This chapter highlights the results and findings related with the research paper. It concentrates on the analysis of the data collected by the author from the questionnaire filled in by the banks officials. The main aim is to understand the key risks associated with Indian banks and to prioritize the same and to discover solutions and alternatives to minimizing these risks. The gathered data will highlight the key risks, threats to the banks, benefits and solution towards risk management. Thus based on all those factors, the author will find whether Indian banks incorporate effective risk management system and how they can minimize the associated risks.
There is a questionnaire, designed to take the responses from Bank Officials. The questionnaire was published both online and also distributed in person. There were 48 respondents to the overall questionnaire and was collected over a time period of 8 days. The questionnaire was filled in person by meeting the bank officials and also emails were sent out to in order to cover greater respondents. The questionnaire was filled by the officials from national, regional, state level and other public-private sector banks operating in India. The data gathered from overall questionnaires was been analyzed using excel with the help of graphs determining the key risks and effectiveness of risk management system. The results and graphs for questionnaire are discussed in this chapter with each question and respective graph followed with it.
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.
Most of the banks do not have dedicated risk management team, policy, procedures and framework in place. Those banks have risk management department, the risk manager’s role is restricted to pre fact and post fact analysis of customer’s credit and there is no segregation of credit, market, operational and strategic risks. There are few banks which have articulated framework and risk quantification. The traditional lending practices, assessment of credits, handling of market risks, treasury functionality and culture of risk-rewards are bane of public sector banks whereas private sector banks and financial institutions are somewhat better in this context. The sheer size and wide coverage of banks is a big hurdle to integrate and generate a cost effective real time operational data for mapping the risks. Most of the financial institutions processes are encircled to ‘functional silos’ follows bureaucratic structure and yet to come up with a transparent and appropriate corporate governance structure to achieve the stated strategic objectives. Since the year 1998 RBI has been giving serious attention towards evolving suitable and comprehensive models for Risk-management. It has laid stress on integrating this new discipline in the working systems of the Banks. In view of this, the risk management division in most of the banks was established in or after 1998 only. All the details regarding the risk management framework is presented by the bank in a policy document called ICAAP.
Identification and prioritizing the key risk was one of the main objectives of this research. As discussed in chapter-2, various risks that a bank is bound to confront were divided into two categories namely, business risks and control risks. Business risk involves the risks arising out of the operations of the bank, the business it is into and the way it conducts its operations. It consists of 8 types of risks namely capital, credit, market, earnings, liquidity, business strategy and environmental, operational and group risk. Control risk measures the risk arising out of any lapses in the control mechanism such as the organizational structure and the management and the internal controls that exist in the bank. Controls risk further consists of internal controls, management, organizational and compliance risk. After taking up the questionnaire it was found that respondents scaled various risk based on their importance ranking the most important as ‘1’ and so on as stated in table below:
Capital Risk 1 Credit Risk 2 Market Risk 3 Earnings 3 Liquidity Risk 4 Business Strategy & Environmental Risk 5 Operational risk 2 Group Risk 5
1. Capital risk is the most crucial type of risk faced by banks. 2. Credit and operational risk are at second level and are equally important. 3. Next most crucial risk faced after capital credit and operational risk is market risk. Earnings risk is also equally important as market risk. 4. Liquidity risk is the next most important risk 5. Least important/ crucial risks are business and group risk. Figure: Hierarchy of business risk
Internal Control 1 Management 2 Organization 3 Compliance 2
1. Internal controls risk the most crucial risk faced. 2. Management and compliance risk are the next most important risks. 3. Risk associated with organization is the least important of all. It can be depicted as: Figure: Hierarchy of controls risk Apart from those risks mentioned under the Basel accord, banks hardly pay attention to other categories of risks. Some of the risks not addressed by most of the banks are: Interest rate risk in the banking book, Settlement risk, Reputational risk, Strategic risk, Legal and compliance risk, Risk of under estimation of credit risk under the standardized approach, Model risk, Residual risk of securitization. Credit risk management: As discussed earlier in chapter-2, Credit risk management enables banks to identify, assess, manage proactively, and optimise their credit risk at an individual level or at an entity level or at the level of a country. The commonly used techniques are econometric technique, neural networks, optimisation models, rule based and hybrid systems. The domains to which they are applied are credit approval, credit rating determination and risk pricing. The various models covering these techniques and domain are Altman’s Z-score model (1968), KMV model for measuring default risk, CreditMetrics, CreditRisk+, etc.
