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Risk Management

Not only in business even in our normal life we find deviation in what we expect and what we achieve Future - uncertain and unpredictable

External factors- influencing decisions- affect planned obj.

These are the uncertainties resulting in adverse outcome in relation to planned objective/ expectation. Financial, Interest Rate, Credit, Liquidity etc Any factors that affects the cash inflow or outflow affects the profitability and the financial position.

Increase- cost of inputs- profit falls Increase in trans cost- profit falls Decrease in taxes- profit rises Increase in cost of living- sales volume decreases

Risk Management
It is a two step process- determining what risks exist in an investment and then handling those risks in a way best suited to your investment objectives.

Risk and Capital: greater the risk greater is the requirement of capital and vice versa. Buz should be able to meet the max loss arising in the course, and avoid bankruptcy. Risk and Cost: Higher the risk higher would be the premium. higher the risk adjusted RoI, better is the reward to the investors

Risk in Banking Business

Elements in banking industry: Corporate Finance: merchant banking, advisory etc (M&A, Govt Debts, Deb and Equity) Retail Banking: Lending, Deposits, Investment advice, Cards services etc Trading and Sales: Treasury- Fixed income, Debt funding, forex etc Payment and Settlement: Payments, Collections, fund transfers etc Other Agency services

Organisation for Risk Mgt

The Board of Directors-overall respo, frame policies and set limits The Risk Mgt Committee of the Boardguidelines, conformity, manning of processes. Committee of senior level executivesimplementation, reviewing. Risk mgt support group- analyse, monitor and report risk profiles to Committee of senior level exec.

Risk Management Process (v.imp)

Risk Identification Risk Measurement Risk Pricing Risk Monitoring and Control Risk Mitigation

Risk Identification
Risks are contracted at transaction level- credit, operational but certain risks are managed at aggregate or portfolio level. Identify various risks and examine its impact o the portfolio and capital requirement. X Branch of Bank Y Ltd lent a loan of Rs.1 crore for 5 years at 1% over BPLR, BPLR being 10%. Loan repaid in quarterly instalments. Loan is funded by a 3 year deposit of Rs.1crore interest being 6%. Identify the risks.

Risk Measurement
Risk measures seeks to capture variations in earnings, market value, losses due to default etc (target variables). 3 categories: Sensitivity, Volatility, Downside Potential

Measuring volatility
Weekly volatility of stocks of X Ltd., based on historical observation
Week 1 2 3 4 5 Closing Price (Rs.) 20 25 22 30 32 Deviation from Mean Squared Deviation -5.8 -0.8 -3.8 4.2 6.2 33.64 0.64 14.44 17.64 38.44

129 Mean


20.96 Volatility

Risk Pricing
Pricing should take into account the following: Cost of deployable funds Operating expenses Loss probabilities Capital charge Pricing is transaction based. This is the key reasons for risk measurement at transaction level.

Risk monitoring and control

Banks should have: An organisational structure Comprehensive risk mgt approach Risk mgt policies Guidelines and other parameters to govern the risk. Feedback is also necessary for controlling.

Risk Mitigation
Credit risks- collateralisations, third party guarantees etc Interest rate risks- interest rate swaps, FRA or futures Forex risks- forwards, options and futures Through diversification also, mitigation of risks is possible.