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Clip 4 — Transcript

by Introduction to Banking · 3,497 words · 601 segments · language en · Watch on YouTube

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0:06So let us see the risk management means
0:10development of or strengthening of the
0:13risk management systems in an
0:15organization or in a bank.
0:18How a bank can strengthen the risk
0:20management systems. I'm giving broadly a
0:23few aspects. There could be some more is
0:27certainly can be added. This is not
0:29always an exhaustive list.
0:32Number one is a credit information
0:35companies which are available in the
0:37system or market is a largely helpful
0:40for banking credit systems. Credit risk
0:44risk systems. What is this civil score?
0:48Civil score is credit information.
0:51This is helpful for the bank in
0:53assessing the borrower's
0:56ability. borrowers solveny, borrowers
1:00creditability. So, credit information
1:02systems are needed and over a period of
1:05time in our country, credit information
1:08systems are strengthening and today's
1:10civil has become a more and more uh are
1:15covering larger part of the borrowers on
1:17the basis of the bank card. So credit
1:20information system is helpful for the
1:23banks in mitigating the credit risk
1:26especially with reference to retail
1:28loans. So today many banks are
1:31comfortable in providing the retail
1:33loans on the basis of the civil score
1:37either it may be for vehicle or it may
1:40be for education or it may be for
1:42personal requirements and all these
1:44things.
1:46So this is an ecosystem
1:49part of the ecosystem. Civil in apart
1:51from civil there are other companies
1:54also. In fact uh the there is an act
1:57credit information companies act is also
1:59there and these companies are coming
2:02under that one. So they are having uh
2:05established uh and providing credit
2:08rating of individual borrowers or credit
2:11scoring of individual borrowers.
2:15The second important uh system which is
2:18needed in a bank and in a financial
2:21market to mitigate the credit risk or to
2:24quantify the credit risk appropriately
2:26is a credit rating models
2:31or credit ratings can be external credit
2:34ratings that means the ratings provided
2:36by some agencies.
2:41It may be cry and various other type of
2:45in international context standard and
2:47pan modis are providing they provide the
2:50rating of uh instruments financial
2:53instruments. Suppose if a company is
2:56coming out with a bond and the credit
2:58rating is given by these external credit
3:00rating agencies. These external credit
3:02rating agencies also providing the
3:05rating of the bank loans also. If a
3:08company is approaching the bank for a
3:10bank a short-term loan or a long-term
3:12loan or a term loan whatever it is uh it
3:15can obtain credit rating from the credit
3:18rating agency and the bank takes this as
3:21a very valuable input or information to
3:24assess the creditworthiness of the
3:26borrower. So credit rating models uh
3:29credit rating systems which are needed
3:32for a in a bank or in a financial market
3:35if external credit rating agencies are
3:37there these are helpful in
3:39quantification of the credit risk
3:42or internally a bank can develop the
3:45credit rating models.
3:47So these are called internal credit
3:49rating models. Suppose the bank is
3:52having a wider portfolio of the sets
3:55like uh providing loans to vehicle,
3:58providing loans against the property,
4:01providing loans to the trader, small
4:03borrowers, large companies and a bank
4:07can have different type of the internal
4:09rating models suitable to different
4:11borrowers are designed for different
4:14products.
4:16So there are banks which are having 15
4:19to 18 credit rating models for
4:22assessment of uh various borrowers. So
4:25the quantification of the credit risk is
4:27possible more and more precisely more
4:30and more accurately through internal
4:33credit rating models. Of course the
4:36external credit rating agencies will
4:38also provide some information. So put
4:41together in some cases these two can be
4:44combined. In some cases it is internal
4:47rating models are sufficient enough to
4:49provide the information for risk
4:51information to the bank.
4:55Bank can constitute an expert team in
4:57assessing the loan proposals.
5:00Suppose if the bank intends to take uh
5:06widen its business or expand its
5:08business in a particular area. Area
5:11means industry.
5:15Then the bank can for example
5:16infrastructure.
5:18Infrastructure business is alltogether
5:20different from regular commercial
5:22banking business. Bank may require an
5:25expert team which can assess the power
5:27projects or which can assist the
5:31building up of the airports
5:33ports.
