EXERCISE ON RISK MANAGEMENT

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Neil Turner
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1 EXERCISE ON RISK MANAGEMENT Q.No.1. Details relating to an Indian Bank are furnished below: Tier 1 capital: Rs1000 crores, Tier 2 capital Rs1200 crores, Risk Weighted Assets (RWA) Rs crores Capital Charge for Market Risk Rs 500 crores, Capital Charge for Operational Risk Rs 300 crores. What would be the bank s Tier- 1 CRAR & total CRAR? Total CRAR = Capital Fund Cr.RWA + (MRWA + ORWA) MRWA = 500/9% = 500 x 100/ 9 = 5555 ORWA = 300/9% = 300 x 100/9 = 3333 CRAR = = 2000 x 100 = 10.58% Tier 1 CRAR = 1000 x 100 = 5.29% (should not be less than 6%) Q.No.2. An exposure of Rs100 lakhs is backed by an A+ Debt security of Rs 30 lakhs. The tenor of the exposure is 3 years. The residual maturity of the Debt Security is 2 years. (Haircut for the debt security is 6%) What is the Net Exposure? As the residual maturity of the collateral is less than the residual maturity of the exposure, there is Maturity mismatch. However, there is no currency mismatch. Haircut of the collateral is 30 x 6% = 1.8. Haircut adjusted collateral value is = (say C*) To determine what would be the value of the haircut-adjusted collateral after adjustment on account of maturity mismatch. = C* x (t 0.25) = x = x 1.75 = (T 0.25) Net exposure = = lakhs 1

2 Q.No.3. For an International Bank, the following details are given: (Amount Rs in crores) Paid up capital 250 Free Reserves 850 Provision for Standard Assets 200 Revaluation Reserves 300 PNCP Shares 400 Subordinated Debt 300 RWA for credit risk & operational risk RWA for Market Risk 4000 Compute the CRAR. Computation of Capital Tier 1 Tier 2 Paid up capital 250 Subordinated Debts 300 Free Reserves 850 Revaluation Reserves (45% of total) 135 PNCP Shares 400 Prov. For Std Assets (1.25% of total RWA) 225 Total Total Capital Fund = = 2160 CRAR = 2160/18000 = 12% Q.No.4. For a Cash Credit Facility, the limit sanctioned is Rs100 crores, where the outstanding balance is Rs 60 crores. A Term Loan of Rs 700 crores is sanctioned, which is to be disbursed in three different stages; i.e Rs 150 crores in the first stage, Rs 200 crores in the second and Rs 350 crores in stage 3. The outstanding balance is Rs 50 crores. Calculate the total exposure. (i) Exposure for Cash Credit: % of 40 = = 68 (ii) Exposure for Term Loan: Balance O/S % of 100 = = 70 (1 st stage 150. Already released 50, balance 100 to be released within an year) Total exposure = = Q.No.5. For an International Bank (Amount in crores) Interest earned Net Non-Interest Income 4700 Profit on sale of fixed assets 350 Cross selling Income 250 Interest Paid Operative Expenses 8800 Provisions

3 What is the Minimum Capital required for Operational Cost as per the Basic Indicator Approach? Gross Income = Net Interest Income + Net Non-Interest Income NII = ( ) = Gross Income = = Min. Capital Requirement = x 15% = Q.No.6. Calculate the Minimum Capital required for meeting Operational Risk under the Basic Indicator Approach for an Indian bank, whose relevant details are shown below: Year 1 Year 2 Year 3 Profit After Tax (PAT) Provisions for Std. Asets Sale of Fixed Assets 60 Staff Expenses Other Operative expenses Insurance Claim Received 120 Other Income Legal Claim Received 27 Gross Income = PAT + Provisions + Operative Expenses Extra Ordinary Income Year 1 = = 740 Year 2 = = 880 Year 3 = = 1254 Average = /3 = 958 Capital Charge = 958 x 15% =

4 Q.No.7 Compute the Volatility (Standard Deviation) of stocks with the following data. Month Cl stock price January 20 February 22 March 38 April 20 May 24 June 34 July 46 August 78 September 76 October 86 November 42 December 90 Month Cl.Stock Price Deviation from Mean Squared Deviation January February March April May June July August

5 September October November December Mean 576/12 = Variance = Square root of = Standard Deviation (Volatility) is Q.No.8 Calculate the BPV of the 7% Bond. Value Rs Yield % Market Price Rs Port Folio value Rs Yield % Market Price Rs Port Folio value Rs % GoI Bond % GoI Bond Market Price Change = = 2.60 Yield Change = = 0.20 (20 basis points) Basis Point Value (BPV) = 2.6/20 =

6 Q.No AAA AA+ AA A+ A BBB C Default AAA AA AA A+ A BBB C Default Based on the above table, answer the following questions. (a) What is the percentage of AAA rated borrowers who remained at the same level during the observation period? 70% (b) What is the number of AAA rated accounts at the end of the observation period? 80 (c) What is the percentage of migration of borrowers from category A to Default? 4 X100/200 = 2% (d) What is the percentage of migration of borrowers from C to Default during the period? 10 x 100/60 = 16.6% (e) How many default borrowers were there in the beginning? Nil (f) What is the percentage of migration of borrowers from AA+ to AA? 14 x 100/100 =14%

7 Q.No.10. An exposure of Rs100 lakhs is backed by financial collateral in the form of NSC of Rs 30 lakhs and eligible A+ Debt Securities of Rs 50 lakhs. The residual tenor of exposure is 3 years and the residual maturity of both the collaterals is 3 years. The weights of NSCs and A+ Debt Security in the basket of assets are 30% and 50% respectively. Based on residual maturity, hair cut applicable to NSC is 2% and that to A+ Debt Security is 6%. Compute the Net Exposure qualifying for capital adequacy. There is no maturity mismatch Haircut for combined securities: a1 H1 a 1 =Weight of the asset, H 1 = Haircut applicable to that asset Hc = (30 x 2) + (50 x 6) = = 3.60 Value of Haircut adjusted collateral = 80 x(1 3.60) = 80 x = Net Exposure = = lakhs 7

Risk Management Risk and Capital Types of Risks Transaction Level Portfolio Level Risk Measurement Based on Sensitivity Based on Volatility

Risk Management Risk and Capital Risk is possible unfavorable impact on net cash flow in future due to uncertainty of happening or nonhappening of events. Capital is a cushion or shock observer required