A REPORT ON RISK MANAGEMENT IN HDFC BANK

Submitted in partial fulfillment of degree of Master of Business Administration Session (2011-13)

Under Supervision of:

Mrs. Sudesh Miss. Meenakshi (Assistant Professor)

Submitted by:
Lovely Thakral Roll No. - 15 MBA(Hons.) Final

UNIVERSITY SCHOOL OF MANAGEMENT, KURUKSHETRA UNIVERSITY, KURUKSHETRA

DECLARATION
I, LOVELY THAKRAL hereby solemnly declare that my work

entitled RISK MANAGEMENT IN HDFC BANK in partial fulfillment for the award of degree of Masters of Business Administration (MBA) submitted in the university school of management, kurukshetra, is my original work. The information and data given in the report is authentic to the best of my knowledge.

(LOVELY THAKRAL)

ACKNOWLEDGEMENT
I have taken efforts in this project. However, it would not have been possible without the kind support and help of many individuals and organizations. I would like to extend my sincere thanks to all of them. I am highly indebted to Mr. Kapil Gambhir for their guidance and constant supervisionS as well as for providing necessary information regarding the project & also for their support in completing the project. I would like to express my gratitude towards MR. NARESH, Chairman of USM Kurukshetra University, kurukshetra for their kind co-operation and encouragement which help me in completion of this project. I would like to express my special gratitude and thanks to Mrs. Sudesh and Miss Meenakshi(Assistant Professor) for giving me such attention and time. My thanks and appreciations also go to my colleague in developing the project and people who have willingly helped me out with their abilities.

(LOVELY THAKRAL)

TABLE OF CONTENTS DECLARATION CERTIFICATE ACKNOWLEDGEMENT CONTENTS INTRODUCTION

(a) About Bank (b) About Risk Management

PAGE NO.

6-16 17-36 37-44 45-48 49-59

REVIEW OF LITERATURE RESEARCH METHODOLOGY ANALYSIS AND INTERPRETATION OF DATA CONCLUSION, FINDINGS AND SUGGESTIONS BIBLIOGRAPHY ANNEXURE

60-62

63-64 65-67

CHAPTER-1 INTRODUCTION

Introduction of Bank
Banking Means "Accepting Deposits for the purpose of lending or Investment of deposits of money from the public, repayable on demand or otherwise and withdraw by cheque, draft or otherwise." -Banking Companies (Regulation) Act,1949 A bank is a financial institution that serves as a financial intermediary. A well organized and efficient banking system is a pre-requisite for economic growth. Banks play an important role in the functioning of organized money market. In order to meet the banking needs of various sections of the society, a large network of bank branches has been established. The term "bank" may refer to one of several related types of entities: A CENTRAL BANK circulates money on behalf of a government and acts as its monetary authority by implementing monetary policy, which regulates the money supply. A COMMERCIAL BANK accepts deposits and pools those funds to provide credit, either directly by lending, or indirectly by investing through the capital markets. Within the global financial markets, these institutions connect market participants with capital deficits (borrowers) to market participants with capital surpluses (investors and lenders) by transferring funds from those parties who have surplus funds to invest (financial assets) to those parties who borrow funds to invest in real assets. A SAVING BANK (known as a "building society" in the United Kingdom) is

similar to a savings and loan association (S&L). They can either be stockholder owned or mutually owned, in which case they are permitted to only borrow from members of the financial cooperative. The asset structure of savings banks and savings and loan associations is similar, with residential mortgage loans providing the principal assets of the institution's portfolio.

Principal Enactment of Banking Functions:

There is an elaborate framework governing the functioning of banks in India. The principal enactment of which governs the functioning of various banks are as under: Banking Regulation Act 1949 State Bank of India Act, 1955 Regional Rural Bank Act, 1976 Companies Act, 1956 Co- operative Societies Act, 1912 or the relevant state Co-operative societies Act

Besides the above enactment the provisions of Reserve Bank of India Act, 1934 also effect the functioning of banks. The Act gives wide powers to Reserve Bank of India to give directions to banks; such directions also have considerable effect on the functioning of banks.

BANKING ACTIVITIES:
Bank activities can be divided in to several parts. RETAIL BANKING, dealing directly with individuals and small businesses. BUSINESS BANKING: providing services to mid-market business; corporate banking, directed at large business entities. PRIVATE BANKING, providing wealth management services to high net worth individuals and families. INVESTMENT BANKING, relating to activities on the financial markets. Indian banking system, over the years has gone through various phases after establishment of Reserve Bank of India in 1935 during the British rule, to function as Central Bank of the country. Earlier to creation of RBI, the central bank functions were being looked after by the Imperial Bank of India. With the 5-year plan having acquired an important place after the independence, the Govt. felt that the private banks may not extend the kind of cooperation in providing credit support, the economy may need. In 1954 the All India

Rural Credit Survey Committee submitted its report recommending creation of a strong, integrated, State-sponsored, State-partnered commercial banking institution with an effective machinery of branches spread all over the country. The recommendations of this committee led to establishment of first Public Sector Bank in the name of State Bank of India on July 01, 1955 by acquiring the substantial part of share capital by RBI, of the then Imperial Bank of India. Similarly during 1956-59, as a result of re-organization of princely States, the associate banks came into fold of public sector banking. Another evaluation of the banking in India was undertaken during 1966 as the private banks were still not extending the required support in the form of credit disbursal, more particularly to the unorganized sector. Each leading industrial house in the country at that time was closely associated with the promotion and control of one or more banking companies. The bulk of the deposits collected, were being deployed in organized sectors of industry and trade, while the farmers, small entrepreneurs, transporters, professionals and self-employed had to depend on money lenders who used to exploit them by charging higher interest rates. In February 1966, a Scheme of Social Control was set-up whose main function was to periodically assess the demand for bank credit from various sectors of the economy to determine the priorities for grant of loans and advances so as to ensure optimum and efficient utilization of resources. The scheme however, did not provide any remedy. Though a no. of branches were opened in rural area but the lending activities of the private banks were not oriented towards meeting the credit requirements of the priority/weaker sectors. On July 19, 1969, the Govt. promulgated Banking Companies (Acquisition and Transfer of Undertakings) Ordinance 1969 to acquire 14 bigger commercial bank with paid up capital of Rs.28.50 cr, deposits of Rs.2629 cr, loans of Rs.1813 cr and with 4134 branches accounting for 80% of advances. Subsequently in 1980, 6 more banks were nationalized which brought 91% of the deposits and 84% of the advances in Public Sector Banking. During December 1969, RBI introduced the Lead Bank Scheme on the recommendations of FK Narasimham Committee. Meanwhile, during 1962 Deposit Insurance Corporation was established to provide insurance cover to the depositors. In the post-nationalization period, there was substantial

increase in the no. of branches opened in rural/semi-urban centers bringing down the population per bank branch to 12000 appx. During 1976, RRBs were established (on the recommendations of M. Narasimham Committee report) under the sponsorship and support of public sector banks as the 3rd component of multi-agency credit system for agriculture and rural development. The Service Area Approach was introduced during 1989. While the 1970s and 1980s saw the high growth rate of branch banking net-work, the consolidation phase started in late 80s and more particularly during early 90s, with the submission of report by the Narasimham Committee on Reforms in Financial Services Sector during 1991. Currently banking in India is generally fairly mature in terms of supply, product range and reach-even though reach in rural India still remains a challenge for the private sector and foreign banks. In terms of quality of assets and capital adequacy, Indian banks are considered to have clean, strong and transparent balance sheets relative to other banks in comparable economies in its region. The Reserve Bank of India is an autonomous body, with minimal pressure from the government. The stated policy of the Bank on the Indian Rupee is to manage volatility but without any fixed exchange rate-and this has mostly been true. Today, while financial market throughout the world is in the process of integrating, major challenges for banks are absorption through adequate capital funds. The need of the hour is to manage the risks, both the micro and macro level. Lack of availability of data & lack of ability to use the available data is the largest obstacles to risk management in banks. The other challenge for implementing risk management is scarcity of trained & skilled manpower and board of directors inability the risk appetite for the banks.

MAJOR DEVELOPMENTS IN BANKING

As we very well know, banking has now become a global activity and a global issue. In the last decades of the 20th cent., computer technology transformed the banking industry. The wide distribution of automated teller machines (ATMs) by the mid-1980s gave customers 24-hour access to cash and account information. On-line banking through the Internet and banking through automated phone systems now allow for electronic payment of bills, money transfers, and loan applications without entering a bank branch.

The RBI allowed resident Indians to maintain foreign currency accounts. The accounts to be known as resident foreign currency (domestic) accounts, can be used to park for ex received while visiting any place abroad by way of payment for services, or money received from any person not resident in India, or who is on a visit to India, in settlement of any lawful obligations. These accounts will be maintained in the form of current accounts with a cheque facility and no interest is paid on these accounts

HOUSING DEVELOPMENT FINANCE CORPORATION (HDFC BANK)

INTRODUCTION
The housing development finance corporation limited (HDFC) was amongst the first to receive an"in-principle" approval from the reserve bank of India (RBI) to set up a bank in the private sector, as part of RBI liberalization of Indian banking industry in 1994. The bank was in corporate in Aug. 1994 in the name of HDFC Bank Ltd. With its registered office in Mumbai, India, HDFC Bank commenced operations as scheduled commercial bank in January 1995. PROMOTOR HDFC is India's premier housing finance company and enjoys an impeccable track record in India as well as in international markets. Since its inception in 1997, the corporation has maintained a consistent and healthy growth in its operations to remain a market leader in mortgage. Its outstanding loan portfolio covers well over a million dwelling units. HDFC has developed significant expertise in retail mortgage loans to different market segments and also has a large corporate client base for its housing related credit facilities. With its experience in the financial markets, a strong franchise, HDFC was ideally positioned to promote a bank in the Indian environment.

