RISK MANAGEMENT IN BANKING SECTOR

Report submitted to BVB College of Engineering & Technology, Hubli By Soumyarani A. Hoskoti. USN: 2BV08MBA54

Under the guidance of Dr. B.R.PATIL.

FEBRUARY TO APRIL 2010 Department of Management Studies BVB College of Engineering & Technology Hubli - 580031

CERTIFICATE

This is to certify that, the report entitled RISK MANAGEMENT IN BANKING SECTOR, which is being submitted to the Department of Management Studies, BVB College of Engineering & Technology, Hubli by Soumyarani A. Hoskoti is a record of bona fide work carried out by her, under my guidance. Soumyarani A. Hoskoti has successfully completed the Project requirements prescribed to her in accordance with the regulations of the Institute. In my opinion, the report has reached the standard of fulfilling the requirements. The results embodied in this report, have not been submitted elsewhere for the award of any other Degree or Diploma.

Dr. B R Patil. Department of Management Studies, HUBLI (INDIA).

Dr. S V Patil Head of the Department BVB College of Engineering & Technology, HUBLI (INDIA).

BVB College of Engineering & Technology, Department of Management Studies,

ACKNOWLEDGEMENT

It is a matter of great pleasure to acknowledge those personalities who have inspired, guided & contributed immensely in bringing out this Project Report. I wish to take this opportunity to express my gratitude to Dr. B R Patil for his valuable guidance in this endeavor. I am thankful to Dr. S V Patil Head of the department, and all the staff members who have helped directly or indirectly to complete this project. I express my deep senses of gratitude to all the Bank Managers & other staff members, for spending their valuable time in filling the questionnaire & helping in successfully completing this Project Report. Finally, I would like to thank my Parents, my teaching & non-teaching faculties, my Friends & all those who have helped me directly or indirectly for the completion of this Project Work.

Date: 15/05/2010 Hubli

Soumyarani A. Hoskoti.

EXECUTIVE SUMMARY

Risk is inherent in any walk of life in general and in financial sectors in particular. Till recently, due to regulate environment, banks could not afford to take risks. But of late, banks are exposed to same competition and hence are compiled to encounter various types of financial and non-financial risks. Risks and uncertainties form an integral part of banking which by nature entails taking risks. There are three main categories of risks; Credit Risk, Market Risk & Operational Risk. In this report it has been discussed in detail. Main features of these risks as well as some other categories of risks such as Regulatory risk & Environment risk. Various tools and techniques to manage Credit Risk, Market Risk and Operational Risk, are also discussed in detail. In report it has also mentioned relevant points of Basels New Capital Accord and its benefits, challenges, impact, role of capital adequacy, Risk Aggregation & Capital Allocation and Risk Based Supervision (RBS), in managing risks in banking sector.

CONTENTS
Certificate Acknowledgement Executive summary CHAPTER I: INTRODUCTION The Theme Introduction Study problem Objectives of the Work Methodology CHAPTER-II: LITERATURE REVIEW 2.1 Introduction 2.2 Basel II Framework 2.2.1 The First Pillar Minimum Capital Requirements 2.2.2 The Second Pillar - Supervisory Review Process 2.2.3 The Third Pillar Market Discipline 2.3 Types of Risks 2.3.1 Credit Risk 2.3.2 Market Risk 2.3.3 Operational Risk 2.3.4 Regulatory Risk 2.3.5 Environmental Risk 2.4 Basels New Capital Accord 2.5 Capital Adequacy 2.6 Risk Aggregation & Capital Allocation 9 10 10 11 12 12 8 9 6 7 7 2 2 3 3 3 4-24 5 1-3

2.7 Risk Based Supervision 2.8 Risk Management: Keys for Effective Risk Management 2.8.1 Market Risk Management 2.8.2 Credit Risk Management 2.8.3 Operational Risk Management: 2.9 Computation of Capital Requirement 2.9.1 Credit Risk Approaches 2.9.2 Market Risk Approaches 2.9.3 Operational Risk Approaches 2.10 Benefits of Basel II 2.11 Limitations of Basel II 2.12 Challenges for Indian Banking System under Basel II 2.13 Impact of Basel II Implementation on the Indian Banking Industry CHAPTER III: PROJECT TASK 3.1 Introduction
3.2 Study Problem 3.3 Objectives

