RISK MANAGEMENT NOTES – PART 1 for 2023 EXAMS
In this post, we will be providing you revision Risk Management notes for paper of CAIIB & Diploma Course of TIRM for 2023.
As the exams are due for the Certified Associate of the Indian Institute of Bankers Exams in June 2023 & for IIBF Diploma in Treasury, Investment & Risk Management in January 2023, Learning Sessions has come up with revisionary notes for the latest attempt as per the latest prescribed Syllabus of these two IIBF Exams.
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RISK MANAGEMENT 2023 VIDEO LECTURES
Before we begin with the notes, we would like to take your attention to our latest recorded lectures of Risk Management for CAIIB & TIRM (Diploma) Courses.
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RISK MANAGEMENT UNIT 1:
COMPONENTS OF ASSETS & LIABILITIES IN THE BANK’S BALANCE SHEET & THEIR MANAGEMENT
- In ALM, goals and objectives are analyzed and developed, and actions are taken to accomplish them such as the development of long-term strategic plans, periodic profit plans, and management rate sensitivity.
- Bank assets represent the ways in which funds are used to generate revenue.
- In the Reserves and Surplus account, the share premium is included as well as the balance in the P&L account.
- Besides refinancing from the RBI, there are other forms of borrowing.
- Besides Bills Payable, Inter-office adjustments, Interest accrued, Provisions for IT, tax deductions at sources, interest taxes, and provisions, are some other liabilities.
- Short-term money market loans are those made in the interbank call money market and repayable within 15 days of the loan being made.
- Securities investments make up a major part of the Bank’s Balance Sheet.
- Cash credits, overdrafts, and loans repayable on demand are all considered loans repayable on demand, although they may have a specific due date.
- The income on Investments is earned in the form of Dividends & Interest.
- The other income may include profit from the sale of Investments &/or other assets.
- As part of Other Income, dividends from subsidiaries and joint ventures are included.
- Banks’ financial management is centered on risk management.
- As a result of deregulation, there have been a number of discriminatory pricing policies introduced, as well as the need to match maturities between assets and liabilities.
- In addition to interest rates and exchange rates, there are liquidity risks involved in the ALM.
- ASSET LIABILITY MANAGEMENT: ALM is the action of planning, acquiring & directing the flow of funds through an organization. The ultimate aim of this procedure is to generate sufficient / regular earnings & to steadily build the organization’s equity over time, while taking appropriate and calculative business risk.
- Various sources from where funds can be raised are:
- Reserves & Surpluses
- Other liabilities & Provisions
- Contingent liabilities.
- The assets side of the balance sheet of bank consists of:
- Cash & balances with RBI
- Balances with Banks & Money at Call & Short Notice
- Fixed Assets
- Other Assets.
- Reasons for growing importance of ALM are:
- Volatility due to deregulation of financial system, interest rates and price level.
- Rapid Innovation of financial products of Banks
- Requirement under the Regulatory Environment
- Increasing awareness among the Top Management.
- An organization’s ALM involves planning, acquiring, and directing the flow of funds.
- In order to implement ALM, it is necessary to understand the market area in which the bank operates.
- In balance sheet restructuring, assets and liabilities are actively managed according to their composition and mix.
- The primary management aim is the control of interest income & expenses and the resulting net interest margins on an ongoing basis.
- The justifications for growing importance of ALM are Volatility, Product Innovation, Regulatory Environment and Management Recognition.
- The Central Banks in different countries including RBI have issued framework and policies for banks to develop ALM policies.
- The parameters that are selected for the aim to stabilize ALM of banks are Net Interest Income, Net Interest Margin and Economic Equity Ratio.
- Net Interest Income equals to Interest Income – Interest Expenses. i.e. (NII = income from interest – expenses to earn interest)
- To stabilize short term profits – banks have to lower down the instabilities in NII.
- Net Interest Margin equals to ‘Net Interest Income’ divided by ‘Average Total Assets’.
- Net Interest Margin can be seen as Spread on earning assets.
- Economic Equity Ratio = Shareholders funds / Total funds.
- Price matching basically aims to maintain the spread by assuring the deployment of liabilities at a rate higher than costs.
- Liquidity is assured by grouping the assets & liabilities based on their maturing profiles.
- Rising interest will benefit when there is +ve gap i.e. Assets > Liabilities and declining interest will benefit when there is -ve gap i.e. Liabilities < Assets.
- At Macro level, ALM leads formulation of critical business policies, efficient disbursement of capital and designing of products with appropriate pricing strategies.
- At Micro level the goals of ALM are to achieve profitability by price matching and by ensuring liquidity through maturity matching.
- The other assets of a Bank include Inter-office adjustments, Interest accrued, advance Tax paid/TDS, Stationary, and stamps, non-Banking assets acquired in fulfillment of claims and other items i.e. clearing items, unadjusted debit balances, and advances provided to the employees.
- Contingent Liabilities includes:
- Claims against the bank which have not been acknowledged as debt,
- liability for partly paid investments,
- liability on forward exchange contracts and
- other items such as arrears of cumulative dividends, bills rediscounted, underwriting, Commitments, estimated amount of contracts remaining to be executed on capital account and not provided for etc.
- An effective ALM technique aims to handle the volume, maturity, mix, quality, rate sensitivity, and liquidity of assets & liabilities as a whole so as to attain a predetermined permissible risk / reward ratio.
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