Risk Mitigation AND Capital Optimisation

Effective Risk Management

A tool of Capital Conservation

Banking sector has witnessed  sea changes during last few years especially after the year 1991 when our government adopted the policy of reformation on International pattern which encompasses liberalization, globalization and privatization.

Banks got greater freedom to decide their own interest rate structure both for deposits and advances. New generation private banks came into picture to compete with public sector banks. RBI issued prudential norms for classification of assets and recognition of income in uniformity with Basel norms.  

Market expanded and new technology came into operation posing new types of risk and challenges. Banks which were focused on priority sector lending were given the burden of lending to large industries, to power sector, to infrastructure sector and so on. Banks are required not only to take care of social welfare scheme thrust upon it by the government but also made responsible for earning profit at par with private players in banking industry.

Obviously as nature and volume of business increases in any industry , it become necessary for prudent promoters to take all preventive measures to mitigate all types of probable risk in time.

It became necessary for each bank to understand nature of various risks in doing business in changed circumstances and under free market economy.

Risk arises when we do not achieve what we expect to achieve by certain act of us. Risk arises when realized return is less than anticipated and expected return on any investment made by us or any lending done by us.

Risk management is effective when we are able to identify it, assess it and are able to take proper steps to mitigate it. Risk assessment is done as per RBI guidelines.

All assets are risk weighted and then as per Basel norms, each bank has to provide capital as per norms set by RBI. If assets are high risk weighted, the bank has to have high capital to comply Basel Norms.

On the contrary if we follow proper systems and procedures, we may ensure optimum use of scarce capital we have. We cannot avoid taking  risk but we may mitigate it by keeping us alert and conscious all the time. We may mitigate risk only when we have proper understanding of risk, how it arises, how it increases and how can it be reduced.

Cause of risk may be

     -Impact of past

    -  Instability of present

    -  Uncertainty of future

In banking, risk is inherent and unavoidable. Our success depends not on avoiding risk but on our ability to mitigate it to the best possible extent.

Banks have to undertake many functions and each of them have some risk factor involved.

Functions may be

• Acceptance of deposits from public.
• Lending funds to public/corporates
• Investing funds in various opportunities
• Collecting cheques/drafts and other Negotiable Instruments
• Remitting funds
• Providing safe deposit lockers
• Acceptance of safe custody items
• Acceptance of standing instructions
• Offering internet banking facilities
• Issuance of credit and other cards including ATM cards
• Offering various products like Mutual funds, insurance products, merchant banking services

Banks deal with public money and it is their duty to conduct safe, secure and quality business. . It is the duty of bank to protect public money and extend hassle free service to its customers.

Broadly speaking risks are of three nature

• Credit Risk, Market Risk and Operational Risk.
• Besides there are other risks such technology risk, reputational risk, legal risk, interest risk, liquidity risk, currency risk, equity risk etc.
• Credit Risk may arise due to non -repayment of loan and due to erosion in value of assets against which loan was allowed. Credit risk arises also due to over exposure to single borrower or over financing in a sector or in an area.
• Operational risk may arise due to failure of system and procedures, failure of people and policies and due to bad governance. It also occurs due to external factors. Operation risk causes loss by way of fraud, faulty transactions, fake transactions etc.

 -      Market Risk is the risk of losses in off and on balance sheet positions arising from movements in market prices.

• Risk management is a process where we identify and assess risk; we measure risk and then decide whether to take risk or not to take it, and how to mitigate it when we take the risk of lending to someone or investing in a fund.
• We take various steps to monitor and control risk and try to mitigate it. For this purpose we try to modify and improve various systems and procedures on continuous basis.

We may mitigate credit risk by improving credit quality. For this purpose we may impart proper training to bank staff to enable him or her to understand various parameters related to credit delivery from pre-sanction level to final disbursement of credit and then monitoring at continuous basis after disbursement of credit. Bank staffs are given exposure in various departments to gain experience on each matter related with credit.

It is more important to understand the character and capacity of credit seeker than to assess various ratios related to financial papers and past performance of the loan seeker.

Bank staffs are made aware about various rules and regulations pertaining to credit and other operational work. Then administrative offices are told to monitor compliance of rules and guidelines in true spirit.  

Adherence of rules and laid down policy for each credit is prime requirement to mitigate avoidable risk. Bank has to carry out Proper pre-sanction inspection of proposed finance, due diligence of customer, due diligence of property offered as security, due diligence on Chartered Accountant who prepare and certify financial statement of the loan seeking party, clearance of various statutory requirement, prospect of sector in which we are going to lend money, generation of Cibil reports, verification of reports on ROC site etc which help bank staff to know about character, capacity and past credit report of the party.

