Risk Management Framework for Indian Banks
Steps to achieve stated objective
1. Corporate governance
Establishment of dedicated risk management department * with the articulation of roles and responsibilities pertaining to identifying, measuring, controlling, monitoring and managing bank-wide risks and a comprehensive articulation of risk management framework comprising the following: -
ultimate accountability of the board of directors to the shareholders for management of all risks;
- risk committee comprising of CEO, one or two non executive board member, and senior management from business units; and
- delegation of responsibility to risk committee.
The key responsibilities of the Board of Directors should be: -
- assess risks and maintain a sound system of internal control and risk management by adopting a suitable framework;
- setting the risk management policies in place; and
- establishment of comprehensive system of control to ensure that the bank’s risk are mitigated and objective of shareholders and stake holders are attained.
The key responsibility of the Risk Committee should be: -
- oversee the risk management function, review and recommendation of policies of the bank;
- approving limits and evaluating the overall effectiveness of bank’s control and risk management infrastructure;
- assess risk-reward profile with respect to risk appetite and recommendation of strategies; and
- evaluation of risk profile for any new product, service, project, strategic investments and bank’s plan of mergers and acquisitions.
(* Schematic diagram of ideal Risk Management Framework for Indian Banks.)
2. Qualitative measures and risk reporting
Qualitative measures ensure that all risk types are properly identified and may not take account of risk quantification. The bank should place a formalized risk-reporting framework and should have appropriate escalation procedures between risk takers to risk managers. Qualitative measures cover the issues relevant to identifying quality of customer, compliance risks, operational risks, money laundering, control and assurance profiles.
The consolidated risk reporting are classified as follows: -
- Reporting by Head of Risk Management Department * to CEO and Risk Committee.
- Reporting by risk managers to Head of Risk Management Department.
- Reporting by business units and support function to Risk Management Department.
3. Quantitative measures
Bank should design performance measures that align the objectives of business unit managers and executives with respect to mission and vision of Bank and the shareholders are central to the value creation process. In order to ensure that value creation remains the ultimate objective of a business unit, target performance measures (Risk adjusted performance management or RAROC ** approach) should be set. Quantification of bank’s risks includes the maximum acceptable loss in terms of credit, market risk and operational risk.
(* Chief Risk Officer.
** RAROC = (revenues - expenses-expected loss)/(economic capital).)
Quantification consists of applying value-at-risk (VaR *) and earning-at-risk (EaR) approach for measuring and controlling quantifiable bank-wide risks (across risk types and business units). However, quantification does not specifically address the following: -
inadequate corporate governance processes;
- reputational risk;
- regulatory risk and
- long-term strategic risk.
Bottllenecks to establish efficient bank-wide risk management framework
a. Data Adequacy
There are several significant VaR models and techniques available for the banks. However, all these models require lot of qualitative and quantitative historical data inputs/information related to credit and facility scoring, probability of customer’s defaults (PD **), articulate information of different collaterals to evaluate recovery rates (RR ***).
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