Important points for Risk Management
Risk and Capital
Risk is possible unfavorable impact on net cash flow in future due to uncertainty of happening or non- happening of events. Capital is a cushion or shock observer required to absorb potential losses in future. Higher the Risks, high will be the requirement of Capital and there will be rise in RAROC (Risk Adjusted
Return on Capital). Types of Risks
Risk is anticipated at Transaction level as well as at Portfolio level. Transaction Level
Credit Risk, Market Risk and Operational Risk are transaction level risk and are managed at Unit level. Portfolio Level
Liquidity Risk and Interest Rate Risk are also transaction level risks but are managed at Portfolio level. Risk Measurement
Based on Sensitivity
It is change in Market Value due to 1% change in interest rates. The interest rate gap is sensitivity
of the interest rate margin of Banking book. Duration is sensitivity of Investment portfolio or Trading
book
Based on Volatility:
It is common statistical measure of dispersion around the average of any random variable such as
earnings, Markto market values, losses due to default etc. Statistically Volatility is Standard deviation of Value of Variables
Calculation
Example 1 : We have to find volatility of Given Stock price over a given period. Volatility may
be weekly or monthly. Suppose we want to calculate weekly volatility. We will note down Stock
price of nos. of weeks. Mean Price = 123.62 and
Variance (sum of Squared deviation from mean) is 82.70
(extracted from weekly Stock prices) Volatility i.e. sd =
∫Variance = ∫82.70 = 9.09
Volatility over Time Horizon T = Daily Volatility X ∫T
Example 2
Daily Volatility =1.5%
Monthly Volatility = 1.5 X ∫30 = 1.5 X 5.48 = 8.22
Volatility will be more if Time horizon is more. Downside Potential
It captures only possible losses ignoring profits and risk calculation is done keeping in view two
components:
7. Potential losses
8. Probability of Occurrence. The measure is more relied upon by banks/FIs/RBI. VaR (Value at Risk is a downside Risk
Measure.)
Risk Pricing Risk Premium is added in the interest rate because of the following:
6. Necessary Capital is to be maintained as per regulatory requirements. 7. Capital is raised with cost. For example there are 100 loan accounts with Level 2 Risk. It means there can be average loss of 2% on
such type of loan accounts: Risk Premium of 2% will be added in Rate of Interest. Pricing includes the following:
j) Cost of Deploying funds
k) Operating Expenses
l) Loss Probabilities
m) Capital Charge
Risk Mitigation
Credit Risk can be mitigated by accepting Collaterals, 3rd party guarantees, Diversification of
Advances and Credit Derivatives.
Interest rate Risk can be reduced by Derivatives of Interest Rate Swaps. Forex Risk can be reduced by entering into Forward Contracts and Futures etc.
If we make advances to different types of business with different Risk percentage, the overall risk will
be reduced through diversification of Portfolio. Banking Book, Trading Book and Off Balance Sheet Items
Banking Book
It includes all advances, deposits and borrowings which arise from Commercial and Retail Banking. These are Held till maturity and Accrual system of accounting is applied. The Risks involved are:
Liquidity Risk, Interest Rate Risk, Credit Default Risk, Market Risk and Operational Risk. Trading Book
It includes Assets which are traded in market. 6. These are not held till maturity. 7. The positions are liquidated from time to time. 8. These are Mark- to–market i.e. Difference between market price and book value is taken as
profit. 9. Trading Book comprises of Equities, Foreign Exchange Holdings and Commodities etc. 10. These also include Derivatives
The Risks involved are Market Risks. However Credit Risks and Liquidity Risks can also be there. Off Balance Sheet Exposures
The Off Balance sheet exposures are Contingent Liabilities, Guarantees, LC and other obligations. It
includes Derivatives also. These may form part of Trading Book or Banking Book after they become
Fund based exposure. Types of Risks
1. Liquidity Risk
It is inability to obtain funds at reasonable rates for meeting Cash flow obligations. Liquidity Risk is of
following types:
Funding Risk: It is risk of unanticipated withdrawals and non-renewal of FDs which are raw material
for Fund based facilities. Time Risk: It is risk of non-receipt of expected inflows from loans in time due to high rate NPAs
which will create liquidity crisis. Call Risk: It is risk of crystallization of contingent liabilities.
includes Frauds Risk, Communication Risk, Documentation Risk, Regulatory Risk, Compliance Risk and
legal risks but excludes strategic /reputation risks. Two of these risks are frequently occurred. Transaction Risk: Risk arising from fraud, failed business processes and inability to maintain
Business Continuity. Compliance Risk: Failure to comply with applicable laws, regulations, Code of Conduct may attract
penalties and compensation. Other Risks are:
3. Strategic Risk: Adverse Business Decisions, Lack of Responsiveness to business changes and no
strategy to achieve business goals. 4. Reputation Risk ; Negative public opinions, Decline in Customer base and litigations etc. 5. Systemic Risks ; Single bank failure may cause collapse of whole Banking System and result into
large scale failure of banks.
