Future of Risk Management in Indian Banking Industry
| June 10,2010 03:55 pm IST
The Indian Economy is booming on the back of strong economic policies and a healthy regulatory regime. The effects of this are far-reaching and have the potential to ultimately achieve the high growth rates that the country is yearning for.
The banking system lies at the nucleus of a country's development robust reforms are needed in India's case to fulfill that. The BASEL II accord from the Bank of International Settlements attempts to put in place sound frameworks of measuring and quantifying the risks associated with banking operations. The paper seeks to showcase the changes that will emerge as a result of banks adopting the international norms.
The structure of the paper is three-fold, where we begin by projecting the risk management scenario and its effects on internal operations of a bank, followed by the changes brought about in the banking sector of India and finally the macro effects on the economy. This enables one to discern the complete scenario that will emerge in the years ahead.
The Risk Management scenario will strengthen owing to the liberalization, regulation and integration with global markets. Management of risks will be carried out proactively and quality of credit will improve, leading to a stronger financial sector.
The calculation of risk will be done by credit scoring models such as Altman's Z Score Model & Merton Model but in a more sophisticated and developed manner. The management information systems (MIS) will be put in place and the level of efficiencies will increase more than proportionately. Risk based pricing will be used for all credit facilities extended by banks. The treasury departments of banks are poised to benefit from the BASEL II accord as would be showcased in the paper.
The future will see a structural change in the banking sector marked by consolidation and a shake-out within the sector. The smaller banks would not have sufficient resources to withstand the intense competition of the sector. Banks would evolve to be a complete and pure financial services provider, catering to all the financial needs of the economy. Flow of capital will increase and setting up of bases in foreign countries will become commonplace.
Finally, the economy will stand to benefit as the banking sector develops. Savings will be mobilized in the right direction and the required funds needed for the country's development will be made available.
The Indian Financial System is tasting success of a decade of financial sector reforms. The economy is surging and has gathered the critical mass to convert it into a force to reckon with. The regulatory framework in India has sparked growth and key structural reforms have improved the asset quality and profitability of banks.
Growing integration of economies and the markets around the world is making global banking a reality.
Widespread use of internet banking has widened frontiers of global banking, and it is now possible to market financial products and services on a global basis. In the coming years globalization would spread further on account of the likely opening up of financial services under WTO. India is one of the 104 signatories of Financial Services Agreement (FSA) of 1997. Thereby giving India's financial sector including banks an opportunity to expand their business on a quid pro quo basis.
As in different sectors, competition is driving growth in the banking sector also. The RBI requires all banks to comply with the standardized approach of the BASEL II accord by 31st March, 2007. The quantification and accounting of various risks would result in a more robust risk management system in the industry.
This paper attempts to project the implications of this transition and its effects on the internal operations of a bank followed by its effects on the banking industry and the economy.
2.0 RISK Management Scenario in the Future
Risk management activities will be more pronounced in future banking because of liberalization, deregulation and global integration of financial markets. This would be adding depth and dimension to the banking risks. As the risks are correlated, exposure to one risk may lead to another risk, therefore management of risks in a proactive, efficient & integrated manner will be the strength of the successful banks. The standardized approach would be implemented by 31st March 2007, and the forward-looking banks would be in the process of placing their MIS for the collection of data required for the calculation of Probability of Default (PD), Exposure at Default (EAD) and Loss Given Default (LGD). The banks are expected to have at a minimum PD data for five years and LGD and EAD data for seven years.
Presently most Indian banks do not possess the data required for the calculation of their LGDs. Also the personnel skills, the IT infrastructure and MIS at the banks need to be upgraded substantially if the banks want to migrate to the IRB Approach.