These are effective credit risk management as a value enhancing activity, consolidating credit lines, efficient use of economic and regulatory capital, ensuring that the bank has a safe level of capital, pricing loans to earn attractive risk-adjusted profits, applying economic capital’s trio of core decision making criteria, use of derivatives to reshape credit profile and technology.
Market risk is defined as the uncertainty in the future values of the Group’s on and off balance sheet financial items, resulting from movements in factors such as interest rates, equity prices, and foreign exchange rates. The drivers of market risk are equity and commodities prices, foreign exchange rates, interest rates, their volatilities and correlations. Market risk can be classified into directional and non-directional risks. Market risk can be measured and managed through the use of Maturity gap analysis, Duration analysis, Convexity, Value-at-Risk (VAR), Stress Testing and the Greeks. In Indian market, being an emerging market, liquidity and inefficiency are the major concerns in the forex, debt and stock markets. Panic and knee jerk reactions are also common (e.g. effect on stock markets during Indo-Pak tension and the recent Government change). All these factors contribute to the market risk of the bank. A· To analyze the market risk management techniques, an exercise of informal discussion and unstructured questionnaire was conducted. Few highlights are given as: The banks have been making progress in the area of Asset Liability Management. But they are still far from achieving the level, which has been attained in banks abroad. All of the banks have set up ALM function and established the requisite organizational framework consisting of the ALCO and the support groups. The composition, scope and functions of these bodies are in accordance with the guidelines. Banks have also made an attempt to integrate ALM and management of other risks to facilitate integrated risk management. Banks are complaint with the regulatory requirements of the RBI regarding the preparation of statements. They have also laid out policies and maintain records as required by the guidelines. Many of them have also achieved 100% coverage of business by ALM. Private Banks and foreign banks have made the most progress. Some of them had a head start in ALM. They have not made the progress that could possibly have been made considering that their problems are not of the magnitude of some other banks.
ALM is concerned with strategic balance sheet management involving risks caused by changes in the interest rates, exchange rates and the liquidity position of the bank. In recent years in India, most of the interest rates have been deregulated; government securities are sold in auctions and banks are also, with a few exceptions free to determine the interest rates on deposits and advances. Hence the ALM function is not simply about risk protection. It should also be about enhancing the net worth of the institution through opportunistic positioning of the balance sheet. The more leveraged an institution is, the more critical the ALM function within the enterprise. The ALM process allows an institution to take on positions, which are otherwise deemed too large without such a function. There are various techniques of risk management to address the different types of risk. ALM primarily aims at managing interest rate risk and liquidity risk.
Indian banks have a very significant proportion of assets and liabilities with no fixed maturity. On the assets side this includes practically all of the working capital finance. Much of this contractually repayable on demand but in practice it is subject to more or less automatic rollovers, even when in the form of loans. On the liabilities side the principal items with no fixed maturity are the current and savings bank accounts. Now the banks approach this problem through behavioural analysis. It is the process of capturing the assets and liabilities as per the buckets given by RBI. As on March 31, 2008, for the scheduled banks together current account and savings bank deposits formed about 28% of external liabilities: again the bulk of the loans and advances (40% of assets) was probably working capital finance. This is a large and significant proportion of the assets and liabilities. All of the banks surveyed follow the classification of assets and liabilities recommended by the RBI. They use the maturity gap model.
Many banks have defined operational risk as any risk not categorised as market or credit risk and some have defined it as the risk of loss arising from various types of human or technical error. Operational risk management techniques come in two basic varieties -bottom -up or top down approaches take aggregate targets such as net income or net asset value, to analyse the operational risk factors and loss events that cause fluctuations in the target..