Proper audit and inspection processes are put in place so that they may effectively detect non-compliance at any stage and help in taking required step much before it causes loss to the bank.

It is checked from time to time that a credit officer works within his delegated power and decisions on credit are taken in transparent manner and record of every decision is kept along with all supporting papers to justify the decision. It is ensured that proper documentation is done for each credit and vetting of documentation is done in case of high value advances by panel advocate to ensure enforceability of the documents.  

Similarly, bank has to frame proper system and processes for accepting of deposits, remittances of fund from one place to other, allotment of safe deposit lockers, collection of cheques, issuance of ATM and credit cards, dealing in foreign exchange etc and have to ensure that all such processes are followed rightly, correctly and sincerely by each staff.

To mitigate risk, it is ensured that KYC compliance is done while opening account of a customer. High value transactions are verified, PAN details are fed in Finacle wherever required, RBI guidelines are followed in cash transaction, and principles of anti-money laundering act are strictly followed.

It is necessary to save banks from losses arising out of fraud committed by bank staff. For this purpose there should be a system of cross checking of transactions by various higher officials depending on the value of transaction. Bank staff of doubtful integrity and bad character should not be given sensitive assignment. Honesty and integrity of staff is more important than his knowledge and skill to perform.

As such, it has to be always kept in mind that staff of absolute and doubtless integrity are only posted as Branch head or posted in vulnerable areas where work is more risk prone and where possibility of loss due to fraudulent intention may be damaging. It has to be seen that the person posted as branch head has the in-built capacity to read and assess the capacity, character and caliber of the person approach for doing business with the bank.

Banks has to issue ATM and credit card to cater to market demand. But bank officials have to assess the paying capacity of a customer, intention of the customer and average annual income before issuing a credit card of certain value in tune with annual income. Similarly before issuance of ATM cards to the customer, it is duty of bank staff to make customer aware of how to use ATM card, how to keep it safely to avoid inherent risk in ATM.

Bank has to have proper customer care mechanism and public grievance redressal system in force. Bank staff has to attend to each complaint received from customer promptly. Redressal of public grievances not only enhances image of the bank and save it from reputation risk, it also gives many important inputs about functioning of a branch and nature and character of staff working in a branch. It enables banks to protect it from probable threat and risk arising out of acts of some of evil nature and ill-motivated staff and ill-motivated borrowers. Only by sincerely reading complain of each complainant customer, bank can save it from losses arising out of fraud, ill-motivated lending, bribe led lending , removal of assets by borrower, erosion in asset quality,  leakage of income arising due to staff working in nexus with unscrupulous customers etc.

Risk also arises due to factors which are not in control of bank, such interest rate risk and foreign exchange risk. Due to change in repo rate, Cash reserve Ratio, SLR; bank rate announced by RBI from time to time, bank has to suffer loss.

To mitigate it, bank has to keep adequate cushion while setting interest rate chargeable on credit. Bank has to have dynamic cash management system. Similarly bank to hedge risk arising out due to frequent and sharp fluctuation in rates of foreign exchange for various currencies in international market.

Risk arises also due to mismatch between maturities pattern of various types of assets and liabilities.

For this purpose bank has to have dynamic process of planning and balancing of assets and liabilities of various maturities. In case of inadequate planning and reassessment of assets and liabilities, bank may face liquidity problem which may ultimately result is payment of penal interest or incur loss and even face reputation risk caused by its inability to meet demand in the market.

It is therefore essential to periodically manage volume, mix, maturities, yields and cost of assets and liabilities in order to maintain liquidity as also to earn adequate Net Interest Income.

• Operational risk is the risk of loss resulting from inadequate or failed internal processes, people and systems or from external events. If we manage people and follow laid down policies, change the system as per need from time to time and ensure compliance in toto, we may mitigate operational risk including legal risk to a great extent.  
• Bank can lessen losses by internal and external fraud by raising skill of manpower, by proper deployment of manpower and by periodical inspections and preventive vigilance audit of selected branches.
• At the same time we may protect bank from damages of physical assets by keeping active and adequate number of fire extinguishers, CCTV, Fire alarm system, smoke detectors, burglar alarm etc.
• We should ensure that proper training is imparted to bank staff and make them aware on how to operate these risk-mitigating instruments.  At the same time, these instruments should be checked periodically to ensure that they are functional in active and efficient way.
• Similarly to mitigate losses arising due to sudden disruption in business , we have to have Business continuity plan in place and have periodical meeting on various issues related to disruption in technology, power, UPS, stand by Finacle server,  adequate record keeping etc.

