PROJECT REPORT

On
Risk Management in Banking Sector
FOR
THE PARTIAL FULFILLMENT OF THE AWARD OF THE DEGREE OF
MASTER OF BUSINESS ADMINSTRATION
FROM GGS IP UNIVERSITY
DELHI
BATCH: 2013-15

SUBMITTED BY:

SUBMITTED TO:

Santu Sinha

Prof Shikha Bhardwaj

ARMY INSTITUTE OF MANAGEMENT & TECHNOLOGY,

GREATER NOIDA (UP) 201306

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Supervisor Certificate

This is to certify that Santu Sinha a student of Master of Business Administration, Batch MBA10, Army Institute Management & Technology, Greater Noida, has successfully completed his
project under my supervision.

During this period, he worked on the project titled Risk Management in Banking Sector in
partial fulfillment for the award of the degree of Master of Business Administration of GGSIP
University, Delhi.

To the best of my knowledge the project work done by the candidate has not been submitted to
any university for award of any degree. His performance and conduct has been good.

Prof Shikha Bhardwaj

Date:

AIMT-Gr. NOIDA

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Acknowledgement
I take this opportunity to show my sincere gratitude to all those who made this study possible.
First of all I am thankful to the helpful staff and the faculty of Army Institute of Management and
Technology. One of the most important tasks in every good study is its critical evaluation and
feedback which was performed by our supervisor Prof Shikha Bhardwaj. I am very thankful to
our supervisor for investing his precious time to discuss and criticize this study in depth, and
explained the meaning of different concepts and how to think when it comes to problem
discussions and theoretical discussions. My sincere thanks go to my family members, who
indirectly participated in this study by encouraging and supporting me.

Santu Sinha
MBA-10

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Table of contents

PAGE
S. No.

TOPIC

NO.

Background of the work

Introduction to the topic

2.1 About Risk Management

Objective to the study

Literature Review

29

Research methodology

37

Data Analysis

39

Findings & Conclusions

50

Bibliography

53

10

Appendices
10.1 Balance sheet

54

10.2 Profit & Loss Account

55

10.3 Cash flow Statement

57

10.4 Schedules to the Accounts

60

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S.N
O

TABLES/FIGUR
ES

NAME

PAGE
NO.

1.
1

Fig 1

Base II Capital Accord

38

2.
2

Fig 2

Capacity Adequacy Ratio

45

3.
3

Fig 3

Risk Weighted Assets

48

4.
4

Fig 4

Net NPAs

52

5.
5

Fig 5

Provision for NPAs

53

6.
6

Fig 6

Exposure to Sensitive Sectors

55

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BACKGROUND OF THE WORK

Risk Management is the application of proactive strategy to plan, lead, organize, and control the
wide variety of risks that are rushed into the fabric of an organizations daily and long-term functioning.
Like it or not, risk has a say in the achievement of our goals and in the overall success of an
organization. Present paper is to make an attempt to identify the risks faced by the banking industry and
the process of risk management. This paper also examined the different techniques adopted by banking
industry for risk management. To achieve the objectives of the study data has been collected from
secondary sources i.e., from Books, journals and online publications, identified various risks faced by the
banks, developed the process of risk management and analyzed different risk management techniques.
Finally it can be concluded that the banks should take risk more consciously, anticipates adverse changes
and hedges accordingly, it becomes a source of competitive advantage, and efficient management of the
banking industry.
KEYWORDS: Risk Management, Banking Sector, Credit risk, Market risk, Operating Risk, Gab
Analysis, Value at Risk (VatR)

INTRODUCTION
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Risk is an inherent part of a Banks business, and effective Risk management is critical to achieving
financial soundness and profitability. It is identified as one of the core competencies for the next
millennium. The Risk management involves implementation of best practices so as to optimize capital
utilization and maximize shareholder value. With well defined policies and procedures in place, Bank
identifies, assesses, monitors and manages the principal risks
Risk is defined as anything that can create hindrances in the way of achievement of certain objectives. It
can be because of either internal factors or external factors, depending upon the type of risk that exists
within a particular situation. Exposure to that risk can make a situation more critical. A better way to deal
with such a situation; is to take certain proactive measures to identify any kind of risk that can result in
undesirable outcomes. In simple terms, it can be said that managing a risk in advance is far better than
waiting for its occurrence. Risk Management is a measure that is used for identifying, analyzing and then
responding to a particular risk. It is a process that is continuous in nature and a helpful tool in decision
making process. According to the Higher Education Funding Council for England (HEFCE), Risk
Management is not just used for ensuring the reduction of the probability of bad happenings but it also
covers the increase in likeliness of occurring good things. A model called Prospect Theory states that a
person is more likely to take on the risk than to suffer a sure loss.
As a financial intermediary, a Bank is exposed to risks that are particular to its lending and trading
businesses and the environment within which it operates. A Banks goal in risk management is to ensure
that it understands, measures and monitors the various risks that arise and that the organization adheres
strictly to the policies and procedures which are established to address these risks.

A Bank is primarily exposed to credit risk, market risk, and operational risk . A Risk management system
identifies, assesses, monitors and manages the risks in accordance with well-defined policies and
procedures.

OBJECTIVES AND SCOPE OF THE STUDY

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Objectives:

To understand the major risks faced by a bank and know the various risk management tools
adopted by it.

To understand the position of risk exposure and the strategies used by a bank from its financial
accounts.

Scope of the study:

Importance of risk management

With special reference to HDFC Bank.

Importance and application of Basel II norms as an important tool for banks

Defining Risk:
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Financial risk in a banking organization is possibility that the outcome of an action or event could bring
up adverse impacts. Such outcomes could either result in a direct loss of earnings / capital or may result in
imposition of constraints on banks ability to meet its business objectives.

Regardless of the sophistication of the measures, banks often distinguishbetween expected and unexpected
losses. Expected losses are those that the bank knows with reasonable certainty will occur (e.g., the
expected default rate of corporate loan portfolio or credit card portfolio) and are typically reserved for in
some manner. Unexpected losses are those associated with unforeseen events (e.g. losses experienced by
banks in the aftermath of nuclear tests, Losses due to a sudden down turn in economy or falling interest
rates). Banks rely on their capital as a buffer to absorb such losses.

Risks are usually defined by the adverse impact on profitability of several distinct sources of uncertainty.
While the types and degree of risks an organization may be exposed to depend upon a number of factors
such as its size, complexity business activities, volume etc, it is believed that generally the banks face
Credit, Market, Liquidity, Operational, Compliance / legal / regulatory and reputation risks

Risk Management
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Risk Management is a discipline at the core of every financial institution and encompasses all the
activities that affect its risk profile. It involves identification, measurement, monitoring and controlling
risks to ensure that
a) The individuals who take or manage risks clearly understand it.
b) The organizations Risk exposure is within the limits established by Board of Directors.
c) Risk taking Decisions are in line with the business strategy and objectives set by BOD.
d) The expected payoffs compensate for the risks taken
e) Risk taking decisions are explicit and clear.
f) Sufficient capital as a buffer is available to take risk
The acceptance and management of financial risk is inherent to the business of banking and banks roles
as financial intermediaries. Risk management as commonly perceived does not mean minimizing risk;
rather the goal of risk management is to optimize risk-reward trade -off. Notwithstanding the fact that
banks are in the business of taking risk, it should be recognized that an institution need not engage in
business in a manner that unnecessarily imposes risk upon it: nor it should absorb risk that can be
transferred to other participants. Rather it should accept those risks that are uniquely part of the array of
banks services.
In every financial institution, risk management activities broadly take place simultaneously at following
different hierarchy levels.
a)Strategic level: It encompasses risk management functions performed by senior management and BOD.
For instance definition of risks, ascertaining institutions risk appetite, formulating strategy and policies for
managing risks and establish adequate systems and controls to ensure that overall risk remain within
acceptable level and the reward compensate for the risk taken.
b)Macro Level: It encompasses risk management within a business area or across business lines.
Generally the risk management activities performed by middle management or units devoted to risk
reviews fall into this category.
c)Micro Level: It involves On-the-line risk management where risks are
actually created. This is the risk management activities performed by
individuals who take risk on organizations behalf such as front office and loan origination functions. The
risk management in those areas is confined to operational procedures and guidelines set by management.

Risk Management framework

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A risk management framework encompasses the scope of risks to be managed, the process/systems and
procedures to manage risk and the roles and responsibilities of individuals involved in risk management.
The framework should be comprehensive enough to capture all risks a bank is exposed to and have
flexibility to accommodate any change in business activities. An effective risk management framework
includes
a) Clearly defined risk management policies and procedures covering risk
identification, acceptance, measurement, monitoring, reporting and control.
b) A well constituted organizational structure defining clearly roles and
responsibilities of individuals involved in risk taking as well as managing it.
Banks, in addition to risk management functions for various risk categories may institute a setup that
supervises overall risk management at the bank.
Such a setup could be in the form of a separate department or banks Risk
Management Committee (RMC) could perform such function*. The structure
should be such that ensures effective monitoring and control over risks
being taken. The individuals responsible for review function (Risk review,
internal audit, compliance etc) should be independent from risk taking units
and report directly to board or senior management who are also not involved
in risk taking.
c) There should be an effective management information system that ensures flow of information from
operational level to top management and a system to address any exceptions observed. There should be an
explicit procedure regarding measures to be taken to address such deviations.
d)The framework should have a mechanism to ensure an ongoing review of systems, policies and
procedures for risk management and procedure to adopt changes.

Integration of Risk Management

Risks must not be viewed and assessed in isolation, not only because a single transaction might have a
number of risks but also one type of risk can trigger other risks. Since interaction of various risks could
result in diminution or increase in risk, the risk management process should recognize and reflect risk
interactions in all business activities as appropriate. While assessing and managing risk the management
should have an overall view of risks the institution is exposed to. This requires having a structure in place
to look at risk interrelationships across the organization.

Risk Evaluation/Measurement.
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Until and unless risks are not assessed and measured it will not be possible to control risks. Further a true
assessment of risk gives management a clear view of institutions standing and helps in deciding future
action plan. To adequately capture institutions risk exposure, risk measurement should represent aggregate
exposure of institution both risk type and business line and encompass short run as well as long run
impact on institution. To the maximum possible extent institutions should establish systems / models that
quantify their risk profile, however, in some risk categories such as operational risk, quantification is quite
difficult and complex. Wherever it is not possible to quantify risks, qualitative measures should be
adopted to capture those risks.
Whilst quantitative measurement systems support effective decision-making, better measurement does not
obviate the need for well-informed, qualitative judgment. Consequently the importance of staff having
relevant knowledge and expertise cannot be undermined. Finally any risk measurement framework,
especially those which employ quantitative techniques/model, is only as good as its underlying
assumptions, the rigor and robustness of its analytical methodologies, the controls surrounding data inputs
and its appropriate application
Contingency planning
Institutions should have a mechanism to identify stress situations ahead of time and plans to deal with
such unusual situations in a timely and effective manner.
Stress situations to which this principle applies include all risks of all types. For instance contingency
planning activities include disaster recovery planning, public relations damage control, litigation strategy,
responding to regulatory criticism etc. Contingency plans should be reviewed regularly to ensure they
encompass reasonably probable events that could impact the organization.
Plans should be tested as to the appropriateness of responses, escalation and communication channels and
the impact on other parts of the institution.
Thus, Risk management is the sum of all proactive management-directed activities within a program that
are intended to acceptably accommodate the possibility of failures in elements of the program.
"Acceptably" is as judged by the customer in the final analysis, but from an organization's perspective a
failure is anything accomplished in less than a professional manner and/or with a less-than-adequate
result.
Risk management as a shared or centralized activity must accomplish the following tasks:

Identity concerns

Identify risks & risk owners

Evaluate the risks as to likelihood and consequences

Assess the options for accommodating the risks

Prioritize the risk management efforts

Develop risk management plans

Authorize the implementation of the risk management plans

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Track the risk management efforts and manage accordingly.

