ANNEXURE C

Name : Shaurabh Srivastava

Phone no : 7836943600
Email-address : shaurabhsrivastava01@gmail.com
Course to which admitted : M.B.A.
Month and year of admission: Feb 2011
Place of study (IIPM center)
Thesis Topic-Credit Risk Assessment and Appraisal A Study on HDFC
Specialization area-Finance

WORK PROGRESS
Risk management offers two avenues for enhancing the value of the bank: Firstly, by
hedging their own exposures, banks can reduce the variability of firm value and enhance
the value of the bank. Secondly, by selling risk-management services to client borrowers,
banks generate fees and help ensure that borrowers will have funds to repay loans, and
take advantage of growth opportunities. The very nature of risk-management services
offered to corporate clients, makes it imperative for the banker to have a sound
understanding of the risks, cash flows, and investment opportunities that its customer can
face.

Effective risk management requires that the risks are first measured and then the
quantified risk be managed with the available tools as per the risk taking capacity of the
bank. Risks can be quantified through Value at Risk (VaR) or any other such approach
and then managed. Risk management can be conducted on a bank's balance sheet through
adjustments in portfolio composition, or off the balance sheet by using a host of risk-
management weapons derived from the technology of financial engineering by using
derivatives.

Although over the last few years, there have been significant developments in
conceptualizing a common framework for measuring market risk and the industry has
produced a wide variety of indices to measure return, but little has been done to
standardize the measure of risk. The somewhat exclusive focus on returns, however, has
led to incomplete performance analysis.

Return measurement gives no indication of the cost in terms of risk (volatility of returns).

Higher returns can only be obtained at the expense of higher risks. While this trade-off is

well known, the risk measurement component of the analysis has not received broad

attention. Investors and trading managers are searching for common standards to measure

market risks and to estimate the risk/return profile of individual assets or asset classes,

better. Not-withstanding the external constraints from the regulatory agencies, the

management of financial firms have also been searching for ways to measure market

risks, given the potentially damaging effect of miscalculated risks on company earnings.

Consequently, banks, investment firms, and corporations are now in the process of

integrating measures of market risk into their management philosophy. They are

designing and implementing market risk monitoring systems that can provide

management with timely information on positions and the estimated loss potential of each

position. One of the widely accepted methods to quantify risk is through Value-at-Risk or

VaR. (Value at Risk is a measure of the maximum potential change in value of financial

instruments with a given probability over a pre-set horizon.)

ADVANTAGE OF QUANTIFIED RISK

Position benchmarks become a function of risk and positions in different markets

while products can be compared through this common measure. A common

denominator rids the standard limit manuals of a multitude of measures, which are

different for every asset class. Limits become meaningful for management as they

represent a reasonable estimate of how much could be lost.

A further advantage of Value-at-Risk limits comes from the fact that VaR measures

risk diversification effects. This leads to a hierarchical limit structure in which the
 risk limit at higher levels can be lower than the sum of risk limits of units reporting to

it.

Setting limits in terms of risk helps business managers to allocate risk to those areas,

which they feel offer the most potential, or in which their firms' expertise is greatest.

This motivates managers of multiple risk activities to favor risk reducing

diversification strategies.

To date, trading and position taking talent have been rewarded to a significant extent

based on total returns. Given the high rewards bestowed on outstanding trading talent

this may bias the trading professionals towards taking excessive risks. It is often

referred to as giving traders a free option on the capital of the firm. The interest of the

firm or capital provider may be getting out of line with the interest of the risk taking

individual unless risks are properly measured and Returns are adjusted for the amount

of risk effectively taken. To do this correctly one needs A standard measure of risks.

Financial institutions such as banks and investment firm swill soon have to meet

capital requirements to cover the risks that they incur as a result of their normal

operations. The RBI guidelines contain proposals for estimating market risk and

defining the resulting capital requirements to be implemented in the banking sector.

The European Union has approved a directive (EEC 93/6), effective January 1996,

that mandates banks and investment firms to set capital aside to cover market risks.
ASSET-LIABILITY MANAGEMENT & INTEREST RATE RISK MANAGEMENT

ASSET-LIABILITY MISMATCH IN BANKING

A bank as its principal operation, acts as a financial intermediary between the depositors

and borrowers. In their off-balance-sheet activities, banks provide customers with tailor-

made instruments for hedging interest rate exposures and on-balance sheet, banks accept

interest rate risk as part of their normal operations. It accommodates the customers'

demands for assets and liabilities, which have different maturities, different interest rate

reset terms, and different degrees of interest rate flexibility. Further, principal customers

are given the option to withdraw deposits at a short notice and repay and renegotiate

loans. These Factors are especially important for banks with extensive retail operations,

offering their customers a variety of deposits and loans with different maturities and

contractual and non-contractual interest reset arrangements. Thus, these activities leave

their net interest income vulnerable to changes with the market interest rate. Effective

management of this risk is fundamental to retail banking.

