1	RISK MANAGEMENT FRAMEWORK IN RBI A PRESENTATION BY R B NANDOSKAR, DGM, RBI SYED SAJJAD HUSSAIN, AGM, RBI
2	Banking Regulation: Legal Framework Main framework-The Banking Regulation Act, 1949 (BR Act) Other related regulations Reserve Bank of India Act, 1934, State Bank of India Act, 1955, State Bank of India (Subsidiary Banks) Act, 1959 Banking Companies (Acquisition and Transfer of Undertakings) Acts, 1970 & 1980. to prescribe standards and monitor liquidity, solvency and soundness of banks, The main objective ensure protection of depositors’ interests .
3	Indian Banking System-structure Multilayered and Diverse Composition Consists of: Scheduled Commercial Banks – 89 Public Sector Banks – 26 [Nationalised Banks – 20 and State Bank Group – 6] Private Sector Banks – 20 Foreign Banks – 43 Regional Rural Banks – 62 Local Area Banks – 4 Registered Non Banking Finance Companies – 12,225 [ Including 254 Deposit Taking NBFCs] Urban Co-cooperative Banks – 1606 Rural Co-operatives – 93656 [ PACs – 93255, DCBs – 370 and SCBs – 31]
4	Banking Regulation: Objectives & Forms Implicit objectives – Promotion of Financial Stability and customers’ protection Forms Prudential Regulation Capital Adequacy, Income Recognition and Asset Classification & Provisioning, Exposure Ceilings, Risk Management etc. Other Regulatory Guidelines Corporate Governance, Fit & Proper, Know Your Customer/Anti Money Laundering, Credit Information Companies, Customer Services
5	Organisational Structure The Board of Directors -the overall responsibility for management of risks. The Risk Management Committee Board level Sub-committee members- CEO and heads of Credit, Market and Operational Risk Management Committees. Role- devise the policy and strategy for integrated risk management. coordination with the Credit Risk Management Committee (CRMC) the Asset Liability Management Committee other risk committees of the bank, if any
6	Typical Organisational Structure for Risk Management
7	Components of risk-Credit Risk The management of credit risk should receive the prime attention of the top management. The Loan Policy, approved by the Board, should cover the methodologies for measurement, monitoring and control of credit risk. Each bank should have a clearly defined scheme of delegation of powers and also evolve a credit approving system, where the loan proposals beyond a pre-specified limit are approved by an 'Approval Grid' or a 'Committee.
8	Credit Risk Contd.. In order to control the magnitude of credit risk, prudential norms on benchmark financial ratios, single borrower or borrower - group exposure, substantial exposure, industry-specific, region-specific and sector-specific exposures, exposure to sensitive sectors, etc. should be covered in the Loan Policy
9	Credit Risk Contd.. Banks should evolve comprehensive credit risk rating system . Put in place a Loan Review Mechanism (LRM) for large advances. Method of tracking non-performing loans /Early warning signals. Tracking migration (upward or downward) of borrowers from one rating scale to another. Inter-bank Exposure and Country Risk.
10	Component of risk-Market Keeping the level of computerisation and MIS, banks have been advised to adopt easy-to-comprehend analytical tools for management of market risk. International banks have made considerable progress in adopting more sophisticated techniques like Duration, Earnings at Risk (EaR), Value at Risk (VaR) and complex simulation models.
11	Market Risk Contd... The Committee also proposes to develop a capital charge for interest rate risk in the banking book for banks where the interest rate risk is significantly above average. In the backdrop of gradual integration of domestic markets with external markets, large banks in India should also adopt more sophisticated techniques in the management of market risk.
12	Component of risk-Liquidity Under ALM Guidelines, banks should also consider putting in place prudential limits on inter-bank borrowings, especially call fundings, purchased funds, core deposits to core assets, off-balance sheet commitments, swapped funds, etc. Banks should also evaluate liquidity profile under bank-specific and market crisis scenarios. Contingency plans should be prepared to measure the ability to withstand sudden adverse swings in liquidity conditions.
13	Component of risk -Interest Rate Banks should fix a definite timeframe for moving over to VaR and Duration approaches for measurement of interest rate risk. Banks should also develop capabilities to undertake stress tests to capture the adverse effects of extreme volatile conditions or outlier events. A scientific internal Funds Transfer Price (FTP) mechanism could be evolved to supplement the ALM.