In 1974, closure of HERSTATT Bank in Germany posed a threat for the entire Banking system
BASEL–I
Bank for International Settlements (BIS) is situated at Basel (name of the city in Switzerland). Moved by
collapse of HERSTATT bank, BCBS – Basel Committee on Banking Supervision consisting of 13
members of G10 met at Basel and released guidelines on Capital Adequacy in July 1988. These
guidelines were implemented in India by RBI w.e.f. 1.4.1992 on the recommendations of Narsimham
Committee. The basic objective was to strengthen soundness and stability of Banking system in India in
order to win confidence of investors, to create healthy environment and meet international standards. BCBS meets 4 times in a year. Presently, there are 27 members. BCBS does not possess any formal supervisory authority. 1996 Amendment
7. Allowed banks to use Internal Risk Rating Model. 8. Computation of VaR daily using 99th percentile. 9. Use of back-testing
10. Allowing banks to issue short term subordinate debts with lock-in clause. Calculation of CRAR (Capital to Risk Weighted Asset Ratio)
Basel – I requires measurement of Capital Adequacy in respect of Credit risks and Market Risks
only as per the following method:
Capital funds(Tier I & Tier II)/(Credit Risk Weighted Assets + Market RWAs + Operational RWAs) X
100
Minimum requirement of CRAR is as under:
As per BASEL-II recommendations 8%
As per RBI guidelines 9%
Banks undertaking Insurance business 10%
New Private Sector Banks 10%
Local Area banks 15%
For dividend declaration by the banks (during previous 2 years and current year) 9%
Tier I & Tier II Capital
Tier –I Capital
Tier –I Capital includes:
8. Paid up capital, Statutory reserves, Other disclosed free reserves, Capital Reserve representing
surplus out of sale proceeds of assets. 9. Investment fluctuation reserve without ceiling. 10. Innovative perpetual Debt instruments (Max. 15% of Tier I capital)
11. Perpetual non-cumulative Preference shares
Less Intangible assets & Losses. 5 Sum total of Innovative Perpetual Instruments and Preference shares as stated above should not
exceed 40% of Tier I capital. Rest amount will be treated as Tier II capital. Tier –II Capital
It includes:
6. Redeemable Cumulative Preference shares, Redeemable non-cumulative Preference shares
& Perpetual cumulative Preference shares, 7. Revaluation reserves at a discount of 55%, 8. General Provisions & Loss reserves up to 1.25 % of RWAs
9. Hybrid debts (say bonds) & Subordinate debts (Long term Unsecured loans) limited to 50% of
Tier –I Capital. Tier – III Capital
Banks may at the discretion of the National Authority, employ 3rd tier of Capital consisting of short term
subordinate debts for the sole purpose of meeting a proportion of capital requirements for market risks. Tier III capital will be limited to 250% of bank’s Tier –I Capital (Minimum of 28.5%) that is required to
support market risks. Tier – II capital should not be more than 50% of Total Capital. Capital adequacy in RRBs
The committee on financial sector assessment has suggested introducing CRAR in RRBs also in a
phased manner. Two ways to improve CRAR
$ By raising more capital. Raising Tier I capital will dilute the equity stake of existing investors including
Govt. Raising Tier II Capital is definitely a costly affair and it will affect our profits. $ Reduction of risk weighted assets by implementing Risk mitigation Policy.
Risk Weights on different Assets
Cash and Bank Balance 0%
Advances against NSC/KVC/FDs/LIC 0%
Govt. guaranteed Advances 0%
Central Govt. Guarantees 0%
State Govt. Guarantees 20%
Govt. approved securities 2.5%
Balance with other scheduled banks having CRR at least 9% 20%
Other banks having CRR at least 9% 100%
Secured loan to staff 20%
Other Staff loans -not covered by retirement dues 75%
Loans upto 1.00 lac against Gold/Silver 50%
Residential Housing Loans O/S above 30 lac 75%
Residential Housing loans O/S upto 30 lac 50%
Residential property if LTV ratio is above 75% 100%
Residential Housing Loans O/S above 75 lac 125%
Mortgage based securitization of assets 77.5%
Consumer Credit / Credit Cards/Shares loan 125%
Claims secured by NBFC-non-deposit taking (other than AFCs) 100%
Venture Capital 150%
Commercial Real Estates 100%
Education Loans (Basel –II -75%) 100%
Other loans (Agriculture, Exports) 100%
Indian Banks having overseas presence and Foreign banks will be on parallel run (Basel -I) and Basel-II
for 3 years commencing from 31.3.2010 up to 31.3.2013. These banks will ensure that : Basel-II
minimum capital requirement continues to be higher than 80% of Basel-I minimum capital
requirement for credit Risk and Market Risk.” Further, Tier –I CRAR should be at-least 6% up to 31.3.2010 and 8% up to 31.3.2011
BASEL II
The Committee on Banking Regulations and Supervisory Practices released revised version in the year
2004. These guidelines have been got implemented by RBI in all the banks of India. Parallel run was
started from 1.4.2006. In banks having overseas presence and foreign banks (except RRBs and local
area banks. Complete switchover has taken place w.e.f. 31.3.2008. In banks with no foreign branch, switchover will took place w.e.f. 31.3.2009. Distinction between Basel I and Basel II
Basel – I measures credit risks and market risks only whereas Basel II measures 3 types of risks i.e. Credit Risk, Operational Risk and Market Risk. Risk weights are allocated on the basis of rating of the
borrower i.e. AAA, AA, A, BBB, BB and B etc. Basel –II also recognized CRM such as Derivatives, Collaterals etc.
Three Pillars of BASEL-II
Pillar –I Minimum Capital Requirement
Pillar – II Supervisory Review Process
Pillar –III Market Discipline
Pillar - I – Minimum Capital Requirement
CRAR will be calculated by adopting same method as discussed above under Basel – I with the only
difference that Denominator will be arrived at by adding 3 types of risks i.e. Credit Risks, Market Risks
and Operational Risks. Credit Risk
Credit Risk is the risk of default by a borrower to meet commitment as per agreed terms and
conditions. In terms of extant guidelines contained in BASEL-II, there are three approaches to
measure Credit Risk given as under:
$ Standardized approach
$ IRB (Internal Rating Based) Foundation approach
$ IRB (Internal Rating Based) Advanced approach
1. Standardized Approach
RBI has directed all banks to adopt Standardized approach in respect of Credit Risks. Under
standardized approach, risk rating will be done by credit agencies. Four Agencies are approved for
external rating:
1. CARE 2. FITCH India 3.CRISIL 4. ICRA
Risk weights prescribed by RBI are as under:
Rated Corporate
Rating & Risk Percentage
$ 20%
6. 30%
6. 50%
(v) 100%
BJ. & below 150%
Education Loans 75%
Retail portfolio and SME portfolio 75% Housing
loans secured by mortgage 50 to 75%
Commercial Real Estates 100%
Unrated Exposure 100%
2. IRBA – Internal rating Based Approach
At present all advances of Rs. 5.00 crore and above are being rated from external agencies in our bank.