Fig-1 states that Competition seems to be a great threat to the banking industry. Around 44%, 28% and 21% respondents feel that competition from other banks in the industry is Extremely, Quite and Slightly important threat that banks are exposed to in present scenario. Currently, India has 88 scheduled commercial banks (SCBs) – 27 public sector banks (that is with the Government of India holding a stake), 31 private banks (these do not have government stake; they may be publicly listed and traded on stock exchanges) and 38 foreign banks. They have a combined network of over 53,000 branches and 17,000 ATMs. This states the extent of competition amongst the Indian banking sector and imposes a threat to the banks from each other. Fig-2 states the variable customers as a threat since customers are the main entity for the banks. Greater the number of customer, more are the chances of expansion and efficient working of the banks. Results show that maximum respondents feel that reduction in customers could be a risk for the bank as it drives of their business to their competitors. The BSE Sensex increased significantly from a level of 13,072 as at end-March 2007 to its peak of 20,873 on January 8, 2008. But with portfolio flows reversing in 2008, partly because of the international market turmoil, the Sensex dropped to a level of 11,328 on October 8, 2008, in line with similar large declines in other major stock markets. This had an impact on banks as banks borrow and lend money among them to meet short-term need for funds they never hold the exact amount of cash that they need to disburse as credit. The ‘inter-bank’ market performs this critical role of bringing cash-surplus and cash-deficit banks together and lubricates the process of credit delivery to companies (for working capital and capacity creation) and consumers (for buying cars, white goods etc). As the global crisis intensified, banks grew increasingly suspicious about each other’s solvency and ability to honor commitments. The inter-bank market shrank as a result and this began to hurt the flow of funds to the ‘real’ economy. The liquidity crunch in the banks has resulted in a tight situation where it has become extremely difficult even for top companies to take loans for their needs. This can be seen from the results as most respondents (approx 80%) do feel that share market volatility may leave bank susceptible to credit and market risks.( https://www.scribd.com/doc/7956331/Indian-Financial-Market-Reasons-and-Solutions) Police arrested a former bank teller of the State Bank of India on charges of conspiring with forgers to place fake Indian notes in a cash box. The bank teller told investigators that he exchanged over INR 15 million ($3,54,563) in counterfeit currency notes with authentic ones in a box managed by the financial institution for daily cash flow transactions on behalf of the Reserve Bank of India (RBI). This points out towards lack of management’s attention towards sound banking functionality. (https://www.algorithmics.com/EN/media/pdfs/Algo-RA0209-CRO-PCagen.pdf)The results states that around 45% respondents feel that lack of management’s attention is quite important to be threat towards banks leading to operational and other risks. There is a scope for new entrants in the market, in spite of capital management and human resource constraints, as there continue to remain opportunities in unbanked areas. With only 30-35% of the population financially included, and the Indian banking industry unsaturated with CAGR of well above 20%, the market definitely has scope to accommodate new players. The results shows that respondents had been biased as majority (28%) feels that new entrants won’t be a threat to their business while 60% feel that new entrants can pose a threat and that new entrants should be allowed only after satisfactorily achieving set milestones for the prior stages, cap on promoter’s holdings and wider public holding in addition to a common banking regulator on a level playing field are essential before they may set themselves up as banks.( https://www.indiainbusiness.nic.in/studies_survey/banking_systemsurvey.pdf) Business risks consists of 8 types of risks namely capital, credit, market, earnings, liquidity, business strategy and environmental, operational and group risk. The results in Fig states that 100% respondents feel that business risk is really important and poses a great threat to the banks with almost 45% stating it as quite important. This states that the banks are really concerned towards risks and thus is vital to employ effective risk management system. Control risks consist of internal controls, management, organizational and compliance risk. The results in Fig states that almost 80% respondents feel that business risk is really important and poses a great threat to the banks whereas few, around15%, feel that control risks isn’t a great threat to the banking sector as compared to business risk This states that the banks are really concerned towards risks and thus is vital to employ effective risk management system. Nonperforming Assets and bad loans have always been crucial threat for the banks efficient functionality. Almost 80% of the banks see personal loans (Fig. 13) as having the greatest potential for default, followed by corporate loans and credit cards. Many banks additionally perceived a level of riskiness in the SME and farm loan sector ( https://www.indiainbusiness.nic.in/studies_survey/banking_systemsurvey.pdf). The results in fig states that respondent’s do feel rising level of NPAs as an important threat but not extremely important as majority around 40% mark it slightly important. Also studies show that Indian banks have the ability to absorb twice the amount of their current NPA levels. Strategies adapted by banks to overcome risks include: A· Integrative growth A· Intensive growth A· Downsizing older business A· Diversification Banks have given following as reasons for high incidence of NPAs A· Improper Loan Appraisal System by Banks A· Poor Risk Management Techniques as a Contribution to NPA’s A· Lack of Strong Legal Framework to initiate action A· Incorrect Evaluation of the Credit Worthiness of the borrower A· Poor Loan Monitoring A· Poor Recovery Mechanisms Analysing the reasons that has led to loans becoming unpopular with the banking industry: A· High Incidences of Non – Performing Assets A· High Costs of Servicing A· Greater Political Interference A· Stricter Formalities to be compiled with A· Falling demand & the Pressure on the Banks The reason as why targets set for loans have not reached by banks includes: A· Projects Placed were not Feasible or Risky in the Respective Category A· Inadequate Security Provided by the Borrowers A· Large No. of Borrowers Whose Credit Worthiness is not Satisfactory A· Fear of NPA’s
Improvement in productivity, Enabling risk adjusted performance, Improved assessment of product profitability, Use of risk sensitive approach in business processes, Better pricing of products and consumer segments, Developing skills for risk transfer products, Competitive advantage, Fraud reduction/deduction, Better understanding and scrutiny of all functionalities of the bank. Enabling a separate risk management system would surely help bank to deal with various risks associated with the industry and help it employ a smooth and efficient functioning. Having a sound risk management system may boost the productivity of the bank as they will have less risk and hence help them build trust by attracting more customers. Fig- shows that 80% respondents, with 35% and 20% thinking it quite and extremely likely respectively, feel that separate risk management system will help increase the productivity of the bank. Fig- shows that 95% respondents feel that a separate risk management system will enable the bank to provide with risk adjusted performance whereas a few regional banks feel that risk might be worth expansion and greater returns in order to attract customers with more interest rates on their deposits and other schemes.