MANAGING CREDIT RISK

Credit risk arises from the potential that an obligor is either unwilling to perform on an obligation or its
ability to perform such obligation is impaired resulting in economic loss to the bank.

In a banks portfolio, losses stem from outright default due to inability or unwillingness of a
customer or counter party to meet commitments in relation to lending, trading, settlement and
other financial transactions. Alternatively losses may result from reduction in portfolio value due
to actual or perceived deterioration in credit quality. Credit risk emanates from a banks dealing
with individuals, corporate, financial institutions or a sovereign. For most banks, loans are the
largest and most obvious source of credit risk; however, credit risk could stem from activities both
on and off balance sheet.
In addition to direct accounting loss, credit risk should be viewed in the context of economic
exposures. This encompasses opportunity costs, transaction costs and expenses associated with a
non-performing asset over and above the accounting loss.
Credit risk can be further sub-categorized on the basis of reasons of default. For instance the
default could be due to country in which there is exposure or problems in settlement of a
transaction.
Credit risk not necessarily occurs in isolation. The same source that endangers credit risk for the
institution may also expose it to other risk. For instance a bad portfolio may attract liquidity
problem.

Limit setting
An important element of credit risk management is to establish exposure limits for single obligors and
group of connected obligors. The size of the limits should be based on the credit strength of the obligor,
genuine requirement of credit, economic conditions and
the institutions risk tolerance.
Credit limits should be reviewed regularly at least annually or more frequently if obligors credit quality
deteriorates.
Credit Administration.
Ongoing administration of the credit portfolio is an essential part of the credit process. Credit
administration function is basically a back office activity that support and control extension and
maintenance of credit. A typical credit administration unit performs following functions:
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Documentation.It is the responsibility of credit administration to ensure completeness of

documentation (loan agreements, guarantees, transfer of title of collaterals etc) in accordance with
approved terms and conditions.
Credit Disbursement. The credit administration function should ensure that the loan application
has proper approval before entering facility limits into computer systems. Disbursement should be
effected only after completion of covenants, and receipt of collateral holdings. In case of
exceptions necessary approval should be obtained from competent authorities.
Credit monitoring. After the loan is approved and draw down allowed, the loan should be
continuously watched over. These include keeping track of borrowers compliance with credit
terms, identifying early signs of irregularity, conducting periodic valuation of collateral and
monitoring timely repayments.
Loan Repayment.The obligors should be communicated ahead of time as and when the
principal/markup installment becomes due. Any exceptions such as non-payment or late payment
should be tagged and communicated to the management. Proper records and updates should also
be made after receipt.
Maintenance of Credit Files. Institutions should devise procedural guidelines and standards for
maintenance of credit files. The credit files not only include all correspondence with the borrower
but should also contain sufficient information necessary to assess financial health of the borrower
and its repayment performance
Collateral and Security Documents. Institutions should ensure that all security documents are
kept in a fireproof safe under dual control. Registers for documents should be maintained to keep
track of their movement.

Procedures should also be established to track and review relevant

insurance coverage for certain facilities/collateral. Physical checks on
security documents should be conducted on a regular basis.
Measuring credit risk.
The measurement of credit risk is of vital importance in credit risk management. A number of qualitative
and quantitative techniques to measure risk inherent in credit portfolio are evolving. To start with, banks
should establish a credit risk rating framework across all type of credit activities. Among other things, the
rating framework may, incorporate:

Business Risk

Industry Characteristics
Competitive Position (e.g. marketing/technological edge)
Management
Financial Risk
Financial condition
Profitability
Capital Structure
Present and future Cash flows
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Internal Risk Rating.

Credit risk rating is summary indicator of a banks individual credit exposure. An internal rating system
categorizes all credits into various classes on the basis of underlying credit quality. A well-structured
credit rating framework is an important tool for monitoring and controlling risk inherent in individual
credits as well as in credit portfolios of a bank or a business line. The importance of internal credit rating
framework becomes more eminent due to the fact that historically major losses to banks stemmed from
default in loan portfolios. An internal rating framework would facilitate banks in a number of ways such
as

Credit selection
Amount of exposure
Tenure and price of facility
Frequency or intensity of monitoring
Analysis of migration of deteriorating credits and more accurate
computation of future loan loss provision
Deciding the level of Approving authority of loan.

The credit risk exposure involves both the probability of Default (PD) and loss in the event of default or
loss given default (LGD).
The former is specific to borrower while the later corresponds to the facility. The product of PD and LGD
is the expected loss.
Ratings review
The risk review functions of the bank or business lines also conduct periodical review of ratings at the
time of risk review of credit portfolio. Risk ratings should be assigned at the inception of lending, and
updated at least annually.
Credit Risk Monitoring & Control
Credit risk monitoring refers to incessant monitoring of individual credits inclusive of Off-Balance sheet
exposures to obligors as well as overall credit portfolio of the bank. Banks need to enunciate a system that
enables them to monitor quality of the credit portfolio on day-to-day basis and take remedial measures as
and when any deterioration occurs. Such a system would enable a bank to ascertain whether loans are
being serviced as per facility terms, the adequacy of provisions, the overall risk profile is within limits
established by management and compliance of regulatory limits. Establishing an efficient and effective
credit monitoring system would help senior management to monitor the overall quality of the total credit
portfolio and its trends. Consequently the management could fine tune or reassess its credit strategy
/policy accordingly before encountering any major setback. The banks credit policy should explicitly
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provide procedural guideline relating to credit risk monitoring. At the minimum it should lay down
procedure relating to:

The roles and responsibilities of individuals responsible for credit risk

monitoring
The assessment procedures and analysis techniques (for individual
loans & overall portfolio)
The frequency of monitoring
The periodic examination of collaterals and loan covenants
The frequency of site visits
The identification of any deterioration in any loan

Credit risk is most simply defined as the potential that a bank borrower or counterpart will fail to meet its
obligations in accordance with agreed terms. The goal of credit risk management is to maximize a banks
risk-adjusted rate of return by maintaining credit risk exposure within acceptable parameters. Banks need
to manage the credit risk inherent in the entire portfolio as well as the risk in individual credits or
transactions. Banks should also consider the relationships between credit risk and other risks. The
effective management of credit risk is a critical component of a comprehensive approach to risk
management and essential to the long-term success of any banking organization.
This paper is being issued by the Basel Committee on Banking Supervision to address how common data
and processes related to loans may be used for assessing credit risk, accounting for loan impairment and
determining regulatory capital requirements. The guidance supersedes Sound practices for loan accounting
and disclosure, published by the Committee in July 1999, and is structured around ten principles that fall
within two broad categories:
Supervisory expectations concerning sound credit risk assessment and valuation for loans
1. The bank's board of directors and senior management are responsible for ensuring that the banks
have appropriate credit risk assessment processes and effective internal controls commensurate
with the size, nature and complexity of the bank's lending operations to consistently determine
provisions for loan losses in accordance with the bank's stated policies and procedures, the
applicable accounting framework and supervisory guidance.
2. Banks should have a system in place to reliably classify loans on the basis of credit risk.
3. A bank's policies should appropriately address validation of any internal credit risk assessment
models.
4. A bank should adopt and document a sound loan loss methodology, which addresses credit risk
assessment policies, procedures and controls for assessing credit risk, identifying problem loans
and determining loan loss provisions in a timely manner.
5. A bank's aggregate amount of individual and collectively assessed loan loss provisions should be
adequate to absorb estimated credit losses in the loan portfolio.
6. A bank's use of experienced credit judgment and reasonable estimates are an essential part of the
recognition and measurement of loan losses.
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7. A bank's credit risk assessment process for loans should provide the bank with the necessary tools,
procedures and observable data to use for assessing credit risk, accounting for impairment of loans
and for determining regulatory capital requirements.
Supervisory evaluation of credit risk assessment for loans, controls and capital adequacy
8. Banking supervisors should periodically evaluate the effectiveness of a bank's credit risk policies
and practices for assessing loan quality.
9. Banking supervisors should be satisfied that the methods employed by a bank to calculate loan loss
provisions produce a reasonable and prudent measurement of estimated credit losses in the loan
portfolio that are recognized in a timely manner.
Banking supervisors should consider credit risk assessment and valuation policies and practices when
assessing a bank's capital adequacy

MANAGING LIQUIDITY RISK:

Liquidity risk is the potential for loss to an institution arising from either its inability to meet its
obligations or to fund increases in assets as they fall due without incurring unacceptable cost or losses.
Liquidity risk is considered a major risk for banks. It arises when the cushion provided by the liquid
assets are not sufficient enough to meet its obligation. In such a situation banks often meet their liquidity
requirements from market.
However conditions of funding through market depend upon liquidity in the market and borrowing
institutions liquidity. Accordingly an institution short of liquidity may have to undertake transaction at
heavy cost resulting in a loss of earning or in worst case scenario the liquidity risk could result in
bankruptcy of the institution if it is unable to undertake transaction even at current market prices.
Banks with large off-balance sheet exposures or the banks, which rely heavily on large corporate deposit,
have relatively high level of liquidity risk. Further the banks experiencing a rapid growth in assets should
have major concern for liquidity.
Liquidity risk may not be seen in isolation, because financial risk are not
mutually exclusive and liquidity risk often triggered by consequence of these other financial risks such as
credit risk, market risk etc. For instance, a bank increasing its credit risk through asset concentration etc
may be increasing its liquidity risk as well. Similarly a large loan default or changes in interest rate can
adversely impact a banks liquidity position. Further if management misjudges the impact on liquidity of
entering into a new business or product line, the banks strategic risk would increase.
Liquidity Risk Strategy:
The liquidity risk strategy defined by board should enunciate specific policies on particular aspects of
liquidity risk management, such as:
a. Composition of Assets and Liabilities. The strategy should outline the mix of assets and liabilities to
maintain liquidity. Liquidity risk
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management and asset/liability management should be integrated to avoid steep costs associated with
having to rapidly reconfigure the asset liability profile from maximum profitability to increased liquidity.
b. Diversification and Stability of Liabilities. A funding concentration
exists when a single decision or a single factor has the potential to result in a significant and sudden
withdrawal of funds. Since such a situation could lead to an increased risk, the Board of Directors and
senior management should specify guidance relating to funding sources and ensure that the
bank have a diversified sources of funding day-to-day liquidity
requirements. An institution would be more resilient to tight market
liquidity conditions if its liabilities were derived from more stable sources.
To comprehensively analyze the stability of liabilities/funding sources the bank need to identify:

Liabilities that would stay with the institution under any

circumstances;
Liabilities that run-off gradually if problems arise; and
That run-off immediately at the first sign of problems.

c. Access to Inter-bank Market. The inter-bank market can be important source of liquidity. However,
the strategies should take into account the fact that in crisis situations access to inter bank market could be
difficult as well as costly.
The liquidity strategy must be documented in a liquidity policy, and
communicated throughout the institution. The strategy should be evaluated periodically to ensure that it
remains valid.
The institutions should formulate liquidity policies, which are recommended by senior
management/ALCO and approved by the Board of Directors (or head office). While specific details vary
across institutions according to the nature of their business, the key elements of any liquidity policy
include:

General liquidity strategy (short- and long-term), specific goals and

objectives in relation to liquidity risk management, process for strategy
formulation and the level within the institution it is approved;
Roles and responsibilities of individuals performing liquidity risk
management functions, including structural balance sheet management,
pricing, marketing, contingency planning, management reporting, lines
of authority and responsibility for liquidity decisions;
Liquidity risk management structure for monitoring, reporting and
reviewing liquidity;
Liquidity risk management tools for identifying, measuring, monitoring
and controlling liquidity risk (including the types of liquidity limits and
ratios in place and rationale for establishing limits and ratios);
Contingency plan for handling liquidity crises.