5:35The expert team can be constituted by a
5:38bank in assessing the specialized loan
5:41proposals like infrastructure or
5:44long-term project finance or a specific
5:47industries which are high-risk
5:49industries.
5:50The bank may constitute a expert team
5:54and bank may develop different loan
5:57pricing models.
5:59As we have said discussed that pricing
6:02is one of the mechanisms of mitigating
6:05the risk.
6:07Either credit information or rating or
6:10constitution of expert team is helpful
6:13for assessment of the risk or
6:15quantification of the risk.
6:18Whereas pricing is helpful for
6:20mitigating the risk.
6:23So the bank can develop different loan
6:25pricing models.
6:27They can keep some of the loans on the
6:29basis of the external benchmark lending
6:31rate.
6:32Some loans on the basis of the marginal
6:35cost lending. Some loans on the basis of
6:38the base price
6:40prime subprime above the prime. And they
6:44can also keep what should be the spread
6:47or the base rate. It may be 2%, 3%, 4%
6:53depends upon the rating of the borrower.
6:56So the load pricing mechanism, load
6:59pricing models are a very helpful
7:02information for the bank in mitigating
7:05the credit risk.
7:09As we have the different type of the
7:10rating models, different type of the
7:12loan pricing models are also available.
7:16Currently in India, banks can price on
7:18the basis of the external benchmark rate
7:21or there is also other mechanism called
7:23marginal cost lending rate which is
7:25called MCLR. Banks may price some loads
7:29on floating rate basis, some on fixed
7:32rate basis. So all this flexibility
7:35which deregulation of interest rates has
7:38given to banks. Banks have opportunity
7:41to develop different type of the loan
7:43pricing models and banks have indeed
7:46having the loan pricing different loan
7:48pricing models.
7:51Then uh documentation part of it.
7:54How do you document a loan is a contract
7:57between the borrower and the bank.
8:00The contract is to be strengthened by
8:02appropriate documents.
8:06The contract is to enforce the contract
8:09should have the feature of the illegal
8:11enforcability.
8:14So appropriate terms and conditions are
8:16to be put up by the bank and should be
8:19acceptable by the borrower.
8:22Bank should have right to recover some
8:24of the loan amount either through sale
8:26of the assets or through other legal
8:29mechanism.
8:31So all this comes documentation.
8:34Documentation helpsful for mitigating
8:37the credit risk. In fact a robust
8:41documentation is helpful for mitigating
8:44the operational risk also.
8:48So documentation is helping the bank in
8:51reducing not only credit risk but also
8:54operational risk
8:58and part of the documentation of course
9:00the loan term sheet will be there. Loan
9:02covenants will be there. Covenants are
9:06terms and conditions given by the bank
9:08to the borrower.
9:10For example, a bank may say that always
9:14the assets against the loan should be
9:16kept loan asset coverage ratio should be
9:20some 50% or 70% or 80%age or maybe
9:24100%age some percentage they may
9:26indicate.
9:28So the bank company has to maintain that
9:31one or the bank may insist that always
9:35the interest coverage ratio should be a
9:37particular level.
9:39This is a part of covenants.
9:42Covenants is a condition terms and
9:45condition built up by the bank to the
9:48borrower and a welld designigned
9:51covenants are helpful for the banks in
9:54mitigating the risk quickly
9:58and other type of the credit risk
9:59mitigation techniques can be collaterals
10:02guarantees
10:04personal guarantees
10:06various other mechanisms can be put up
10:09by the bank uh in mitigating the risk.
10:11It can be taking the assets or it can be
10:14providing the guarantees. These are
10:16helpful for the bank
10:19and bank systems, credit risk management
10:22system should have early warning signals
10:25also
10:26because lot of information every about
10:29every company is available in the
10:33market. Daily companies are entering
10:35into different type of the transactions
10:38and if a bank has given loan to a
10:41particular company, it is increasingly
10:43difficult for a bank to monitor all
10:46these type of the transactions in
10:48reference to a particular company. What
10:50contracts are entered? What contracts
10:52are withdrawn? Whether the order book is
10:54building up or not, is the company
10:56facing some risk out of any other
10:58counterparty
11:00or is there any risk because of the
11:02global factors
11:04or is there any risk because of some
11:05geographical factors.
