HOLISTIC RISK MANAGEMENT: AN APPROACH TO

INDIAN BANKING SECTOR

Presented by –

Mr. Minaketan Dash.

MBA,(Student,2008-10), DRIEMS B-School.
Tangi, Cuttack, 754022. Ph no: +919777122126
E-mail: dashminaketan2@gmail.com.

Mr. Sasikant Tripathy.

Lecturer in Finance, DRIEMS B-School.
Tangi, Cuttack, 754022.ph no : +919337026846
E-mail: sk.tripathy@sify.com

Address correspondence -
DRIEMS B- School,
Kairapari,Tangi.
Cuttack,754022.
Ph no – (0671) 2695061/062/063/064/065/066.

Contributed To – “ACADEMY OF BUSINES ADMINISTRATION”

BHUBANESWAR.
 HOLISTIC RISK MANAGEMENT: AN APPROACH TO INDIAN BANKING
SECTOR
Mr.Minaketan Dash
Mr. Sasikanta Tripathy
Abstract
As we know risk and return are two sides of a coin so for each and every business,
there must be risk which leads towards return. At the present scenario as the scope of
economy is going to be broader likewise the scope of money market is also going to rise
which leads to the existence of huge number of banks. Evidence from across the world
suggests that a sound and evolved banking system is required for sustained economic
development. India has a better banking system in comparison to other developing countries,
but there are several issues that need to be ironed out. The pivotal issue is risk management.
As their functional scope is increasing day by day risk management is also simultaneously
becoming as an important obligation for that sector. This paper has given a birds’ eye view
about the enterprise risk management (ERM) or the integrated risk management (IRM) as a
tool for managing the risk factor which will leads to a major expanation as well as alteration
in functional area of Indian banking sector. In this paper the author is to demystify about the
steps involved in enterprise risk management and how the integration of these steps will leads
towards risk management which is now treated as a most competitive strategy for each and
every investment institution and banking sector. As it is the time of retrieval of economy so
each banking organization should concentrate on it by which again we may not face this type
of credit crunch crisis in near future. Also in this paper the author is to highlight about
different types risks generally faced by the banking institution and there management steps
taken by this tool of enterprise risk management. At last it is concluded by highlighting the
effectiveness of this tool in case of risk management which indirectly leads to expand the
scope of Indian money market and the strategy against global foreign market.
Key Words – ERM, Sustained economic development, integrated risk management, Credit
crunch crisis, Competitive strategy.
------------------------------------------------------------------------------------------------------------
* MBA (2008-10), DRIEMS Business School, Tangi, Cuttack- 754022, Orissa, Phone: +91-
0671- 2695061-65; Mobile:; Email: dashminaketan2@gmail.com

** Lecturer- Finance, DRIEMS Business School, Tangi, Cuttack- 754022, Orissa, Phone:
+91-0671- 2695061-65 Mobile: 09337026846 Email: sk.tripathy@sify.com
INTRODUCTION-
In spite of the credit crisis if we will open the passage of Indian banking history for
last few days we can get the idea regarding the improvement of Indian banking sector
comparison to other country .So for an emerging sector like banking sector risk is a threat as
well as opportunity .So the concept of risk management is a most important for each banking
organization. Although the concept of ERM has existed before long days still the
implementation part is ineffective. So just before going to know about its implementation lets
first discuss about its framework. Risk management is the identification, assessment, and
prioritization of risks followed by coordinated and economical application of resources to
minimize, monitor, and control the probability and/or impact of unfortunate events. Risks can
come from uncertainty in financial markets, project failures, legal liabilities, credit risk,
accidents, natural causes and disasters as well as deliberate attacks from an adversary.
IMPORTANCE OF RISK MANAGEMENT-
Risk Management is a comprehensive process adopted by banks that seeks to minimize the
adverse effects it is exposed to due to various factors-
economic
political
environmental
some of them inherent to the business , others unforeseen and unexpected

Objective of study-
The objective of the present study is to find out:

1. To know about the theoretical aspect of Risk management approach.

2. To know about the implementation of this approach in Indian banking sector.
3. Effectiveness of this approach in mitigating the different types of risks faced
by Indian banking sector.
4. Study about the strength and weakness of Indian banking sector and its
prediction.
Methodology-
This paper enlightens about the effectiveness of this ERM approach in case of
managing risk factor in Indian banking sector by taking the different types of risk
faced by Indian banking sector. At last in findings it is suggested about the emerging
technique used in this Risk management approach, this study is a descriptive study.
The data are collected here from secondary sources like magazine, newspaper,
journal, articles and websites.
Review of holistic risk management approach?
Before going to know about holistic risk management first we should know about ERM,
where it is an approach coming under the scope of enterprise risk management, so first we
should know about the framework of ERM. The purpose of establishing an enterprise risk
management process is to give management a way in which they are able to effectively deal
with this uncertainty associated with risks and opportunities. Management can then determine
how much risk the company is willing to take on as it strives to create value.

SETTING OBJECTIVES

COMMUNICATE &
IDENTIFY RISKS
MONITOR

CONTROL RISKS ASSESS RISKS

TREAT RISKS

This framework discusses details about the steps involved in ERM. But the concept of
holistic risk management is narrower than ERM. Holistic risk management is the holistic
approach where all steps involved in ERM is not taken into consideration. That is why it is
called as holistic approach.
Steps involved in enterprise risk management-
1. Setting Objectives
The first step in the ERM process is the setting of objectives. Objectives are simply what an
entity strives to achieve. Objectives can be short-term, or long-term, or they can be
quantitative (numeric), or qualitative (non-numeric).
Objectives should be:
 Specific: Objectives should be precisely defined.
 Measurable: The method of measuring the objective should be defined.
 Agreed to: All interested parties need to agree to the objectives.
 Realistic and Attainable: Objectives must realistic and they must be attainable. If
they’re not, then they are superfluous.
 Timely: Objectives should be specific as to when they are to be achieved.
Note: As we can see, objectives should be SMART.
A direct benefit of ERM is that it may reveal some objectives that are not clear or understood
by those responsible to achieving them. It’s recommended that time be taken in an effort to
clarify the objectives before moving on to the next step – identifying risks.

Identifying and Assessing Risks

The next step in the ERM process is the identification of risks. The goal in this step is to
produce a list of risks and then assess them. There are a number techniques used to identify
risks. Some of these techniques are shown in Exhibit B.
In the process of using the list, it may be necessary to use more than one item on the list. The
key is to make sure that as many risks are identified as possible. If some risk fail to be
recognized, this could result in problems for the company.
Risk Identification Techniques
INTERNAL INTERVIEWING and DISCUSSION:
Interviews.
Questionnaires.
Brainstorming.
Control Self-assessment and other facilitated workshops.
SWOT analysis (Strength, weaknesses, opportunities, and threats).

EXTERNAL SOURCES:
Comparison with other organizations.
Discussion with peers.
Benchmarking.
Risk consultants.
TOOLS, DIAGNOSTICS, and PROCESSES:
Checklists.
Flowcharts.
Scenario analysis.
Value chain analysis
Business process analysis.
Systems engineering.
Process mapping.
Treating and Controlling Risks
Once the risks have been assessed, management must then decide how it is going to manage
them. In the ERM process there should be a conscious decision about risk. There are different
actions that management can take for any given risk, including:
 Transfer the risk to another party. This can be done through signing a long-term
contract with a supplier. You transfer the risk of future price increases.
 Avoid the risk. This is generally the not most desirable thing to do, but in some cases,
it may be unavoidable.
 Reduce the negative effect of the risk. This might include hedging, or some other
method.
 Accept some or all of the consequences of the particular risk. You take on the risk
because you know that if you are successful, you will indeed be very successful.

In this stage, the risks with the greatest loss and the greatest probability of occurring are
handled first, and risks with lower probability of occurrence and lower loss are handled later.
In practice the process can be very difficult, and balancing between risks with a high
probability of occurrence but lower loss vs. a risk with high loss but lower probability of
occurrence can often be mishandled.

Implementation of ERM as a holistic approach-

Implementation of ERM and implementation from holistic prospective is a different
concept. Because applying the ERM is a total application of all steps whether it is needed or
not so that it can be cost effective as well as time effective, also to access the risk the
organization will never face another risk.