IRBA is based on bank’s internal assessment. It has two variants (Foundation and advanced). Bank will
do its own assessment of risk rating and requirement of Capital will be
calculated on
i)Probability of default (PD)
j)Loss given default (LD)
k) Exposure of default (ED)
l)Effective maturity. (M)
Bank has developed its own rating module system to rate the undertaking internally. The internal rating is
being used for the following purposes:
m)Credit decisions
n) Determination of Powers
o) Price fixing
Rating by Outside Agencies
The risk weights corresponding to the newly assigned rating symbols are as under:
Table : PART A – Long term Claims on Corporate – Risk Weights Long
Term Ratings
CARE CRISIL Fitch ICRA Risk Weights (%) CARE AAA
CRISIL AAA Fitch AAA ICRA AAA 20 CARE AA CRISIL
AA Fitch AA ICRA AA 30 CARE A CRISIL A Fitch A ICRA
A 50
CARE BBB CRISIL BBB Fitch BBB ICRA BBB 100
CARE BB & below CRISIL BB & below Fitch BB & below ICRA BB & below 150 Unrated
Unrated Unrated Unrated 100
How to Calculate RWAs and Capital Charge in respect of Credit risk
Ist Step : Calculate Fund Based and Non Fund Based Exposure
2nd Step: Allowable Reduction
3rd Step : Apply Risk Weights as per Ratings
4th Step: Calculate Risk Weighted Assets
5th Step : Calculate Capital Charge
Ist Step: Calculate Fund Based and Non Fund Based Exposure:
Example:
Fund Based Exposure (Amount in ‘000)
Nature of loan Limit Outstanding Undrawn portion
CC 200 100 100
Bills Purchased 60 30 30
Packing Credit 40 30 10
Term Loan 200 40 160
Total Outstanding 200
Out of Undrawn portion of TL, 60 is to drawn in a year and balance beyond 1 year.
Adjusted Exposure:
100% Outstanding(Unrated) = 200
20% of Undrawn CC, BP & PC (140*20/100) = 28
20% of Undrawn TL (1 yr) (60*20/100) = 12
50% of Undrawn TL (>1Yr) (100*50/100) = 50
Total Adjusted Exposure FB limits 290
Non Fund Based Exposure (Amount in ‘000)
Type of NBF Exposure CCF Adjusted Exposure
Financial Guarantees 90 100% 90
Acceptances 80 100% 80
Standby LC 50 100% 50
Clean LC 50 100% 50
Unconditional Take out finance 100 100% 100
Performance Guarantee 80 50% 40
Bid Bonds 20 50% 10
Conditional Take out finance 50 50% 25
Documentary LC 40 20% 8
Total Adjusted Exposure FB limits = 453
Total Adjusted Exposure = 290000+453000 = 7,43,000
2nd Step: Allowable Reduction after adjusting CRMs (Credit Risk Mitigates)
Reduction from adjusted exposure is made on account of following eligible financial collaterals:
Eligible Financial Collaterals . 7. Deposits being maintained by a borrower under lien. 8. Cash (including CDs or FDs), Gold, Govt Securities, KVP, NSC, LIC Policy, Debt Securities, Mutual Funds’ 9. Equity and convertible bonds are no more eligible CRMs. Formula for Deposits under lien: C*(1-Hfx) X Mf
(C=Amount of Deposit; Hfx =0 (if same currency), Hfx = 0.08 (if diff currency) Mf = Maturity factor). Formula for Approved Financial collaterals: C*(1-Hc-Hfx) *Mf ) - E*He
Haircuts(He–Haircut for Exposure & Hc-Haircut for Collateral)
Haircut refers to the adjustments made to the amount of exposures to the counter party and also the
value of collateral received to take account of possible future fluctuations in the value of either, on
account of market movements. Standardized Supervisory Haircuts for collateral /Exposure have been
prescribed by RBI and given in the said circular. Capital Requirement for collateralized transaction
E* = max { 0, [E X (1+He) – C X (1-Hc- Hfx) } ]
E* - exposure value alter risk mitigation
E – Current value of exposure for which coll. Qualifies
C = current value of collateral received
Hfx = Haircut appropriate for currency mismatch between collateral and exposure. E* will be multiplied by the risk weight of the counter party to obtain RWA amount.
Illustrations clarifying CRM
In the case of exposure of Rs 100 (denominated in USD) having a maturity of 6 years to a BBB rated
(rating by external credit rating agency) corporate borrower secured by collateral of Rs 100 by way of A+
rated corporate bond with a maturity of 6 years, the exposure amount after the applicable haircut @ 12%, will be Rs 112 and the volatility adjusted collateral value would be Rs 80, (after applying haircut @ 12%
as per issue rating and 8% for currency mismatch) for the purpose of arriving at the value of risk weighted
asset & calculating charge on capital. There is an exposure of Rs 100 to an unrated Corporate (having no rating from any external agency)
having a maturity of 3 years, which is secured by Equity shares outside the main index having a market
value of Rs 100. The haircut for exposure as well as collateral will be 25%. There is no currency mismatch in this case. The volatility adjusted exposure and collateral after application of haircuts works out to Rs 125 and Rs
75 respectively. Therefore, the net exposure for calculating RWA works out to Rs 50. There is a demand loan of Rs 100 secured by bank’s own deposit of Rs 125. The haircuts for
exposure and collateral would be zero. There is no maturity mismatch. Adjusted exposure and
collateral after application of haircuts would be Rs 100 and Rs 125 respectively. Net exposure for the
purpose of RWA would be zero
Other Examples
No. 1: • Exposure----------------------------------------- 100 lac with tenure 3 years
• Eligible Collateral in A+ Debt Security -----30 lac with Residual maturity 2 years
• Hair cut on Collateral is 6%
• Table of Maturity factor shows hair cut as 25% for remaining maturity of 2 years/
Calculate Value of Exposure after Risk Mitigation:
Solution:
Value of Exposure after Risk Mitigation = Current Value of Exposure – Value of adjusted collateral for Hair cut and maturity mismatch
Value of Adjusted Collateral for Hair cut = C*(1-Hc) = 30(1-6%) = 30*94% = 28.20
Value of Adjusted Collateral for Hair cut and Maturity Mismatch = C*(t-0.25) / (T-0.25) = 28.20*(2-.25)/(3-.25) = 17.95
(Where t = Remaining maturity of Collateral T= Tenure of loan )
Value of Exposure after Risk Mitigation = 100-17.95= 82.05 lac. No. 2
An exposure of Rs. 100 lac is backed by lien on FD of 30 lac. There is no mismatch of maturity.