11:09All this is to be captured and these are
11:12called early warning signal systems.
11:16That means a larger part of the
11:18information is being processed
11:22and some summary is being provided to
11:25the bank and the bank can take an
11:28appropriate action or a quick action to
11:31mitigate the loss. For example, if a
11:34company's orders are withdrawn,
11:37assume that if a company has faced the
11:40risk of
11:41order whatever it is having the orders,
11:44it must have withdrawn.
11:46Then what is the opportunity for the
11:48bank? Immediately the bank may ask the
11:51company to restrict the loan withdrawals
11:55also.
11:57Otherwise the company may take
11:59opportunity of entire loan amount and
12:02possibility is there loan may be
12:04diversified for other purposes then
12:07there is a risk for the bank because
12:09such loan cannot be recovered quickly as
12:11it is used for other non- businesses uh
12:16aspects or it may be used for in a
12:18different way. So any type of the
12:20diversification can be mitigated. So
12:23early warning signals are very very
12:25important and today technology is
12:28facilitating processing of all this
12:31information.
12:32So one of the areas where continuously
12:36technology companies can work is how
12:39this early warning systems can be
12:41strengthened.
12:44Quarterly information is available from
12:46the financial statements are reported to
12:49the stock exchange.
12:52Various other corporate events are
12:53reported to the stock exchange
12:56or even other type of the information is
12:58available about the contracts and
13:00expansion investment decisions and other
13:03borrowings. So much of the information
13:06even CEO resignation
13:08by a company if the bank has given loan
13:11to a particular company assume that the
13:14CEO of that company has been resigned or
13:17some of the key employees have resigned
13:19from that company. Is it a risk to the
13:21business? Yes. Is it a warning signal to
13:23the bank? Yes. Is it to be captured by
13:26the bank? Yes. How do they capture it?
13:29Appropriately designing the early
13:31warning signals.
13:33So these are all the various types of
13:36the components of the a robust risk
13:40management system.
13:43In fact, regulator like regulator orb is
13:47created a system called krillic.
13:50That means if a particular loan has
13:54become a bad loan in one of the banks
13:57accounts,
13:59other banks may not be knowing about
14:01this one. So RBI is asking the banks to
14:05report on a particular system. So this
14:08system is accessible to the banks only.
14:11So banks knows that so and so company
14:14has defaulted on a particular loan to a
14:17particular bank
14:19that indicates another early warning.
14:22So over a period of time in the
14:25financial system the credit risk
14:27ecosystem is strengthening tit.
14:33It is out of the credit uh information
14:36companies. Establishment of the credit
14:39rating models and credit rating agencies
14:43and proper monitoring of these credit
14:45rating agencies
14:48and wide opportunity for loan pricing
14:51models and strengthening of the
14:54documentation
14:55and credit risk mitigation techniques
14:58and uh early warning signals can be
15:01processed or early warning signals can
15:03be developed out of processing of the
15:06information. Now we have the opportunity
15:09of application of all AI models
15:13different type of the AI models in early
15:16warning signal information processing
15:18because information may be available
15:20from manual reports press statements
15:23communication of other through other
15:25channels or maybe one of the companies
15:30senior management team or maybe CEO of
15:33the company is continuously traveling
15:36You may get some photos on other social
15:39media. That is also an early warning
15:41signal. Why he or family is traveling
15:44continuously?
15:48Is it any way bank is facing going to
15:51face the risk out of this one? Is the
15:53bank money is going to be used for this
15:55purpose?
15:58So technology plays a great role in uh
16:02strengthening of the risk management
16:04systems especially credit rating credit
16:07risk management systems uh in an economy
16:11in a financial system and specific to a
16:14bank also.
16:15So what opportunities are available?
