6.

Risk management:
According to the RBI circular issued on risk management by the RBI the broad
Parameters of risk management function should encompass:

Organizational structure
Comprehensive risk measurement approach
Risk management policies approved by the Board which should be consistent with
the broader
Business strategies, capital strength, management expertise and overall willingness
to assume risk
Guidelines and other parameters used to govern risk taking including detailed
structure of prudential limits
Strong MIS for reporting, monitoring and controlling risks
Well laid out procedures, effective control and comprehensive risk reporting
framework
Separate risk management framework independent of operational Departments and
with clear delineation of levels of responsibility for management of risk
Periodical review and evaluation

The banking industry recognizes that an institution need not engage in business in a
manner that unnecessarily imposes risk upon it; nor should it absorb risk that can be
efficiently transferred to other participants. Rather, it should only manage risks at the firm
level that are more efficiently managed there than by the market itself or by their owners
in their own portfolios. It has been argued that risks facing all financial institutions can be
segmented into three separable types, from a management perspective. These are: Risks
that can be transferred to other participants, Risks that can be eliminated or avoided by
simple business practices, Risks that must be actively managed at the firm level
Risk is the fundamental element that drives financial behavior. Without risk, the financial
system would be vastly simplified. However, risk is omnipresent in the real world.
Financial Institutions, therefore, should manage the risk efficiently to survive in this highly
uncertain world. The future of banking will undoubtedly rest on risk management
dynamics. Only those banks that have efficient risk management system will survive in the
market in the long run. The effective management of credit risk is a critical component of
comprehensive risk management essential for long-term success of a banking institution.
Risk is the potentiality that both the expected and unexpected events may have an Adverse
impact on the banks capital or earnings. The expected loss is to be borne by the borrower
and hence is taken care by adequately pricing the products through risk premium and
reserves created out of the earnings. It is the amount expected to be lost due to changes in
credit quality resulting in default. Whereas, the unexpected loss on account of individual
exposure and the whole portfolio is entirely is to be borne by the bank itself and hence is to
be taken care by the capital.

Credit risk is the oldest and biggest risk that bank, by virtue of its very nature of business,
inherits. This has however, acquired a greater significance in the recent past for various
reasons. Foremost among them is the wind of economic liberalization that is blowing
across the globe. India is no exception to this swing towards market driven economy.
Better credit portfolio diversification enhances the prospects of the reduced concentration
credit risk as empirically evidenced by direct relationship between concentration credit
risk profile and NPAs of public sector banks.
Banks are confronted with various kinds of financial and non-financial risks viz., credit,
market, interest rate, foreign exchange, liquidity, equity price, legal, regulatory, reputation,
operational etc. These risks are highly interdependent and events that affect one area of
risk can have ramifications for a range of other risk categories. Thus, top management of
banks should attach considerable importance to improve the ability to identify measure,
monitor and control the overall level of risks undertaken
6.1 What is Risk?
Risk is the chance of something happening that may have an impact on the achievement of
objectives. Risk is measured in terms of consequences and likelihood combined to arrive at
a risk rating from Low to Very High
6.2 Characteristics of risk

Uncertainty
Concerning Loss

6.3 Classification of Risk:

Pure Risk : It is used to designate those situations that involve the chance of loss Or
no loss e.g. - Fire, Robbery & disaster
Speculative Risk: It is the situation where there is possibility of gain
e.g. - gambling, investment & decision
Fundamental Risk : These involve losses that are impersonal in origin .They are
group risks, these risks leads to many consequences e.g.- unemployment , Inflation,
Earthquake
Particular Risk : These include losses that are arise out of individual events & are
felt by rather than individuals rather than by entire group e.g. - burning of house &
robbery of a bank.

Dynamic Risk: Dynamic risks are those resulting from the changes in the economy.
These dynamic risks normally benefit society over a long period of time since they
are result of adjustments to the misallocation of resources.
Static Risks: It involves those losses that occur even if there is no change in the
economy. Static losses tend to occur with degree of regularity over time & are
predictable. Unlike dynamic risk, static risk is not a source of gain to the society.
Some individuals suffer financial loss due to perils of nature & dishonesty of the
individuals.
Transferable Risk : These include all the risks which can be transferred to
another person or entity e.g. Pure risks
Non transferable Risk : These include all the risks which cannot be transferred to
another person or entity e.g. Speculative Risks
Internal Risk: It includes all the risks within organization e.g. - In 2006 July
Associated Press reported that a secretary working at Coke's head office in Atlanta."
is accused of helping two men steal trade secrets from her employer and try to sell
them to rival PepsiCo Inc."
External risk: These include all the risks that are produced by a non human source
and are beyond human control.
6.4 Concept of risk management:
Every Organization across the world is working with a goal to maximize profits &
maximization of Shareholder's wealth. Due to the advanced technologies life is very
comfortable now a day but at the same time risk & uncertainties are increased in same or
greater proportion. Organizations can increase their profit margins by two ways:

By increasing profits & maintaining risk at the constant level

By reducing risk to a lower extent.