To be effective the liquidity policy must be communicated down the line

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throughout in the organization. It is important that the Board and senior

management/ALCO review these policies at least annually and when there are any material changes in the
institutions current and prospective liquidity risk
profile. Such changes could stem from internal circumstances (e.g. changes in business focus) or external
circumstances (e.g. changes in economic conditions).
Reviews provide the opportunity to fine tune the institutions liquidity policies in light of the institutions
liquidity management experience and development of its business. Any significant or frequent exception
to the policy is an important barometer to gauge its effectiveness and any potential impact on banks
liquidity risk profile.
Institutions should establish appropriate procedures and processes to
implement their liquidity policies. The procedural manual should explicitly narrate the necessary
operational steps and processes to execute the relevant liquidity risk controls. The manual should be
periodically reviewed and updated to take into account new activities, changes in risk management
approaches and systems.
ALCO/Investment Committee
The responsibility for managing the overall liquidity of the bank should be delegated to a specific,
identified group within the bank. This might be in the form of an Asset Liability Committee (ALCO)
comprised of senior management, the treasury function or the risk management department. However,
usually the liquidity risk management is performed by an ALCO. Ideally, the ALCO should comprise of
senior management from each key area of the institution that assumes and/or manages liquidity risk. It is
important that these members have clear authority over the units responsible for executing liquidityrelated transactions so that ALCO directives reach these line units unimpeded. The ALCO should meet
monthly, if not on a more frequent basis. Generally responsibilities of ALCO include developing and
maintaining appropriate risk
management policies and procedures, MIS reporting, limits, and oversight programs. ALCO usually
delegates day-to-day operating responsibilities to the bank's treasury department. However, ALCO should
establish specific procedures and limits governing treasury operations before making such delegation.
To ensure that ALCO can control the liquidity risk arising from new products and future business
activities, the committee members should interact regularly with the bank's risk managers and strategic
planners.

Liquidity Ratios and Limits

Banks may use a variety of ratios to quantify liquidity. These ratios can also be used to create limits for
liquidity management. However, such ratios would be meaningless unless used regularly and interpreted
taking into account qualitative factors. Ratios should always be used in conjunction with more qualitative
information about borrowing capacity, such as the likelihood of increased requests for early withdrawals,
decreases in credit lines, decreases in transaction size, or shortening of term funds available to the bank.
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To the extent that any asset-liability management decisions are based on financial ratios, a bank's assetliability managers should understand how a ratio is constructed,
the range of alternative information that can be placed in the numerator or denominator, and the scope of
conclusions that can be drawn from ratios.
Because ratio components as calculated by banks are sometimes inconsistent, ratio-based comparisons of
institutions or even comparisons of periods at a single institution can be misleading.
i. Cash Flow Ratios and Limits. One of the most serious sources of liquidity
risk comes from a bank's failure to "roll over" a maturing liability. Cash
flow ratios and limits attempt to measure and control the volume of
liabilities maturing during a specified period of time.
ii. Liability Concentration Ratios and Limits. Liability concentration ratios
and limits help to prevent a bank from relying on too few providers or
funding sources. Limits are usually expressed as either a percentage of
liquid assets or an absolute amount. Sometimes they are more indirectly
expressed as a percentage of deposits, purchased funds, or total liabilities.
iii. Other Balance Sheet Ratios. Total loans/total deposits, total loans/total
equity capital, borrowed funds/total assets etc are examples of common
ratios used by financial institutions to monitor current and potential
funding levels.
In addition to the statutory limits of liquid assets requirement and cash reserve requirement, the board and
senior management should establish limits on the nature and amount of liquidity risk they are willing to
assume. The limits should be periodically reviewed and adjusted when conditions or risk tolerances
change. When limiting risk exposure, senior management should consider the nature of the bank's
strategies and activities, its past performance, the level of earnings, capital available to absorb potential
losses, and the board's tolerance
for risk. Balance sheet complexity will determine how much and what types of limits a bank should
establish over daily and long-term horizons. While limits will not prevent a liquidity crisis, limit
exceptions can be early indicators of excessive risk or inadequate liquidity risk management.
Internal Controls
In order to have effective implementation of policies and procedures, banks should institute review
process that should ensure the compliance of various procedures and limits prescribed by senior
management. Persons independent of the funding areas should perform such reviews regularly.
Monitoring and Reporting Risk Exposures
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Senior management and the board, or a committee thereof, should receive reports on the level and trend of
the bank's liquidity risk at least quarterly. A recent trend in liquidity monitoring is incremental reporting,
which monitors liquidity through a series of basic liquidity reports during stable funding periods but
ratchets up both the frequency and detail included in the reports produced during periods of liquidity
stress. From these reports, senior management and the board should learn how much liquidity risk the
bank is assuming, whether management is complying with risk limits, and whether managements
strategies are consistent with the board's expressed risk tolerance. The sophistication or detail of the
reports should be commensurate with the complexity of the bank.
MANAGING OPERATIONAL RISK
Operational risk is the risk of loss resulting from inadequate or failed
internal processes, people and system or from external events. Operational risk is associated with human
error, system failures and inadequate procedures and controls. It is the risk of loss arising from the
potential that inadequate information system; technology failures, breaches in internal controls, fraud,
unforeseen catastrophes, or other operational problems may result in unexpected losses or reputation
problems. Operational risk exists in all products
and business activities.
Operational risk event types that have the potential to result in substantial losses includes Internal fraud,
External fraud, employment practices and workplace safety, clients, products and business practices,
business disruption and system failures, damage to physical assets, and finally execution, delivery and
process management.
The objective of operational risk management is the same as for credit, market and liquidity risks
that is to find out the extent of the financial institutions operational risk exposure; to understand what
drives it, to allocate capital against it and identify trends internally and externally that would help
predicting it. The management of specific operational risks is not a new practice; it has always been
important for banks to try to prevent fraud, maintain the integrity of internal controls, and reduce errors in
transactions processing, and so on. However, what is relatively new is the view of operational risk
management as a comprehensive practice comparable to the management of credit and market risks in
principles. Failure to understand and manage operational risk, which is present in virtually
all banking transactions and activities, may greatly increase the likelihood that some risks will go
unrecognized and uncontrolled.
Operational Risk Management Principles
There are 6 fundamental principles that all institutions, regardless of their size or complexity, should
address in their approach to operational risk management.
a) Ultimate accountability for operational risk management rests with the board, and the level of risk that
the organization accepts, together with the basis for managing those risks, is driven from the top down by
those charged with overall responsibility for running the business.
b) The board and executive management should ensure that there is ineffective, integrated operational risk
management framework. This should incorporate a clearly defined organizational structure, with defined
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roles and responsibilities for all aspects of operational risk management/monitoring and appropriate tools
that support the identification, assessment, control and reporting of key risks.
c) Board and executive management should recognize, understand and have defined all categories of
operational risk applicable to the institution. Furthermore, they should ensure that their operational risk
management framework adequately covers all of these categories of operational risk, including those that
do not readily lend themselves to measurement.
d) Operational risk policies and procedures that clearly define the way in which all aspects of operational
risk are managed should be documented and communicated. These operational risk management policies
and procedures should be aligned to the overall business strategy and should support the continuous
improvement of risk management.
e) All business and support functions should be an integral part of the overall operational risk management
framework in order to enable the institution to manage effectively the key operational risks facing the
institution.
f) Line management should establish processes for the identification, assessment, mitigation, monitoring
and reporting of operational risks that are appropriate to the needs of the institution, easy to implement,
operate consistently over time and support an organizational view of operational risks and material
failures.

Operational Risk Function

1 A separate function independent of internal audit should be established for effective management of
operational risks in the bank. Such a functional set up would assist management to understand and
effectively manage operational risk. The function would assess, monitor and report operational risks as a
whole and ensure that the management of operational risk in the bank is carried out as per strategy and
policy.
2 To accomplish the task the function would help establish policies and standards and coordinate various
risk management activities. Besides, it should also provide guidance relating to various risk management
tools, monitors and handle incidents and prepare reports for management and BOD.

Risk Assessment and Quantification

Banks should identify and assess the operational risk inherent in all material products, activities,
processes and systems and its vulnerability to these risks.
Banks should also ensure that before new products, activities, processes and systems are introduced or
undertaken, the operational risk inherent in them is subject to adequate assessment procedures. While a
number of techniques are evolving, operating risk remains the most difficult risk category to quantify. It
would not be feasible at the moment to expect banks to develop such measures.
However the banks could systematically track and record frequency, severity and other information on
individual loss events. Such a data could provide a meaningful information for assessing the banks
exposure to operational risk and developing a policy to mitigate / control that risk.
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Risk Management and Mitigation of Risks

Management need to evaluate the adequacy of countermeasures, both in terms of their effectiveness in
reducing the probability of a given operational risk, and of their effectiveness in reducing the impact
should it occur. Where necessary, steps should be taken to design and implement cost-effective solutions
to reduce the operational risk to an acceptable level. It is essential that ownership for these actions be
assigned to ensure that they are initiated. Risk management
and internal control procedures should be established by the business units, though guidance from the risk
function may be required, to address operational risks. While the extent and nature of the controls adopted
by each institution will be different, very often such measures encompass areas such as Code of Conduct,
Delegation of authority, Segregation of duties, audit coverage, compliance, succession planning,
mandatory leave, staff compensation, recruitment and training, dealing with customers, complaint
handling, record keeping, MIS, physical controls, etc

Risk Monitoring
An effective monitoring process is essential for adequately managing operational risk. Regular monitoring
activities can offer the advantage of quickly detecting and correcting deficiencies in the policies, processes
and procedures for managing operational risk. Promptly detecting and addressing these deficiencies can
substantially reduce the potential frequency and/or severity of a loss. There should be regular reporting of
pertinent information to senior management and the board of directors that supports the proactive
management of operational risk. Senior Management should establish a programme to:
a) Monitor assessment of the exposure to all types of operational risk faced by the institution;
b) Assess the quality and appropriateness of mitigating actions, including
the extent to which identifiable risks can be transferred outside the
institution;
c) Ensure that adequate controls and systems are in place to identify and
address problems before they become major concerns.
It is essential that:
i) Responsibility for the monitoring and controlling of operational risk
should follow the same type of organizational structure that has been
adopted for other risks, including market and credit risk;
ii) Senior Management ensure that an agreed definition of operational risk
together with a mechanism for monitoring, assessing and reporting it is
designed and implemented; and
iii) This mechanism should be appropriate to the scale of risk and activity
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undertaken.
Operational risk metrics or Key Risk Indicators (KRIs) should be established for operational risks to
ensure the escalation of significant risk issues to appropriate management levels. KRIs are most easily
established during the risk assessment phase. Regular reviews should be carried out by internal audit, or
other qualified parties, to analyze the control environment and test the effectiveness of implemented
controls, thereby ensuring business operations are conducted in a controlled manner.
Risk Reporting
Management should ensure that information is received by the appropriate people, on a timely basis, in a
form and format that will aid in the monitoring and control of the business. The reporting process should
include information such as:

The critical operational risks facing, or potentially facing, the institution;

Risk events and issues together with intended remedial actions;
The effectiveness of actions taken;
Details of plans formulated to address any exposures where appropriate;
Areas of stress where crystallization of operational risks is imminent; and
The status of steps taken to address operational risk.

Establishing Control Mechanism

5.9.1 Although a framework of formal, written policies and procedures is critical, it needs to be reinforced
through a strong control culture that promotes sound risk management practices. Banks should have
policies, processes and procedures to control or mitigate material operational risks. Banks should assess
the feasibility of alternative risk limitation and control strategies and should adjust their operational risk
profile using appropriate strategies, in light of their overall risk appetite and profile. To be effective,
control activities should be an integral part of the regular activities of a bank.
In business, the term Operational Risk Management (ORM) is the oversight of many forms of day-today operational risk including the risk of loss resulting from inadequate or failed internal processes,
people and systems, or from external events. Operational risk does not include market risk or credit risk.
Benefits of ORM

Reduction of operational loss.

Lower compliance/auditing costs.
Early detection of unlawful activities.
Reduced exposure to future risks.