BUSINESS FOCUS HDFC bank's mission is to be a world class Indian bank. The bank has aim to build sound customer franchises across district business so as to be the prefer provider of banking services in the segment that the bank operates in and to achieve healthy growth in profitability, consistent with the bank's risk appetite. The bank is committed to maintain the highest level of ethical standards, professional integrity and regulatory compliance. HDFC bank's business philosophy is based on four core values: 1. 2. 3. 4. Operational Excellence Customer Focus Product Leadership People.

CAPITAL STRUCTURE As on 31st March, 2012 the authorized share capital of the Bank is Rs. 550 crore. The paid-up capital as on the said date is Rs. 469,33,76,540 (234,66,88,270 equity shares of Rs. 2/- each).

TIMES BANKS AMALGAMATION In a mile stone transaction in Indian banking industry, Times bank limited (another new private sector bank promoted by Bennett, Coleman & Co. times group) was merged with HDFC bank ltd., effective February 26, 2000. As per the scheme of amalgamation approved by the share holders of both banks and Reserve bank of India. DISTRIBUTION NETWORK HDFC bank has its Headqarters in Mumbai. The bank at present has an enviable network of 2544branches spread over 1399 cities across the country. All branches are linked on an online real time basis. The banks expansion plans take into account the need to have a presence in all major industrial and commercial centers where its

corporate customers are located as well as the need to build a strong retail customer base for both deposits and loans products. Being a clearing settlement bank to various leading stock exchanges, the bank has branches in centers where the NSE/BSE have a strong and active member base. The bank also have a network of 8913ATM's across India. TECHNOLOGY HDFC bank operates in a highly automated environment in terms of information technology and communication systems. All the bank's branches have connectivity which enables the bank to offer speedy funds transfer facility to its customers. Multi branch access is also provided to retail customers through the branch network and automated teller machines (ATMs) The bank has made substantial efforts and investments in acquiring the best technology available internationally to build the infrastructure for a world class bank has prioritized its engagement in technology and the internet as one of its key goals and has already made significant progress in web enabling its core business. In each office its business, the Bank has succeeded in leveraging its market position, expertise and technology to create a competitive advantage and build market share.

BUSINESS PROFILE
HDFC Bank caters to wide range of banking services covering both commercial and investment banking on the wholesale side and transactional branch banking on the retail side. The bank three key business areas 1. WHOLESALE BANKING SERVICES The Bank's target is primary large blue-chip manufacturing companies in the Indian corporate sector and to a lesser extent, emerging mid sized corporate. For these corporate the Bank provides a wide range of commercial and transactional Banking services including working capital finance trade services, transactional services,

cash management etc. The Bank is also a leading provider of structure solution which combine cash management services with vendors and distributor finance for facilitating superior supply chain management for its corporate customers. Based on its superior product delivery service levels and strong customer orientation, the Bank has made significant in roads into the Banking consortia of a number of leading India corporate including Multinationals, Companies from the domestic business house and prime public sector companies. It is recognized as a leading provider of cash management and transactional Banking solutions to corporate customers, Mutual Funds, Stock Exchange Members and Bank. 2. RETAIL BANKING SERVICES: The objective of retail bank is to provide its target market customer a full range of financial products and banking service, giving the customer a one-stop window for all his/her banking requirements. The products are backed by world-class services and delivered to the customers through the growing branch network as well as though alternative delivery channels like ATMs, phone banking, net banking and mobile banking. The HDFC bank preferred programs for high net worth individuals, the HDFC bank plus and the investment advisory services program have been designed keeping in mind heads of customers who seek distinct financial solutions information and advice on various investment avenues. The also had a wide array of retail ban products including auto loans, loans against marketable securities, personal loans and loans for two wheelers. It is also a leading provider of depository service to retail customers offering customers the facility to hold their investments in electronic form. HDFC Bank was the first bank in India to launch an international debit card in association with VISA ( Visa election) and issue the master card Maestro debit card as well. The debit card allows the use to directly debit his account at the point of purchase at a merchant establishment, in India and overseas. The bank launch its credit card in association with VISA in November 2002. The bank is also one of the leading players in the "merchant acquiring" business with 26,400 point of sale (pos) terminals for debit/credit cards acceptance at merchant establishments. The bank is well positioned as a leader in various net

based B2C opportunities including a wide range of interest banking services for fixed deposit, loans, bill payments etc.

3.

TREASURY OPERATIONS Within this business the bank has three main product areas foreign exchange and derivative, local currency, money market & debt securities and equities. With the liberalization of the financial market in India, corporate need more sophisticated risk management information advice and product structure. These and find pricing on various treasury product are provided through the bank treasury team.

AWARDS AND ACHIVEMENTS-:

2012

Forbes Asia

Fab 50 Companies - Winning for the 6th year

IBA Banking - Best Online Bank Technology Awards - Best use of Business Intelligence 2011 - Best Customer Relationship Initiative - Best Risk Management & Security Initiative - Best use of Mobility Technology in Banking Dun & Bradstreet Banking Awards 2012 IDRBT Banking Technology Excellence Awards 2011-12 Asia Money 2012 - Overall Best Bank - Best Private Sector Bank - Asset Quality - Private Sector - Retail Banking -Private Sector Best Bank in 'IT for Operational Effectiveness' category

Best Domestic Bank in India

India's Top 500 Best Bank in India Companies -Dun & Bradstreet Corporate Awards OFinance Asia - Best Managed Company - Best CEO - Mr. Aditya Puri

UTI Mutual Fund CNBC TV 18 Financial Advisor Awards 2011

- Best Performing Bank - Private

Asian Banker - Best Retail Bank in India International - Best Bancassurance Excellence in Retail - Best Risk Management Financial Services Awards 2012 5th Loyalty Summit Customer and Brand Loyalty award Skoch foundation 2012 ICAI Awards 2011 SHG/JLG linkage programme Excellence in Financial Reporting

SWOT ANALYSIS
STRENGHTS : The Bank has a strong retail depository base & has more than million customers. Bank boasts of a strong brand equity. ISO 9001 certification for its depository & custody operations & for its backend processing of retail operation & direct banking operatiosn. The bank has a near competitive edge in area of operations. The bank has a market leader in cash settlement service for the major stock exchanges in its country. HDFC Bank is one of the largest private sector bank working in India. It has a highly automated environment in terms of information technology & communication system. Infrastructure is best.

It has many innovative products like kids Advantage scheme, NRI services.

WEAKNESS : Some gaps in range for certain sectors. Customer service staff need training. Processes and systems, etc Management cover insufficient. Sectoral growth is constrained by low unemployment levels and competition for staff Account opening and delivery of cheque book take comparatively more time. Lack of availability of different credit products like CC Limit, Bill discounting Facilities. OPPORTUNITY : Branch expansion Door step services Greater liberalization in foreign ownership via FDI in Indian Pvt. Sector Banks. CC/ OF Facilities. Infrastructure improvements & better systems for trading & settlement in the govt. securities & foreign exchange markets. THREATS: The bank has started facing competition from players like SBI, PNB Bank in the finance market itself. This reduce the profit margins in the future. Some Pvt. Banks have 7 days banking.

INTRODUCTION OF RISK MANAGEMENT

Risk an unwanted event which may or may not occur. Risk the fact that a decision is made under conditions of known probabilities. i.e probability of an unwanted event which may or may not occur . Risks are to be judged according to probability-weighted averages of the severity of their outcomes. Risk is the potential that a chosen action or activity will lead to a loss. . Risk provides the basis for opportunity. Risk arises as a result of exposure. Financial ma rk et exposure may provide strategic or competitive benefits. Risk is the likelihood of losses resulting from events such as changes in market prices. Since it is not always t o eliminate risk, understanding it is an important step in determining how to manage it. Identifying exposures and risks forms the basis for an appropriate financial risk management strategy In financial term risk are of two type the first is systemic risk and other is non-systemic risk, if risk can be defined in one word , it would be volatile. Risk can be traced to the Latin word Rescum meaning Risk at Sea or that which cuts. Risk is associated with uncertainty and reflected by way of charge on the fundamental/ basic i.e. in the case of business it is the Capital, which is the cushion that protects the liability holders of an institution. These risks are inter-dependent and events affecting one area of risk can have ramifications and penetrations for a range of other categories of risks. Business is the art of extracting money from others pocket, sans resorting to violence. But profiting in business without exposing to risk is like trying to live without being born. Everyone knows that risk taking is failure prone as otherwise it would be treated as sure taking. Hence risk is inherent in any walk of life in general and in financial sectors in particular. Of late, banks have grown from being a financial intermediary into a risk intermediary at present. In the process of financial intermediation, the gap of which becomes thinner and thinner, banks are exposed to severe competition and hence are compelled to encounter various types of financial and non-financial risks. Risks and uncertainties form an integral part of banking which by nature entails taking risks. Business grows mainly by taking risk. Greater the risk, higher the profit and hence the business unit must strike a trade off between the two. The essential functions of risk management are to identify, measure and more importantly monitor the profile of the bank. While NonPerforming Assets are the legacy of the past in the present, Risk Management system the pro-active action in the present for the future. is