Solution:
Hair Cut for CRM i.e. FDR is zero. Hence Value of Exposure after Risk Mitigation is 100 lac – 30 lac = 70 lac
Computation of CRAR
In a bank ; Tier 1 Capital = 1000 crore
Tier II Capital = 1200 crore
RWAs for Credit Risk = 10000 crore
Capital Charge for Market Risk = 500 crore
Capital Charge for Op Risk = 300 crore
Find Tier I CRAR and Total CRAR. Solution:
RWAs for Credit Risk = 10000 crore
RWAs for Market Risk = 500/.09 = 5556 crore
RWAs for Op Risk = 300/.09 = 3333 crore
Total RWS = 10000+5556+3333 = 18889 crore
Tier I Capital = 1000 crore
Tier II Capital can be up to maximum 1000 crore
Total Capital = 2000 crore
Tier I CRAR = Eligible Tier I Capital /Total RWAs = 1000/18889=5.29% Total
CRAR = Eligible Total Capital /Total RWAs = 2000/18889 = 10.59% We may
conclude that Tier I Capital is less than the required level. Credit Risk Mitigates
It is a process through which credit Risk is reduced or transferred to counter party. CRM
techniques are adopted at Transaction level as well as at Portfolio level as under:
At Transaction level:
4. Obtaining Cash Collaterals
5. Obtaining guarantees
At portfolio level
4. Securitization
5. Collateral Loan Obligations and Collateral Loan Notes
6. Credit Derivatives
1. Securitization
It is process/transactions in which financial securities are issued against cash flow generated from
pool of assets. Cash flow arising from receipt of Interest and Principal of loans are used to pay interest and
repayment of securities. SPV (Special Purpose Vehicle) is created for the said purpose. Originating bank transfers assets to SPV and it issues financial securities.
2. Collateral Loan Obligations (CLO) and Credit Linked Notes (CLN)
It is also a form of securitization. Through CLO, bank removes assets from Balance Sheet and issues
tradable securities. They become free from Regulatory Capital. CLO differs from CLN (Credit link notes in the following manner.
i) CLO provide credit Exposure to diverse pool of credit where CLN relates to single credit.
ii) CLO result in transfer of ownership whereas CLN do not provide such transfer.
iii) CLO may enjoy higher credit rating than that of originating bank. 3. Credit Derivatives
It is managing risks without affecting portfolio size. Risk is transferred without transfer of assets from the
Balance Sheet though OTC bilateral contract. These are Off Balance Sheet Financial Instruments. Credit
Insurance and LC are similar to Credit derivatives. Under a Credit Derivative PB (Prospective buyer)
enter into an agreement with PS (Prospective seller) for transfer of risks at notional value by making of
Premium payments. In case of delinquencies, default, Foreclosure, prepayments, PS compensates PB
for the losses. Settlement can be Physical or Cash. Under physical settlement, asset is transferred
whereas under Cash settlement, only loss is compensated. Credit Derivatives are generally OTC instruments. ISDA (International Swaps and Derivatives
Association) has come out with documentation evidencing such transaction. Credit Derivatives are:
vii) Credit Default Swaps
viii) Total Return Swaps
ix) Credit Linked Notes
x) Credit Spread Options
Operational Risk
Operational Risk is the risk of loss resulting from
iii. Inadequate or failed internal processes, people and system.
iv. External events such as dacoity, burglary, fire etc.
It includes legal risks but excludes strategic /reputation risks.
Identification
(iii) Actual Loss Data Base
(iv) RBIA reports
(v) Risk Control & Self Assessment Survey
(vi) Key Risk indicators
(vii) Scenario analysis
Four ways to manage Risk
8. Prevent
9. Reduce
10. Transfer
11. Carry/Accept
Operational Risk – Measurement
Three approaches have been defined to measure Operational Risk at the bank: • Basic Indicator approach
• Standardized approach
• AMA i.e. Advanced measurement approach
Basic Indicator Approach
15% of Average positive gross annual income of previous 3 years will be requirement of capital. To start
with banks will have to adopt this approach and huge capital is required to be maintained. In our bank, estimated requirement of capital will be about Rs. 1000 crore. The Standardized Approach
All banking activities are to be divided in 8 business lines. 1) Corporate finance 2) Trading &
Sales 3) Retail Banking 4) Commercial Banking 5) Asset Management 6) Retail brokerage 7)
Agency service 8) Payment settlement
Within each business line, Capital requirement will be calculated as under:
By multiplying the average gross income generated by a business over previous 3 years by a factor
β ranging from 12 % to 18 % depending upon industry-wise relationships as under:
Retail Banking, Retail Brokerage and Asset Management -----------12%
Commercial Banking and Agency Services--------------------------- 15%
Corporate, Trading and Payment Settlement------------------------ 18%
Advanced Measurement Approach
Capital requirement is calculated by the actual risk measurement system devised by bank’s own internal
Operational Risk Measurement methods using quantitative and qualitative criteria. Our bank has started
measuring actual losses and estimating future losses by introducing statement of Operational Risk Loss
data w.e.f. 1.4.2005. Minimum 5 year data is required for a bank to switch over to AMA. How to calculate RWAs for Operational Risk?
RWAs for Operational Risk = Capital Charge / 0.09% (If required CAR is 9%)
Operational Risk – Scenario Analysis
It is a term used in measurement of Operational Risk on the basis of scenario estimates. Banks use scenario analysis based on expert opinion in conjunction with external data to evaluate its
exposure to high severity events.