14	Capital for Market Risk It would be desirable to adopt international standards on providing explicit capital cushion for the market risk to which banks are exposed. Small banks operating predominantly in India could adopt the standardised approach Large banks and banks operating in international markets should develop expertise in evolving internal models for measurement of market risk.
15	Operational Risk Operational risk is emerging as an important feature of sound risk management in the wake of phenomenal increase in the volume of financial transactions, high degree of structural changes and complex technological support systems. Banks should adopt proper systems for measurement, monitoring and control of operational risk.
16	Basel Accord I Basel I (1988 Basel Accord), was primarily concerned with providing capital to absorb losses on account of credit risk. Capital charge for credit risk introduced since 1992-93. Market risks introduced in 1996. Purpose: Strengthen the capital base of banks Link capital base with risks in on-balance sheet and off-balance sheet items Assets of banks were classified and grouped in five categories.
17	Basel II To promote adoption of strong risk management system by banks – June 26, 2004. Three mutually reinforcing pillars: Pillar 1 - Minimum capital requirements each bank must hold to cover its exposure to credit, market and operational risk. Pillar 2 - Supervisory review of capital adequacy that aim to ensure that a bank's capital level is sufficient to cover its overall risk. Pillar 3 - Market discipline and details minimum levels of public disclosure.
18	Basel II - Pillar II Supervisory Review and Evaluation Process (SREP) envisages establishment of suitable risk management system in banks and their review by the supervisor. Banks to have adequate capital to support all the risks in their business. Encourage banks to develop and use better risk management techniques for monitoring and managing their risks. Well defined internal assessment process (ICAAP)
19	Internal Capital Adequacy Assessment Process Risks identified through ICAAP Manner of monitoring & managing of risks Impact of risk profile changes on the capital results of stress test / scenario analysis Review of ICAAP outcome by the Board at least once a year or as and when necessary. Board should assess & document whether ICAAP has achieved the objective envisaged Senior Management to review the reports regularly to evaluate the sensitivity of assumptions used and assess the validity of capital assessments made.
20	Pillar III- Guidelines for Market Discipline Market discipline is to complement the minimum capital requirements and SREP. The aim is to encourage market discipline by developing a set of disclosure requirements which will allow market participants to assess key pieces of information on the scope of application, capital, risk exposures, risk assessment processes and the capital adequacy of the institution.
21	High Level Steering Committee (HLSC) under the Chairmanship of DG A High Level Steering Committee (HLSC) was constituted under the Chairmanship of Dr. K. C. Chakrabarty, Deputy Governor for Review of Supervisory Processes for Commercial Banks with representation from RBI, commercial banks and the academia. The Committee was mandated to review the extant approaches, methodologies, processes/tools for onsite and off-site supervision, Supervisory Rating & Stress Testing Frameworks and recommend measures for a gradual progression to a Risk Based Supervision Framework. The High Level Steering Committee submitted its report on June 11, 2012.
22	Timeline for RBS Implementation November 2012: Preparedness for transition and hiring of consultant March- May 2013: Data requirements sent to banks & data received June 2013 onwards: Model developments and finalization Reserve Bank of India (RBI) is implementing a risk-based approach for the supervision of banks in India from April, 2013 onwards in a phased manner and selected 30 banks in 2012-13 cycle.
23	Stress Testing Guidelines on stress testing were issued to banks on June 26, 2007. Banks were required to operationalise their formal stress testing framework in accordance with these guidelines from March 31, 2008. The guidelines were updated on December 2, 2013, in tune with BCBS Principles for Sound Stress Testing Practices and Supervision, after considering the stress experienced by banks in the recent past. Banks to adopt guidelines from April 1, 2014.
24	Basel III
25	Basel III In the implementation of Basel III guidelines we have adopted a cautious approach inasmuch as the minimum capital requirement has been kept at 1 percentage point higher than that stipulated under Basel III to address the possible inadequacies in the capital allocation process and also the model risks in banks. The implementation schedule is also marginally advanced by 9 months to be complied by March 31, 2018 against the Basel requirement of January 01, 2019.
26	Capital Conservation Buffer The Capital Conservation Buffer (CCB) is designed to ensure that banks build up capital buffers during normal times (i.e. outside periods of stress) which can be drawn down as losses are incurred during a stressed period. The requirement is based on simple capital conservation rules designed to avoid breaches of minimum capital requirements.
