__BANK FINANCIAL MANAGEMENT (BFM) __

Unit - 8: Risk and Basic Risk Management Framework

Unit - 8: Risk and Basic Risk Management Framework

Credit Risk, Market Risk and Operational Risk are transaction level risk and are managed at Unit level.

Liquidity Risk and Interest Rate Risk are also transaction level risks but are managed at Portfolio level.

It is change in Market Value due to 1% change in interest rates. The interest rate gap is sensitivity of the interest rate margin of Banking book. Duration is sensitivity of Investment portfolio or Trading book.

It is common statistical measure of dispersion around the average of any random variable such as earnings, Mark-to- market values, losses due to default etc.

Example 1 : We have to find volatility of Given Stock price over a given period. Volatility may be weekly or monthly. Suppose we want to calculate weekly volatility. We will note down Stock price of nos. of weeks.

Mean Price = 123.62 and

Variance (sum of Squared deviation from mean) is 82.70

(extracted from weekly Stock prices)

Volatility i.e. sd = ∫Variance = ∫82.70 = 9.09

Daily Volatility =1.5%

Monthly Volatility = 1.5 X ∫30 = 1.5 X 5.48 = 8.22

1. Potential losses

2. Probability of Occurrence. The measure is more relied upon by banks/FIs/RBI. VaR (Value at Risk is a downside Risk Measure.)

• Necessary Capital is to be maintained as per regulatory requirements.

• Capital is raised with cost. For example there are 100 loan accounts with Level 2 Risk. It means there can be average loss of 2% on such type of loan accounts: Risk Premium of 2% will be added in Rate of Interest. Pricing includes the following:

1. Cost of Deploying funds

2. Operating Expenses

3. Loss Probabilities

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