Having a separate risk management system surely helps to analyze the risk capability and limits of each products and portfolios which the banks deal in. Sometimes to offer greater return banks come up with portfolios which are more susceptible to risks. Thus the risk department can help minimize those risks and help choose products and services with greater returns and minimal risks to offer its clients. Fig- shows that 29% respondents feel that its slightly likely whereas around 40% (extremely and quite likely) feel that risk management will benefit with improved assessment of product profitability. There are 16% respondents who are biased on whether this may help to provide product profitability or not, as greater risk tends to greater returns. Fig- shows that approx 80% respondents feel that having a separate risk management will benefit to incorporate a risk sensitive approach in business processes the banks deal with. This includes the portfolios the banks invest and trades, the MF and loans provided by the banks and better asset management with minimal risks. Incorporating a risk management department would help the employee to develop skills towards risk management. This might help to train the employee with required knowledge towards risk assessment of products and come up with products and portfolios with greater returns and less risk to impart faith towards its customers. Fig shows that over 30% respondents feel that its slight likely that separate risk management will help develop skills for risk transfer products whereas approx 30% and 15%, quite & extremely likely, respectively favour it. Still there are few respondents approx 20% who doesn’t favour and stay biased and feel its slightly unlikely that separate risk management might help develop skills for risk transfer products. Micro: basic granular knowledge of typical transactions and the risks attending them; 2. Macro: an understanding of what portfolio of risks is created by the sum of these transactions; and 3. Model: an understanding of how in this business model we make money, and what happens if critical underlying assumptions are wrong. Fig- shows that 35% and 20% respondents feel it quite and extremely likely that risk management would help relief in capital charge whereas 275 feel its slight likely that risk management may help in capital relief. 17% respondents feel that Risk management may surely help release the NPA burden but still there will be defaults such as customer credit defaults, bad debts, share market volatility, etc which cannot be overcome even by effective risk management and thus they doesn’t support this variable as a benefit towards banks. Incorporating risk management would help bank attain transparency at its operational level, enable better capital management, liquidity management, portfolio management, and enhance board level perspective. This can be seen from fig- which states that approx 40%, 20%and 30% respondents feel it quite, extremely and slight likely that risk management would benefit bank have competitive edge over their rivals. There has been stunning fraud in India in recent years. The companies are able to arm twist the auditors who play a vital role in fraud detection. Implementing better risk management policies such as strict KYC norms, more stringent audit measure and stricter regulatory vigil really help banks detect fraud and take effective measures to eradicate such frauds. Fig-shows that around 70% (11%, 24% and 32% feeling extremely, quite and slightly likely resp.) respondents feel that separate risk management system will be beneficial for banks to deal with frauds. The implementation of proper risk management system helps bank aid their reputation and impart global recognition and presence. Fig shows that 35% respondents feel that this approach might list them on global markets and crack deals with foreign banks. For example the merger between State bank of India and PNB Paribas lead to formation of SBI life Insurance, India’s largest private life insurer. This shows that effective risk approach would be highly beneficial for the banks.
Risk management activities will be more pronounced in future banking because of liberalization, deregulation and global integration of financial markets. This would be adding depth and dimension to the banking risks. As the risks are correlated, exposure to one risk may lead to another risk, therefore management of risks in a proactive, efficient & integrated manner will be the strength of the successful banks. The standardized approach was to be implemented by 31st March 2007, and the forward-looking banks placed their MIS for the collection of data required for the calculation of Probability of Default (PD), Exposure at Default (EAD) and Loss Given Default (LGD). The banks are expected to have at a minimum PD data for five years and LGD and EAD data for seven years. Presently most Indian banks do not possess the data required for the calculation of their LGDs. Also the personnel skills, the IT infrastructure and MIS at the banks need to be upgraded substantially if the banks want to migrate to the IRB Approach.
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