Risk is an opportunity as well as a threat, and has different meanings for different users. The banking industry is exposed to different risks such as forex volatility risk, variable interest rate risk, market play risk, operational risk, and credit risk. Risk manifest themselves in many ways and the risks in banking are a result of many diverse activities, executed from many locations and by numerous people. As financial intermediary, banks borrow funds and lend them as a part of their primary activity. This intermediation activity of banks exposes them to a host of risks. The volatility in the operating environment of banks will aggravate the effect of the various risks Today, while financial market throughout the world is in the process of integrating, major challenges for banks are absorption through adequate capital funds. The need of the hour is to manage the risks, both the micro and macro level. Lack of availability of data & lack of ability to use the available data is the largest obstacles to risk management in banks. The other challenge for implementing risk management is scarcity of trained & skilled manpower and board of directors inability the risk appetite for the banks. The art of managing risk is more challenging than ever. Risk managers face a wide range of demands, from working with multiple variables to finding technology solutions that generate comprehensive risk analysis real time to access to accurate, updated market information is a critical component in the process. Even more critical is that a highly flexible and parameterizable framework that can quickly; integrate into a companys existing infrastructure. Over the past decade or so the markets have seen once debacle after another, each of which has brought its own set of lessons from some of which the markets market still need to learn. Enterprise risk management is about optimizing the process with which risks are taken and managed. Risk management is the identification, assessment, and prioritization of risks followed by coordinated and economical application of resources to minimize, monitor, and control the probability and/or impact of unfortunate events or to maximize the realization of opportunities. Risk management is the practice of creating economic value in a firm by using financial instruments to manage exposure to risk, particularly credit risk and market risk. Other types include Foreign exchange, Shape, Volatility, Sector, Liquidity, Inflation risks, etc. Similar to general risk management, financial risk management requires

identifying its sources, measuring it, and plans to address them. In general, the process of risk management can be summarized as follows: Identify and prioritize key financial risks. Determine an appropriate level of risk tolerance. Implement risk management strategy in accordance with policy. Measure, report, monitor, and refine as needed.

Risk Analysis and Risk Management has got much importance in the Indian Economy during this liberalization period. The foremost among the challenges faced by the banking sector today is the challenge of understanding and managing the risk. The very nature of the banking business is having the threat of risk imbibed in it. Banks' main role is intermediation between those having resources and those requiring resources. For management of risk at corporate level, various risks like credit risk, market risk or operational risk have to be converted into one composite measure. Therefore, it is necessary that measurement of operational risk should be in tandem with other measurements of credit and market risk so that the requisite composite estimate can be worked out and RBI guidelines the investigation of risk analysis and risk management in Co-Op banks is being most important. Risk Analysis, in a broad sense, is any method qualitative and/or quantitative for assessing the impacts of risk on decisions.. The goal of any of these methods is to help the decision-maker choose a course of action, given a better understanding of the possible outcomes that could occur.

Classification Of Risk
Systematic risk Unsystematic risk

SYSTEMATIC RISK is the risk associated with market return. This is the risk to the value of an investment portfolio that cannot be attributed to the specific risk of an individual investment. Sources of systematic risk would be macroeconomic factors such as inflation, changes in interest rate, flucation in currencies , recession , wars , etc. that effect

the whole market. Systemic risk, also called market risk or un-diversifiable risk, is a risk of security that cannot be reduced through diversification. Participants in the market, like hedge funds, can be the source of an increase in systemic risk and transfer of risk to them may, paradoxically, increase the exposure to systemic risk.

Systemic Risk can be classified into three broad categories: Liquidity risk Credit risk Interest rate risk

UNSYSTEMATIC RISK, sometimes called specific risk, idiosyncratic risk, residual risk, or diversifiable risk, is the company-specific or industry-specific risk in a portfolio, which is uncorrelated with aggregate market returns. The risk that is specific to an industry or firm. Examples of unsystematic risk include losses caused by labor problems, nationalization of assets, or weather conditions. This type of risk can be reduced by assembling a portfolio with significant diversification so that a single event affects only a limited number of the assets.

SIGNIFICANT RISK IN BANK

Banks have been described as being in the business of managing risks. Bank risks may be categorised in a number of ways. One view is that bank risks fall into four main categories: credit risk , market risk, interest rate risk and liquidity risk.

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.

Components of credit risk management

A typical Credit risk management framework in a financial institution may be broadly categorized into following main components. a) Board and senior Managements Oversight b) Organizational structure c) Systems and procedures for identification, acceptance, measurement, monitoring and control risks. The very first purpose of banks credit strategy is to determine the risk appetite of the bank. Once it is determined the bank could develop a plan to optimize return while keeping credit risk within predetermined limits. The banks credit risk strategy thus should spell out a) The institutions plan to grant credit based on various client segments and products, economic sectors, geographical location, currency and maturity b) Target market within each lending segment, preferred level of diversification/concentration. c) Pricing strategy.

Systems and Procedures

Credit Origination. Banks must operate within a sound and well-defined criteria for new credits as well as the expansion of existing credits. Credits should be extended within the target markets and lending strategy of the institution. Before allowing a credit facility, the bank must make an assessment of risk profile of the customer/transaction. This may include a) Credit assessment of the borrowers industry, and macro economic factors. b) The purpose of credit and source of repayment. c) The track record / repayment history of borrower. d) Assess/evaluate the repayment capacity of the borrower. e) The Proposed terms and conditions and covenants. In case of new relationships consideration should be given to the integrity and repute of the borrowers or counter party as well as its legal capacity to assume the liability. Prior to entering into any new credit relationship the banks must become familiar with the borrower or counter party and be confident that they are dealing with individual or organization of sound repute and credit worthiness. However, a bank must not grant credit simply on the

basis of the fact that the borrower is perceived to be highly reputable i.e. name lending should be discouraged.

Limit setting
An important element of credit risk management is to establish exposure limits for single obligors and group of connected obligors. Institutions are expected to develop their own limit structure while remaining within the exposure limits set by State Bank of Pakistan. The size of the limits should be be set on the credit strength of the obligor, genuine requirement of credit, economic conditions and the institutions risk tolerance. 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: a. 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. Outstanding documents should be tracked and followed up to ensure execution and receipt. b. 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. c. 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. d. 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.

e. 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. It need not mention that information should be filed in organized way so that external / internal auditors or SBP inspector could review it easily. f. 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.

Credit Risk Monitoring & Control

Credit risk monitoring refers to incessant monitoring of individual credits inclusive of OffBalance 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. provide procedural guideline relating to credit risk monitoring. At the minimum it should lay down procedure relating to:a) The roles and responsibilities of individuals responsible for credit risk monitoring b) The assessment procedures and analysis techniques (for individual loans & overall portfolio) c) The frequency of monitoring d) The periodic examination of collaterals and loan covenants f) The identification of any deterioration in any loan Given below are some key indicators that depict the credit quality of a loan: a. Financial Position and Business Conditions. The most important aspect about an obligor is its financial health, as it would determine its repayment capacity. Consequently institutions need carefully watch financial standing of obligor. The Key financial performance indicators on profitability, equity, leverage and liquidity should be analyzed.

While making such analysis due consideration should be given to business/industry risk, borrowers position within the industry and external factors such as economic condition, government policies, regulations. For companies whose financial position is dependent on key management personnel and/or shareholders, for example, in small and medium enterprises, institutions would need to pay particular attention to the assessment of the capability and capacity of the management/shareholder(s). b. Conduct of Accounts. In case of existing obligor the operation in the account would give a fair idea about the quality of credit facility. Institutions should monitor the obligors account activity, repayment history and instances of excesses over credit limits. For trade financing, institutions should monitor cases of repeat extensions of due dates for trust receipts and bills. c. Loan Covenants. The obligors ability to adhere to negative pledges and financial covenants stated in the loan agreement should be assessed, and any breach detected should be addressed promptly.

Liquidity risk :In banking, liquidity is the ability to meet obligations when they come due without incurring unacceptable losses. Managing liquidity is a daily process requiring bankers to monitor and project cash flows to ensure adequate liquidity is maintained. Maintaining a balance between short-term assets and short-term liabilities is critical. For an individual bank, clients' deposits are its primary The investment portfolio represents a smaller portion of assets, and serves as the primary source of liquidity. 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.

Early Warning indicators of liquidity risk.

An incipient liquidity problem may initially reveal in the bank's financial monitoring system as a downward trend with potential long-term consequences for earnings or capital. Given below are some early warning indicators that not necessarily always lead to liquidity problem for a bank; however these have potential to ignite such a problem. Consequently management needs to watch carefully such indicators and exercise further scrutiny/analysis wherever it deems appropriate. Examples of such internal indicators are: a) A negative trend or significantly increased risk in any area or product line. b) Concentrations in either assets or liabilities. c) Deterioration in quality of credit portfolio. d) A decline in earnings performance or projections. e) Rapid asset growth funded by volatile large deposit.

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 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. 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. 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; Contingency plan for handling liquidity crises.