Risks faced by Indian banking sector (challenges as well as opportunity)

 As we know banking is a risky business so there must be some opportunity by the
avoidance of these risks. The most important characteristic is it is a very high leverage
business. According to statistics in India the degree of leverage is 17.6 comparison to US as
15. If we will compare the contribution of other sector like farming sector, automobile sector
etc. with the degree of risk associated with it is very less than the banking sector. RBI would
be in the process of shifting to risk-based supervision (RBS) wherein the focus of its
supervisory attention on the banks is in accordance with the risk each bank poses to itself and
the system. The inceptions of RBS will require banks to reorient their original setup towards
RBS and put in place an efficient Risk Management architecture, internal auditing focusing
on risk, strengthening MIS and set up of compliance units
Evidence from across the world suggests that a sound and evolved banking system is
required for sustained economic development. India has a better banking system in place vis
a vis other developing countries, but there are several issues that need to be ironed out.
Credit Risk:- The potential financial loss resulting from the failure of customers to
honor fully the terms of a loan or contract. This definition is being expanded to include the
risk of loss in portfolio value as a result of migration from a higher risk grade to a lower one.

Credit risk may take various forms, such as:

 in the case of direct lending, that funds will not be repaid;
 in the case of guarantees or letters of credit, that funds will not be forthcoming
from the customer upon crystallization of the liability under the contract;
 in the case of treasury products, that the payment or series of payments due from
the counterparty under the respective contracts is not forthcoming or ceases;
 in the case of securities trading businesses, that settlement will not be effected;
 in the case of cross-border exposure, that the availability and free transfer of
currency is restricted or ceases
• Market Risk:- The risk to earnings arising from changes in interest rates or exchange
rates, or from fluctuations in bond, equity or commodity prices. Banks are subject to market
risk in both the management of their balance sheets and in their trading operations. Market
risks such as interest rate and foreign exchange risks become more complex as financial
institutions and corporate gain access to new securities and markets, and foreign participation
changes the dynamics of domestic markets. For instance, banks will have to quote rates and
take unhedged open positions in new and possibly more volatile currencies. Similarly,
changes in foreign interest rates will affect banks’ interest sensitive assets and liabilities.
Foreign participation can also be a channel through which volatility can spill-over from
foreign to domestic markets
• Operational Risk:- The potential financial loss as a result of a breakdown in day-to-
day operational processes. Operational risk can arise from failure to comply with policies,
laws and regulations, from fraud or forgery, or from a breakdown in the availability or
integrity of services, systems or information.
Operational risk may increase with FCAC.4 For instance, legal risk stemming from the
difference between domestic and foreign legal rights and obligations and their enforcements
becomes important with fuller capital account convertibility. For instance, differences in
bankruptcy codes can complicate the assessment of recovery values. Similarly, differences in
the legal treatment of secured transactions for repos can lead to unanticipated losses
• Cash management risk:- – It is the most crucial issue liquidity management is an
integral part of the fund management.
If the technology helps to reduce the lead time for collection and payments of cheques at
banks, it not only helps the clients to increase their cash management but also helps the banks
to increase their liquidity.

• Liquidity Risk:- – Every bank has the need for a certain amount of liquidity in order
to meet short term liability payments. e.g. - net outflows due to unanticipated
withdrawals/non-renewal Compensate for non-receipt of expected inflows of funds &
Crystallization of contingent liability. Liquidity risk will include the risk from positions in
foreign currency denominated assets and liabilities. Potentially large and uneven flows of
funds, in different currencies, will expose the banks to greater fluctuations in their liquidity
position and complicate their asset-liability management as banks can find it difficult to fund
an increase in assets or accommodate decreases in liabilities at a reasonable price and in a
timely fashion.
• Interest rate risk
Interest rate risk can be defined as exposure of bank's net interest income to adverse
movements in interest rates. A bank's balance sheet consists mainly of rupee assets and
liabilities. Any movement in domestic interest rate is the main source of interest rate risk.

Over the last few years the treasury departments of banks have been responsible for a
substantial part of profits made by banks. Between July 1997 and Oct 2003, as interest rates
fell, the yield on 10-year government bonds (a barometer for domestic interest rates) fell,
from 13 per cent to 4.9 per cent. With yields falling the banks made huge profits on their
bond portfolios.

Now as yields go up (with the rise in inflation, bond yields go up and bond prices fall as the
debt market starts factoring a possible interest rate hike), the banks will have to set aside
funds to mark to market their investment.