Risk management is a scientific approach to the problem of dealing with the pure risks
faced by individuals and business.
6.4 What is Risk Management?
IDENTIFICATION, ANALYSIS & ECONOMIC CONTROL OF THOSE RISKS WHICH CAN
THRATEN THE ASSETS OR THE EARNING CAPACITY OF AN ENTERPRISE

Three folded nature of Risk Management is highlighted in the definition. Risk must be
identified before they can be measured, & only after their impact has been evaluated & at
same time Cost of control must be commensurate with the benefits to be derived.
It also mentions the assets & earning capacity of organization .These assets can be physical
or human. However, risk does not strike at assets directly & for this reason the definition
also mentions the earning capacity of an Enterprise.
Risk Management is the culture, processes and structures that are directed towards the
effective management of potential opportunities and adverse effects within retail
operational environment. Risk management is an integral part of the retail approach to
decision-making and accountability.
Most banks employ real-time monitoring of transactions, with rule-based engines that help
them pick transactions that are risky based on rules defined by them. The banks then
review the transactions to determine whether they are fraudulent or genuine. However,
fraud is dynamic. Hence, the rules also have to be dynamic to ensure that the changing
fraud patterns can be quickly identified.
Nature of risk management:

It is scientific approach to the problem of dealing with the pure risks faced by
individuals & business. It deals with insurable & uninsurable risk & appropriate
techniques for dealing with them. Basic difference between insurance management & risk
management is that insurance management includes all the techniques other than
insurance [e.g. non insurance, retention etc].
But insurance management is restricted to the area of those risks that are considered to be
insurable. Risk management on the other hand is concerned with pure risks
regardless of whether they are insurable or not, it has emphasis on reducing the cost of
handling risk by any means they are considered as appropriate.
6.5 RISK MANAGEMENT PROCESS IN FICCL
The process of financial risk management is an ongoing one. Strategies need to be
implemented and refined as the market and requirements change. Refinements may reflect
changing expectations about market rates, changes to the business environment, or
changing international political conditions, for example. In general,
The process can be summarized as follows:

Identify and prioritize key financial risks.

Determine an appropriate level of risk tolerance.
Implement risk management strategy in accordance with policy.
Measure, report, monitor, and refine as needed.

Risk management needs to be looked at as an organizational approach, as management of

risks independently cannot have the desired effect over the long term. This is especially
necessary as risks result from various activities in the firm and the personnel responsible
for the activities do not always understand the risk attached to them.

The company has following below steps in risk management process are:
1. Determining objectives: - determination of objectives is the first step in the risk
management function. The objective may be to protect profits, or to develop competitive
advantage. The objective of risk management needs to be decided upon by the
management. So that the risk manager may fulfill his responsibilities in accordance with
the set objectives.
2. Identifying Risks :- Every organization faces different risks, based on its business, the
economic, social and political factors, the features of the industry it operates in like the
degree of competition, the strengths and weakness of its competitors, availability of raw
material, factors internal to the company like the competence and outlook of the
management, state of industry relations, dependence on foreign markets for inputs, sales
or finances, capabilities of its staff and other innumerable factors.
3. Risk Evaluation: - Once the risks are identified, they need to be evaluated for
ascertaining their significance. The significance of a particular risk depends upon the size of
the loss that it may result in, and the probability of the occurrence of such loss. On the basis
of these factors, the various risks faced by the corporate need to be classified as critical
risks, important risks and not-so-important risks. Critical risks are those that may result in
bankruptcy of the firm. Important risks are those that may not result in bankruptcy, but
may cause severe financial distress.
4. Development of policy: - Based on the risk tolerance oevel of the firm, the risk
management policy needs to be developed. The time frame of the policy should be

comparatively long , so that the policy is relatively stable. A policy generally takes the
form of a declaration as to how much risk should be covered.
5. Development of strategy: - Based on the policy, the firm then needs to develop the
strategy to be followed for managing risk. A strategy is essentially an action plan, which
specifies the nature of risk to be managed and the timing. It also specifies the tools,
techniques and instruments that can be used to manage these risks. A strategy also deals
with tax and legal problems. Another important issue that needs to be specified by the
strategy is whether the company would try to make profits out of risk management or
would it stick to covering the existing risks.
6. Implementation: - Once the policy and the strategy are in place, they are to be
implemented for actually managing the risks. This is the operational part of risk
management. It includes finding the best deal in case of risk transfer, providing for
contingencies in case of risk retention, designing and implementing risk control
programs etc.
7. Review: - The function of risk management needs to be reviewed periodically,
depending on the costs involved. The factors that affect the risk management decisions
keep changing, thus necessitating the need to monitor the effectiveness of the decisions
taken previously.