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A bank is a financial institution whose primary activity is to act as a payment agent for customers and to borrow and lend money. In other words, an institution where one can place and borrow money and take care of financial affairs.
Functions of Banks:
Lending money to public(loans) Transferring money from one place to another (Remittances) Acting as trustees Keeping valuables in safe custody Government business
Types of Banks:
Public sector Banks Private sector Banks Co-operative Banks Development Banks/Financial institutions
HDFC BANK
HDFC Bank Limited is an Indian financial services company based in Mumbai, Maharashtra. It was incorporated in 1994. HDFC Bank is the fifth largest bank in India by assets. It is also the largest bank by market capitalization as of 1 November 2012. As on Jan 2 2014, the market cap value of HDFC was around USD 26.88B, as compared to Credit Suisse Group with USD 47.63B. The bank was promoted by the Housing Development Finance Corporation, a premier housing finance company (set up in 1977) of India. As of 31 March 2013, the bank had assets of INR 4.08 trillion. For the fiscal year 2012-13, the bank has reported net profit of INR 69 billion, up 31% from the previous fiscal year. Its customer base stood at 28.7 million customers on 31 March 2013. Products HDFC Bank offers the following four core products: Personal banking Under Personal Banking, HDFC offers:
Accounts & Deposits Loans Cards Demat Investments Insurance Forex Premium Banking Private Banking
Investments & Insurance Research Reports Loans Premium Banking Payment Services
Accounts & Deposits Business Financing Trade Services Payments & Collections Cards
Wholesale banking HDFC offers Wholesale Banking for Corporates and Financial Institutions & Trusts. The Bank also provides services such as Investment Banking and other services in the Government sector. Services Wholesale banking services HDFC Bank provides a range of commercial and transactional banking services, including working capital finance, trade services, transactional services, cash management, etc to large, small and mid-sized corporates and agriculture-based businesses in India. The bank is also a leading provider of these services to its corporate customers, mutual funds, stock exchange members and banks.
Retail banking services HDFC Bank was the first bank in India to launch an International Debit Card in association with VISA (Visa Electron). The bank also issues the MasterCard Maestro debit card. The Bank launched its credit card business in late 2001. By the end of June 2013, it had a credit card base of 5.94 million. By March 2012, the bank had a total card base (debit and credit cards) of over 19.7 million. The Bank is also one of the leading players in the "merchant acquiring" business with over 240,000 point-of-sale (POS) terminals for debit / credit cards acceptance at merchant establishments. The Bank is positioned in various net based B2C opportunities including a wide range of Internet banking services for Fixed Deposits, Loans, Bill Payments, etc.
swaps. A major reason for lack of term money market is the obscene of the practice of ALM system among bank for identifying mismatches in carols time periods. The recent RBI guidelines to lend on a term and also offer two way quotes in the market. The advisory group on banking supervision constituted by RBI recommended greater orientation of banks management OECD principal of corporate governed recognizes the risk management as area of increasing importance for board which is related to corporate strategy.
Combination This reflects the old adage of not putting all eggs in one basket. The risk of default is less when the financial assets are distributed over a number of issuers instead of locking them with a single issuer. It pays to have multiple suppliers of raw materials instead of relying on a sole supplier. A well-diversified company has a lower risk of experiencing a recession. Transfer Risk reduction can be achieved by transfer. The transfer can be of three types. In the first type, the risk can be transferred by transferring the asset/liability itself. For instance, the risk emanating by holding a property or a foreign currency security can be eliminated by transferring the same to another. The second type of transfer involves transferring the risk without transferring the asset/liability. The exchange risk involved in holding a foreign currency asset/liability can be transferred to another by entering into a forward contract/currency swap. Similarly, the interest rate risk can be transferred by entering into an interest rate swap. The third type of transfer involves making a third party pay for the losses without actually transferring the risk. An insurance policy covering the third party risk is an example of this. When a bank takes a policy to cover the losses incurred on account of misuse of lost credit cards, it is in effect finding someone to finance the losses while it still has the obligation to pay the Merchant Establishment. Except for the approach of avoidance, the bank can effectively adopt others since by avoiding risks the bank will not be making any profits. Banks can neither do without profits nor risks. However, mere acceptance of these risks to remain profitable does not suffice. Apart from the losses that can be incurred due to the risks, there is also an ultimate danger that the bank itself may fail. The question that arises at this point is what should the bank do in order to take risk for greater returns and at the same time does not end up in losses? Risk management is the solution to such a situation.