TYPES OF OPERATIONAL RISK:

Internal Fraud - bribery, misappropriation of assets, tax evasion, intentional mismarking of positions
External Fraud - theft of information, hacking damage, third-party theft and forgery
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Employment Practices and Workplace Safety - discrimination, workers compensation, employee health
and safety
Clients, Products, & Business Practice - market manipulation, antitrust, improper trade, product defects,
fiduciary breaches, account churning
Damage to Physical Assets - natural disasters, terrorism, vandalism
Business Disruption & Systems Failures - utility disruptions, software failures, hardware failures
Execution, Delivery, & Process Management - data entry errors, accounting errors, failed mandatory
reporting, negligent loss of client assets

BASEL II
Before 1988, many central banks allowed different definitions of capital in order to make their country's
bank appear as solid than they actually were. In order to provide a level playing field the concept of
regulatory capital was standardized in BASEL I. Along with definition of regulatory capital a basic
formula for capital divided by assets was constructed and an arbitrary ratio of 8% was chosen as minimum
capital adequacy. However, there were drawbacks in the BASEL I as it did not did not discriminate
between different levels of risk. As a result a loan to an established corporate was deemed as risky as a
loan to a new business. Also it assigned lower weight age to loans to banks as a result banks were often
keen to lend to other banks.
The BASEL II accord proposes getting rid of the old risk weighted categories that treated all corporate
borrowers the same replacing them with limited number of categories into which borrowers would be
assigned based on assigned credit system. Greater use of internal credit system has been allowed in
standardized and advanced schemes, against the use of external rating. The new proposals avoid sole
reliance on the capital adequacy benchmarks and explicitly recognize the importance of supervisory
review and market discipline in maintaining sound financial systems.
THE THREE PILLAR APPROACH
The capital framework proposed in the New Basel Accord consists of three pillars, each of which
reinforces the other. The first pillar establishes the way to quantify the minimum capital requirements, is
complemented with two qualitative pillars, concerned with organizing the regulator's supervision and
establishing market discipline through public disclosure of the way that banks implement the Accord.
Determination of minimum capital requirements remains the main part of the agreement, but the proposed
methods are more risk sensitive and reflect more closely the current situation on financial markets.

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Fig.1 Base II Capital Accord

First Pillar: Minimum Capital Requirement

The first pillar establishes a way to quantify the minimum capital requirements. While the new framework
retains both existing capital definition and minimal capital ratio of 8%, some major changes have been
introduced in measurement of the risks. The main objective of Pillar I is to introduce greater risk
sensitivity in the design of capital adequacy ratios and, therefore, more flexibility in the computation of
banks' individual risk. This will lead to better pricing of Risks.
Capital Adequacy Ratio signifies the amount of regulatory capital to be maintained by a bank to account
for various risks inherent in the banking system.
The Capital Adequacy ratio is measured as;

Total
Regulatory
Capital
(unchanged)
Credit Risk + Market Risk + Operational Risk

Bank's

Capital

(minimum

8%)

Regulatory capital is defined as the minimum capital, banks are required to hold by the regulator, i.e. "The
amount of capital a bank must have". It is the summation of Tier I and Tier II capital.
1. Credit Risk:
The changes proposed to the measurement of credit risk are considered to have most far reaching
implications. Basel II envisages two alternative ways of measuring credit risk.
The Standardized Approach

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The standardized approach is conceptually the same as the present Accord, but is more risk sensitive. The
bank allocates a risk-weight to each of its assets and off-balance-sheet positions and produces a sum of
risk-weighted asset values. Individual risk weights currently depend on the broad category of borrower
(i.e. sovereigns, banks or corporate). Under the new Accord, the risk weights are to be refined by
reference to a rating provided by an external credit assessment institution that meets strict standards.

The Internal Ratings Based Approach (IRB)

Under the IRB approach, distinct analytical frameworks will be provided for different types of loan
exposures. The framework allows for both a foundation method in which a bank estimate the probability
of default associated with each borrower, and the supervisors will supply the other inputs and an advanced
IRB approach, in which a bank will be permitted to supply other necessary inputs as well. Under both the
foundation and advanced IRB approaches, the range of risk weights will be far more diverse than those in
the standardized approach, resulting in greater risk sensitivity.
2. Operational Risk:
Basel II Accord set a capital requirement for operational risk. It defines operational risk as "the risk of
direct or indirect loss resulting from inadequate or failed internal processes, people and systems or from
external events". Banks will be able to choose between three ways of calculating the capital charge for
operational risk the Basic Indicator Approach, the Standardized Approach and the advanced
measurement Approaches.
The Second Pillar: Supervisory Review Process
The supervisory review process requires supervisors to ensure that each bank has sound internal processes
in place to assess the adequacy of its capital based on a thorough evaluation of its risks. Supervisors would
be responsible for evaluating how well banks are assessing their capital adequacy needs relative to their
risks. This internal process would then be subject to supervisory review and intervention, where
appropriate.
The Third Pillar: Market Discipline
The third pillar of the new framework aims to bolster market discipline through enhanced disclosure by
banks. Effective disclosure is essential to ensure that market participants can better understand banks' risk
profiles and the adequacy of their capital positions. The new framework sets out disclosure requirements
and recommendations in several areas, including the way a bank calculates its capital adequacy and its
risk assessment methods. The core set of disclosure recommendations applies to all banks, with more
detailed requirements for supervisory recognition of internal methodologies for credit risk, credit risk
mitigation techniques and asset securitization.

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CHALLENGES FOR INDIAN BANKING SYSTEM

UNDER BASEL II
A feature, somewhat unique to the Indian financial system is the diversity of its composition. We have the
dominance of Government ownership coupled with significant private shareholding in the public sector
banks and we also have cooperative banks, Regional Rural Banks and Foreign bank branches. By and
large the regulatory standards for all these banks are uniform.
Costly Database Creation and Maintenance Process:
The most obvious impact of BASEL II is the need for improved risk management and measurement. It
aims to give impetus to the use of internal rating system by the international banks. More and more banks
may have to use internal model developed in house and their impact is uncertain. Most of these models
require minimum 5 years bank data which is a tedious and high cost process as most Indian banks do not
have such a database .

Additional Capital Requirement:

In order to comply with the capital adequacy norms we will see that the overall capital level of the banks
will raise a glimpse of which was seen when the RBI raised risk weightages for mortgages and home
loans in October 2004. Here there is a worrying aspect that some of the banks will not be able to put up
the additional capital to comply with the new regulation and they may be isolated from the global banking
system.
Large Proportion of NPA's:
A large number of Indian banks have significant proportion of NPA's in their assets. Along with that a
large proportion of loans of banks are of poor quality. There is a danger that a large number of banks will
not be able to restructure and survive in the new environment. This may lead to forced mergers of many
defunct banks with the existing ones and a loss of capital to the banking system as a whole.
Relative Advantage to Large Banks:
The new norms seem to favor the large banks that have better risk management and measurement
expertise. They also have better capital adequacy ratios and geographically diversified portfolios. The
smaller banks are also likely to be hurt by the rise in weightages of inter-bank loans that will effectively
price them out of the market. Thus banks will have to restructure and adopt if they are to survive in the
new environment.

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LITERATURE REVIEW
Risk Management and Risk based Supervision in Banks has been the subject of study of many Agencies
and Researchers and Academicians. There is a treasure of literature available on the subject.
A careful selection of relevant material was a formidable task before the Researcher. Efforts have been
made to scan the literature highly relevant to the Context.
The main sources of literature have been the Website of the Reserve Bank of India, the website of the
Basle Committee on Banking Supervision and the websites of several major Banks both in India and
abroad. The publications of Academicians engaged in the Risk Management and Central Banking
Supervision sphere also throws valuable insights in to the area. The occasional Research papers published
by Reserve Bank, the speeches of the Governor and the Deputy Governors of the Reserve Bank of India,
the Publications of the Reserve Bank of India, the Indian Banks Association have proved quite relevant to
the study.

LITERATURE REVIEW INTERNATIONAL PERSPECTIVE

Crouhy, Gala, Marick(26) have summarized the core principles of Enterprise wide Risk Management.
As per the authors Risk Management culture should percolate from the Board Level to the lowest level
employee. Firms will be required to make significant investment necessary to comply with the latest best
practices in the new generation of Risk Regulation and Management. Corporate Governance regulation
with the advent of Sarbanes-Oxley Act in US and several other legislations in various countries also
provide the framework for sound Risk Management structures. Hitherto, Enterprise wide Risk
Management existed only for name sake. Generally firms did not institute a truly integrated set of Risk
measures, methodologies or Risk Management Architecture. The ensuing decades will usher in a new set
of Risk Management tools encompassing all the activities of a Corporation. The integrated Risk
Management infrastructure would cover areas like Corporate Compliance, Corporate Governance, Capital
Management etc. Areas like business risk, reputation risk and strategic risk also will be incorporated in
the overall Risk Architecture more formally. As always it will be the Banks and the Financial Services
firms which will lead the way in this evolutionary process. The compliance requirements of Basel II and
III accords will also oblige Banks and Financial institutions to put in place robust Risk Management
methodologies. 50 The authors felt that it is generally felt that Risk Management concerns largely with
activities within the firm. However, during the next decade Governments in different countries would
desire to have innovatively drawn Risk Management system for the whole country. The authors draw
reference to the suggestions of Nobel Laureate Robert Merton who suggested that a country with exposure
to a few concentrated industries should be obliged to diversify its excessive exposures by arranging
appropriate swaps with other countries with similar problems. Risk Management offers many other
potential macro applications to improve the management of their social security measures etc. They draw
references to the spread of Risk Management Education worldwide.
Carl Felsenfeld (27) outlined the patterns of international Banking regulation and the sources of
governing law. He reviewed the present practices and evolving changes in the field of control systems
Page | 29

and regulatory environment. The book dealt a wide area of regulatory aspects of Banking in the United
States, regulation of international Banking, international Bank services and international monetary
exchange. The work attempted in depth analysis of all aspects of Bank Regulation and Supervision.
Money Laundering has been of serious concern worldwide. Its risk has wide ramifications. Money
Laundering has lead to the fall of Banks like BCCI in the past. In this context the book on Anti-Money
Laundering: International Practice and Policies by John Broome
Published by Sweet and Maxwell (August 2005) reviews the developments in the area of Money
Laundering. The author explains with reference to case studies the possible effects of Money Laundering.
The book gives a comprehensive account of the existing rules and practices and suggests several
improvements to make the control systems and oversight more failsafe.
Hannan and Hanweck (28) felt that the insolvency for Banks become true when current losses exhaust
capital completely. It also occurs when the return on assets (ROA) is less than the negative capital-asset
ratio. The probability of insolvency is explained in terms of an equation p, 1/(2(Z2 ). The help of Zstatistics is commonly employed by Academicians in computing probabilities.
Daniele Nouy (29)elaborates the Basel Core Principles for effective Banking Supervision, its
innovativeness, content and the challenges of quality implementation. Core Principles are a set of
supervisory guidelines aimed at providing a general framework for effective Banking supervision in all
countries. They are innovative in the way that they were developed by a mixed drafting group and they
were comprehensive in coverage, providing a checklist of the principal features of a well designed
supervisory system. The core Principles specify preconditions for effective banking supervision
characteristics of an effective supervisory body, need for credit risk management and elaborates on
Principle 22 dealing with supervisory powers. Dearth of skilled human resources, poor financial strength
of supervisor and consequent inability to retain talented staff, inadequate autonomy and the need for
greater understanding of modern risk management techniques are identified as the main difficulties in
quality implementation. The critical elements of infrastructure, legal framework that supports sound
banking supervision and a credit culture that supports lending practices are the essence of a strong
banking system. Widespread failures have occurred during a period of increased vulnerability that can be
traced back to some regime change induced by policy or by external conditions.