27	Issues in implementation of Basel III - Liquidity Basel III requires a high level of liquidity to be maintained through a pool of unencumbered liquid assets. While Indian banks maintain a large pool of liquid assets in compliance with the Statutory Liquidity Ratio, they may not technically qualify as liquid assets under Basel III as these are not freely available to banks for liquidity purposes. Requiring banks to maintain liquid assets over and above the SLR could put them in a competitively disadvantageous position. We are, therefore, considering as to what extent the SLR can be reckoned towards Basel III requirements for holding liquid assets.
28	Leverage Ratio Basel III prescribes a leverage ratio (ratio of Tier 1 capital to total exposures including off-balance sheet items) as backstop measure to supplement the risk-based capital adequacy ratio. Our view has been that since for Indian banks, the SLR requirements are substantial and carry little risks, these should be kept out of the leverage ratio. However, this was not accepted by the BCBS. But the comforting news is that the leverage ratio of Indian banks is modest compared to the levels being contemplated.
29	Implementation challenges in Basel II advanced approaches (skills,technology) While all commercial banks in India have adopted standardised approaches under Basel II by March 2009, the implementation of advanced approaches is under various stages. As the advanced approaches are technology intensive and also require highly skilled workforce, it is going to be challenging for banks going forward. Availability of data for building and testing advanced models and for building scenarios would be another serious challenge.
30	Compensation policy The compensation policies encouraged employees to increase short term profit without adequate recognition of risks and long-term consequences that their activities posed to the organisation. To address these concerns, Reserve Bank issued guidelines on compensation practices for private and foreign banks, based on the international initiatives.
31	Capacity building measure for Corporate Governance Training to employees in area of Core Banking Solution (CBS) To identify potential operational risks arising out of technology adoption in the banking sector. IT Vision Document for 2011-17 emphasising the need for risk controls, risk mitigation systems, fraud detection/prevention and business continuity plans (BCP). The establishment of the Centre for Advanced Financial Research and Learning (CAFRAL) to boost the capacity building efforts as well as promote research in regulation and supervision
32	Financial Stability Reviews and Reports To create awareness of the vulnerabilities in the system To initiate prompt corrective action, Reserve Bank periodically (on a half-yearly basis) brings out Financial Stability Reports and reviews sharing the results of its macro- prudential surveillance to assess systemic risk build in the economy. Building of countercyclical provisions for resilience against the cyclical shocks
33	Dynamic Provisioning In India, banks have a stock of floating provisions which we have not permitted to be used, except under a situation of systemic stress. While the floating provisions may serve the purpose of countercyclical provision, a framework is necessary for allowing its use. As an interim measure, we have developed a methodology based on the Spanish dynamic provisioning system which has been put up for public comments.
34	Securitisation Securitization guidelines have been extensively redesigned to dissuade the ‘originate to distribute’ model and to build the ‘skin in the game’ by prescribing Minimum Holding Period (MHP) prior to securitisation and Minimum Retention Requirement (MRR) after securitisation- in the aftermath of financial crisis of 2008.
35	Financial Stability and Development Council (FSDC) In order to have a formalised coordination mechanism, a Financial Stability and Development Council (FSDC) under the Chairmanship of the Finance Minister has been constituted. A sub-committee of FSDC under the chairmanship of the Governor, Reserve Bank of India ensures coordination amongst the regulators during normal times.
36	Setting up of Holding Companies At present, most of the financial groups in India are led by banks and organised under the Bank Subsidiary model. This model, however, puts the onus on the parent bank for corporate governance, performance and capital requirement of the subsidiaries. Besides, the parent carries very substantial reputational risk. The Working Group on ‘Introduction of Holding Company structure in India for banks’ has recommended migration of major financial conglomerates to the holding company structure to address these limitations to some extent. Necessary legal amendments will have to be put in place for facilitating such migration.
37	Financial Sector Legislative Reforms Commission (FSLRC) Sound and unambiguous legislative framework is a prerequisite for an efficient regulatory system. At present, in India, there are about 60 Acts and multiple rules and regulations, many of which are archaic and the large number of amendments have made the laws ambiguous and complex. Government of India has constituted a Financial Sector Legislative Reforms Commission (FSLRC) to rewrite and streamline the financial sector laws, rules and regulations to bring them in harmony with India’s fast growing financial sector.
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