Systematic Risk
Systematic risk is the risk of asset value change associated with systematic factors. It is sometimes referred to as market risk, which is in fact a somewhat imprecise term. By its nature, this risk can be hedged, but cannot be diversified completely away. In fact, systematic risk can be thought of as undiversifiable risk. All investors assume this type of risk, whenever assets owned or claims issued can change in value as a result of broad economic factors. As such, systematic risk comes in many different forms. For the banking sector, however, two are of greatest concern, namely variations in the general level of interest rates and the relative value of currencies. Because of the bank's dependence on these systematic factors, most try to estimate the impact of these particular systematic risks on performance, attempt to hedge against them and thus limit the sensitivity to variations in undiversifiable factors. Accordingly, most will track interest rate risk closely. They measure and manage the firm's vulnerability to interest rate variation, even though they cannot do so perfectly. At the same time, international banks with large currency positions closely monitor their foreign exchange risk and try to manage, as well as limit, their exposure to it. In a similar fashion, some institutions with significant investments in one commodity such as oil, through their lending activity or geographical franchise, concern themselves with commodity price risk. Others with high single-industry concentrations may monitor specific industry concentration risk as well as the forces that affect the fortunes of the industry involved.
Credit Risk
Credit risk or default risk may be defined as the potential that a bank borrower or counterparty will fail no meet its obligations in accordance with the agreed terms. Sources of credit risk exist throughout the activities of the bank, these are:
Loans, which are the largest and most important sources of credit risk. Loans and advances constitute nearly 65% of the total assets of the scheduled commercial banks in India at the end of any normal financial year. Investment (in non-SLR instruments), including certificate of deposits, commercial paper, equity shares of PSUs and private corporate sector, brands / debentures / preference shares issued by PSUs and private corporate sector etc. The exposure to such investments in respect of the scheduled commercial banks of India may be 7-9% of the total assets as at the end of March of any normal financial year. 3 Off balance sheet activities / items. These item are not booked on the balance sheets and are of a contingent nature, and hence carry a definite element of risk although they generate a fee income for the banks, Indian banks are presently exposed to the offbalance sheet item such as foreign exchange contracts, guarantees, acceptance etc. These, put together, constitute 6-7% of the total assets in respect of the scheduled commercial bank in India at the end of the March of any normal year. With further liberalization, banks are taking up new types of off-balance sheet exposures such as future, swaps, options, etc. The remaining 25 to 30% of demand and time liabilities of the banks in locked up by way of cash. Reserve Ratio (CRR) or Statutory Liquidity Ratio (SLR). Credit risk is generally made up of transaction risk or default risk and portfolio risk. Transaction risk arises from individual credit transactions of the bank at a micro-level and is evaluated through technical, financial and economic analyses of individual borrowers Project. Whereas, portfolio risk arises out of the total credit exposures of the bank at a micro-level. Portfolio risk may be intrinsic, e.g. a particular group or type of customers or industry may have a higher risk profile as compared to the other group or types. Portfolio risk may also arise out of undue concentration to credits to single borrowers or counterparties, a group of connected borrowers or counterparties, particular industries / sectors, borrowers in a particular geographic location, etc. In the event that a particular group or industry experiences downturn, the entire portfolio may turn into non-performing assets, at least at that pointed time.
Market Risk
Market Risk may be defined as the possibility of loss to a bank caused by the changes in the market variables. It is the risk that the value of on/off-balance sheet positions will be adversely affected by movements in equity and interest rate markets, currency exchange rates and commodity prices.
Market risk is the risk to the banks earnings and capital due to changes in the market level of interest rates or prices of securities, foreign exchange and equities, as well as the volatilities of those prices. Market Risk management provides a comprehensive and dynamic framework for measuring, monitoring and managing liquidity, interest rate, foreign exchange and equity as well as commodity price risk of a bank that needs to be closely integrated with the banks business strategy.