In addition, scenario analysis is used to assess impact of deviations from correlation assumptions in the
bank’s Operational Risk measurement framework to evaluate potential losses arising from operational
risk loss events. Operational Risk Mitigation
Insurance cover, if available can reduce the operational risk only when AMA is adopted for
estimating capital requirements. The recognition of insurance mitigation is limited to 20% of total
Operational Risk Capital Charge calculated under AMA. Practical Example - AMA approach
Under AMA approach, Estimated level of Operational Risk is calculated on the basis of: • Estimated probability of occurrence
• Estimated potential financial impact • Estimated impact of internal control. Estimated Probability of Occurrence: This is based on historical frequency of occurrence &
estimated likelihood of future occurrence. Probability is mapped on scale of 5 as under:
Negligible risk -----1
Low risk-------------2
Medium Risk--------3
High Risk------------4
Very High Risk------5
For Calculation, following formula is used:
Estimated level of Operational Risk = {Estimated probability of occurrence x Estimated potential
financial impact x Estimated impact of internal control} ^0.5 ^0.5 implies Under root of whole
Example:
Probability of occurrence = 2 (medium)
Probability of Financial impact = 4 (very high)
Impact of Financial control = 50%
Solution
[ 2x4x(1-0.5)] ^0.5 = ∫4 = 2 (Low)
Market Risk
It is simply risk of losses on Balance sheet and Off Balance sheet items basically in investments due to
movement in market prices. It is risk of adverse deviation of mark to Market value of trading portfolio
during the period. Any decline in the market value will result into loss. Market Risk involves the following:
d) Risk Identification
e) Risk Measurement
f) Risk monitoring and control
g) Risk mitigation
Risk and Capital
Risk is possible unfavorable impact on net cash flow in future due to uncertainty of happening or non- happening of events. Capital is a cushion or shock observer required to absorb potential losses in future. Higher the Risks, high will be the requirement of Capital and there will be rise in RAROC (Risk Adjusted
Return on Capital). Types of Risks
Risk is anticipated at Transaction level as well as at Portfolio level. Transaction Level
Credit Risk, Market Risk and Operational Risk are transaction level risk and are managed at Unit level. Portfolio Level
Liquidity Risk and Interest Rate Risk are also transaction level risks but are managed at Portfolio level. Risk Measurement
Based on Sensitivity
It is change in Market Value due to 1% change in interest rates. The interest rate gap is sensitivity
of the interest rate margin of Banking book. Duration is sensitivity of Investment portfolio or Trading
book
Based on Volatility:
It is common statistical measure of dispersion around the average of any random variable such as
earnings, Markto market values, losses due to default etc. Statistically Volatility is Standard deviation of Value of Variables
Calculation
Example 1 : We have to find volatility of Given Stock price over a given period. Volatility may
be weekly or monthly. Suppose we want to calculate weekly volatility. We will note down Stock
price of nos. of weeks. Mean Price = 123.62 and
Variance (sum of Squared deviation from mean) is 82.70
(extracted from weekly Stock prices) Volatility i.e. sd =
∫Variance = ∫82.70 = 9.09
Volatility over Time Horizon T = Daily Volatility X ∫T
Example 2
Daily Volatility =1.5%
Monthly Volatility = 1.5 X ∫30 = 1.5 X 5.48 = 8.22
Volatility will be more if Time horizon is more. Downside Potential
It captures only possible losses ignoring profits and risk calculation is done keeping in view two
components:
7. Potential losses
8. Probability of Occurrence. The measure is more relied upon by banks/FIs/RBI. VaR (Value at Risk is a downside Risk
Measure.)
Risk Pricing Risk Premium is added in the interest rate because of the following:
6. Necessary Capital is to be maintained as per regulatory requirements. 7. Capital is raised with cost. For example there are 100 loan accounts with Level 2 Risk. It means there can be average loss of 2% on
such type of loan accounts: Risk Premium of 2% will be added in Rate of Interest. Pricing includes the following:
j) Cost of Deploying funds
k) Operating Expenses
l) Loss Probabilities
m) Capital Charge
Risk Mitigation
Credit Risk can be mitigated by accepting Collaterals, 3rd party guarantees, Diversification of
Advances and Credit Derivatives.
Interest rate Risk can be reduced by Derivatives of Interest Rate Swaps. Forex Risk can be reduced by entering into Forward Contracts and Futures etc.
If we make advances to different types of business with different Risk percentage, the overall risk will
be reduced through diversification of Portfolio. Banking Book, Trading Book and Off Balance Sheet Items
Banking Book
It includes all advances, deposits and borrowings which arise from Commercial and Retail Banking. These are Held till maturity and Accrual system of accounting is applied. The Risks involved are:
Liquidity Risk, Interest Rate Risk, Credit Default Risk, Market Risk and Operational Risk. Trading Book
It includes Assets which are traded in market. 6. These are not held till maturity. 7. The positions are liquidated from time to time. 8. These are Mark- to–market i.e. Difference between market price and book value is taken as
profit. 9. Trading Book comprises of Equities, Foreign Exchange Holdings and Commodities etc. 10. These also include Derivatives
The Risks involved are Market Risks. However Credit Risks and Liquidity Risks can also be there. Off Balance Sheet Exposures
The Off Balance sheet exposures are Contingent Liabilities, Guarantees, LC and other obligations. It
includes Derivatives also. These may form part of Trading Book or Banking Book after they become
Fund based exposure. Types of Risks
1. Liquidity Risk
It is inability to obtain funds at reasonable rates for meeting Cash flow obligations. Liquidity Risk is of
following types:
Funding Risk: It is risk of unanticipated withdrawals and non-renewal of FDs which are raw material
for Fund based facilities. Time Risk: It is risk of non-receipt of expected inflows from loans in time due to high rate NPAs
which will create liquidity crisis. Call Risk: It is risk of crystallization of contingent liabilities.
includes Frauds Risk, Communication Risk, Documentation Risk, Regulatory Risk, Compliance Risk and
legal risks but excludes strategic /reputation risks. Two of these risks are frequently occurred. Transaction Risk: Risk arising from fraud, failed business processes and inability to maintain
Business Continuity. Compliance Risk: Failure to comply with applicable laws, regulations, Code of Conduct may attract
penalties and compensation. Other Risks are:
3. Strategic Risk: Adverse Business Decisions, Lack of Responsiveness to business changes and no
strategy to achieve business goals. 4. Reputation Risk ; Negative public opinions, Decline in Customer base and litigations etc. 5. Systemic Risks ; Single bank failure may cause collapse of whole Banking System and result into
large scale failure of banks.