13 14 15 15 15 16 18 19 20 21 22 23 25-27 26 26 26 26 27 27 28-53 29 32 36 40 43 47 50

3.3.1 Data Collection

3.5 Scope of the Survey CHAPTER-IV: ANALYSIS AND INTERPRETATION

CHAPTER-V: FINDINGS AND SUGGESTIONS 5.1 Findings 5.2 Suggestions CHAPTER VI: CONCLUSIONS 6.1 Conclusion CHAPTER VII: ANNEXURE 7.1 Questionnaire 7.2 References

54-56 55 56 57-58 58 59-69 59 69

LIST OF FIGURES
Figure Number Awareness of Regulation Figure 4.1.1: Readiness for the new Basel proposal Figure 4.1.2: Gap analysis Figure 4.1.3: Priority to new Basel regulatory framework Figure 4.1.4: View of Basel II regulation Organizational Structure Figure 4.2.1: Assignment of risk manager Figure 4.2.2: Whom does risk manager report Figure 4.2.3: Time dedication Figure 4.2.4: Number of people work Figure 4.2.5: Risk Committee Reporting Ability Figure 4.3.1: Reports produced for Figure 4.3.2: External reporting drive internal reporting Figure 4.3.3: External reporting affect decision making process Figure 4.3.4: Frequency of internal reporting Figure 4.3.5: Production of specific internal reporting Compliance with Basel II Figure 4.4.1: Approach that best suit organization Figure 4.4.2: Cost/Benefit analysis Figure 4.4.3: Regulatory capital consumption be motivation Title Page Number 29 30 30 31

32 33 34 34 35

36 37 37 38 39

40 41 42

Capital Allocation Figure 4.5.1: Estimation of the regulatory capital consumption Figure 4.5.2: Outsource activities for high capital consumption Figure 4.5.3: Insure Risk

43 44 44

Figure 4.5.4: Allocation of economic capital Figure 4.5.5: Use of Basel II requirements Basel II Action Plan Figure 4.6.1: Establishment of action plan Figure 4.6.2: Execution of action plan Figure 4.6.3: Largest spending area Figure 4.6.4: Current progress Technology Figure 4.7.1: IT infrastructure Figure 4.7.2: IT solution for Risk management Figure 4.7.3: Review of potential IT solutions available Figure 4.7.4: Difficulties that you foresee

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47 48 48 49

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LIST OF TABLES
Table Number Table 2.9.1.1: The differences between foundation IRB and advanced IRB 4.1 Awareness of Regulation Table 4.1.1: Readiness for the new Basel proposal Table 4.1.2: Gap analysis Table 4.1.3: Priority to new Basel regulatory framework Table 4.1.4: View of Basel II regulation 4.2 Organizational Structure Table 4.2.1: Assignment of risk manager Table 4.2.2: Whom does risk manager report Table 4.2.3: Time dedication Table 4.2.4: Number of people work Table 4.2.5: Risk Committee 4.3 Reporting Ability Table 4.3.1: Reports produced for Table 4.3.2: External reporting drive internal reporting Table 4.3.3: External reporting affect decision making process Table 4.3.4: Frequency of internal reporting Table 4.3.5: Production of specific internal reporting 4.4 Compliance with Basel II Table 4.4.1: Approach that best suit organization Table 4.4.2: Cost/Benefit analysis Table 4.4.3: Regulatory capital consumption be motivation 4.5 Capital Allocation Table 4.5.1: Estimation of the regulatory capital consumption Table 4.5.2: Outsource activities for high capital consumption Table 4.5.3: Insure Risk 29 29 30 31 Title Page Number 17

32 33 33 34 35

36 36 37 38 38

40 40 41

43 43 44

Table 4.5.4: Allocation of economic capital Table 4.5.5: Use of Basel II requirements 4.6 Basel II Action Plan Table 4.6.1: Establishment of action plan Table 4.6.2: Execution of action plan Table 4.6.3: Largest spending area Table 4.6.4: Current progress 4.7 Technology Table 4.7.1: IT infrastructure Table 4.7.2: IT solution for Risk management Table 4.7.3: Review of potential IT solutions available Table 4.7.4: Difficulties that you foresee

45 45

47 47 48 49

50 51 51 52