Liquidity Risk Measurement and Monitoring

An effective measurement and monitoring system is essential for adequate management of liquidity risk. Consequently banks should institute systems that enable them to capture liquidity risk ahead of time, so that appropriate remedial measures could be prompted to avoid any significant losses. It needs not mention that banks vary in relation to their liquidity risk (depending upon their size and complexity of business) and require liquidity risk measurement techniques accordingly. For instance banks having large networks may have access to low cost stable deposit, while small banks have significant reliance on large size institution deposits. However, abundant liquidity does not obviate the need for a mechanism to measure and monitor liquidity profile of the bank. An effective liquidity risk measurement and monitoring system not only helps in managing liquidity in times of crisis but also optimize return through efficient utilization of available funds Contingency Funding Plans In order to develop a comprehensive liquidity risk management framework, institutions should have way out plans for stress scenarios. Such a plan commonly known as Contingency Funding Plan (CFP) is a set of policies and procedures that serves as a blue

print for a bank to meet its funding needs in a timely manner and at a reasonable cost. A CFP is a projection of future cash flows and funding sources of a bank under market scenarios including aggressive asset growth or rapid liability erosion. To be effective it is important that a CFP should represent managements best estimate of balance sheet changes that may result from a liquidity or credit event. A CFP can provide a useful framework for managing liquidity risk both short term and in the long term. Further it helps ensure that a financial institution can prudently and efficiently manage routine and extraordinary fluctuations in liquidity. The scope of the CFP is discussed in more detail below. Use of CFP for Routine Liquidity Management For day-to-day liquidity risk management integration of liquidity scenario will ensure that the bank is best prepared to respond to an unexpected problem. In this sense, a CFP is an extension of ongoing liquidity management and formalizes the objectives of liquidity management by ensuring: a) A reasonable amount of liquid assets are maintained. b) Measurement and projection of funding requirements during various scenarios. c) Management of access to funding sources.

Interest rate risk:Interest rate risk is the exposure of a bank's financial condition to adverse movements in interest rates. Accepting this risk is a normal part of banking and can be an important source of profitability and shareholder value. However, excessive interest rate risk can pose a significant threat to a bank's earnings and capital base. Changes in interest rates affect a bank's earnings by changing its net interest income and the level of other interest-sensitive income and operating expenses. Changes in interest rates also affect the underlying value of the bank's assets, liabilities and off-balance sheet instruments because the present value of future cash flows (and in some cases, the cash flows themselves) change when interest rates change. Accordingly, an effective risk management process that maintains interest rate risk within prudent levels is essential to the safety and soundness of banks. FACTORS THAT INFLUENCE INTEREST RATES

Interest rate levels are in essence determined by the laws of supply and demand. In an economic environment in which demand for loans is high, lending institutions are able to command more lucrative lending arrangements. Conversely, when banks and other institutions find that the market for loans is a tepid one (or worse), interest rates are typically lowered accordingly to encourage businesses and individuals to take out loans. Another key factor in determining interest rates is the lending agency's confidence that the moneyand the interest on that moneywill be paid in full and in a timely fashion. Default risk encompasses a wide range of circumstances, from borrowers who completely fail to fulfill their obligations to those that are merely late with a scheduled payment. If lenders are uncertain about the borrower's ability to adhere to the specifications of the loan arrangement, they will often demand a higher rate of return or risk premium. Borrowers with an established credit history, on the other hand, qualify for what is known as the prime interest rate, which is a low interest rate.

Reasons why banks increase the interest rates.

1. Increase savings, which will reduce bankruptcies and foreclosure:- Many bankruptcies and foreclosures could be avoided if individuals and businesses had an adequate savings account to buffer them during times like this. 2. Increase value of the dollar, which will reduce inflation that is just around the corner:-The massive amount of money ($5 trillion) that has been added in the last year is making its way through the market and when its gets to the people, it will create a massive wave of inflation. Higher interest rates would help to reduce spending, which will reduce inflating prices as more people bid for items that are in short supply. 3. Increase bank deposits so banks can lend money to small businesses whom can in turn create new jobs:-Banks need money, but not printed money that will lead to inflation. They need real money that has been saved by the productivity of workers. The increase in bank deposits will help banks lend money to the wave of small businesses that are going to spring up and will be the biggest creators of new jobs. 4. Increase the rate of failed business models to clear the system:-New businesses that have a chance at creating new jobs by building new products at a profit need the old businesses to fail. Higher interest rates will force businesses that are no longer viable in the market to fold quicker, which will help get them out of the marketplace so that their

workers (employees) and capital (bank loans) can be freed up to be used by new and growing businesses. This is what capitalism is best at doing, but the government is interfering in the process. 5. Increase the motivation of entrepreneurs to go after opportunities:-Entrepreneurs are in high demand to rebuild the economy by going after new ideas to produce profitable products and build a business of lasting value and wealth. Low interest rates cheapen the value of money and therefore reduce the value of hard work to produce long-term wealth. What good is it to work-hard to gain money when it has little value in putting it to work for you? Interest rate risks can be categorized in different ways, and there is usually some overlap between categories. One approachthat is well suited for a book-value perspectiveis to break interest rate risk into three components: Term structure risk, Basis risk, Options risk.

Term structure risk is risk due to changes in the fixed income term structure. It arises
if interest rates are fixed on liabilities for periods that differ from those on offsetting assets. One reason may be maturity mismatches. Suppose an insurance company is earning 6% on an asset supporting a liability on which it is paying 4%. The asset matures in two years while the liability matures in ten. In two years, the firm will have to reinvest the proceeds from the asset. If interest rates fall, it could end up reinvesting at 3%. For the remaining eight years, it would earn 3% on the new asset while continuing to pay 4% on the original liability. Term structure risk also occurs with floating rate assets or liabilities. If fixed rate assets are financed with floating rate liabilities, the rate payable on the liabilities may rise while the rate earned on the assets remains constant. In general, any occasion on which interest rates are to be reseteither due to maturities or floating rate resets is called are pricing. The date on which it occurs is called the reprising date. It is this terminology that motivates the alternative name "reprising risk" for tem structure risk. If a portfolio has assets reprising earlier than liabilities, it is said to be asset sensitive. This is because near term changes in earnings are going to be driven by interest rate resets on those assets.

Similarly, if liabilities reprise earlier, earnings are more exposed to interest rate resets on those liability, and the portfolio is called liability sensitive. Basis risk is risk due to possible changes in spreads. In fixed income markets, basis risk arises form changes in the relationship between interest rates for different market sectors. If a bank makes loans at prime while financing those loans at Libor, it is exposed to the risk that the spread between prime and Libor may narrow. If a portfolio holds junk bonds hedged with short Treasury futures, it is exposed to basis risk due to possible changes in the yield spread of junk bonds over Treasuries. Basis risk is another name for spread risk. Options risk, as a component of interest rate risk, is risk due to fixed income options options that have fixed income instruments or interest rates as underlies. Options may be stand-alone, such as caps or swaptions. They may also be embedded, as with the call feature of callable bonds or the prepayment of mortgage-baked securities (MBS). In some respects, options risk is just another component of term structure risk. This argument needs to be explored differently for the book value and market value perspectives.

Yield curve risk:

Reprising mismatches can also expose a bank to changes in the slope and shape of the yield curve. Yield curve risk arises when unanticipated shifts of the yield curve have adverse effects on a bank's income or underlying economic value. For instance, the underlying economic value of a long position in 10-year government bonds hedged by a short position in 5-year government notes could decline sharply if the yield curve steepens, even if the position is hedged against parallel movements in the yield curve. A line that plots the interest rates, at a set point in time, of bonds having equal credit quality, but differing maturity dates. The most frequently reported yield curve compares the threemonth, two-year, five-year and 30-year U.S. Treasury debt. This yield curve is used as a

benchmark for other debt in the market, such as mortgage rates or bank lending rates. The curve is also used to predict changes in economic output and growth.

. If the yield curve steepens, this means that the spread between long- and short-term interest rates increases. Therefore, long-term bond prices will decrease relative to shortterm bonds. Changes in the yield curve are based on bond risk premiums and expectations of future interest rates. 'Flat Yield Curve':- A yield curve in which there is little difference between short-term and long-term rates for bonds of the same credit quality. This type of yield curve is often seen during transitions between normal and inverted curves. 'Inverted Yield Curve':-An interest rate environment in which long-term debt instruments have a lower yield than short-term debt instruments of the same credit quality. This type of yield curve is the rarest of the three main curve types and is considered to be a predictor of economic recession.

Partial inversion occurs when only some of the short-term Treasuries (five or 10 years) have higher yields than the 30-year Treasuries do. An inverted yield curve is sometimes referred to as a "negative yield curve".

Instruments for Quantifying Interest Rate Risks

As for measuring interest rate risk in the banking book, there are many techniques and processes available that differ from each other in terms of complexity and accuracy. In this respect, the following principle applies: the larger and more complex interest rate risks in the banking book are, the more advanced the risk measurement and management processes of the credit institution concerned should be. Both earnings measures refl ecting net interest income earned in the given reporting period (earnings perspective) and net interest income measures for a given point in time such as the economic value of capital (or of the interest rate book)63 (economic value perspective) can be used as target measures for risk analysis.