In 1974, closure of HERSTATT Bank in Germany posed a threat for the entire Banking system
BASEL–I
Bank for International Settlements (BIS) is situated at Basel (name of the city in Switzerland). Moved by
collapse of HERSTATT bank, BCBS – Basel Committee on Banking Supervision consisting of 13
members of G10 met at Basel and released guidelines on Capital Adequacy in July 1988. These
guidelines were implemented in India by RBI w.e.f. 1.4.1992 on the recommendations of Narsimham
Committee. The basic objective was to strengthen soundness and stability of Banking system in India in
order to win confidence of investors, to create healthy environment and meet international standards. BCBS meets 4 times in a year. Presently, there are 27 members. BCBS does not possess any formal supervisory authority. 1996 Amendment
7. Allowed banks to use Internal Risk Rating Model. 8. Computation of VaR daily using 99th percentile. 9. Use of back-testing
10. Allowing banks to issue short term subordinate debts with lock-in clause. Calculation of CRAR (Capital to Risk Weighted Asset Ratio)
Basel – I requires measurement of Capital Adequacy in respect of Credit risks and Market Risks
only as per the following method:
Capital funds(Tier I & Tier II)/(Credit Risk Weighted Assets + Market RWAs + Operational RWAs) X
100
Minimum requirement of CRAR is as under:
As per BASEL-II recommendations 8%
As per RBI guidelines 9%
Banks undertaking Insurance business 10%
New Private Sector Banks 10%
Local Area banks 15%
For dividend declaration by the banks (during previous 2 years and current year) 9%
Tier I & Tier II Capital
Tier –I Capital
Tier –I Capital includes:
8. Paid up capital, Statutory reserves, Other disclosed free reserves, Capital Reserve representing
surplus out of sale proceeds of assets. 9. Investment fluctuation reserve without ceiling. 10. Innovative perpetual Debt instruments (Max. 15% of Tier I capital)
11. Perpetual non-cumulative Preference shares
Less Intangible assets & Losses. 5 Sum total of Innovative Perpetual Instruments and Preference shares as stated above should not
exceed 40% of Tier I capital. Rest amount will be treated as Tier II capital. Tier –II Capital
It includes:
6. Redeemable Cumulative Preference shares, Redeemable non-cumulative Preference shares
& Perpetual cumulative Preference shares, 7. Revaluation reserves at a discount of 55%, 8. General Provisions & Loss reserves up to 1.25 % of RWAs
9. Hybrid debts (say bonds) & Subordinate debts (Long term Unsecured loans) limited to 50% of
Tier –I Capital. Tier – III Capital
Banks may at the discretion of the National Authority, employ 3rd tier of Capital consisting of short term
subordinate debts for the sole purpose of meeting a proportion of capital requirements for market risks. Tier III capital will be limited to 250% of bank’s Tier –I Capital (Minimum of 28.5%) that is required to
support market risks. Tier – II capital should not be more than 50% of Total Capital. Capital adequacy in RRBs
The committee on financial sector assessment has suggested introducing CRAR in RRBs also in a
phased manner. Two ways to improve CRAR
$ By raising more capital. Raising Tier I capital will dilute the equity stake of existing investors including
Govt. Raising Tier II Capital is definitely a costly affair and it will affect our profits. $ Reduction of risk weighted assets by implementing Risk mitigation Policy.
Risk Weights on different Assets
Cash and Bank Balance 0%
Advances against NSC/KVC/FDs/LIC 0%
Govt. guaranteed Advances 0%
Central Govt. Guarantees 0%
State Govt. Guarantees 20%
Govt. approved securities 2.5%
Balance with other scheduled banks having CRR at least 9% 20%
Other banks having CRR at least 9% 100%
Secured loan to staff 20%
Other Staff loans -not covered by retirement dues 75%
Loans upto 1.00 lac against Gold/Silver 50%
Residential Housing Loans O/S above 30 lac 75%
Residential Housing loans O/S upto 30 lac 50%
Residential property if LTV ratio is above 75% 100%
Residential Housing Loans O/S above 75 lac 125%
Mortgage based securitization of assets 77.5%
Consumer Credit / Credit Cards/Shares loan 125%
Claims secured by NBFC-non-deposit taking (other than AFCs) 100%
Venture Capital 150%
Commercial Real Estates 100%
Education Loans (Basel –II -75%) 100%
Other loans (Agriculture, Exports) 100%
Indian Banks having overseas presence and Foreign banks will be on parallel run (Basel -I) and Basel-II
for 3 years commencing from 31.3.2010 up to 31.3.2013. These banks will ensure that : Basel-II
minimum capital requirement continues to be higher than 80% of Basel-I minimum capital
requirement for credit Risk and Market Risk.” Further, Tier –I CRAR should be at-least 6% up to 31.3.2010 and 8% up to 31.3.2011
BASEL II
The Committee on Banking Regulations and Supervisory Practices released revised version in the year
2004. These guidelines have been got implemented by RBI in all the banks of India. Parallel run was
started from 1.4.2006. In banks having overseas presence and foreign banks (except RRBs and local
area banks. Complete switchover has taken place w.e.f. 31.3.2008. In banks with no foreign branch, switchover will took place w.e.f. 31.3.2009. Distinction between Basel I and Basel II
Basel – I measures credit risks and market risks only whereas Basel II measures 3 types of risks i.e. Credit Risk, Operational Risk and Market Risk. Risk weights are allocated on the basis of rating of the
borrower i.e. AAA, AA, A, BBB, BB and B etc. Basel –II also recognized CRM such as Derivatives, Collaterals etc.
Three Pillars of BASEL-II
Pillar –I Minimum Capital Requirement
Pillar – II Supervisory Review Process
Pillar –III Market Discipline
Pillar - I – Minimum Capital Requirement
CRAR will be calculated by adopting same method as discussed above under Basel – I with the only
difference that Denominator will be arrived at by adding 3 types of risks i.e. Credit Risks, Market Risks
and Operational Risks. Credit Risk
Credit Risk is the risk of default by a borrower to meet commitment as per agreed terms and
conditions. In terms of extant guidelines contained in BASEL-II, there are three approaches to
measure Credit Risk given as under:
$ Standardized approach
$ IRB (Internal Rating Based) Foundation approach
$ IRB (Internal Rating Based) Advanced approach
1. Standardized Approach
RBI has directed all banks to adopt Standardized approach in respect of Credit Risks. Under
standardized approach, risk rating will be done by credit agencies. Four Agencies are approved for
external rating:
1. CARE 2. FITCH India 3.CRISIL 4. ICRA
Risk weights prescribed by RBI are as under:
Rated Corporate
Rating & Risk Percentage
$ 20%
6. 30%
6. 50%
(v) 100%
BJ. & below 150%
Education Loans 75%
Retail portfolio and SME portfolio 75% Housing
loans secured by mortgage 50 to 75%
Commercial Real Estates 100%
Unrated Exposure 100%
2. IRBA – Internal rating Based Approach
At present all advances of Rs. 5.00 crore and above are being rated from external agencies in our bank.
