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Types of Risks and its Management in Banking



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here in thus presentation, we discussed about the what is risks and four major types of risk in Banking and its control measures.

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Types of Risks and its Management in Banking

  1. 1. Types Of Risks and Its Management In Banking & Rural Finance
  2. 2. What is Risk Management? Identification of Risks Assessment of Risks Prioritization of Risks minimize monitor control Probability of unfortunate events maximize Realization of opportunities Resources
  3. 3. Types of Risk in Banking & Rural Finance Credit or Default Risk Liquidity Risk Interest Rate Risk Market Risk
  4. 4. Credit Risk  Credit risk is the risk of default on a debt that may arise from a borrower failing to make required payments Methods to measure Expected Loss Method Altman Z score
  5. 5. Credit Risk -Expected Loss Method Probability of Default (PD) is the likelihood that a loan will not be repaid and will fall into default. The credit history of the borrower and the nature of the investment must be taken into consideration when calculating PD Loss Given Default (LGD) the credit loss incurred if an obligor of the bank defaults. LGD = 1- RR Exposure at Default (EAD) is equal to outstanding loan amount (OS) plus the percentage of unused loan commitment (COM) drawn- down by the borrower EAD = OS + (COM – OS) * (UGD)
  6. 6. Altman Z score = 1.2*X1 + 1.4*X2 + 3.3*X3 + 0.6*X4 + 0.99*X5 Where : X1 is Working capital / Total Assets X2 is Retained Earning / Total Assets X3 is EBITDA/ Total Assets X4 is market Value of Equity / Total Liabilities X5 is Net Sales / Total Assets
  7. 7. Liquidity Risk  Liquidity risk occurs when an individual investor, business or financial institution cannot meet short-term debt obligations  Method to measure :- Liquidity Coverage Ratio Net Stable Funding Ratio
  8. 8. Liquidity Coverage ratio Types Of Assets Examples Max Cap Level 1 Cash, central Bank Reserve 100% Level 2A Corporate Bonds 40% Level 2B Mortgage, Stocks 15% Jan 1, 2015 Jan 1, 2016 Jan 1, 2017 Jan 1, 2018 Jan 1, 2019 60% 70% 80% 100%90%
  9. 9. Interest Rate Risk The Potential loss from unexpected changes in Interest rate which can significantly alter the bank profitability and market value of equity Interest Rate Risk Management Repricing Risk Yield Curve Risk Basic Risk Embedded Option Risk
  10. 10. Market Risk Market risk is the possibility for an investor to experience losses due to factors that affect the overall performance of the financial markets in which he is involved Method to measure ; - Value at Risk
  11. 11. For Example :- If VAR(95) = 3% 5% chance to lose max 3% of its market value Market Risk Management  Value at Risk (VaR) is a statistical technique used to measure and quantify the level of financial risk within a firm or investment portfolio over a specific time frame Var(95%) -2.898550725 12.4 Var (99%) -4.398826979 2.48 Var(99.5%) -4.593874834 1.24 Value at Risk
  12. 12. Bank – MFI Securitization Process • Securitization is the process of taking an illiquid asset, or group of assets, and through financial engineering, transforming them into a security. • MFI lend money at 20% interest rate • Bank buy MFI customer loans portfolio at 10% interest rate • Difference between MFI and Bank interest Rate in known as Interest Spread • MFI get additional source of fund to expand their loan portfolio
  13. 13. Securitization Process Subscription Monthly Payout Collection SPV Obligors (MF Loans) Service / Collection agent (MFs/NBFCS) Originators (MFS/NBFCs) Investor in PTC Credit Enhancement Provider (MFs/NBFCs) Subordinated Principal / Over Collateral
  14. 14. Techniques to Mitigate Risk in Securitization • Waterfall Mechanism: • Excess Interest Spread • Credit Enhancement • Over Collateralization:
  15. 15. Thanks