Scenario analysis and stress testing is yet another tool used to asses areas of potential problems in a given portfolio. Identification of future changes in economic conditions like
Counterparty Risk
Counter party risk comes from non-performance of a trading partner. The nonperformance may arise from counterpartys refusal to perform due to an adverse price movement caused by systematic factors, or from some other political or legal constraint that was not anticipated by the principals. Diversification is the major tool for controlling nonsystematic counterparty risk. Counterparty risk is like credit risk, but it is generally viewed as a more transient financial risk associated with trading than standard creditor default risk. In addition, counterpartys failure to settle a trade can arise from other factors beyond a credit problem.
Liquidity Risk
Liquidity risk can best be described as the risk of a funding crisis. While some would include the need to plan for growth and unexpected expansion of credit, the risk here is seen more correctly as the potential for a funding crisis. Such a situation would inevitably be associated with an unexpected event, such as a large charge off, loss of confidence, or a crisis of national proportion such as a currency crisis. In any case, risk management here centers on liquidity facilities and portfolio structure. Recognizing liquidity risk leads the bank to recognize liquidity itself as an asset, and portfolio design in the face of illiquidity concerns as a challenge.
Operational Risk
Operational risk is associated with the problems of accurately processing, settling, and taking or making delivery on trades in exchange for cash. It also arises in record keeping, processing system failures and compliance with various regulations. As such, individual operating problems are small probability events for well-run organizations but they expose a firm to outcomes that may be quite costly.
Legal Risks
Legal risks are endemic in financial contracting and are separate from the legal ramifications of credit, counterparty, and operational risks. New statutes, tax legislation, court opinions and regulations can put formerly well-established transactions into contention even when all parties have previously performed adequately and are fully able to perform in the future. For example, environmental regulations have radically affected real estate values for older properties and imposed serious risks to lending institutions in this area.
or exposure, and the need to hedge against systematic risk of a particular type. The limits described above lead to passive risk avoidance and/or diversification, because managers generally operate within position limits and prescribed rules. Beyond this, guidelines offer firm level advice as to the appropriate level of active management, given the state of the market and the willingness of senior management to absorb the risks implied by the aggregate portfolio. Such guidelines lead to firm level hedging and asset-liability matching. In addition, securitization and even derivative activity are rapidly growing techniques of position management open to participants looking to reduce their exposure to be in line with management's guidelines.
(iv)Incentive Schemes
To the extent that management can enter incentive compatible contracts with line managers and make compensation related to the risks borne by these individuals, then the need for elaborate and costly controls is lessened. However, such incentive contracts require accurate position valuation and proper internal control systems. Such tools which include position posting, risk analysis, the allocation of costs, and setting of required returns to various parts of the organization are not trivial. Notwithstanding the difficulty, well designed systems align the goals of managers with other stakeholders in a most desirable way. In fact, most financial debacles can be traced to the absence of incentive compatibility, as the cases of the deposit insurance and maverick traders so clearly illustrate
D. STRATEGY FORMULATION: A strategy is that which is developed to implement a policy. Clearly, a strategy will then be relatively for a shorter period. Given the exposure and volatilities, a strategy helps in managing these risks. Firstly, the possible options and the risks attached to them are examined in order to known the affect on each option on the cash flows and the earnings. With this information, a strategy will be developed to identify the sources of losses/gains and how efficiently the risks can be shifted to enhance profits while reducing the exposure. Strategy differ widely depending on the nature of exposure , the type of transaction, etc. and will also state the instruments that are to be used to manage exposure, tenors and counterparties. E. MONITERING RISK: laying down strategy will not less to risk management since risk profile cannot be static. Volatile circumstance may change the risk level of the investment and hence require the banks to restore the same to the set targets levels. For instance, the bank takes a long position on a loan of US $1mn. At an exchange rate so Rs.43.50, the risk which the bank is ready to take is up to Rs.0.10 variation. In absolute terms this will be Rs. 1 lakh. However, the exchange rate goes down by Rs. 0.15 due to which the loss to the bank is Rs. 1.5 lakh. This is beyond the target set by the bank. In such circumstances, the bank can take a long position in US $ if it believes that the rate will move up. And in case the rates are expected to go down further, it can either enter into a forward contract or exit from the long position taking up the loss. In either case the bank needs to have a view about the market regarding its future behavior. The objective of risk management is not to prohibit or prevent risk taking, but to ensure that the risks are consciously taken with full knowledge, clear purpose and understanding so that it can be measured and mitigated. The purpose of managing risk is to prevent an institution from suffering unacceptable loss causing an institution to fail or materially damage its competitive position. Functions of risk management should actually be bank specific dictated by the size and quality of balance sheet, complexity of functions, technical/professional manpower and the status of MIS in place in that bank. There may not be one-size-fits-all risk management module for all the banks to be made applicable uniformity.