IRBA is based on bank’s internal assessment. It has two variants (Foundation and advanced). Bank will
do its own assessment of risk rating and requirement of Capital will be
calculated on
i)Probability of default (PD)
j)Loss given default (LD)
k) Exposure of default (ED)
l)Effective maturity. (M)
Bank has developed its own rating module system to rate the undertaking internally. The internal rating is
being used for the following purposes:
m)Credit decisions
n) Determination of Powers
o) Price fixing
Rating by Outside Agencies
The risk weights corresponding to the newly assigned rating symbols are as under:
Table : PART A – Long term Claims on Corporate – Risk Weights Long
Term Ratings
CARE CRISIL Fitch ICRA Risk Weights (%) CARE AAA
CRISIL AAA Fitch AAA ICRA AAA 20 CARE AA CRISIL
AA Fitch AA ICRA AA 30 CARE A CRISIL A Fitch A ICRA
A 50
CARE BBB CRISIL BBB Fitch BBB ICRA BBB 100
CARE BB & below CRISIL BB & below Fitch BB & below ICRA BB & below 150 Unrated
Unrated Unrated Unrated 100
How to Calculate RWAs and Capital Charge in respect of Credit risk
Ist Step : Calculate Fund Based and Non Fund Based Exposure
2nd Step: Allowable Reduction
3rd Step : Apply Risk Weights as per Ratings
4th Step: Calculate Risk Weighted Assets
5th Step : Calculate Capital Charge
Ist Step: Calculate Fund Based and Non Fund Based Exposure:
Example:
Fund Based Exposure (Amount in ‘000)
Nature of loan Limit Outstanding Undrawn portion
CC 200 100 100
Bills Purchased 60 30 30
Packing Credit 40 30 10
Term Loan 200 40 160
Total Outstanding 200
Out of Undrawn portion of TL, 60 is to drawn in a year and balance beyond 1 year.
Adjusted Exposure:
100% Outstanding(Unrated) = 200
20% of Undrawn CC, BP & PC (140*20/100) = 28
20% of Undrawn TL (1 yr) (60*20/100) = 12
50% of Undrawn TL (>1Yr) (100*50/100) = 50
Total Adjusted Exposure FB limits 290
Non Fund Based Exposure (Amount in ‘000)
Type of NBF Exposure CCF Adjusted Exposure
Financial Guarantees 90 100% 90
Acceptances 80 100% 80
Standby LC 50 100% 50
Clean LC 50 100% 50
Unconditional Take out finance 100 100% 100
Performance Guarantee 80 50% 40
Bid Bonds 20 50% 10
Conditional Take out finance 50 50% 25
Documentary LC 40 20% 8
Total Adjusted Exposure FB limits = 453
Total Adjusted Exposure = 290000+453000 = 7,43,000
2nd Step: Allowable Reduction after adjusting CRMs (Credit Risk Mitigates)
Reduction from adjusted exposure is made on account of following eligible financial collaterals:
Eligible Financial Collaterals . 7. Deposits being maintained by a borrower under lien. 8. Cash (including CDs or FDs), Gold, Govt Securities, KVP, NSC, LIC Policy, Debt Securities, Mutual Funds’ 9. Equity and convertible bonds are no more eligible CRMs. Formula for Deposits under lien: C*(1-Hfx) X Mf
(C=Amount of Deposit; Hfx =0 (if same currency), Hfx = 0.08 (if diff currency) Mf = Maturity factor). Formula for Approved Financial collaterals: C*(1-Hc-Hfx) *Mf ) - E*He
Haircuts(He–Haircut for Exposure & Hc-Haircut for Collateral)
Haircut refers to the adjustments made to the amount of exposures to the counter party and also the
value of collateral received to take account of possible future fluctuations in the value of either, on
account of market movements. Standardized Supervisory Haircuts for collateral /Exposure have been
prescribed by RBI and given in the said circular. Capital Requirement for collateralized transaction
E* = max { 0, [E X (1+He) – C X (1-Hc- Hfx) } ]
E* - exposure value alter risk mitigation
E – Current value of exposure for which coll. Qualifies
C = current value of collateral received
Hfx = Haircut appropriate for currency mismatch between collateral and exposure. E* will be multiplied by the risk weight of the counter party to obtain RWA amount.
Illustrations clarifying CRM
In the case of exposure of Rs 100 (denominated in USD) having a maturity of 6 years to a BBB rated
(rating by external credit rating agency) corporate borrower secured by collateral of Rs 100 by way of A+
rated corporate bond with a maturity of 6 years, the exposure amount after the applicable haircut @ 12%, will be Rs 112 and the volatility adjusted collateral value would be Rs 80, (after applying haircut @ 12%
as per issue rating and 8% for currency mismatch) for the purpose of arriving at the value of risk weighted
asset & calculating charge on capital. There is an exposure of Rs 100 to an unrated Corporate (having no rating from any external agency)
having a maturity of 3 years, which is secured by Equity shares outside the main index having a market
value of Rs 100. The haircut for exposure as well as collateral will be 25%. There is no currency mismatch in this case. The volatility adjusted exposure and collateral after application of haircuts works out to Rs 125 and Rs
75 respectively. Therefore, the net exposure for calculating RWA works out to Rs 50. There is a demand loan of Rs 100 secured by bank’s own deposit of Rs 125. The haircuts for
exposure and collateral would be zero. There is no maturity mismatch. Adjusted exposure and
collateral after application of haircuts would be Rs 100 and Rs 125 respectively. Net exposure for the
purpose of RWA would be zero
Other Examples
No. 1: • Exposure----------------------------------------- 100 lac with tenure 3 years
• Eligible Collateral in A+ Debt Security -----30 lac with Residual maturity 2 years
• Hair cut on Collateral is 6%
• Table of Maturity factor shows hair cut as 25% for remaining maturity of 2 years/
Calculate Value of Exposure after Risk Mitigation:
Solution:
Value of Exposure after Risk Mitigation = Current Value of Exposure – Value of adjusted collateral for Hair cut and maturity mismatch
Value of Adjusted Collateral for Hair cut = C*(1-Hc) = 30(1-6%) = 30*94% = 28.20
Value of Adjusted Collateral for Hair cut and Maturity Mismatch = C*(t-0.25) / (T-0.25) = 28.20*(2-.25)/(3-.25) = 17.95
(Where t = Remaining maturity of Collateral T= Tenure of loan )
Value of Exposure after Risk Mitigation = 100-17.95= 82.05 lac. No. 2
An exposure of Rs. 100 lac is backed by lien on FD of 30 lac. There is no mismatch of maturity.
