Providing software solutions since 1976
Providing software solutions since 1976
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Leaving a lot to chance - Sept 25, 2002 Most banks don't provide for market risk and are unable to scope of risk accurately across all its dimension RE-REGULATION, consolidation and increased competition have brought banks face to face with new challenges - risk management, in particular. Global markets have become increasingly volatile and interrelated. More and more complex instruments, leveraged for increasing profits substantially, are being traded. The implications of this exercise are yet to be fully understood, Lending has become commoditised. And, as usual, NPAs presistently dot the balance sheets. The critical question therefore is: Have all dimensions or risk-that impact both short-term and long-term goals of liquidity, profitability and solvency been taken into account? This is pertinent especially since risk is at the core of achieving profits. To appreciate the magnitude of the problem, let us focus on banks. Today, banks are faced with both credit and market risk. While most banks, following RBI guidelines, have based their capital adequacy ratio (CAR) on credit risk, only one in 25 banks have accounted for market risks. What does this mean? CAR gives a measure of the risk cover that a bank must have in terms of amount of capital, in the event of defaulting creditors/risky investments, to remain solvent. However, if the entire extent of risk exposure by the bank does not form the basis of measurement of CAR, that becomes the biggest risk of all. Credit risk is one aspect of risk taken by the banks - the other critical component being market risk. Market risk arises from the movement in market price and deal with interest rate risk, debt/equity risk, foreign exchange risk and commodities risk. It currently contributes to more than 50% of banks profit margins that is not being covered. This is a precarious situation. Worse, the vulnerability of the case does not end here. Event if all dimensions or risk are considered to calculate CAR, there is a distinct lack of IT solutions that can measure risk accurately and dynamically, across all possible parameters/scenarios, to arrive at a sound risk management strategy. At this stage, therefore, though there is an appreciation of the upside of risk vis-a-vis returns, there is no way to measure the implications of downside risk. So the problem is two-fold: one is of banks not taking into account the market risks while calculating their CAR and second is of not being able to measure risk accurately across all its dimensions. Let us consider the first problem. To tackle this issue, as per RBI guidelines, in keeping with Basel II recommendations, by March '03, banks have to incorporate the underlying market risk measures, alone with credit risk, to arrive at the CAR. However, this is easier said than done as it leads into another challenge. To elaborate, conventional IT systems are not capable of measuring all dimensions or risk. To begin with, the data is not accurate.
This is plainly reflected in the
crucial risk: return ratios arrived at by key decision makers -
typically based on past experience, a sense of whether the current
risk position is aggressive or moderate and static reports from
disparate data sources. Secondly, these ratios reflects only the
current position of investments, validated by marking to market
the existing portfolios, to arrive at the current market exposure.
It does not reflect future market risks. |
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