This will make it difficult to show huge profits from treasury operations. This concern
becomes much stronger because a substantial percentage of bank deposits remain invested in
government bonds.

Banking in the recent years had been reduced to a trading operation in government securities.
Recent months have shown a rise in the bond yields has led to the profit from treasury
operations falling. The latest quarterly reports of banks clearly show several banks making
losses on their treasury operations. If the rise in yields continues the banks might end up
posting huge losses on their trading books. Given these facts, banks will have to look at
alternative sources of investment.

Interest rates and non-performing assets

The best indicator of the health of the banking industry in a country is its level of NPAs.
Given this fact, Indian banks seem to be better placed than they were in the past. A few banks
have even managed to reduce their net NPAs to less than one percent (before the merger of
Global Trust Bank into Oriental Bank of Commerce, OBC was a zero NPA bank). But as the
bond yields start to rise the chances are the net NPAs will also start to go up. This will
happen because the banks have been making huge provisions against the money they made
on their bond portfolios in a scenario where bond yields were falling.

Reduced NPAs generally gives the impression that banks have strengthened their credit
appraisal processes over the years. This does not seem to be the case. With increasing bond
yields, treasury income will come down and if the banks wish to make large provisions, the
money will have to come from their interest income, and this in turn, shall bring down the
profitability of banks.

Competition in retail banking

The entry of new generation private sector banks has changed the entire scenario. Earlier the
household savings went into banks and the banks then lent out money to corporate. Now they
need to sell banking. The retail segment, which was earlier ignored, is now the most
important of the lot, with the banks jumping over one another to give out loans. The
consumer has never been so lucky with so many banks offering so many products to choose
from. With supply far exceeding demand it has been a race to the bottom, with the banks
undercutting one another. A lot of foreign banks have already burnt their fingers in the retail
game and have now decided to get out of a few retail segments completely.

The nimble footed new generation private sector banks have taken a lead on this front and the
public sector banks are trying to play catch up.

The PSBs have been losing business to the private sector banks in this segment. PSBs need to
figure out the means to generate profitable business from this segment in the days to come.

The urge to merge

In the recent past there has been a lot of talk about Indian Banks lacking in scale and size.
The State Bank of India is the only bank from India to make it to the list of Top 100 banks,
globally. Most of the PSBs are either looking to pick up a smaller bank or waiting to be
picked up by a larger bank.

The central government also seems to be game about the issue and is seen to be encouraging
PSBs to merge or acquire other banks. Global evidence seems to suggest that even though
there is great enthusiasm when companies merge or get acquired, majority of the
mergers/acquisitions do not really work.

So in the zeal to merge with or acquire another bank the PSBs should not let their common
sense take a back seat. Before a merger is carried out cultural issues should be looked into. A
bank based primarily out of North India might want to acquire a bank based primarily out of
South India to increase its geographical presence but their cultures might be very different.
So the integration process might become very difficult. Technological compatibility is
another issue that needs to be looked into in details before any merger or acquisition is
carried out.

The banks must not just merge because everybody around them is merging. As Keynes wrote,
"Worldly wisdom teaches us that it's better for reputation to fail conventionally than succeed
unconventionally". Banks should avoid falling into this trap.

Application of ERM in managing risk.-

Here the application of ERM is analyzed by taking one risk into consideration with reference
to Indian banking scenario (ICICI BANK)
Credit risk
Step 1:
Putting objective: Here the objective is to know about the risk.
Step 2:
Identify it: Identifying it, what type of credit risk is it?
Step 3:
Analyze it: Here to know what are the causes of this risk.

 In the case of direct lending, that funds will not be repaid;

 In the case of guarantees or letters of credit, that funds will not be forthcoming from
the customer upon crystallization of the liability under the contract;
 In the case of treasury products, that the payment or series of payments due from the
counterparty under the respective contracts is not forthcoming or ceases;
 In the case of securities trading businesses, that settlement will not be effected;
 In the case of cross-border exposure, that the availability and free transfer of currency
is restricted or ceases.

The diagrammatical representation of analyzing risk-

 M
• .anagingD
Step 4: Treat it /controlling part: Once the risks have been assessed, management must
then decide how it is going to manage them. In the ERM process there should be a conscious
decision about risk. There are different actions that management can take for any given risk

1. They spelled out the target markets, risk acceptance / avoidance levels, risk tolerance
limits, preferred levels of diversification and concentration, credit risk measurement,
monitoring and controlling mechanisms in a precise manner.

