credit Risk: Simple credit products(loans normally backed by

collateral, few products)

Market Risk: Simple market riskproducts (dealing in g-sec/ limitedcorporate bond market/ limited FX

market)

Operational Risk: Not a majorconcern

Increasing Complexity & Size

Current Environment Future Environment

Credit Risk: Credit Derivatives

Project Finance

Market Risk: Multiple currencies Investments in securities across

countries Investments in corporate bonds

Swaps/ Options otherderivatives

Operational Risk: Increasingly important with

complex systems andprocesses, operations across

time zones and markets


8/19

8

RAROC - Base for Integrated Risk Management

RAROC

22%

Risk-adjustedNet income

1750

Risk-adjusted

After tax income

1.75%

Average

Lending assets

100,000

Total capital

8000

Risk-adjusted

Net income

2.20%

Net Tax

0.45%

Total capital

8.0 %

Risk-adjusted

income

5.60 %

Costs

3.40 %

Credit Risk Capital

4.40 %

Market Risk Capital

1.60 %

Operational Risk Capital 2.00 %

Income

6.10 %

Expected

Loss 0.50 %

RAROC could be carried out for the bank as a

whole or a business segment.

RAROC allows a bank to take a comprehensiverisk view and forms the base for IRM


9/19

9

Integrated Risk Management in a Bank

What is Integrated Risk Management?

Measure, monitor and manageall therisksacross the bank.

Bank wideintegrated riskmanagement infrastructurein terms ofpeople, policies and systems

Common and consistent riskmeasurement and quantification

methodologiesacross all riskcategories

Aggregation of risks andestimation ofeconomic capitalto assist in risk/return decision making

Compliance

Integrated

Risk

Manageme

nt

Organisation

Structure


10/19

10

Perceived advantages of IRM

Facilitates strategic value creation

Key to regulatory compliance

Mechanism for efficient allocation of economic capital

Enables bank to maximise returns Lower capital costs

Better decision making due to scenario analysis

Risk adjusted pricing

Loss reduction due to understanding of correlations

Elimination of unwanted exposures


11/19

11

1

2





12/19

12

IRM Implementation Important Facets

IT Infrastructure

Risk Communication and Control

Centralised

risk function

(analytics and

management)

New product

assessment

Quantification

Aggregation

Risk-adjusted

performance

measurement

Controls on

Risk takers

Risk reportingRisk

Policy

Policy Risk Models PerformanceMeasurment

MIS


13/19

13

1

2





14/19

14

IRM Challenges identification of gaps inexisting risk management practices

Organisation Structure

Risk Management Policies

Management Information Systems

Information Technology Systems

Top Management Oversight

Risk Analytics

Processes and Systems

Reviewing and improving existing

Credit Risk

Market Risk

Operational Risk

Basel II

ALM

Business Risk

Reputation Risk

Beyond Basel II


15/19

15

IRM Challenges - measurement of risks

Credit Risk

Probability of Default

Loss Given Default

Exposure at Default

Market Risk

Trading Book (VaR)

Interest Rate Risk on Banking Book

Operational Risk (evolving)

Requires collection of data over time, development of measurement

models, back testing of models


16/19

16

IRM Challenges Risk Aggregation

Correlations among risk silos

OVERALL ECONOMIC CAPITAL

RISKCATEGORY

RISK SILOCREDIT RISK

Cor

pora

teI

Corp

o

rateII

RetailP

ool

CorrelationsAcross

Companies

OPERATIONALRISK

Busin

ess

Line1

Busin

essLin

e2

Correlationsacross

Businesses

MARKET RISKCAPITAL

Intere

stR

a

teRisk

ForeignEx

ch

an

geRisk

Comm

odi

tyRisk

Correlationsacross

Asset classes

Equity

Risk


17/19

17

IRM Challenges - modelling of correlationsacross risk categories & risk silos

Modelling correlations requires data and is not easy

Fat tails in credit risk create problems


18/19

18

IRM Challenges - Improving IT systems

Internal risk scoring models for credit Portfolio Management Models

Models for estimating VaR for Market risk

Operational Risk databases

Asset Liability Management System

Data warehouse having interfaces for Analytical

Modelling

Reporting

Options for developing Risk Management Systems In-house

Off-the-shelf

Sizeable investments in IT infrastructure required for implementing Basel II


19/19

19

Thank you

CRISIL Investment & Risk Management ServicesCRISIL [email protected]

Ph.no: 91 22 56537371
mailto:[email protected]:[email protected]

Mr Ravi Mohan

Documents

Transcript of Mr Ravi Mohan