16:18Wider opportunities are available in the
16:20strengthening of this uh credit rating
16:23systems or credit risk management
16:25systems in a bank and in general in the
16:28financial system out of processing of
16:30the information coming from various
16:32sources. Then uh how to manage the
16:37market risk as well as the liquidity
16:40risk and uh interest rate risk.
16:45This system available is asset liability
16:48management system in a bank. It is being
16:52reported to alco committee. Asset
16:55liability management committee. This
16:57committee is expected to meet very
16:59periodically. Normally this committee
17:01meets uh once in fortnite or in some
17:04large banks even it may meet in once in
17:07a week also.
17:10So what this committee will do? This
17:12committee will discuss about changes
17:15taking place in the deposits market,
17:18interest rates of the deposits markets
17:21and what interest rates are to be
17:23charged
17:25based upon the external scenario in the
17:27market. What is the opportunity
17:29available for the bank to meet the
17:31liquidity requirement? Should the bank
17:34be a lender of the liquidity? Should the
17:36bank be a borrower of the liquidity?
17:41Borrower of the liquidity bank is
17:43borrowing liquidity from various sources
17:46or lender of the liquidity bank is
17:49lending excess money with to other
17:51mechanisms.
17:53So asset liability management system is
17:55helpful in
17:58identifying the inflows and outflows and
18:00risk arising out of that one. That is
18:03where liquidity risk is largely being
18:05monitored.
18:07Also the repricing risk.
18:10If the bank is having huge floating rate
18:13loans and fixed rate liabilities, the
18:16bank should expose opportunities explore
18:19the opportunities of mitigating the
18:22liquidity risk repricing risk arising
18:25out of these floating rate loans as well
18:27as fixed rate liabilities. So asset
18:30liability management system is also part
18:32of the risk management system of a bank.
18:36In this asset liability management
18:37system even the bank can build up the
18:40market risk management system or bank
18:42may keep separately market risk
18:44management system. Market risks
18:46management system is quantifying the
18:49potential loss out of the trading.
18:53So the market risk management system
18:55consist continuously evaluates on what
18:58would be the potential loss to the bank
19:01if the market price of particular
19:03financial asset is coming down. If there
19:07is a 1%age fall in the either in the
19:10bond prices or in the currency prices or
19:14in the equity prices, what should be the
19:17mechanism the bank should have? What
19:20type of the potential loss the bank is
19:21going to face once it is quantified? How
19:24the bank can mitigate that one? what
19:27flexibility is available in either in
19:30hedging on balance sheet basis or on off
19:33balance sheet basis or preparing keeping
19:36a capital amount ideally for that one.
19:39So this is where market risk is being
19:42managed. So bank should have credit risk
19:45management system, asset liability
19:48management system and market risk
19:50management system. So separate
19:53department mentally can be constituted
19:56for the purpose of the market risk
19:57management where banks can concentrate
20:00on this uh management of the market
20:03risk. In addition to that bank should
20:06have super appropriate internal audit
20:09and concurrent audit systems.
20:13The auditors it have to identify the
20:16loopholes
20:18and plug bank should give an opportunity
20:21for the bank to strengthen this uh
20:25loophole to to plug these loopholes
20:29to address these weaknesses.
20:31So audit system is very very important
20:34in a bank which is very helpful for
20:37strengthening the risk management
20:38system.
20:40A bank may use very sophisticated
20:43models. But unfortunately, if the audit
20:46systems are not good or audit systems
20:48are unable to identify the weaknesses
20:52or failures
20:54then these sophisticated models are not
20:56going to protect the bank from the
20:58losses
21:00because the actions are possible out of
21:02the identification of the failures which
21:05will come out of audit systems. So
21:09current concurrent audit system or
21:11internal audit systems are very much
21:13important for a bank in developing the
21:16risk management system.
21:20Apart from that finally the governance
21:24is very much important.
21:26How the governance is bank governance is
21:29there. Bank governance means
21:31it is a chairman of the bank, managing
21:35director or CEO of the bank, other
21:38executive full-time directors,
21:40independent directors, shareholder
21:43directors
21:45and in Indian corp governance system for
21:47banks is very very comprehensive. In
21:50public sector banks, a director is
21:54appointed by the government of India
21:56called as a CA director. He's a
21:58chartered accountant or she's a
22:00chartered accountant. Her job is to see
22:04mostly relating to accounting and audit
22:06systems. Often this CA director is a
22:10head of the audit committee also.