Patrick Honohan (30) explains the use of budgetary funds to help restructure a large failed
Bank/Banking system and the various consequences associated with it. The article discusses how
instruments can best be designed to restore Bank capital, liquidity and incentives. It considers how
recapitalization can be modelled to ensure right incentives for new operators/managers to operate in a
prudent manner ensuring good subsequent performance It discusses how Governments budget and the
interest of the tax payer can be protected and suggest that monetary policy should respond to the
recapitalization rather determine its design. The author proposes the following four distinct policy tools to
achieve four distinct goals-injecting assets, adjusting capital claims on the Banks, rebalancing the govts
own debt management and managing monetary policy instruments to maintain stability. The author also
assessed the effect of bank recapitalization for budget and debt management and implications for
monetary policy and macro-economic environment in his article.
Jacques de Larosiere, former Managing Director of the International Monetary Funddiscusses the
implications of the new Prudential Framework. He explains at length how the new Regulatory code could
Page | 30

have some dangerous side effects. The increased capital requirements as decided by the Basel Committee
on Banking Supervision in September 2010 will affect the amount of own funds would affect the
profitability of the Banks. The consequences of such increased capital requirements would incentivise the
Banks to transfer certain operations that are heavily taxed in terms of capital requirements to shadow
Banking to avoid the scope of regulation. The risks of such a practice might affect the financial stability.
While the Central Banking authorities might contemplate registration and supervision of such shadow
banking entities like the hedge funds and other pools, such a course might be more cumbersome than
expected. The new regulation would result in the Banks to reduce activities with rather poor margins. For
example they may reduce exposure to small and medium enterprises or increase credit costs or concentrate
on more profitable but higher risk activities. He is also critical of the proposal of Basel to introduce an
absolute leverage ratio that might push Banks to concentrate their assets in riskier operations. The author
feels that the banking model which favours financial stability and economic growth might become the
victim of the new prudential framework, and force Banks to search for assets with maximum returns
despite the attendant risks.
William Allen of Cass Business School, City University Londonstrongly criticizes the Basel Committee
on Banking Supervision announcement increasing the capital requirements as part of Basel III. The aims
of increasing the capital are two-fold. Firstly the objective is to increase the amount of liquid assets held
by Banks and reduce their reliance on short term funding. It also aims at limiting the extent to which
Banks can achieve maturity transformation. This focus on liability management, as per him will prove
counter-productive, as has been proved historically by the recent financial crisis. As a strategy to meet the
new Capital Accord Banks will be forced to amass large amounts of liquid assets, in addition to the
amounts they will need to repay special facilities provided by the Governments and Central Banks. The
liquidity coverage ratio envisaged in the Accord also will require Banks to hold 100% liquid asset
coverage against liquidity commitments, and this will seriously impair the profitability of the Banks. The
eligible liquid assets for this purpose will be predominantly Govt. Securities. This might motivate
Governments to rely on this cheaper credit and some Governments may resort to abuse of this credit, thus
creating a moral hazard. If a Government loses its creditworthiness, this will become 0% for Basel II
purposes thus putting the Banks to a sudden jerk as the Securities would become ineligible as liquid
assets. The author goes on to explain the conflict of interest of the members of the Basel Committee as
some times these members are influenced by the Governments and their recommendations might not be
taken as independent judgment. Thus the author thinks that this regulation is seriously defective. He
opines that this serious lacuna could be removed by enlarging the opportunities for liquid assets to be
created out of the Banks claims on the private sector as well. As per him, Commercial Bills could be
considered to be eligible for this purpose as they are self liquidating transactions. As commercial Bills are
accepted by Banks, it is less likely that they will be in default. The cardinal point in liquidity management
to be remembered is that Commercial Banks cannot aim at zero risk. In that case they would need to their
assets in currency and would have to charge their customers for accepting deposits. The solution is not to
aim thoughtlessly at excessive liquidity, but in putting in place Robust Risk Management practices.
Abel Mateus which appeared also in the IUP Journal of Banking & Insurance Law, Vol.VIII, Nos.1 & 2,
2010 made a thorough study of the Regulatory reform requirements in the modern context after the global
meltdown. He starts by summarizing the basic principles that should be covered in the financial reforms.
He reviews the progress achieved by the Financial Stability Board (FSB) and Basel Committee on
Banking Supervision. He discusses the unresolved issues like the relationship between competition policy
and financial stabilization policies. He throws particular light on the oft quoted Too-Big-To-Fail (TBTF)
concept. He outlines measures to improve the supervision of capital markets to protect consumers and
Page | 31

Investors. The articles discusses at length the revision of Bank Capital Requirements and Accounting
Procedures, revising the role of Credit Rating Agencies, the supervision and regulation of Hedge Funds,
Commodity Funds and Private Equity Funds. Complex issues of Derivatives Regulation, Mortgage
Securitization etc. Have also been discussed and the author came out with suggested methods to address
these difficult issues.
The LSE Report of the London School of Economics and Political Sciences (34) is a very important
document in analyzingthe role of finance in the build-up to the recent crisis. The tax bail bail-outs have
been criticized and the gradual increase in the equity financing would shift the responsibility of any crisis
towards the shareholders.
As per Peter Boone and Simon Johnson, the global financial system is facing grave risks due to the
bail-out policy of the Western Governments. As Regulatory bodies like the Central Banks are keen to
increase the degree of oversight, the Banks would create new loopholes. The authors opine that in the
absence of any international treaty for the regulation of global financial institutions, macro prudential
measures and proper Risk Management systems are necessary for the management of financial system.
As per Goodhart the cost of Bank failures can be very large which lends justification to impose tighter
supervisory and regulatory measures. He argues that the proposals under the Basel III to increase the
capital higher levels like 20-30% are very justified. This is strongly objected by Laurence Kotlikoff
who feels such higher levels of capital would penalise the Shareholders and Depositors and goes against
the very principle that Financial Institutions are agencies which should have the benefits of gearing.
Bessone, Biagio feels that Banks are special as they not only accept and deploy large amounts of
uncollateralised public funds in a fiduciary capacity, but also leverage such funds through credit creation.
Thus Banks have a fiduciary responsibility. Banks play a crucial role in deploying funds mobilized
through deposits for financing economic activity and providing the lifeline for the payments system. A
well regulated Banking System is very central to the countrys economy. The author examines the way
Banking and other financial institutions interact with each other during different stages of economic
development. As per the author the shareholders of the banks who are supposedly owners have only a
minor stake and the considerable leveraging capacity of banks put them in control of very large volume of
public funds, though their actual stake may be very limited say sometimes only ten per cent or even lower.
The author feels that in the light of this leveraging capacity, the Banks should act as trustees. The author
underlines the need for the Supervisors and Regulators of the countrys Banking system to discharge the
onerous responsibility of ensuring that the Bank Managements fulfill this fiduciary relationship well, as in
a developing economy there is far less tolerance for downside risks among depositors, many of whom
place their life savings in the Banks. The author feels that diversification of ownership is desirable as the
risk of concentration of ownership canlead to moral hazard problem and linkages of owners with
businesses. When the ownership is diversified there is greater need for corporate governance and
professional management in order to safeguard the depositors interest and ensure systemic stability.
Hence the regulatory and supervisory framework has to ensure that banks follow prudent and transparent
accounting practices and are managed in accordance with the best practices for risk management.
As per G.Dalai, D.Rutherberg, M.Sarnat and B.Z.SchreiberRisk is intrinsic to banking. However the
management of risk has gained prominence in view of the growing sophistication of banking operations,
derivatives trading, securities underwriting and corporate advisory business etc.

Page | 32

Risks have also increased on account of the on-line electronic banking, provision of bill presentation and
payment services etc. The major risks faced by financial institutions are of course credit risk, interest rate
risk, foreign exchange risk and liquidity risk.
Credit risk management requires that Banks develop loan assessment policies and administration of loan
portfolio, fixing prudential per borrower, per group limits etc. The tendency for excessive dependence on
collateral should also be looked into. The other weaknesses in Credit Risk Management are inadequate
risk pricing, absence of loan review mechanism and post sanction surveillance. Interest rate risk arises due
to changes in interest rates significantly impacting the net interest income, mismatches between the time
when interest rates on asset and liability are reset etc. Management of interest rate risk involves employing
methods like Value-at-Risk (VaR), a standard approach to assess potential loss that could crystallize on
trading portfolio due to variations in market interest rates and prices. Foreign Exchange risk is due to
running open positions. The risk of open positions of late has increased due to wide variations in
exchange risks. The Board of Directors should law down strict intra-day and overnight positions to ensure
that the Foreign Exchange risk is under control.
Chief Risk Officer, Alden Toevs of Commonwealth Bank of Australiastates that a major failure of risk
management highlighted by the global financial crisis was the inability of financial institutions to view
risk on a holistic basis. "The global financial crisis"exposed, with chilling clarity, the dangers of
thinking in silos, particularly where risk management is concerned says the author. The malady is due to
the Banks focusing on individual risk exposures without taking into consideration the broader picture. As
per the author the root of the problem is the failure of the Banks to consider risks on an enterprise-wide
basis. The new relevance and urgency for implementing the Enterprise Risk Management (ERM) is due
to the regulatory insistence with a number of proposals to ensure that institutions stay focused on the big
picture. In a way the Three Pillar Approach frame work of the Basel II Accord is an effort to fulfill this
requirement. The risk weighted approaches to Credit Risk on the basis of the asset quality,allocation of
capital to Operational Risk and Market Risks nearly capture all the risks attendant to a Banks functioning.

LITERATURE REVIEW: INDIAN PERSPECTIVE

Rekha Arunkumar and Koteshwar feel that the Credit Risk is the oldest and biggest risk that Banks, by
virtue of their very nature of business inherit. The pre-dominance of credit risk is the main component in
the capital allocation. As per their estimate credit risk takes the major part of the Risk Management
apparatus accounting for over 70 per cent of all Risks. As per them the Market Risk and Operational Risk
are important, but more attention needs to be paid to the Credit Risk Management in Banks.
Reserve Bank of India, Volume 3, 1967-81 gives very valuable account of the evolution of Central
Banking in India. This third volume describes vividly the background against which the Reserve Bank of
India came into being on April 1, 1935. Before the establishment of the Reserve Bank, the Central
Banking functions were handled by the Imperial Bank of India.
The Royal Commission on Indian Currency and Finance (Hilton Young Commission) 1926
recommended that there is conflict of interest in the Imperial Bank of India functioning as the controller of
currency while also functioning as a Commercial Bank. After detailed analysis on the ownership,
constitution and composition of the ownership, RBI was established by a Bill in the Legislative Assembly.
Page | 33

