25-08-2017, 09:32 PM
Risk Management Systems in Banks
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Introduction
Banks in the process of financial intermediation are confronted with various kinds of financial
and non-financial risks viz., credit, interest rate, foreign exchange rate, liquidity, equity price,
commodity price, legal, regulatory, reputational, operational, etc. These risks are highly
interdependent and events that affect one area of risk can have ramifications for a range of other
risk categories. Thus, top management of banks should attach considerable importance to
improve the ability to identify, measure, monitor and control the overall level of risks
undertaken.
Risk Management Structure
A major issue in establishing an appropriate risk management organisation structure is
choosing between a centralised and decentralised structure. The global trend is towards
centralising risk management with integrated treasury management function to benefit from
information on aggregate exposure, natural netting of exposures, economies of scale and easier
reporting to top management. The primary responsibility of understanding the risks run by the
bank and ensuring that the risks are appropriately managed should clearly be vested with the
Board of Directors. The Board should set risk limits by assessing the bank’s risk and risk-
bearing capacity. At organisational level, overall risk management should be assigned to an
independent Risk Management Committee or Executive Committee of the top Executives that
reports directly to the Board of Directors. The purpose of this top level committee is to empower
one group with full responsibility of evaluating overall risks faced by the bank and determining
the level of risks which will be in the best interest of the bank. At the same time, the Committee
should hold the line management more accountable for the risks under their control, and the
performance of the bank in that area. The functions of Risk Management Committee should
essentially be to identify, monitor and measure the risk profile of the bank. The Committee
should also develop policies and procedures, verify the models that are used for pricing complex
products, review the risk models as development takes place in the markets and also identify new
risks. The risk policies should clearly spell out the quantitative prudential limits on various
segments of banks’ operations.
Credit Approving Authority
Each bank should have a carefully formulated scheme of delegation of powers. The banks
should also evolve multi-tier credit approving system where the loan proposals are approved by
an ‘Approval Grid’ or a ‘Committee’. The credit facilities above a specified limit may be
approved by the ‘Grid’ or ‘Committee’, comprising at least 3 or 4 officers and invariably one
officer should represent the CRMD, who has no volume and profit targets. Banks can also
consider credit approving committees at various operating levels i.e. large branches (where
considered necessary), Regional Offices, Zonal Offices, Head Offices, etc. Banks could consider
delegating powers for sanction of higher limits to the ‘Approval Grid’ or the ‘Committee’ for
better rated / quality customers. The spirit of the credit approving system may be that no credit
proposals should be approved or recommended to higher authorities, if majority members of the
‘Approval Grid’ or ‘Committee’ do not agree on the creditworthiness of the borrower. In case of
disagreement, the specific views of the dissenting member/s should be recorded.
Risk Rating
Banks should have a comprehensive risk scoring / rating system that serves as a single point
indicator of diverse risk factors of a counterparty and for taking credit decisions in a consistent
manner. To facilitate this, a substantial degree of standardisation is required in ratings across
borrowers. The risk rating system should be designed to reveal the overall risk of lending,
critical input for setting pricing and non-price terms of loans as also present meaningful
information for review and management of loan portfolio. The risk rating, in short, should
reflect the underlying credit risk of the loan book. The rating exercise should also facilitate the
credit granting authorities some comfort in its knowledge of loan quality at any moment of time.
Loan Review Mechanism (LRM)
LRM is an effective tool for constantly evaluating the quality of loan book and to bring about
qualitative improvements in credit administration. Banks should, therefore, put in place proper
Loan Review Mechanism for large value accounts with responsibilities assigned in various areas
such as, evaluating the effectiveness of loan administration, maintaining the integrity of credit
grading process, assessing the loan loss provision, portfolio quality, etc. The complexity and
scope of LRM normally vary based on banks’ size, type of operations and management practices.
It may be independent of the CRMD or even separate Department in large banks.