Solution:
Hair Cut for CRM i.e. FDR is zero. Hence Value of Exposure after Risk Mitigation is 100 lac – 30 lac = 70 lac
Computation of CRAR
In a bank ; Tier 1 Capital = 1000 crore
Tier II Capital = 1200 crore
RWAs for Credit Risk = 10000 crore
Capital Charge for Market Risk = 500 crore
Capital Charge for Op Risk = 300 crore
Find Tier I CRAR and Total CRAR. Solution:
RWAs for Credit Risk = 10000 crore
RWAs for Market Risk = 500/.09 = 5556 crore
RWAs for Op Risk = 300/.09 = 3333 crore
Total RWS = 10000+5556+3333 = 18889 crore
Tier I Capital = 1000 crore
Tier II Capital can be up to maximum 1000 crore
Total Capital = 2000 crore
Tier I CRAR = Eligible Tier I Capital /Total RWAs = 1000/18889=5.29% Total
CRAR = Eligible Total Capital /Total RWAs = 2000/18889 = 10.59% We may
conclude that Tier I Capital is less than the required level. Credit Risk Mitigates
It is a process through which credit Risk is reduced or transferred to counter party. CRM
techniques are adopted at Transaction level as well as at Portfolio level as under:
At Transaction level:
4. Obtaining Cash Collaterals
5. Obtaining guarantees
At portfolio level
4. Securitization
5. Collateral Loan Obligations and Collateral Loan Notes
6. Credit Derivatives
1. Securitization
It is process/transactions in which financial securities are issued against cash flow generated from
pool of assets. Cash flow arising from receipt of Interest and Principal of loans are used to pay interest and
repayment of securities. SPV (Special Purpose Vehicle) is created for the said purpose. Originating bank transfers assets to SPV and it issues financial securities.
2. Collateral Loan Obligations (CLO) and Credit Linked Notes (CLN)
It is also a form of securitization. Through CLO, bank removes assets from Balance Sheet and issues
tradable securities. They become free from Regulatory Capital. CLO differs from CLN (Credit link notes in the following manner.
i) CLO provide credit Exposure to diverse pool of credit where CLN relates to single credit.
ii) CLO result in transfer of ownership whereas CLN do not provide such transfer.
iii) CLO may enjoy higher credit rating than that of originating bank. 3. Credit Derivatives
It is managing risks without affecting portfolio size. Risk is transferred without transfer of assets from the
Balance Sheet though OTC bilateral contract. These are Off Balance Sheet Financial Instruments. Credit
Insurance and LC are similar to Credit derivatives. Under a Credit Derivative PB (Prospective buyer)
enter into an agreement with PS (Prospective seller) for transfer of risks at notional value by making of
Premium payments. In case of delinquencies, default, Foreclosure, prepayments, PS compensates PB
for the losses. Settlement can be Physical or Cash. Under physical settlement, asset is transferred
whereas under Cash settlement, only loss is compensated. Credit Derivatives are generally OTC instruments. ISDA (International Swaps and Derivatives
Association) has come out with documentation evidencing such transaction. Credit Derivatives are:
vii) Credit Default Swaps
viii) Total Return Swaps
ix) Credit Linked Notes
x) Credit Spread Options
Operational Risk
Operational Risk is the risk of loss resulting from
iii. Inadequate or failed internal processes, people and system.
iv. External events such as dacoity, burglary, fire etc.
It includes legal risks but excludes strategic /reputation risks.
Identification
(iii) Actual Loss Data Base
(iv) RBIA reports
(v) Risk Control & Self Assessment Survey
(vi) Key Risk indicators
(vii) Scenario analysis
Four ways to manage Risk
8. Prevent
9. Reduce
10. Transfer
11. Carry/Accept
Operational Risk – Measurement
Three approaches have been defined to measure Operational Risk at the bank: • Basic Indicator approach
• Standardized approach
• AMA i.e. Advanced measurement approach
Basic Indicator Approach
15% of Average positive gross annual income of previous 3 years will be requirement of capital. To start
with banks will have to adopt this approach and huge capital is required to be maintained. In our bank, estimated requirement of capital will be about Rs. 1000 crore. The Standardized Approach
All banking activities are to be divided in 8 business lines. 1) Corporate finance 2) Trading &
Sales 3) Retail Banking 4) Commercial Banking 5) Asset Management 6) Retail brokerage 7)
Agency service 8) Payment settlement
Within each business line, Capital requirement will be calculated as under:
By multiplying the average gross income generated by a business over previous 3 years by a factor
β ranging from 12 % to 18 % depending upon industry-wise relationships as under:
Retail Banking, Retail Brokerage and Asset Management -----------12%
Commercial Banking and Agency Services--------------------------- 15%
Corporate, Trading and Payment Settlement------------------------ 18%
Advanced Measurement Approach
Capital requirement is calculated by the actual risk measurement system devised by bank’s own internal
Operational Risk Measurement methods using quantitative and qualitative criteria. Our bank has started
measuring actual losses and estimating future losses by introducing statement of Operational Risk Loss
data w.e.f. 1.4.2005. Minimum 5 year data is required for a bank to switch over to AMA. How to calculate RWAs for Operational Risk?
RWAs for Operational Risk = Capital Charge / 0.09% (If required CAR is 9%)
Operational Risk – Scenario Analysis
It is a term used in measurement of Operational Risk on the basis of scenario estimates. Banks use scenario analysis based on expert opinion in conjunction with external data to evaluate its
exposure to high severity events.
In addition, scenario analysis is used to assess impact of deviations from correlation assumptions in the
bank’s Operational Risk measurement framework to evaluate potential losses arising from operational
risk loss events. Operational Risk Mitigation
Insurance cover, if available can reduce the operational risk only when AMA is adopted for
estimating capital requirements. The recognition of insurance mitigation is limited to 20% of total
Operational Risk Capital Charge calculated under AMA. Practical Example - AMA approach
Under AMA approach, Estimated level of Operational Risk is calculated on the basis of: • Estimated probability of occurrence
• Estimated potential financial impact • Estimated impact of internal control. Estimated Probability of Occurrence: This is based on historical frequency of occurrence &
estimated likelihood of future occurrence. Probability is mapped on scale of 5 as under:
Negligible risk -----1
Low risk-------------2
Medium Risk--------3
High Risk------------4
Very High Risk------5
For Calculation, following formula is used:
Estimated level of Operational Risk = {Estimated probability of occurrence x Estimated potential
financial impact x Estimated impact of internal control} ^0.5 ^0.5 implies Under root of whole
Example:
Probability of occurrence = 2 (medium)
Probability of Financial impact = 4 (very high)
Impact of Financial control = 50%
Solution
[ 2x4x(1-0.5)] ^0.5 = ∫4 = 2 (Low)
Market Risk
It is simply risk of losses on Balance sheet and Off Balance sheet items basically in investments due to
movement in market prices. It is risk of adverse deviation of mark to Market value of trading portfolio
during the period. Any decline in the market value will result into loss. Market Risk involves the following:
d) Risk Identification
e) Risk Measurement
f) Risk monitoring and control
g) Risk mitigation
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