It was in 1948 that the Reserve Bank of India was nationalised under the RBI(Transfer to Public
Ownership) Act, 1948. The earlier volumes viz., Volume I and Volume II covered the developments in
Central Banking up to 1967. Volume III covers the period 1967 to 1981. This is the most dynamic
period in the history of Commercial Banking. The Government was very critical of the attitudes of the
Private Banks for their failure to be socially responsible, which led the Govt. To impose social control on
Banks. Mrs. Indira Gandhi nationalised 14 Banks during July 1969. Reserve Bank was given newer
responsibilities in terms of the Developmental role. The RBI was assigned not only the role of maintaining
monetary and fiscal stability but also the developmental role of establishing institutional framework to
complement commercial banking to help agriculture, SSI and Export Sectors. RBI, despite the criticism
of not enjoying adequate autonomy due to the interference of the Finance Ministry (with Govt. Ownership
of most Banking Companies) has been able to commendably discharge the regulatory functions. True it
was during this period that the performance of the Indian Banks deteriorated with most Nationalised
Banks wiping out their capital and their Balance Sheets showing huge negativities in terms of quality of
assets etc.
The period covered by the Volume III is the pre-liberalizationand pre-reform period and the Reserve Bank
had to compromise on its regulatory and supervisory role in view of the Govt. Control over Banks.
Banking Law and Regulation 2005 published by Aspen Publishers looks at the regulatory practices
relating to Banks and Financial Institutions. The book analyses the various provisions of the GrammLeach Baily Act, 1999, the Financial Institutions Recovery and Enforcement Act 2002, the Federal
Deposit Insurance Corporation Improvement Act, and the Fair and Accurate Credit Transactions Act
2003.
S.K.Bagchi observed that in the world of finance more specifically in Banking, Credit Risk is the most
predominant risk in Banking and occupies roughly 90-95 per cent of risk segment. The remaining
fraction is on account of Market Risk, Operations Risk etc. He feels that so much of concern on
operational risk is misplaced. As per him, it may be just one to two per cent of Banks risk. For this small
fraction, instituting an elaborate mechanism may be unwarranted. A well laid out Risk Management
System should give its best attention to Credit Risk and Market Risk. In instituting the Risk Management
apparatus, Banks seem to be giving equal priority to these three Risks viz., Credit Risk, Operational Risk
and Market Risk. This may prove counter-productive. Securitization and Reconstruction of Financial
Assets Enactment of Security Interest Act, 2002. (SARFAESI ACT).
Govt. Of India has taken the initiative of making the legislation to help Banks to provide better Risk
Management for their asset portfolio. Risk Management of the Loan book has been posing a challenge to
the Banks and Financial Institutions which are helpless in view of the protracted legal processes. The act
enables Banks to realise their dues without intervention of Courts and Tribunals. As a part of the Risk
Management strategies, Banks can set up Asset Management Companies (AMC) to acquire Non
Performing Assets of Banks and Financial agencies by paying the consideration in the form of
Debentures, Bonds etc. This relieves the Bank transferring the asset to concentrate on their loan book to
secure that the quality of the portfolio does not deteriorate. The act contains severe penalties on the
debtors. The AMC is vested with the power of issuing notices to the Borrowers calling for repayment
within 60 days. If the borrower fails to meet the commitment, the AMC can take possession of the
secured assets and appoint any Agency to manage the secured assets. Borrowers are given the option of
appealing to the Debt Tribunal, but only after paying 75% of the amount claimed by the AMC. There are
strict provisions of penalties for offences or default by the securitization or reconstruction company. In
case of default in registration of transactions, the company officials would be fined upto Rs.5,000/- per
Page | 34

day. Similarly non-compliance of the RBI directions also attract fine up to Rs.5 lakhs and additional fine
of Rs.10,000/- per day. This has proved to be a very effective Risk Management Tool in the hands of the
Banks.The Report of the Banking Commission 1972 RBI Mumbai. The Commission made several
recommendations for making the Indian Banking system healthier. The commission observed that the
system of controls and supervisory oversight were lax and underlined the need for closure supervision of
Banks to avoid Bank failures. However most of the recommendations of the Commission lost their
relevance in view of the priorities of the Government which is more concerned with its political
compulsions. The nationalisation of Banks and the tight controlon the Banks of the Govt. Left little scope
for implementation of the recommendations of the Commission. If only the recommendations which are
meant to restore tighter regulatory measures, strengthening of the internal control systems and
professionalization of the Bank Boards were properly appreciated and implementation, Indian Banks
would not have ended in the mess of erosion of capital, mounting burden of non-performing assets.etc. A
well known study analyzing the performance of Commercial Banks in India was conducted by Vashist
(1991).
Avtar Krishna Vashist: Public Sector Banks in India H,.K.Publishers &Distributors, New Delhi
1991.In order to find out relative performance of different Banks, composite weighted growth index,
relative growth index and average growth index of Banks were constructed. The study revealed that
Commercial Banks did well with respect to Branch expansion, deposit mobilization and deployment of
credit to the Priority Sectors. But they showed poor performance in terms of profitability. After
identifying the causes of the decline in profitability a number of suggestions were made to improve the
performance of Commercial Banks in the Country.
Dr.Atul Mehrotra, Dean, Vishwakarma Institute of Managementemphasizes the need for promotion
of Corporate Governance in Banks in these uncertain and risky times. This paper discussed at length
Corporate Governance related aspects in Banks as also touches upon the principles for enhancing
Corporate Governance in Banks as suggested by BCBS. The author felt that despite the RBIs initiatives
on the recommendations of the Consultative Group of Directors of Banks/Financial Institutions under the
Chairmanship of Dr.A.S.Ganguly, member of the Board for Financial Supervision, there is more ground
to be covered before Indian Banks are in a position to attain good Governance Standards.
As per the author he Public Sector Banks with Government ownership control almost over 80 per cent of
banking business in India. This complicates the role of the Reserve Bank of India as the regulator of the
financial system. The role of the Government performing simultaneously multiple functions such as the
manager, owner, quasi-regulator and sometimes even as super-regulator presents difficulties in the matter.
Unless there is clarity in the role of the Government, and unless Boards of the banks are given the desired
level of autonomy, it will be difficult to set up healthy governance standards in the Banks.
As a part of the Review of literature, the Reports of various Committees and Commissions have been
perused. Important among them are given below:
The Report of the Committee on the Financial System 1991 Chairman Shri M.Narasimhamby far is the
most important document while discussing the Reform process in Indian Banking. The following
recommendations made by the Committee which were largely implemented put the Indian Banking
system on an even keel:

Page | 35

Main Recommendations:
1. Operational flexibility and functional autonomy
2. Pre-emption of lendable resources to be stopped by progressively reducing the SLR and CRR
3. Phasing out of directed Credit Programmes
4. Deregulation of interest rates
5. Capital Adequacy requirements to be gradually stepped up
6. Stricter Income Recognition norms
7. Provisioning requirements tightened
8. Structural Organisation

Three to four Large Banks (including State Bank of India) which could become international in
character
Eight to ten national banks with a network of branches throughout the country engaged in
universal banking
Local Banks whose operations would be generally confined to a specific region
Rural Banks including Regional Rural Banks confined to rural areas

9) Level playing field for Public Sector and Private Sector Banks
10) No further nationalisation
11) Entry of Private Sector Banks recommended
12) Banks required to take effective steps to improve operational efficiency through computerisation,
better internal control systems etc.

RESEARCH METHODOLOGY
Page | 36

Descriptive Research:

The research conducted is primarily descriptive in nature. Review of all available secondary data was
done, in order to gain insight into the Risk Management in Banks. This design was chosen specifically
because it enables one to gain thorough insight into "why", "how" and "when" something occurs. The goal
is to learn 'what is going on here?' and to investigate social phenomena without explicit exceptions and is
an attempt to 'unearth' a theory from the data itself rather than from a a pre-disposed hypothesis.

In order to achieve the objectives of the study a literature survey was undertaken to understand the
concept of risk management and various components associated with risk management ,the analysis and
results were based purely on data collected from secondary sources.
The research work done involved the following steps:

Data pertaining to the issue was collected extensively through magazines, articles, books and
primarily the internet.

Data was examined to gain an understanding of the topic and form a basis of the introduction.
The various articles and previous research reports on the topic were examined as a part of the
literature review. This helped in understanding various viewpoints that had been formed earlier
about the subject under consideration. It also enabled find a direction for the research and
effectively carry it out further.
Also a rationale for conducting the study was developed in order to support the further importance
of carrying out the research work.
Based on the results and the outcome of the overall study, plausible conclusions were drawn and
recommendations were given into the matter under consideration.

LIMITATIONS
Page | 37

Though sample data was available on the subject, but updated data was less and finding accurate facts and
figures was slightly tough. It is relevantly new field of study and not a lot of behavioral has been done in
this context. Therefore there is no comparative study in the project.
only secondary data is available for the research, there is no primary data used in the project ,
which is again a constraint for the research done time constraint.

DATA ANALYSIS
Page | 38

1. Capital Adequacy:
CAR Capital Adequacy ratio: The ratio of capital to risk weighted assets
IN year 2010:
Tier 18.57%
Tier 24.51%
Total13.08%
IN year 2009:
Tier 18.55%
Tier 2
Total

2.86%
11.44%
CAR
13.08%

14.00%

11.41%

12.00%
10.00% 8.57%

8.55%

8.00%
6.00%

4.51%
2.86%

4.00%
2.00%
0.00%
Tier 1 Tier 2 Total
FY 10

Tier 1 Tier 2 Total

FY 09

Fig 2 Capital Adequacy ratio

The Banks total Capital Adequacy Ratio (CAR) as at March 31, 2010 stood at 13.1% as against the
regulatory minimum of 9.0%. Tier-I CAR was 8.6%.
During 2009-10, the Bank raised Rs.410 crores of subordinated debt qualifying as Lower Tier II capital,
Rs.1,085 crores of Upper Tier II capital (including US$ 100 million in foreign currency) and Rs.200
crores of perpetual debt qualifying as Hybrid Tier I capital.
CAR TierI:The Tier I capital has increased to Rs.635271 lacs from Rs 514991 lacs.
CAR Tier II:The Tier II capital has increased to Rs.333999 lacs from Rs 172071 lacs.

Page | 39

2. BREAK UP OF LIABILITIESOF HDFC BANK in 2010

(in Rs. Lacs)
Capital

31939

Reserves and Surplus

611376

Deposits

6,829,794

Borrowings

281539

Other Liabilities and Provisions

1368913
91,235,6

Total

In the given pie chart we can see that Deposits has got the maximum share (74%) total, it means that
HDFC Bank has this much of deposits which is the main source of their funds and others have got very
small proportions of total liabilities as shown by the table above.

3.BREAK UP OF ASSETS OF HDFC BANK in 2010

Page | 40

(in Rs. Lacs)

Cash and balances with Reserve Bank of India

5,182,48

Balances with Banks and Money at Call and Short notice

3,971,40

Investments

30,564,
80

Advances

46,944,7
8

Fixed Assets

966,67
3,605,4

Other Assets

Total

91,235,6
1

In the given pie chart we can see that loans and advances has got the maximum share (51.45%) total ,it
means that HDFC Bank deploys maximum amount of money in providing loans and so has to earn its
profit mainly through this means, and then comes Net investment (33.5%).

4. Risk weighted assets:

Page | 41

Fig 3 Risk weighted assets

The assets are assigned risk weights depending on the risk exposure a particular asset has. Then the book
value of assets is multiplied with the risk weights to get risk weighted assets. The higher is its value,
higher is the risk involved.

5. CASH IN HAND AND BANK BALANCE

Page | 42

746,5
Cash in hand

Balances with Reserve Bank of India

443597
1,653,2

Balances with Banks In India

Balances with Banks outside India

43279
190,0

Money at call and short notice in India

0
1,695,3

Money at call and short notice outside India

Total

915388

These balance sheet items make an important part of risk weighted assets. There is no risk with cash in
hand and balance with RBI, so they are assigned zero as their risk weights whereas others get a very small
percentage as their risk weights

6. INVESTMENTS :
(In Rs lacs)
Page | 43

Government securities

22,544,2
2

Other approved securities

68

Shares

58,31

Debentures and Bonds

7,389,85

Subsidiary / Joint Ventures

21,56

Units, Certificate of Deposits and Others

549,96

Total

30,564,5
8

The above pie chart shows the proportions of total investments in different instruments. All the
instruments have different risk exposures and they again make an important part of risk weighted assets.
Among these, Government securities are the most secure, which also make the highest proportion of total
investments, and shares are the most risky.

7. ADVANCES
Page | 44

(In lacs)
Secured by tangible assets

32,845,4
4

Covered by Bank/Government Guarantees

522,36

Unsecured

13,576,9
8

Total

46,944,7
8

Most of the advances given are secured by tangible assets. But the liquidity of those assets is again in
question. Almost 30% of advances are unsecured, so accordingly the risk management strategies and the
provisions have to be made.