Gap Analysis
Gap analysis refers to the allocation of interest-sensitive assets and liabilities, including off balance sheet (OBS) positions, to a number of predefined time bands64 according to maturity (fi xed rate assets) or according to the remaining time to reprising (floating rate assets). To simplify the process, allocation is based on par or book values.65 Since numerous banks use gap analysis as a first step in analyzing interest risk (from an economic value perspective), it is important that they model the cash flows arising from their transactions as accurately as possible66 to produce a meaningful breakdown of their interest sensitive positions by maturity/reprising dates. Accuracy is increased by augmenting the number of time bands (i.e. reducing the band-width). The number of time bands should be adjusted to the type of transaction (e.g. different currencies) and its complexity as well as to the resulting inherent risk. For instance, a credit institution with a high share of money market transactions will have to narrowly space its near-term time bands. By contrast, a credit institution with commitments primarily in medium- to longterm time bucket will put the main emphasis on medium- to long-term time bands when depicting maturities. Maturity Gap Analysis

The simplest analytical techniques for calculation of IRR exposure begins with maturity Gap analysis that distributes interest rate sensitive assets, liabilities and off-balance sheet positions into a certain number of pre-defined time-bands according to their maturity (fixed rate) or time remaining for their next reprising (floating rate). Those assets and liabilities lacking definite reprising intervals (savings bank, cash credit, overdraft, loans, export finance, refinance from RBI etc.) or actual maturities vary from contractual maturities (embedded option in bonds with put/call options, loans, cash credit/overdraft, time deposits, etc.) are assigned time-bands according to the judgement, empirical studies and past experience of banks. The positive Gap indicates that banks have more RSAs than RSLs. A positive or assets sensitive Gap means that an increase in market interest rates could cause an increase in NII. Conversely, a negative or liability sensitive Gap implies that the banks NII could decline as a result of increase in market interest rates. The negative gap indicates that banks have more RSLs than RSAs. Gap is the difference between a banks assets and liabilities maturing or subject to repricing over a designated period of time. The Gap is used as a measure of interest rate sensitivity. The Positive or Negative Gap is multiplied by the assumed interest rate changes to derive the Earnings at Risk (EaR). The EaR method facilitates to estimate how much the earnings might be impacted by an adverse movement in interest rates. The changes in interest could be estimated on the basis of past trends, forecasting of interest rates, etc. the banks should fix EaR which could be based on last/current years income and a trigger point at which the line management should adopt on-or off-balance sheet hedging strategies may be clearly defined. In case banks could realistically estimate the magnitude of changes in market interest rates of various assets and liabilities (basic risk) and their past behavioural pattern (embedded option risk), they could standardize the gap by multiplying the individual assets and liabilities by how much they will change for a given change in interest rate. Thus, one or several assumptions of standardized gap seem more consistent with real world than the simple gap method. With the Adjusted Gap, banks could realistically estimate the Earnings at Risk (EaR). Duration Gap Analysis Duration is a measure of change in the value of the portfolio due to change in interest rates. Duration of an asset or a liability is computed by calculating the weighted average value of

all the cash-flows that it will produce with each cash-flow weighted by the time at which it occurs. It is expressed in time periods. Duration of high coupon bond is always shorter than duration of low coupon bonds because of larger cash inflow from higher interest payments. With zero coupon bonds, the duration would be equal to maturity. By calculating the duration of the entire asset and liability portfolio, the duration gap can be calculated, that is, the mismatch in asset and liability duration and, if necessary, corrective action may be taken to create a duration match. Measuring the duration Gap is more complex than the simple gap model. The attraction of duration analysis is that it provides a comprehensive measure of IRR for the total portfolio. The duration analysis also recognizes the time value of money. Duration measure is addictive so that banks can match total assets and liabilities rather than matching individual accounts.

Operational risk:
Operational risk is the risk of loss arising from various types of technical or human error or failed internal process, legal hurdles, fraud, and failure of people and system and from external agencies. The Basal committee defines operational risk as the risk of direct or indirect loss resulting from inadequate of failed internal process, people and system or from external events. Operational risk events are associated with weak links in internal control procedures. Operational risk involves break- down of internal control and corporate governance leading error, fraud, failure to perform in a timely manner, and compromise on the interest of the bank resulting in financial loss. Operational risks- Components Banks face operational risk in day-to day operations. Such risk may be related to its activities of traditional banking business or the business related to new generation banking business and use of computers and tele-communication systems. While the nature of the risk in both types of activities may be more or less similar, for e.g. break down of systems and procedures, errors, frauds etc. but the level of risk in computerized environment is

much more than level of risk in traditional banking business. Risk in traditional banking business Systems and procedures in banks are prescribed with the aim to safeguard the banks assets from external or internal threats. Internally, the risk comes from breakdown and internal control and corporate governance that can lead to financial losses through error, fraud, theft, burglary, or failure to perform in a timely manner. Such breakdowns can also cause the interest of the banks to be compromised in some other way for e.g. by the dealers, lending officers, or other staffs exceeding their authority or conducting business in an unethical manner. Operational risk is having three interlinked segments: People, process and systems related risk including legal risks External events related risk Strategic and reputation risk

People process and system related risks in banking issues generally cover: Payment/settlement risk due to breakdown in process/ reconciliation systems. Incorrect process of service charges/ cost( other than interest matter) Inappropriate product selection/ product complexity especially in related segments. Lack of integration of various processes, e.g., Deposit of cash by a customer of Demand Draft and subsequent issue of DD. Inadequate infrastructure for control of process/ systems. Inadequate data information execution. Fraud of staff or by others.

External Event related risks are generally the following (which are not only applicable to banking but to their lending areas as well): Act of God such as flood, Earthquake, Volcano or any other natural calamities affecting business. Act of miscreants such as Terrorist attacks or disruption or law and order problem. Strategic and Reputation Risks may be broadly the following ones:

Adverse business decision by the Top management arising out of inadequate/ inappropriate appreciation of market / industry changes, etc, and/ or ineffective implementation of Top management decisions may be treated as Strategic Risk areas, which may affect a banks profit/ capital.

Shrinkage of market share is a symptom of Reputation Risk, which has the effect on Goodwill of a bank and in turn may affect banks profit/capital.

Operational Risk Management The Basle committee formulated new rules on the capital adequacy, which are supposed to be introduced from 2005. The major issue of Basle II recommendations is the operational risk. Banks are yet to get clarity on the issues which are to be included in operational risk. System vendors have identified that a proper workflow and process automation would help reduce and detect errors. Apart from automating, right levels of audit and control are to be introduced to reduce operational risk. Increased operational efficiency of the system would reduce operational risk. The paper "Operational Risk: Automate to Eliminate" discusses how automation can play a role in mitigating operational risk. The key factor in internet banking is the faith of the people on the regulations. But will it exist when they come to know that Bill Gates' credit card details were stolen by a hacker? Some of the new generation banks like ICICI Bank, UTI Bank, HSBC, HDFC Bank have introduced internet banking. The paper "Banking on the Net: The Risk Factors" discusses the operational risk related issues. To mitigate the operational risk in internet banking, multi-layer security like digital certification, encryption, two level passwords have been introduced. Once the right infrastructure is in place, relatively risk free internet banking will see a boom with more banks joining the activity. To boost the sentiment of the stock market, the RBI recently had introduced margin trading. Of late, many banks have burnt their fingers in the stock market scams in one way or the other. In spite of strict monitoring systems, some of the banks have indulged in large lending to stock market operators in the recent past. As a consequence many heads have rolled in some of the leading private banks

CHAPTER-2 LITERATURE REVIEW

Literature Review
Simon Kwan Robert A. Eisenbeis (December 28, 1995) examining the tradeoffs between risk, inefficiency and capitalization. The results confirm the belief that these three variables are simultaneously determined. Furthermore, asymmetries were identified in the relationship between risk and inefficiencies. In the inefficiency equations, the measures of loan quality are consistently negative and statistically significant for all except the smallest size category of banks. The sign indicates that as asset quality declines (NPA increases), measured inefficiencies, derived under the assumption of risk neutrality, decline. The asset risk equations examine the effects of asset choice, growth and inefficiencies on loan risk. The last set of equations examines the relationships between capitalization, returns and inefficiency. The measured effects of inefficiencies are statistically negative and significant, suggesting that institutions with greater inefficiencies are less well capitalized, which is consistent with the moral hazard hypothesis and risk taking hypothesis identified

in the NPA equation. Anthony M. Santomero (February 1997) Measures the risk management techniques in the industry. It reports the standard of practice and evaluates how and why it is conducted in the particular way chosen. In addition, critiques are offered where appropriate. This paper discusses that risk can be managed through four steps standards and reports, position limits or rules, investment guidelines or strategies, incentive contracts and compensation. It reports the state of risk management techniques in the industry -- questions asked, questions answered and questions left unaddressed by respondents. This report cannot recite a litany of the approaches used within the industry, nor can it offer an evaluation of each and every approach. Rather, it reports the standard of practice and evaluates how and why it is conducted in the particular way chosen. But, even the best practice employed within the industry is not good enough in some areas. David H Pyle ( July 1997) says that credit risk are defined as a changes in portfolio value due to the failure of counter parties to meet their obligation or non dur to change in the market perception of their ability to continue to do so. Ideally a bank risk management system would integrate this source of risk with market risks discussed to produce an overall measure of banks loss potential. Banks managers need a measures that allow active efficient management of the banks risk postion. Brian Gray (October 1998) Measures the Australian banking sector relating to the measurement and management of credit risk. The issue of possible regulatory-induced inefficiencies has emerged in the Australian market. Developments are occurring quickly and credit modeling will become much more significant for banks in the medium term. Very importantly, growing competition in the provision of financial services may be increasing the competitive disadvantages associated with existing arrangements. As supervisors of the Australian banking system, we are keen to see the supervisory structure evolve with the market. Without trying to downplay the complexities that will be involved, we believe there is a strong case to commit to the development of an approach to capital adequacy that utilizes better measures of credit risk and portfolio modeling techniques. Jack L. King (DECEMBER 1998) develops a definition for operational risk by first considering its general relation to the firm. A useful breakdown of causes, failures and losses is presented as a framework for discussion of current definitions. Then, a clear definition for operational risk is proposed, followed by a description of its relationship to