Asset-Liability Management (ALM) is important for a bank as it defines the capacity of

the bank to repay for the liabilities as they mature. The objective of ALM is to ensure

liquidity and maximize the income through widening the spread between returns and

costs. Asset-Liability Management is broadly defined as the coordinated management of

a bank's balance sheet to allow for alternative interest-rate, liquidity, and prepayment

scenarios. Three commonly used techniques for Asset Liability Management are

On-balance sheet methods by reprising the asset and liabilities.

Off-balance-sheet methods for hedging interest-rate risk such as interest-rate futures,

options, swaps, caps, collars, and floors; and

 Securitization i.e., the management of interest-rate risk by removing risky assets from

the balance-sheet.

Asset-Liability Management is highly correlated to the interest-rate risk management. For

the investor, the interest-rate risk is the impact on his cost of financing and his return on

investment due to a change in the interest-rate.

Generally the pattern of Asset-Liability mismatch is such that there is an excess of

liabilities over assets at the short-end of the scale, and conversely at the long-end. With

non-bank customers, 70 percent of liabilities mature on demand or at 15 days or less

notice, while 60 percent of assets had a residual maturity of 3 or more years.

INTEREST RATE RISK IN BANKING

Interest rate risk is present when the interest rates earned on assets do not adjust to an

equal extent or at the same time as the interest rate paid on liability. This may occur

because

the maturity of asset-liability may differ;

contractual interest rate re-setting arrangements may be different;

competition and other factors may inhibit repricing adjustment for products with non-

contractual resets; or

Options to prepay loans or redeem deposits are utilized.

Where the fixed price liabilities have a longer maturity than assets, the intermediary is

faced with the necessity to reinvest funds, which become available when assets mature.

Uncertainty exists because of the difficulty, in the absence of hedging on futures markets,

of foretelling the yield, which will be received on those reinvested funds relative to the

costs in the form of interest and expenses of carrying the liability portfolio. Conversely,

in the case of positive maturity transformation, a situation when asset have a longer
maturity than liabilities, there is a need for the intermediary to refinance its asset holdings

by the issue of new liabilities. Risk arises form the uncertainty surroundings the interests

rate which will need for the intermediary to refinance its asset holdings by the issue of

new liabilities. Risk arises from the uncertainty surrounding the interest rate which is

required to be paid to attract funds or, alternatively, from the need to sell (liquidate) assets

at an uncertain market price, if refinancing is not to be pursued. The bank in this case is

`liability sensitive' and increases in the interest rates that adversely affect its net interest

income also reduce the market value of assets and its liquidity.
 QUESTIONNAIRE

1. Have you identified all the risks your organization faces?

2. Do you subscribe to the view that modern businesses can be run without applying
effective risk management principles?
3. Do you have documented risk management Policies?
4. Do your business plans take Risk Management into consideration?
5. Are inputs from Risk Management part of strategic business decisions in your
organizations?
6. Do you capture risk data with the Business data?
7. Does the Bank calculate the specific risk exposure?
8. Are you aware that good corporate governance requires integration of risk
management into business function?
9. Has your organization drawn up a Business Continuity Plan (BCP) and does it
guarantee minimum level of recovery within a time frame acceptable to the
stakeholders whatever be the cause of failure?
10. Are your management staffs trained in Risk Management techniques?
11. Does the Bank impose limit on the Derivative transaction?
12. Does the management approach being used ensure the co-ordination of all the
individual sub-projects; ensure communication among the different sub-project
teams, and address shared or horizontal issues?
13. Does the project have scheduled checkpoints or "gates" when it will be reviewed
and where management will decide on its future, and if necessary, take
appropriate corrective action?
14. Are scheduled reviews specified in the contract?
15. Are plans in place to manage the known risks?
16. Are plans are in place to review and update the risk assessment over the course of
the project either when there is significant change or at pre-defined times during a
long project?
17. Is there a change management process in place to ensure that changes are
analyzed quickly to determine their impact (risk, cost and time) and that this
information is brought to the attention of the appropriate level of management as
soon as possible?
18. How would you rate the potential for financial loss due to any of the following:
Human error or fraud: low medium high
 Competitive disadvantage: low medium high
Incomplete information: low medium high
Operational disruption: low medium high
Please provide reasonable details regarding your responses:

19. Is the Banks training support and user documentation for this system adequate?

20. What would be the best way to improve security or quality for this system?