Page | 45

8. NPAs NON PERFORMING ASSETS:

NET NPAs
FY 09

Rs.15518 lacs

FY 10

Rs.20289 lacs

net NPAs
25000

20289

20000
in lacs

15518

15000
10000
5000
0

FY 09
15518

FY 10
20289

Fig 4 Net NPAs

PROVISIONS FOR NPAs
FY 09

Rs35371 lacs

FY 10

RS.45487 lacs

Provisions for NPAs

50000
40000
in lacs

30000

45487

35371

20000
10000
0

FY 09
35371

FY 10
45487

Fig 5 provision for NPAs

NON PERFORMING ASSETS CATEGORY IN 2010
Sub-standard 173,72
Doubtful 105,08
Page | 46

Loss 176,07
As at March 31

454,87

Provisions for NPAs FY 10

17372

17607

Sub standard
Doubtful
Loss

10508

Advances are classified as performing and non-performing based on the Reserve Bank of India guidelines.
Interest on non-performing advances is transferred to an interest suspense account and notrecognized in
the Profit and Loss Account until received.
In respect of restructured standard and sub-standard assets, provision is made for interest component
specified while restructuring the assets, based on the Reserve Bank of India guidelines. The substandard
assets which are subject to restructuring are eligible to be upgraded to the standard category only after a
minimum period of one year after the date when the first payment of interest or principal, whichever is
earlier, falls due, subject to satisfactory performance during the said
period. Once the asset is upgraded, the amount of provision made earlier, net of the amount provided for
the sacrifice in the interest amount in present value terms, as aforesaid, is reversed.

9. EXPOSURE TO SENSITIVE SECTORS

Page | 47

(in Rs. lacs)

FY 09

483453

FY 10

732012

FY 09

159421

FY 10

156448

exposure to sensitive sectors

800000
732012
700000
600000
500000 483453
in lacs400000
300000
200000
100000
0
FY 09 FY 10
Real estate

159421156448

FY 09 FY 10
Capital market

Fig 6 exposure to sensitive sectors

Exposure to real estate in the bank has increased tremendously in 2010 whereas exposure to capital
market remains almost the same.

10. DEBT TO EQUITY:

Page | 48

The ratio in year 2010 is 11.04.The debt RS.7111333 lacs comprising of deposits of Rs.6829794 lacs and
borrowings of Rs. 281539 lacs. Further the equity of the bank amounting to Rs.643315 lacs included
capital as 31939 lacs and reserves and surplus as Rs.611376 lacs.

11. QUICK ASSETS TO CURRENT LIABILITIES:

The ratio in year 2010 is 0.66
It is one of the important measures of the liquidity risk. The Quick assets of the bank were Rs.915388 lacs
in 2010. Quick Assets include cash and balance with RBI as Rs.518248 lacs and money at call and short
notice as RS.397140 lacs. Current liabilities amounts to Rs. 1368913 lacs.

12. LIQUID ASSETS TO ADVANCES: The ratio for the year is 19.50% The advances in the bank is
Rs 4694478 lacs in year 2010. Liquid assets include cash and balances with RBI as Rs. 518248 lacs and
balances with banks and money at call and short notice as Rs.397140 lacs.

FINDINGS & CONCLUSIONS

Page | 49

FINDINGS
1. Capital Adequacy:
The Banks total Capital Adequacy Ratio (CAR) as at March 31, 2010 is 13.1% as against the regulatory
minimum of 9.0%. Tier-I CAR was 8.6%.
2. BREAK UP OF LIABILITIESOF HDFC BANK
After analysis of the data HDFC Bank has got maximum deposits 74% of total,it means that HDFC
Bank has this much of deposits which is the main source of their funds.
3.BREAK UP OF ASSETS OF HDFC BANK
Loans and advances has got maximum share 51.45% total ,it means that HDFC Bank deploys maximum
amount of money in providing loans.
4. RISK WEIGHTED RISK
The assets are assigned risk weights depending on the risk exposure a particular asset has. Then the book
value of assets is multiplied with the risk weights to get risk weighted assets. The higher is its value,
higher is the risk involved.
5. INVESTMENTS
The proportions of total investments in different instruments.
Government securities
Other approved securities
Shares
Debentures & Bonds
All the instruments have different risk exposures and they again make an important part of risk weighted
assets.

6. NPAs NON PERFORMING ASSETS

Performing and non-performing based on the Reserve Bank of India guidelines. Interest on nonperforming advances is transferred to an interest suspense account and not recognized in the Profit and
Loss Account until received.

7. EXPOSURE TO SENSITIVE SECTORS

Page | 50

Exposure to real estate in the bank has increased tremendously in 2010 whereas exposure to capital
market remains almost the same
8. DEBT TO EQUITY
The ratio in year 2010 is 11.04.
9. QUICK ASSETS TO CURRENT LIABILITIES
The Quick assets of the bank were Rs.915388 lacs in 2010.
Quick Assets include cash and balance with RBI.
10. LIQUID ASSETS TO ADVANCES
The ratio for the year is 19.50%.
Liquid assets include cash and balances with RBI.

CONCLUSIONS
Page | 51

Risk can be defined as any uncertainty about a future event that threatens the organizations ability to
accomplish its mission. No business exists without risks or has zero risk orientation. Risk management
cannot be eliminated but enables the organizations to bring it to manageable proportions. Risk
management is basically a five step process, involving (i)avoidance (ii)Loss control (iii) Separation
(iv)Combination and (v) Transfer.
The increasing amount of competitive and regulatory pressures has compelled various organizations to an
enterprise risk management framework. Banks are exposed to different types of risks. Risk management
framework can be treated as a mirror of efficient corporate governance of a financial institution.
Globalization and significant competition between foreign and domestic banks, survival and optimizing
returns are very crucial for banks. There are of course a few fundamental pillars that necessitate a well
defined risk management framework in any bank, which are corporate culture, different procedures and
the technology aspect. Along with the efficient risk management practices, the other important factor for
success is selecting the efficient customer and providing innovative and value added financial products
and services to them. Risk limitation is a part of risk management. The bank should first find what amount
of risk it can absorb in order to limit its risk exposure. The risk management process must be evolved
within the organization. The basic framework of risk management consists of the elements such as interest
rate risk, credit risk, liquidity risk, exchange rate risk.
Effective risk management strategies can be implemented by integrating effective bank-level
management, operational supervision and market discipline. The first pillar of Basel II is designed to help
cover risks within the financial institutions ,the second pillar intends to ensure the presence of sound
processes at each bank, the third pillar attempts to boost market discipline through enhanced disclosure by
banks.

BIBLIOGRAPHY
Page | 52

REFERENCES
BOOKS:
ICFAI Journal Risk management in banks
Value reporting and Global comparative advantage(Banking and Finance)- HDFC Bank
Operational excellence in Risk Management by Mike Brook banks, Dr. Tony

Gandy & Pierre Pour

query.
WEBSITES:
www.google.com
www.creditrisk.com
www.hdfcbank.com
www.about.com
www.answers.com

APPENDIX-1
BALANCESHEET
Page | 53

Balance Sheet
As at March 31, 2014
Rs. in 000
Schedule

As at
31-Mar-14

As at
31-Mar-139

4,577,433

4,253,841

4,009,158

210,618,369

142,209,460

29,135

54,870

CAPITAL AND LIABILITIES

Capital

Equity Share Warrants

Reserves and Surplus

Employees Stock Options (Grants) Outstanding

Deposits

1,674,044,394

1,428,115,800

Borrowings

129,156,925

91,636,374

Other Liabilities and Provisions

206,159,441

162,428,229

Total

2,224,585,697

1,832,707,732

Cash and Balances with Reserve Bank of India

Balances with Banks and Money at Call and Short
notice

154,832,841

135,272,112

144,591,147

39,794,055

Investments

586,076,161

588,175,488

Advances

1,258,305,939

988,830,473

Fixed Assets

10

21,228,114

17,067,290

Other Assets

11

59,551,495

63,568,314

Total

2,224,585,697

1,832,707,732

12

4,790,515,044

4,059,816,885

81,248,646

85,522,390

ASSETS

Contingent Liabilities
Bills for Collection
Principal Accounting Policies and Notes forming
integral part of the financial statements

17 & 18

APPENDIX-2
PROFIT AND LOSS ACCOUNT
Page | 54

Profit and Loss Account

For the year ended March 31, 2014
Rs. in 000
Year Ended
31-Mar-10

Year Ended
31-Mar-09

13
14

161,729,000
38,076,106

163,322,611
32,906,035

Total

199,805,106

196,228,646

15
16

77,862,988
57,644,827

89,111,044
55,328,058

34,810,282

29,340,152

170,318,097

173,779,254

29,487,009
34,555,658

22,449,392
25,746,345

64,042,667

48,195,737

7,371,752
5,492,919
912,305

5,612,349
4,253,841
722,940

9,343
2,948,701
1,994,599
(14,900)
45,327,948

5,900
2,244,939
938,660
(138,550)
34,555,658

64,042,667

48,195,737

Rs.

Rs.

Schedule
I.

INCOME
Interest earned
Other income

II. EXPENDITURE
Interest expended
Operating expenses
Provisions and contingencies [includes provision for
income tax
of Rs. 1,340,44 lacs (Previous year : Rs. 1,054,31
lacs)]

Total
III
. PROFIT
Net Profit for the year
Profit brought forward
Total

IV. APPROPRIATIONS
Transfer to Statutory Reserve
Proposed dividend
Tax (including cess) on dividend
Dividend (including tax / cess thereon) pertaining to
previous year paid during the year
Transfer to General Reserve
Transfer to Capital Reserve
Transfer to / (from) Investment Reserve Account
Balance carried over to Balance Sheet
Total

EARNINGS PER EQUITY SHARE (Face value Rs.

V. 10 per share)

Page | 55

Basic
Diluted
Principal Accounting Policies and Notes forming
integral part of the financial statements

67.56
66.87

52.85
52.59

17 & 18

Page | 56

APPENDIX-3
CASH FLOW STATEMENT

Cash Flow Statement

For the year ended March 31, 2014
Rs. in 000
Particulars

2013-2014

2012-2009

42,891,365

32,992,534

3,943,917

3,599,088

30,082

279,856

4,408,528

4,442,222

19,389,292

16,057,967

500,000

50,000

1,204,814

Provision for wealth tax

5,500

6,100

Contingency provisions

1,511,134

1,528,129

(40,242)

(41,890)

72,639,576

60,118,820

(2,339,283)

(29,544,309)

Cash flows from operating activities

Net profit before income tax
Adjustments for :
Depreciation
(Profit) / Loss on Revaluation of Investments
Amortisation of premia on investments
Loan Loss provisions
Floating Provisions
Provision against standard assets

(Profit) / Loss on sale of fixed assets

Adjustments for :
(Increase) / Decrease in Investments
(Increase) / Decrease in Advances
Increase / (Decrease) in Borrowings
Increase / (Decrease) in Deposits
(Increase) / Decrease in Other assets
Increase / (Decrease) in Other liabilities and
provisions

Direct taxes paid (net of refunds)

Net cash flow from / (used in) operating
activities

(289,364,758) (212,421,813)
38,185,551

(24,944,226)

245,928,594

202,337,174

2,019,737

992,702

40,854,639

324,110

107,924,056

(3,137,542)

(14,025,156)

(14,223,562)

93,898,900

(17,361,104)
Page | 57

Cash flows from investing activities

Purchase of fixed assets
Proceeds from sale of fixed assets
Net cash used in investing activities

HDFC Bank Limited Annual Report 2009-10

(5,637,118)

(6,752,720)

121,996

114,946

(5,515,122)

(6,637,774)

28

Page | 58

Cash Flow Statement

For the year ended March 31, 2014
Rs. in 000
Particulars

2013-2014

2012-20139

5,559,685

878,060

4,009,158

36,080,586

28,750,000

(665,000)

(460,000)

(4,263,184)

(3,018,580)

(722,940)

(512,005)

35,989,147

29,646,633

(15,104)

(317)

21,635,341

Net increase in cash and cash equivalents

124,357,821

27,282,779

Cash and cash equivalents as at April 1st

175,066,167

147,783,388

Cash and cash equivalents as at March 31st

299,423,988

175,066,167

Cash flows from financing activities

Money received on exercise of stock options by employees
Proceeds from issue of Convertible Warrants
Proceeds from issue of equity shares
Proceeds from issue of Upper & Lower Tier II capital Instruments
Redemption of subordinated debt
Dividend paid during the year
Tax on Dividend
Net cash generated from financing activities
Effect of Exchange Fluctuation on Translation reserve
Cash and cash equivalents on amalgamation

APPENDIX-3
Page | 59

SCHEDULES TO THE ACCOUNTS

As at March 31, 2014
Rs. in 000
As at
31-Mar-14

As at
31-Mar-13

SCHEDULE 1 - CAPITAL
Authorised Capital
55,00,00,000 (31 March, 2014 : 55,00,00,000) Equity Shares of
Rs. 10/- each

5,500,000

5,500,000

Issued, Subscribed and Paid-up Capital

45,77,43,272 (31 March, 2014 : 42,53,84,109) Equity Shares of
Rs. 10/- each

4,577,433

4,253,841

4,577,433

4,253,841

22,987,291
7,371,752

15,193,539
2,181,403
5,612,349

30,359,043

22,987,291

7,360,523
2,948,701

5,115,584
2,244,939

10,309,224

7,360,523

III. Balance in Profit and Loss Account

45,327,948

34,555,658

IV. Share Premium Account

Opening Balance
Additions during the year

65,437,981
45,351,571

64,794,740
643,241

110,789,552

65,437,981

10,635,564
-

145,218
10,490,346

10,635,564

10,635,564

956,510
1,994,599

17,850
938,660

Total
SCHEDULE 2 - RESERVES AND
SURPLUS
I. Statutory Reserve
Opening Balance
Additions on amalgamation
Additions during the year
Total
II. General Reserve
Opening Balance
Additions during the year
Total

Total
V.