famous historical losses. Finally, key success criteria are presented and suggestions for the direction of future efforts toward development of a consensus on an operational risk approach are made. Operations may include several functional parts of the organization, but certainly include the manufacturing value chain of the firm. Operations in investment banking can be thought of as the activities that follow from the time the trader echoes Done. until the financial effects of the contract are recorded in an accurate and timely manner. For a modern investment bank, this involves several transaction-processing tasks that record and verify the detailed characteristics of a financial contract. As investment products have become more complicated, as markets have increased in volatility, and as volumes have grown over recent years, the processing of contracts through the financial firms operations has become increasingly difficult. Ila Patnaik & Ajay Shah (December 2002) Measures the interest rate risk of a sample of major banks in India, using two methodologies. The first consists of estimating the impact upon equity capital of standardized interest rate shocks. The second consists of measuring the elasticity of bank stock prices to fluctuations in interest rates. Finding is that there is strong heterogeneity across banks in India in their interest rate exposure. Their results emphasize that a casual perusal of gap statements is an unsatisfactory approach to measuring interest rate risk. There is a need for banks and their supervisors to reduce the gap statement into a single scalar: the rupee impact of a given shock to the yield curve. they seek to measure the interest rate risk exposure of banks, using information from within a bank. If future cash flows can be accurately estimated, then the impact upon the NPV of assets and liabilities of certain interest rate shocks can be measured. Wolfgang Bauer and Marc Ryser (November 2002) analyze optimal risk management strategies of a bank financed with deposits and equity in a one period model. The bank's motivation for risk management comes from deposits which can lead to bank runs. In the event of such a run, liquidation costs arise. The hedging strategy that maximizes the value of equity is derived. We identify conditions under which well known results such as complete hedging, maximal speculation or irrelevance of the hedging decision are obtained. The initial debt ratio, the size of the liquidation costs, regulatory restrictions, the volatility of the risky asset and the spread between the risk less interest rate and the deposit rate are shown to be the important parameters that drive the bank's hedging decision.

Beverly J. Hirtle (September 2003) emphasis on disclosure and market discipline rests on the assumption that the disclosures made by financial institutions provide meaningful information about risk to market participants. Various recommendations have been made by supervisors and the financial services industry about the types of information that would be most effective in conveying an accurate picture of financial firms true riskexposures as they evolve over time. compared with information already available in regulatory reports, market risk capital figures are most useful for tracking changes in individual organizationsrisk exposures over time. Despite a number of theoretical and practical reasons to doubt the ability of market risk capital figures to predict future market risk, the regulatory report figures do appear to contain valuable information about future risk exposures. R.S. Raghavan (February 2003) define that risk management is not to prohibit or prevent risk taking activity, but to ensure that the risks are consciously taken with full knowledge, clear purpose. Under these paper techniques which were used for managing the risk are Loan Review Mechanism, Risk rating model, portfolio management, ALM etc. The effectiveness of risk measurement in banks depends on efficient Management Information System, computerization and net working of the branch activities. Marco Moscadelli (July 2004) compare the sensitivity of conventional actuarial distributions and models stemming from the Extreme Value Theory in representing the highest percentiles of the data sets: the exercise shows that the extreme value model, in its Peaks Over Threshold representation, explains the behavior of the operational risk data in the tail area well. Then, measures of severity and frequency of the large losses are gained and, by a proper combination of these estimates, a bottom-up operational risk capital figure is computed for each Business Line. Finally, for each Business Line and in the eight Business Lines as a whole, the contributions of the expected losses to the capital figures are evaluated and the relationships between the capital charges and the corresponding average level of Gross Incomes are determined and compared with the current coefficients envisaged in the simplified approaches of the regulatory framework. As the exercise makes clear, the EVT analysis requires that specific conditions be fulfilled in order to be worked out, the most important of which are the i.i.d. assumptions for the data and, as concerns the GPD model, a satisfactory stability of the inference to an increase of the pre-set (high)

threshold. Amadou Sy (April 2005) )Measures and assesses the management of interest rate risk of banks government securities portfolios in India, which it identifies as a key risk for the banking system. Value-at-risk methods were used to manage interest risk. The main finding is that some public sector and old private banks are vulnerable to a reversal of the interest rate cycle, while foreign and new private banks have built adequate defenses. As a result, a Key priority for the Indian authorities will be to scrutinize the risk management practices of individual banks. Given the potential for interest shocks higher than the one percentage point increase studied in the paper, an accelerating convergence towards Basel I risk-weighted capital charges, and the adoption of the Basel II, Pillar II approach for interest rate risk supervision, especially for those banks most vulnerable to a reversal of the interest rate cycle, could help ensure the stability of the financial system. Brigitte Godbillon-Camus and Christophe J. Godlewski (December 2005) focused on informations type role in credit risk management in banks. In a principal-agent model with moral hazard with hidden information where a banker requires information on assets return in order to manage credit risk through equity allocation for VaR coverage, we show that using additional soft information allows to economize equity, thanks to soft informations higher precision. However, this type of information being not verifiable, it requires to implement a particular wage scheme in order to avoid manipulation by the credit officer. These results provide theoretical evidence on soft informations advantage in credit risk management, as we show that VaR can be reduced, which allows to economize equity, even if the bank must implement a specific organizational structure and an adequate wage scheme. Technical Assistance Consultants Report (November 2008) describe that risk management and ALM are not static activities. Both continue to evolve and new aspects are presented that challenge the organizations capacity. Regular board oversight together with a periodic and detailed review process has to be built into the framework to ensure focus remains appropriate and relevant. practical starting point is to construct a framework for risk management considering the detail of the business activities the bank is involved in, analysing and ranking the risks involved in the various businesses and deciding how much risk the bank should take. While the headline categories in the risk management framework will be similar for all banks, the needs in both analysis and management will

vary considerably for banks of different sizes and operating in markets of different stages of development. The crisis that began with the subprime mortgages and has now become a global meltdown of markets, banks and other institutions should leave no doubt that effective risk management and ALM in banks is not an optional function. All banks irrespective of size need to develop a strategy and implementation plan for both areas that is properly aligned to the individual banks strategy. Salman Ahmed Sheikh, Dr. Amanat Ali Jalbani (July 2009) measures the risk management procedure of Islamic banks by giving a differential analysis of the risk management discussing only the unique characteristic of risk management in Islamic banks. this papers concludes that equity based business of Islamic banks posing a slightly more risk than conventional banks is well mitigated by Islamic banks through their effectives and adequate risk management procedures. A strong ROE of both Islamic and conventional banks shows that both banks are profitable Dr. B. Charumathi (June, 2010) measuring the Interest Rate Risk in one of the public sector banks in India, viz., Indian Bank, by using Gap Analysis Technique. Using publicly available information, this paper attempts to assess the interest rate risk carried by the Indian Bank. Banks should use the information about these risks as key input in their strategic business planning process. While increasing the size of the balance sheet, the degree of asset liability mismatch should be kept in control. Because, the excessive mismatch would result in volatility in earnings. Banks can also use sensitivity analysis for risk management purpose. This study used gap analysis for measuring the interest rate risk under different assumptions such as introduction of negative and positive interest rate shock, adjusting and counter balancing the portfolio. It is found that the bank is exposed to interest rate risk. Proper portfolio adjustment aiming at high yielding advances and using interest rate swap could make the bank to improve its net income than ever before. Suresh Chandra Bihari (DECEMBER 2011) Credit derivative is one kind of arrangement which allows one party to transfer, for a premium, the defined credit risk, computed with reference to a notional value, of a reference asset which may or may not owned by one or more other parties. the defined credit risk, computed with reference toa notional value, of a reference asset which may or may not owned by one or more other parties. It includes Credit Default Swap, Total Return swap, Credit linked notes, Credit spared option etc. CDS helps whole markets because it provides an effective means to

