Risk Management Framework for Indian Banks
| May 19,2010 12:24 pm IST
Risk management is relatively new and emerging practice as far as Indian banks are concerned and has been proved that it’s a mirror of efficient corporate governance of a financial institution. Globalisation and significant competition between foreign and domestic banks, survival and optimizing returns are very crucial for banks and financial institutions.
However, selecting the efficient customer and providing innovative and value added financial products and services are another paramount factors. In a volatile and dynamic market place for achieving sustainable business growth and shareholder’s value, it is essential to develop a link between risks and rewards of all products and services of the bank. Hence, the banks should have efficient risk management framework to mitigate all internal and external risks.
The objective of this article is to envisage ideal framework of bank-wide risk management for Indian Banks. The presence of accurate measures of bank-wide risk management practice increase shareholder’s returns and allows the risk-taking behavior of bank to be more closely aligned with strategic objectives. Bank-wide risk management practice should aim to enhance the drivers of shareholder’s value such as: -
- Risk adjusted performance measurement
- Consistency of earnings and
- Quality and transparency of management
The important steps of the efficient framework of banking concern should ensure all risks are identified, prioritized, quantified, controlled and managed in order to achieve an optimal risk-reward profile. This entails ideal and dedicated coordination of risk management across the bank’s various business units. However, the approach to monitoring and enforcing the adherence of business units within the bank may vary. The factors that influence this decision are: -
- The feasibility decisions of the business unit.
- The regulatory requirements in respect of the business unit.
- The cost of effective monitoring and controlling steps.
Benefits of Bank-wide risk management
Risk management is a line function that needs to be addressed by each individual cost center and business unit. However, a centralized bank-wide risk management framework has certain advantages for the Bank. The advantages are: -
- Improving capital efficiency by
- providing an objective basis for allocating resources
- reducing expenditures on immaterial risks and
- exploring natural hedges and portfolio effects
- Supporting informed decision making by
- uncovering areas of high potential adverse impact on drivers of share value, and
- identifying and exploiting areas of risk-based advantage context.
- Building investor confidence by
- establishing a process to stabilize results by protecting them from disturbances, and
- demonstrating proactive risk stewardship
- Define cost and profitability centers
- Profitability and cost allocation on customer, product, services and branch wide
Current state of Risk management practices in Indian banks
Most of the banks do not have dedicated risk management team, policy, procedures and framework in place. Those banks have risk management department, the risk manager’s role is restricted to prefact and postfact analysis of customer’s credit and there is no segregation of credit, market, operational and strategic risks. There are few banks have articulated framework and risk quantification. However, the outputs are far from the stressed or actual losses due to usage of un-compatible implications.
The traditional lending practices, assessment of credits, handling of market risks *, treasury functionality and culture of risk-rewards are hauls of public sector banks. Where as private sector banks and financial institutions are some-what better in this context.
(* Market risk includes all derivative products such as interest rate, foreign exchange, equity, liquidity and commodity risk.)
The sheer size and wide coverage of banks is a big hurdle to integrate and generate a cost effective real time operational data for mapping the risks. Most of the financial institutions processes are encircled to ‘functional silos’ follows bureaucratic structure and yet to come up with a transparent and appropriate corporate governance structure to achieve the stated strategic objectives.