Amalgamation Reserve
Opening Balance
Additions during the year
Total

VI. Capital Reserve

Opening Balance
Additions during the year

Page | 60

Total
VI
I. Investment Reserve Account
Opening Balance
Additions during the year
Deductions during the year
Total

2,951,109

956,510

276,250
33,300
(48,200)

414,800
17,092
(155,642)

261,350

276,250

HDFC Bank Limited Annual Report 201314

Page | 61

Schedules to the Accounts

As at March 31, 2010
Rs. in 000
As at
31-Mar-10

As at
31-Mar-09

59,257,373
19,968,349

29,224,076
33,238,704

112,925,608

87,385,781

7,602,887

7,602,887

6,405,224

4,976,781

206,159,441

162,428,229

24,352,560

15,861,868

129,480,281
1,000,000

118,410,244
1,000,000

Total

130,480,281

119,410,244

Total
SCHEDULE 7 - BALANCES WITH BANKS AND MONEY AT CALL
AND SHORT NOTICE
In
I. India
(i) Balances with Banks :
(a) In current accounts
(b) In other deposit accounts

154,832,841

135,272,112

3,132,856
3,959,118

2,439,891
6,610,615

Total

7,091,974

9,050,506

5,150,000
98,354,000

12,422,500

Total

103,504,000

12,422,500

Total

110,595,974

21,473,006

3,062,216
-

5,298,405
1,014,400

30,932,957

12,008,244

Total

33,995,173

18,321,049

Total

144,591,147

39,794,055

SCHEDULE 5 - OTHER LIABILITIES

AND PROVISIONS
I. Bills Payable
II. Interest Accrued
III
.
Others (including provisions)
Contingent Provisions against standard
IV. assets
Proposed Dividend (including tax on
V. dividend)
Total
SCHEDULE 6 - CASH AND BALANCES WITH RESERVE
BANK OF INDIA
Cash in hand (including foreign currency
I. notes)
II. Balances with Reserve Bank of India
(a) In current accounts
(b) In other accounts

(ii) Money at call and short notice :

(a) With banks
(b) With other institutions

II. Outside India

(i) In current accounts
(ii) In deposit accounts
(iii
)
Money at call and short notice

SCHEDULE 8 - INVESTMENTS

A. Investments in India in
(i) Government securities
(ii) Other approved securities
(iii
)
Shares
(iv
)
Debentures and Bonds
(v) Subsidiaries / Joint Ventures
(vi Units, Certificate of Deposits and
)
Others
Total

HDFC Bank Limited Annual Report 2009-10

510,499,288
4,972

521,565,829
12,500

1,035,278

397,334

11,392,914
1,550,991

19,428,414
1,550,991

61,120,668

45,218,242

585,604,111

588,173,310

Schedules to the Accounts

As at March 31, 2010
Rs. in 000

B. Investments outside India - Others*

* Comprises of Shares and Bonds

Total

(i) Gross Value of Investments

(a) In India
(b) Outside India
Total
(ii) Provision for Depreciation
(a) In India
(b) Outside India
Total
(iii
) Net Value of Investments
(a) In India
(b) Outside India
Total
SCHEDULE 9 - ADVANCES
A (i) Bills purchased and discounted
(ii) Cash Credits, Overdrafts and Loans repayable on demand
(iii Term
) loans
Total
B

(i)
(ii)
(iii
)

Secured by tangible assets*

Covered by Bank / Government Guarantees
Unsecur
ed
* Including advances against Book
Debts

C.

I.

Total

Advances in India
(i) Priority Sector
(ii) Public Sector
(iii
)
Banks
(iv
)
Others
Total Advances in

As at
31-Mar-10
472,050

As at
31-Mar-09
2,178

586,076,161

588,175,488

586,188,289
472,050

588,727,406
2,178

586,660,339

588,729,584

584,178
-

554,096
-

584,178

554,096

585,604,111
472,050

588,173,310
2,178

586,076,161

588,175,488

63,614,705
239,852,615

48,553,378
215,972,035

954,838,619

724,305,060

1,258,305,939

988,830,473

892,327,958
29,462,230

734,678,312
24,956,098

336,515,751

229,196,063

1,258,305,939

988,830,473

441,575,680
52,634,745

297,815,970
30,831,056

6,229,141

3,666,663

738,082,100

648,182,980

1,238,521,666

980,496,669

India
II. Advances Outside India
(i) Due from Banks
(ii) Due from Others
Bills Purchased and
a) discounted
b) Syndicated Loans
c) Others

(Advances are net of provisions)

HDFC Bank Limited Annual Report 2009-10

454,412
19,329,861

469,480
7,864,324

Total Advances Outside

India

19,784,273

8,333,804

Total Advances

1,258,305,939

988,830,473

Schedules to the Accounts

As at March 31, 2010
Rs. in 000
As at
31-Mar-10

As at
31-Mar-09

7,160,665
2,735,762
(99,347)

5,243,809
1,298,061
669,230
(50,435)

9,797,080

7,160,665

1,482,660
338,370
(43,207)

815,063
356,312
318,536
(7,251)

1,777,823

1,482,660

8,019,257

5,678,005

27,792,009
5,607,003
(663,269)

18,187,640
4,906,684
5,460,218
(762,533)

32,735,743

27,792,009

16,480,946
3,605,576
(481,414)

10,865,469
2,972,979
3,271,247
(628,749)

19,605,108

16,480,946

13,130,635

11,311,063

4,613,605
(66,682)

438,277
4,175,328
-

SCHEDULE 10 - FIXED ASSETS

A. Premises (including Land)
Gross Block
At cost on 31st March of the preceding year
Additions on amalgamation
Additions during the year
Deductions during the year
Total
Depreciation
As at 31st March of the preceding year
Additions on amalgamation
Charge for the year
On deductions during the year
Total
Net Block
Other Fixed Assets (including furniture and
B. fixtures)
Gross Block
At cost on 31st March of the preceding year
Additions on amalgamation
Additions during the year
Deductions during the year
Total
Depreciation
As at 31st March of the preceding year
Additions on amalgamation
Charge for the year
On deductions during the year
Total
Net Block
C. Assets on Lease (Plant and Machinery)
Gross Block
At cost on 31st March of the preceding year
Additions on amalgamation
Additions during the year
Deductions during the year

Total

HDFC Bank Limited Annual Report 2009-10

4,546,923

4,613,605

Schedules to the Accounts

As at March 31, 2010
Rs. in
000

Depreciation
As at 31st March of the preceding year
Additions on amalgamation
Charge for the year
On deductions during the year
Total

As at
31-Mar-10

As at
31-Mar-09

4,092,927
(66,682)

117,412
3,966,210
9,305
-

4,026,245

4,092,927

442,456
-

320,865
121,591
-

442,456

442,456

78,222

78,222

21,228,114

17,067,290

14,317,388
9,918,159
254,552
5,934
1,800,000
4,110,247

14,182,607
9,064,297
310,936
5,934
3,878,934

29,145,215

36,125,606

59,551,495

63,568,314

Lease Adjustment Account

As at 31st March of the preceding year
Additions on amalgamation
Charge for the year
On deductions during the year
Total
Unamortised cost of assets on lease
Total
SCHEDULE 11 - OTHER ASSETS
I. Interest accrued
II. Advance tax (net of provision)
III. Stationery and stamps
IV. Non banking assets acquired in satisfaction of claims
V. Bond and share application money pending allotment
VI. Security deposit for commercial and residential property
VII
.
Others*
Total

*Includes deferred tax asset (net) of Rs. 843,51 lacs (previous year : Rs. 862,82 lacs)
SCHEDULE 12 - CONTINGENT LIABILITIES
I.
II.

Claims against the bank not acknowledged as debts - Taxation

Claims against the bank not acknowledged as debts - Others

III.

Liability on account of outstanding forward exchange contracts

Liability on account of outstanding derivative
contracts
Guarantees given on behalf of constituents - in
India
Acceptances, endorsements and other
obligations

IV.
V.
VI.

5,903,698
88,810

2,230,978,616

5,694,200
456,475
2,338,927,66
3
1,533,722,30
0

94,818,797

76,353,601

128,152,628

93,873,829

2,281,083,550

VII.

Other items for which the Bank is

contingently liable
Total

49,488,945

10,788,817

4,790,515,044

4,059,816,88
5

Schedules to the Accounts

For the year ended March 31, 2010
Rs. in 000

SCHEDULE 13 - INTEREST EARNED

I. Interest / discount on advances / bills
II. Income from investments
III. Interest on balance with RBI and other inter-bank funds
IV Others
Total
SCHEDULE 14 - OTHER INCOME
I. Commission, exchange and brokerage
II. Profit on sale of investments
III. Profit / (Loss) on revaluation of investments
IV. Profit on sale of building and other assets (net)
V. Profit on exchange transactions (net)
VI. Miscellaneous income
Total
SCHEDULE 15 - INTEREST EXPENDED
I. Interest on Deposits
II. Interest on RBI / Inter-bank borrowings *
III. Other interest
Total
* Includes interest on subordinated debt.
SCHEDULE 16 - OPERATING EXPENSES
I. Payments to and provisions for employees
II. Rent, taxes and lighting
III. Printing and stationery
IV. Advertisement and publicity
V. Depreciation on banks property
VI. Directors fees, allowances and expenses
VII Auditors fees and expenses
VII
I. Law charges
IX. Postage, telegram, telephone etc.
X. Repairs and maintenance

Year Ended
31-Mar-10

Year Ended
31-Mar-09

120,982,785
39,812,866
809,588
123,761

121,367,462
40,079,598
1,842,584
32,967

161,729,000

163,322,611

28,305,856
3,480,775
(30,082)
40,242
6,102,097
177,218

24,572,966
4,105,383
(279,856)
41,890
5,986,077
(1,520,425)

38,076,106

32,906,035

69,977,123
7,455,177
430,688

80,154,548
8,847,614
108,882

77,862,988

89,111,044

22,891,755
5,610,460
1,645,410
831,177
3,943,917
4,453
10,314

22,381,984
5,073,955
1,670,614
1,086,768
3,599,088
4,214
13,302

323,084
3,258,797
4,537,974

193,062
3,343,654
3,029,322

XI. Insurance
XII
.
Other Expenditure*
Total

1,610,602

1,387,532

12,976,884

13,544,563

57,644,827

55,328,058