hedge and trade credit risk. CDS allows financial institutions to manage their exposures, in better way and investors benefit from a magnified investment universe. Do not put all the eggs in one basket is the best to reflect the concept of diversification, especially in investor environment. If an investor invests all money to buy the stocks of the one company then there is a very high probability of losing everything in case if company goes bankrupt. Muhammad Farhan Akhtar, Khizer Ali, Shama Sadaqat (January 2011) Measures the liquidity risk associated with the solvency of a financial institution, with a purpose to evaluate liquidity risk management (LRM) through a comparative analysis between conventional and Islamic banks of Pakistan. This paper investigates the significance of Size of the firm, Networking Capital, Return on Equity, Capital Adequacy and Return on Assets (ROA), with liquidity Risk Management in conventional and Islamic banks of Pakistan. The analyzed statistics figures show the mean, standard deviation, maximum and minimum values of conventional and Islamic banks. The opportunity has been tested with the Pearson correlation coefficients test. The matrix explains that in general the correlation between the explanatory variables is not well-built that multi co linearity problems are not severe. Anuradha Sivakumar &Runa Sarkar evaluate the various alternatives available to the Indian corporate for hedging financial risks. The paper also looks at the necessity of managing foreign currency risks, and looks at ways by which it is accomplished. Indian banks are actively hedging their foreign exchanges risks with forwards, currency and interest rate swaps and different types of options such as call, put, cross currency and range-barrier options. Dr. Yogieta S. Mehra explore the range of practices used by Indian Banks in management of operational risk essential for achievement of Advanced Measurement Approach for a cross section of Indian Banks and perform a comparative analysis with AMA compliant banks worldwide. The study also analyses the impact of size and ownership of banks on the range of operational risk management practices used by the banks .and finding is that the Indian banks should learn lesson from sub-prime crisis that regular updating of selfassessment results, scenario analysis results. Joan Selorm Tsorhe1Anthony Q. Q. Aboagye and Anthony Kyereboah-Coleman make a investigation which is related to the impact of stakeholders of banks on the management of bank capital risk, credit risk and liquidity risk. This research state that Bank stakeholders include the board of directors,

shareholders, depositors and regulators. Board strength does not have significant impact on capital risk, credit risk nor liquidity risk. Deposit or behavior appears to significantly impact only liquidity management, but not capital nor credit risk management. Jens Hilsche Mungo Wilson investigate the information in corporate credit ratings relevant to investors concerned about credit risk. We show that ratings relate to two economically different aspects of credit risk: raw default probability and systematic default risk, or the tendency to default in bad times (discount rate)they explain little of the variation in default probability across firms; and they fail to capture the considerable variation in default probabilities and empirical failure rate over the business cycle. This means that either credit ratings are simply not at the frontier of default prediction or that delivering optimal default probability forecasts is not the sole objective of rating agencies.

CHAPTER-3 RESEARCH METHDOLOGY

RESEARCH METHDOLOGY Statement of problem

In view of growing complexity of banks business and the dynamic operating environment, risk management has become very significant, especially in the financial sector. Risk at the apex level may be visualized as the probability of a banks financial health being impaired due to one or more contingent factors. While the parameters indicating the banks health may vary from net interest margin to market value of equity, the factor which can cause the important are also numerous. For instance, these could be default in repayment of loans by borrowers, change in value of assets or disruption of operation due to reason like technological failure. While the first two factors may be classified as credit risk and market risk, generally banks have all risks credit risk and market risk as operational risk.

Objectives of the research

Objectives of this research are verifying the integrity of internal risk management systems. During the verification process, we will test independently in proportion to the risk We will validate periodically; all key control functions within a bank, even those designated as low risk. Beside the general purpose of the research, the following specific objectives have been mentioned in the research:

To Perform sufficient testing to verify the integrity of internal risk management systems. To Identifying significant risks. To Evaluating and understanding the significant reason of arising risks in the banks. To Recommend action plan for reducing risk.

RESEARCH DESIGN
A research designs is the arrangement of conditions for collection and analysis data in a manner that aims to combine relevance to the research purpose with economy in procedure. Research Design is the conceptual structure with in which research in conducted. Research Design includes and outline of what the researcher will do form writing the hypothesis and it operational implication to the final analysis of data. A research design is a framework for the study and is used as guide in collection and analyzing the data. Descriptive research design will be used in this research. It includes survey and fact finding inquiries of different kinds. The major purpose of descriptive research is description of the state of the affairs, as it exists at present.

SOURCES OF DATA COLLECTION

This study involves the secondary data. Source of secondary data will be internal data which is available within the HDFC bank other source will be published data i.e from journals and newspapers etc.

SAMPLING DESIGN

Sampling may be defined as the selection of some part of an aggregate or totality on the basis of which a judgment or inference about the aggregate or totality is made. In simple words, it is the process of obtaining information about the population by examining only a part of it.

Sampling Technique convenience sampling Sample Size HDFC bank. Sampling Area -Ismilabad

LIMITATIONS OF THE STUDY

No study is without limitations, whether it is of any type & so this study may also have certain limitations .In a rapidly changing environment, analysis on one day or in one segment can change very quickly. The environmental changes are vital to be considered in order to assimilate the findings. As the topic of research is wide, so time is the main constraint in the research. Lack of risk analysis and risk management department and lack of experienced member in bank branches can be another problem in this research.

CHAPTER-4 DATA ANALYSIS AND

INTERPRETATION

The aim of study is to Identifying significant risks and to evaluating and understanding the significant reason of arising risks in the bank so to get the result first of all we have analysis the interest rate structure of HDFC bank. Interest rate structure of HDFC Particular Deposit rates 1 to 3 years 3 to 5 years Over 5 years Lending rate Base rate Benchmarking rate 6.00-7.00% 6.50-7.50% 6.5-7.5% 8% 12.5% 8.25-9.00% 7.75-9.5% 8.5-9.25% 10.75% 15.25% 9.00-9.25% 7.75-9.5% 8.5-9.25% 10.5% 15% As on Ist April 2010 As on Ist April 2011 As on 1st April 2012

HDFC Bank reviewed the interest rates on retail term deposits and keeping in view credit demand, inflation and liquidity scenario, the Bank has decided to increase the term deposit rates by 25, The highest interest on term deposits would be 9.25%. In response to increase in cost of funds, where deposit rates have been increased upto 100 bps, and keeping in view the market conditions The HDFC Bank Limited has decreased its lending rates by 0.25 percent, or 25 basis points with effect from Friday, April 20, 2012.

HDFC Bank has revised its Base Rate or the minimum lending rate from 10.75 percent to 10.50 percent per annum. The HDFC Bank determines its interest rates on new loans and advances, including consumer loans, with reference to base rate with effect from July 01, 2010.HDFC Bank has also decreased its Benchmark Prime Lending Rate (BPLR) for home loans and consumer loans from 15.25 percent to 15.00 percent per annum. These benchmark rates are used for determining the interest rates on home loans and advances sanctioned up to June 30, 2010.

Now we will see how the changing interest rate affect the asset & liabilities of bank i.e how the interest rate affect the deposit and advances. It may be that when interest rate change than deposit will increase and advances will be decrease because of increasing interest rate but it is not always so its depend on marketing condition.

Impact of interest rate on Asset & liabilities Rs.in crore Particular Liabilities Deposits Current deposit Saving deposit Total Asset Total F.Y 2012
176282 16838 13639 206759

F.Y 2011
180486 23742 13936 218164 157098 157098

F.Y 2010
157204 10124 10305 177633 135329 135329

Loans& advances 154984

154984

From the above tabulation we can easily see that, as changes in deposit rate reflects in changes in the deposits funds and similarly changes in lending rate reflects in changes in advances. now below table shows that how much deposit and advances are to be changed in 2011 compare to 2010 and changes in Ist quarter 2012 compare to 2011.this changes are shown both in amount and percentages.

Changes in deposits and advances

Particulars Deposits Advances

Changes amount
40531 21769

in % changes Changes in % changes from 2010 to amount from 2011 to 2011 2012
22.8% 16.08% 11405 2114 -5.22% -1.34%

Interpretation:From the above analysis we can see that in 2011 advances of bank was increased upto 16.08% i.e. there is difference between advances of 2010 and 2011 is 21769 cr.but 1n 2012 in ist quarter advances are decreased compare to last year and reason it low advances rate compare to loan rate And deposits is also increased up to 22.8% in 2011 compare to 2010.and differences between deposits of 2010 &2011 is 40531 cr. but also deposits is also decreased upto 5.22% in 2012 Ist quarter compare to 2011.and differences between advances of 2011 & 2012 is 2114.now this changes are to be shown through graph.
25.00% 20.00% 15.00% 10.00% 5.00% 0.00% Deposits -5.00% -10.00% Advances

%change from2010 to 2011 %change from2011 to 2012

Due to change in interest rate asset & liabilities are to be changed and because of it liquidity of bank are changed so bank have to manage their liquidity through basket system Measuring and managing liquidity needs are vital for effective operation of banks..Banks management should measure not only the liquidity positions of banks on an ongoing basis but also examine how liquidity requirements are likely to evolve under different assumptions. liquidity has to be tracked through maturity or cash flow mismatches. For measuring and managing net funding requirements, the use of a maturity ladder and calculation of cumulative surplus or deficit of funds at selected maturity dates is adopted as a standard tool.

