Market Risk Final

7/31/2019 Market Risk Final

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What is Market Risk?

Risk Management Organization Structure

Policy Framework

Types of Market Risk

Value at Risk

Stress Test

Monday, October 29, 2012Market Risk 2


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Market Risk is defined as the possibility ofloss to a bank caused by changes in themarket variables.

BIS defines market risk as the risk thatthe value of on-or off-balance-sheet

positions will be adversely affected bymovements in equity and interest ratemarkets, currency exchange rates andcommodity prices



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RBI provided guidance note on

1.Liqudity Risk Management

2.Market Risk Management

i)Interest Rate Risk

ii) Foreign exchange risk

iii)Commodity price risk

iv)Equity price risk



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The Board of Directors -

The Risk ManagementCommittee

The Asset-Liability ManagementCommittee (ALCO)

Market Risk Group



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The responsibilities of Risk Managementcommittee Setting policies and guidelines for Market risk

measurement, Management and reporting

Reviewing and approving market risk limits,including triggers or stop losses.

Appointment of qualified and competent staffto calculate market risk.

Appointment of independent market riskmanager



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The responsibilities of Market RiskManager Ensuring that traders and Operations are

properly applying all policies and procedurew.r.t market risk

Immediately advising to line management; if

procedure or policy curtaining business.

Ensuring the usage of risk limits accuratelyreflects current and expected market condition



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Risk Identification All Risk Taking Units must operate within an

approved, current Market Risk Product program;this should define procedures, limits and controlsfor all aspects of the product.

The final product transaction program shouldinclude market risk measurement at anindividual product and aggregate portfoliolevel.



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Limits and Triggers Risk Taking Units must have procedures that monitor

activity to ensure that they remain within approvedlimits at all times.

Mandatory market risk limits are required for FactorSensitivities and Value at Risk for mark to markettrading and appropriate limits.

Approved Management Action Triggers or Stop-loss

are required for all mark to market risk takingactivities.

Risk Taking Units are expected to apply additional,appropriate market risk limit, including limits for basisrisk, to the products involved.



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Risk Monitoring A rate reasonability process is required to ensure

that all transactions are executed and revaluedat prevailing market rates.

Financial Models used for revaluations forincome recognition purposes or to measure ormonitor Price Risk must be independently tested

and certified.

Stress tests must be performed at least quarterlyfor both trading and accrual portfolios.



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Risk Reporting

Senior management reports should

be timely

be reasonably accurate

highlight portfolio risk concentrations

include written commentary

be concise



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The Risk that bank may suffer a lossesas a result of adverse exchange ratemovement during a period in which ithas an open position in an individualforeign currency.



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Three Important issues that need to beaddressed

Nature and Magnitude of exchange risk The strategy to be adopted for hedging or

managing exchange risk.

The tools of Managing exchange risk.



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The tools of Managing exchange risk.

Foreign exchange Forward contracts

Currency option Future and forward



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Bank needs to Lay out clear and unambiguous performance

measurement criteria

Accountability norms and financial limits

Management must specify in operational termsthe goals of exchange risk management.



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Interest rate risk is the risk where changesin market interest rates might adverselyaffect a bank s financial condition.

Immediate impact -Net Interest Income (NII)

Long term impact - the Bank s net worth(Economic Value Perspective) .Present value offuture cash flows (and in some cases, the cashflows themselves) change when interest rateschange.



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In a well functioning risk managementsystem, banks broadly position their

balance sheet into

Trading Books

Banking Books



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Trading Book Held primarily for generating profit on short-term

differences in prices/yields

Price risk is the prime concern of banks in tradingbook

Should ideally be marked to market on a dailybasis

Estimation through internally developed Value atRisk (VaR) models.



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Banking Book Main Focus on economic value changes

Held to Maturity Variety of techniques that incorporate assumptions

on behavioral pattern of assets, liabilities & caneasily capture the full range of exposures againstbasis risk, embedded option risk, yield curve risk,etc.



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Sources of Interest Rate Risk Repricing risk - Arises from timing differences in the

maturity (for fixed rate) and repricing (for floatingrate) of bank assets, liabilities

Yield curve risk - Repricing mismatches can alsoexpose a bank to changes in the slope and shapeof the yield curve.



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VaR is defined as an estimate ofpotential loss in a position or asset/liability

or portfolio of assets/liabilities over agiven holding period at a given level ofcertainty.

VaR is an estimate of the loss likely to

suffer, not the actual loss at certain levelof confidence



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Generic term describing varioustechniques used by banks to gauge their

potential vulnerability to exceptional, butplausible, events.

Stress testing addresses the large movesin key market variables of that kind thatlie beyond day to day risk monitoring butthat could potentially occur.



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Process

Identifying the potential movements

Identifying market variables to stress

Deciding how much to stress them

Deciding Time frame for stress analysis



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RBI - Guidance Note on Market RiskManagement

RBI - Risk Management Systems in Banks



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Thank You

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Documents

Market Risk Final