Many risks arise to bank due to inadequate or wrong information fed in the Finacle and in other processes. And for every risk measured by bank as per RBI guidelines, banks have to provide capital in uniformity with RBI Guidelines.

In order to conserve capital which is very scarce, it is necessary to understand the measures to be taken in this regard. Following are some suggested ways which may help bank in optimum utilization of scarce capital.

• For doing optimum business with a given amount of capital fund, we must ensure that the assets are appropriately risk weighted.
• We should ensure that branches enter the collaterals in Finacle and link them to the customer loan account without fail. Value of land, plant and machinery obtained as collateral security should be properly entered in the system.
• In case the loan account is transferred to another branch, branch should transfer the collaterals also to transferee branch.
• We should update external credit rating of the customers in Finacle
• We should ensure that a performance guarantee is not classified as a financial guarantee (and vice versa) in the system. Because risk weightage of performance guarantee is less than that of financial guarantee.
• Expired LC which has no bills are outstanding should be reversed.
• Similarly, expired Bank Guarantees BG should be reversed in 7 days after the date of expiry or expiry of the claim period whichever is in conformity with bank’s instructions.
• Guarantees like ECGC, CGTMSE, central government, state government etc obtained for credit risk mitigation should be recorded in the system.
• To revisit the un-availed portion of sanctioned limits and we should make necessary correction in Finacle, if required. This is because bank has to provide even on unavailed portion of sanctioned limit.
• We should ensure that proper and adequate securities are fed into the system in respect of all the credit facilities by all branches.
• Creation of limit nodes and linking the facility account with the same.
• In case of term loans, if the disbursement schedule stretches beyond one year, then year wise drawdown schedule which is duly certified by the borrower should be obtained. Disbursement schedule should be entered in Finacle in case of such term loans.
• To ensure good housekeeping by regular monitoring of inter-branch/ inter-bank and various impersonal accounts viz. suspense, sundry etc.

Various branches have different potential of business.
Some of branches are critical and naxal affected whereas some other branches are prone to political disturbances. Some of branches are situated in industrial areas and large scope of lending to increase industrial advances whereas some other branches have potential for retail lending. Some branches are situated in areas where potential to mobilize low interest deposits such as saving and current deposits whereas some branches have scope to mobilize long term deposits.  

In such position, it is desirable to segregate branches in different categories and as per their potential we should post manpower there who may be skilled enough to cope with the demand of the branch. Some branches are profit center where scope of lending is huge and that of deposit is less. Proper Human resource Management may help banks in generating higher profit with lesser number of manpower.

Similarly every customer is assessed by bank from cost and benefit point of view. We have Matched Fund Transfer Pricing (MFTP ) System which helps in making granular analysis of each customer to know whether doing business with the customer is profitable venture or not. This tool makes continuous analysis of cost of fund and yield on advances for each customer and for each branch which enable us to know whether a branch will earn profit or not in any quarter.

Audit and inspection department use to carry out audit of branches to assess, ascertain and judge working of a branch under various parameters. It helps in detecting fraud and credit risk in time. It helps to identify good performing staff and indicates probable risk due to inefficiency of bank staff. Auditors help in detecting leakage of income in various processes taking place in a branch. In addition to it, there is a system of annual revenue audit of big branches which also help in detecting leakage of income and making recovery of the same.

Auditors are to check that in all new sanctions, proper rate of interest is fed in Finacle. They have to verify that all eligible advances are rated annually and as per their risk rating, interest rate is finalized and fed in Finacle.

Here it is important to say that if a branch does not reduce rate of interest as per risk rating, there is a risk of customer leaving our bank and account being taken over by some other bank offering lower rate of interest. This causes loss of business and loss of profit and tarnishes image of the bank. Similarly if rate of interest is not increased as per fresh risk rating, chances of leakage of income arises. Both way bank is looser. As such it has to be ensured that all eligible credit facilities are rated every year as per audited financials of the company.

In an era of tough competition when each public or private offer competitive interest rates, we have to have inter action with all valued customers to understand their difficulties and to assess their loyalty to bank and future plan . In case we apprehend that customer is likely to shift to other bank in greed of getting lower interest rate on their credits , we may bargain with them ,persuade them and in case of need arrange for lowering of interest rate by giving concessions after taking due permission from competent authorities.

If we are alert and devoted to customers happiness all the day and all the time we may serve better to our customers, win their heart and loyalty and finally we may enhance our market share in the business.

12th  April 2016