Case Study
Bank of Baroda
The Client BANK OF BARODA has significant International presence with a network of 57 Offices in 19 countries including 38 branches of the bank and 17 branches of its seven subsidiaries besides 2 representative offices in Malaysia and China and a network of more than 2700 branches in India. In the U.K, since the 1990s the bank has been using the Misys-Equation core banking application to support its activities at its London Main Office and other branches. This application runs on the IBM AS400 Operating platform. IIL Risk Management has been providing various IT related services to the bank. The Problem Bank of Baroda U.K conducts it's clearing through NatWest/Royal Bank of Scotland. The bank (main office and branches) receives all clearing information such as cheques, giro credits and direct debits from NatWest on a daily basis as printed statements along with the related instruments. The process involves classifying each payment and posting the resultant transactions into Misys Equation core banking product manually. Checks have to be made in respect of stopped cheque, blocked account, inactive account, closed account and incorrect accounts. Moreover, the account numbers held at NatWest do not exactly match with that in the Misys-Equation database. Manual entries were error prone requiring additional verification. This process therefore, called for considerable effort and use of human resources contributed to operational risk. The Solution IIL Risk Management has provided a solution to automate the entire process end to end with the necessary validations at every level of the data pass through. The objective being the reduction of manual effort to a minimum and improvement in the accuracy of posted transactions and operational efficiency. The implemented solution integrates with electronic receipt of Agency Credit Clearing data from NatWest based on APACS (Association of Payment Clearing Services) standards 27 and 29, which define the specification of files exchanged between banks and their customers. Both Microsoft and IBM technologies are used with suitable data transfer methodology to IBM AS/400. An MS Windows based front-end provides a user-friendly interface to process downloaded data from NatWest, carry out necessary checks to ensure data integrity and to transfer the data to AS/400. IBM AS/400 operations menu guides the user to process the transferred data, categorizing the transactions as 'OK' to post and 'Exceptions' based on established business validation rules and to tally the credit/Debit totals with those from NatWest. The automatic mapping function enables correction of incorrect account numbers. All the Branches including the Main Office have access to menu options to view and correct the exceptions. A specially written automatic posting program handles the posting of accounting entries into Misys-Equation.
The Benefits Implementation of the automated clearing system increased the speed of processing, drastically reduced manual errors, eliminated delays in posting customer accounting entries and kept up-todate individual customer accounts. The solution is centrally managed from the Head Office and use of the AS/400 platform on which the banking application runs, allows branches to handle their part of the data effectively while not worrying about uploading and managing their branch specific clearing data
CONCLUSION
The objective of risk management is not to prohibit or prevent risk taking, but to ensure that the risks are consciously taken with full knowledge, clear purpose and understanding so that it can be measured and mitigated. The purpose of managing risk is to prevent an institution from suffering unacceptable loss causing an institution to fail or materially damage its competitive position. Functions of risk management should actually be bank specific dictated by the size and quality of balance sheet, complexity of functions, technical/professional manpower and the status of MIS in place in that bank. There may not be one-sizefits-all risk management module for all the banks to be made applicable uniformity. Hence it is depends upon a banking industry whether tomanage accept ignore avoid exploit or reduce the banking risk. Managing risk is a tool and technique differs from one bank to another that how they are treat with them and this will directly decide the future of bank. A good risk managing banking industry can easily survive in acompetitive banking area.