Page 197 - DCOM304_INDIAN_FINANCIAL_SYSTEM

Indian Financial System

Notes Credit Risk

Banks should put in place the loan policy covering the methodologies for measurement,
monitoring and control of credit risk. Banks should also evolve comprehensive credit ration
system that serves as a single point indicator of diverse risk factors of counter parties in relation
to credit and investment decisions.
Proposals for investment should be subjected to the same degree of credit risk analysis as loan
proposals. Portfolio quality should be evaluated on an ongoing basis rather than near about
balance sheet date. Risk evaluation should be on the basis of total exposure, credit and investment
decisions combined.
As regards off-balance sheet exposures, the current and potential credit exposures may be
measured on a daily basis. A suitable framework to provide a centralized overview of the
aggregate exposure on other banks is to be evolved. The banks should also develop an internal
matrix that reckons the counter party and country risk.

Liquidity Risk

Banks should put in place prudential limits on interbank borrowings, especially call fundings,
purchased funds, core deposits to core assets, off-balance sheet commitments and swapped
funds. Liquidity profile should be evaluated under bank specific and market crisis scenarios.
Contingency plans should be prepared to measure the ability to withstand sudden adverse
swings in liquidity conditions.

Interest Rate Risk

A time-frame should be fixed for moving over to value at risk (VAR) and duration approaches
for measurement of interest rate risk.

Market Risk

Explicit capital cushion based on international standards should be provided for the market
risks to which banks are exposed.
Operational Risk

In view of the phenomenal increase in the volume of financial transactions, proper systems for
measurement, monitoring and control of operational risk should be set up. Suitable
methodologies for estimating and maintaining economic capital should be developed.
The design of the risk management should be oriented towards the banks own requirement
dictated by the size and complexity of business risk philosophy, market perception and the
existing level of capital. Banks can evolve their own systems compatible with the type and size
of operations as well as risk perception. It is neither possible nor necessary to adopt uniform
risk management system in all banks on account of the diversity and varying size of balance
sheet items.

The success of ALM depends on the effective existence of (1) information and policies, and (2)
risk management system. There should be asset-liability managers and an asset-liability
committee (ALCO) that manages the bank's balance sheet in such a manner so as to minimize
the volatility in its earnings, liquidity and equity to changes in market conditions. The successful
pursuit of the objective would manifest in stable net interest margins, optimal earnings, adequate
liquidity and effective control of financial risk. For this purpose the strong. ALCO must be

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