2. Prepared a comprehensive credit rating / scoring models being applied in the spheres
of retail and non-retail portfolios of the bank.

3. Standardized credit approval process

4. Followed Proactive credit risk management practices in the form of studies of

rating-wise distribution probability of defaults of borrowers, etc.

In this stage, the risks with the greatest loss and the greatest probability of occurring are
handled first, and risks with lower probability of occurrence and lower loss are handled later.
In practice the process can be very difficult, and balancing between risks with a high
probability of occurrence but lower loss vs. a risk with high loss but lower probability of
occurrence can often be mishandled.
Step 5:

Communicating and monitoring it:

The last but not the least step is to communicate it to all departments also to monitor it to
know the effectiveness of the ERM process. Otherwise we can alter the step of total process
according to our need. This is the final stage of the ERM process. In this final stage,
management has the responsibility to review and make necessary changes in order to mitigate
potential risks that can hinder the achievement of objectives. The goal of ERM is not to
become risk adverse, but to develop and implement a system whereby risk-related
information is able to flow downward, across, and up the company.

In regards to monitoring, activities should periodically reassess risk and the effectiveness of
controls to manage risk.

RISK Management Scenario in the Future of banking sector-

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 would be
implemented by 31st March 2007, and the forward-looking banks would be in the process of
placing 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.

Findings-

Best practices that companies can use as a reference when implementing ERM. Engage
senior management and board of directors that set “the tone from the top” and provide
organizational support and resources. Independent ERM functions under the leadership of
chief risk officer (CRO), who reports directly to the CEO with a dotted line to the board.
Established ERM framework that incorporates all of the company’s key risks: strategic risk,
business risk, operational risk, market risk, and credit risk. A risk-aware culture fostered by a
common language, training, and education, as well as risk-adjusted measures of success and
incentives. Written policies with specific risk limits and business boundaries, which
collectively represent the risk appetite of the company. An ERM dashboard technology and
reporting capability that integrates key quantitative risk metrics and qualitative risk
assessments. Robust risk analytics to measure risk concentrations and interdependencies,
such as scenario and simulation models. Integration of ERM in strategic planning, business
processes, and performance measurement. Optimization of the company’s risk-adjusted
profitability via risk-based product pricing, capital management, and risk-transfer strategies.
In summary, “ERM is essential in today’s business environment, as an holistic approach
where companies are required to disclose risk factors in the financial reports and the board of
directors regularly questions top management about the company’s risk.”1

1
.
Conclusion -

Enterprise risk management can be a powerful management tool, but its successful
implementation will require, education and training of managers at all levels of the
organization, including the board. But, there are limitations to ERM. Like any program,
human judgment is still required, and human judgment in regards to risks can be faulty; thus
leading to errors or mistakes.

A major weakness to the ERM system is that two or more people can collude together, or
management can override ERM decisions. Thus, even with the best of ERM systems, “these
limitations preclude a board and management from having absolute assurance as to the
achievement of the company’s objectives.”

Bibliography

Articles/newspaper-

1. “A new world of Risks, Best review of life/health insurance” January 2000,page 3,4.

2. “An Empirical Investigation of the Characteristics of Firms Adopting

Enterprise Risk Management” Pagach Donald ,Professor of Accounting,
Edition February 2007.
3. “A.M. Best Enterprise Risk Model – A Holistic Approach To Measure Capital
Adequacy” July 2001
4. The Economics Time,Kolkata,17/11/2009, page 17,18

References-

1. SHAH AJAY and THOMAS SUSAN. “Systemic fragility in Indian banking:

Harnessing information from the equity market.” Technical report.

2. Statements on Management Accounting, Enterprise Risk Management: Framework,

Elements, and Integration, pg. 34t, IGIDR, Bombay, India (December 2000)

3. Enterprise Risk Management – Integrated Framework, Executive Summary,

September 2004
4. Enterprise Risk Management and the Road to Success, Carl Burch,Rusia.

Websites-

1. www.rbi.org

2. www.yahooanswer.com

3. www.albert.com

4. www.google.com

5. www.wikipedia.com