22:14So audit committee is consisting of
22:18independent directors
22:20other functional full-time directors but
22:23not managing director.
22:27Audit committee is not having the
22:29managing director as a member.
22:32Managing director is always out of audit
22:34committee.
22:36So governance system in a bank is very
22:39very important and over a period of time
22:42reserve bank of India and companies act
22:46and sebi with reference to all listed
22:48entities listed banks have enhanced have
22:51been focusing on strengthening of the
22:54governance system governance system a
22:56suitable government corporate governance
22:58a strong governance system is very very
23:01essential for
23:03excellent building up of the risk
23:05management system. Who reports to whom?
23:09For example, risk management system.
23:11Risk management function is to be
23:13monitored by chief risk officer of the
23:16bank. The chief risk officer is directly
23:20accountable to the board not to the
23:23managing director.
23:25That much of the freedom is given to the
23:28CRO.
23:30What happens? That means the CRO is not
23:33influenced by the business decisions.
23:35Normally managing director is always
23:38focused on the business or CEO is always
23:41focused on the business because CEO
23:43wanted to increase the business.
23:46Once the business is going up, CEOs are
23:49happy and business doing well, income is
23:52generated, CEO is happy. Suppose income
23:55is generated as per the quarterly
23:57projections or as per the annual
23:59projections. CEO is very happy but is
24:02that income coming out of the extra risk
24:05or not? Is it coming because of the
24:08additional risk? That is to be pointed
24:11out by the chief risk officer.
24:15So the chief risk officer plays an
24:18important role as a governance mechanism
24:20in the banking system in the risk
24:23management system. So governance is very
24:25very important aspect
24:28and chief risk officer is independently
24:31live is reporting to the board as well
24:34as sometimes
24:37in a year a couple of times maybe
24:40quarterly basis the chief risk officer
24:43is
24:45meeting the independent directors
24:48separately
24:50that means functional directors are
24:52excluded the chief Risk officer can say
24:55to the independent directors risk is
24:57coming from these sources or she or he
25:00may be facing the risk from the
25:04functional directors that can be
25:06reported to the chief risk officer
25:08reported to the independent director
25:10separately
25:15also the other important aspect is
25:17compliance officer chief compliance
25:20officer.
25:22So chief compliance officer is seeing
25:24that whether the bank is compliant to
25:26various things. Compliance is an
25:28important aspect. We will come to know
25:31only if there is a failure in the
25:33compliance. What would be the loss out
25:35of that one? As long as things are going
25:38on very well, people may think
25:40compliance is not okay some accounting
25:43function. No, compliance is not only an
25:46accounting function. It is a very
25:48helpful aspect for the strengthening of
25:50the risk management in a bank. So both
25:54CRO and CCO these are all expected to be
25:58independent positions not influenced by
26:01the business decisions and they are
26:04directly reporting to the port
26:08and even financial statements are first
26:11of all directly reported to the auditors
26:14are directly reporting to the audit
26:16committee. Once they have audited the
26:18financial statements
26:20then only the audit committee will
26:22present the financial statements under
26:25the board. Audit committee will uh
26:27members will be there in the board also
26:29while discussing the financial
26:31statements and audit committee can give
26:34their opinions when the financial
26:36statements are being presented in the
26:38board.
26:39So the risk mitigation various types of
26:42the risks what we have discussed risk
26:45identification management and one
26:48mitigation depends upon what type of the
26:52risk management systems
26:54a bank is focusing and there is always a
26:57continuous effort due to changes in the
27:00global environment because of the Basel
27:03committee subsequent to the Basel commit
27:08financial crisis in 2008 and subsequent
27:11to other changes. Basel committee is
27:13consistently emphasizing on
27:17continuously emphasizing on
27:18strengthening of the risk management
27:20systems. Out of that governance of the
27:23banks is also an important aspect.
27:26Quantification of the risks we can see
27:29it in subsequent classes.

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