Managing liquidity through basket system

A. TOTAL OUTFLO WS B. TOTAL INFLOWS C. MISMATC H( B-A ) D.CUMUL ATIVE MISMATC H E. C as % To A 2298.23 650.39 5340.41 1030.2 5 3042.18 379.86 3042.18 3422.0 4 58% 4000.67 4343.16 5316.08 3045.41 4282.88 4079.91 -955.26 -60.28 1236.17 9027.30 18607.6 3 9580.33 10750.6 6 106% 4637.58 4483.12 -154.46 10596.20 19876.47 10064.70 -9811.77 784.43 50149.77

2466.78 2406.50 1170.33

132%

-24%

-1%

-23%

-3%

-49%

Interpretation:Basket system are used for measuring the future cash flows of banks. Basket system is used to manage the liquidity on daily basis ,weekly basis , monthly basis, and quartly basis. Basket system is helpful to calculate the accurate cash flow in bank.so from above table we can anlyze the accurte future cash flow of bank so that bank comes to know when the liquidity can be decreased and when liquidity can be increased .Now we can identify that in 1to 14 days the actual in cash flow is 3042.18 i.e. inflow is greater than outflow now bank

has not liquidity risk. and in 15 to 28 days cash flow is 379.86 i.e. within 15 to 28 days bank liquidity is good. Now in 29 to 3 months bank liquidity is at risk because there is negative cash flow i.e. outflow is more than inflow. Now in this case bank have to manage their liquidity by arrange the cash liquidity can be arranged through working capital if bank has.in 3 to 6 month bank liquidity is also at risk but risk is low as compared to 29 to 3 months now negative cash flow is 60.28 where in 29 to 3 months negative cash flow is 955.26.now 6 months to 1 year liquidity risk becomes to end because there is positive cash flow now inflow is increase as compared to outflow so actual cash flow is 1236.17.this is positive sign for bank. In 1 to 3 years liquidity is increased up to 9580.33.in this case bank have no need to arrange the cash and no need more working capital. In 3 to 5 years liquidity is at risk because there is negative cash flow. now liquidity has to be decreased up to 154.46.and in 3 to 5 years risk is to be increased up to 9811.77 .so bank have to arrange liquidity so that bank can complete their liability .the reason of negative cash flow is not receiving interest on loan and NPA is also one of big reason of decrease liquidity .and another reason is more maturity of deposits and at one time.

Analysis of credit risk

Change in interest rate not only reason of liquidity risk but also reason of credit risk. When interest rate increase then chances of NPA is also increase .. The non performing assets impacts drastically to the working of the banks. The efficiency of a bank is not always reflected only by the size of its balance sheet but by the level of return on its assets. NPAs do not generate interest income for the banks. NPAs have a deleterious effect on the return on assets .They erode current profits through provisioning requirements because banks are required to make provisions for such NPAs from their current profits.

Details of Non-Performing Assets of the Bank Rs. in crore PARTICULARS F.Y 200910 F.Y201011 F.Y201112 F.Y201213

Gross NPA at the beginning of the year Addition during the year Reduction during the year Gross NPAs as at 31st March Net NPAs as at the 1st April

898.52 266.45 455.13 759.84 660.84

939.84 220.96 440.45 789.52 691.35

891.35 191.43 429.46 769.35 680.32

856.27 95.34 415.36 756.33 670.28

From the above tabulation we can analyze the asset of IDBI bank i.e. how much NPA is changed in last 2 years. and NPA add & deduct during the year.anlyze the differences in gross NPA in last 2 years and differences in net NPA i n last 2 years.

Asset quality Gross NPA Net NPA

Changes 2010-2011 in amount

29.68 30.51 4.6% 3.9%

Change 2011s in 2012 amount

20.17 11.03 -2.5% -1.6%

Change 2012s in 2013 amount

13.02 10.04 -1.7% -1.4%

Interpration:The banks asset quality in the fourth quarter has improved on sequential basis despite issues like increasing bad loans and corporate debt restructuring. Its net Non-Performing Asset (NPA) improved to 1.7% per cent, against 2.5 per cent a year ago, while its net NPA saw a marginal improvement at 1.4% per cent while in 2011 this improvement is 1.6 %. Slippages came primarily from the SME segment and management expects the stress from this sector to continue over the next 12 quarters. Slippages were on the higher side, considering the fact that the bank had already switched over to system-based NPA recognition platform.. To prevent the credit risk bank have to create the provision . Provision are create according to NPA.i.e if NPA is more than provision will be more and vice versa.provision have the impact on profit. Because provision are create from profits. So there is interlink between interest rate ,liquidity and credirability of bank. When the interest rate changed then banks liquidity is also changed which show the interest income and interest expended.ie. how much interest income is changed as compare to interest

expanded. And we know that interest rate is also cause of credit risk.for credit risk provision are to be create which have also impact on profit.

RATIO ANALYSIS
Ratio analysis is one of the most powerful tools of financial analysis. It is the process of establishing and interpreting various ratios. It is the help of ratios that the financial statements can be analyzed more clearly and decisions made from such analysis. Now we will find the various ratio like current ratio, interest coverage ratio, working capital ratio, net profit margin ratio, interest rate spread ratio. PARTICULAR Current ratio Interest coverage ratio Working capital to total asset ratio Net profit margin ratio Interest rate spread F.Y 2011-12 1.02 1.9 0.95 8.12 2.77 F.Y 2010-11 0.79 1.4 0.76 6.71 2.14 F.Y 2009-10 0.65 0.84 0.84 5.95 2.25

Interpretation:From above table we can analyses that current ratio is increase from last year i.e. in 2009 current ratio is 0.65 which is become 0.79 in 2010 and subsequently it increase in 2011 up to 1.02.and interest coverage ratio is also increase. In 2010 the ratio is 1.4 which is more as compared to 2009 .now in 2011 the ratio is 1.9 which show good growth. if talk about working capital ratio its also increase but this is not good sign because it means bank have to need more fund for manage working capital in 2011 working capital ratio is 0.95 where in 2010 and in2009 the ratio is 0.76 & 0.84 respectively .But net profit margin ratio is also increase. In 2009 the net profit margin ratio is 5.95 which become 6.71 in 2010 and in 2011 the ratio becomes 8.12. That is good sign for bank. In last interest rate spread is also increase from last few years in 2009 the interest rate spread ratio is 2.25 but in 2010 it becomes 2.14 but further in2011 it increase up to 2.77 .

Capital adequacy ratio:This ratio is used to protect depositors and promote the stability and efficiency of financial systems Two types of capital are measured: tier one capital, which can absorb losses

without a bank being required to cease trading, and tier two capital, which can absorb losses in the event of a winding-up and so provides a lesser degree of protection to depositors. Capital adequacy ratios measure the amount of a bank's capital in relation to the amount of its risk weighted credit exposur . There is an important condition that Tier II Capital cannot exceed 50% of Tier-I Capital for arriving at the prescribed Capital Adequacy Ratio. Capital Adequacy Ratio is calculated based on the assets of the bank. The values of bank's assets are not taken according to the book value but according to the risk factor involved. The value of each asset is assigned with a risk factor in percentage terms. CAR primarily adjusts for assets that are less risky by allowing banks to "discount" lowerrisk assets. CAR to protect depositors, thereby maintaining confidence in the banking system.

(Rs. in crore) PARTICULAR Tier I Tier-II Total tier (I +II) Risk weighted assets Capital adequacy ratio 2011 2010 CAPITAL FUND
17364 9854 27218 216082 12.60% 20979 9909 30888 248760 12.42 %

2009
20946 9672 30619 250297 12.23 %

Interpretation:From the above analysis we can say that capital adequacy ratio in 2010 is 12.42 which is more as compare to 12.23 in 2009.but in 2011 capital adequacy ratio becomes 12.60% . which is also more than 12.42 in 2010.so it means bank have potential to manage the risk .and depositors have also less risk if bank have more capital adequacy ratio. because it increase the liquidity of bank.

CHAPTER-5 CONLUSION, FINDING AND SUGGESSTION

CONCLUSION

Banking is nothing but financial inter-mediation between the financial savers on the one hand and the funds seeking business entrepreneurs on the other hand. As such, in the process of providing financial services banks assume various kinds of risks i.e interest rate risk, credit risk and liquidity risk. Therefore, banking practices of securities based lending and investment policies, need to change the approach and mindset, rather radically, to manage and mitigate the perceived risks, so as to ultimately improve the quality of the asset portfolio. There may not be one-size-fits-all risk management module for all the banks to be made applicable uniformly. Balancing risk and return is not an easy task as risk is subjective and not quantifiable whereas return is objective and measurable. If there exist a way of converting the subjectivity of the risk into a number then the balancing exercise would be meaningful and much easier. The result show that the major source of income i.e. interest are to be increased however interest rate have to be changed time to time. In the recent years, market risks associated with the holding of securities has increased, so greater awareness is required while extending loans. The level of interest rate margin is one of the most important parameters for gauging the efficiency. liquidity risk can be converted to solvency risk if bank raise the deposit rate beyond the some level to refinance deposits. so to manage the risk bank have to used various models & approaches. Banks need to accept that market changes and increased sophistication in risk management techniques require that update initial framework. In the ultimate analysis, it is human factor and vigilance at all levels which are most important to mitigate risk. The quality of people, their level of knowledge and integrities and concern for the organization are the pillars for success of any operational risk framework in any organization, especially Banks which deal in financial assets of the people. Banks need risk management packages to also for effective risk management and mitigation, effective capital allocation, gain competitive advantage, develop the robust system and process, improve reporting systems and transparency, and cost reduction through detailed data analysis.

FINDING

Here I analyzed the last three year period (2009, 2010, and 2011) of HDFC. On these data collection I analyzed their impact of changing interest on asset & liabilities and analyzed the maturity bucket system non performing assets and last ratio analysis .I found that till 2011 bank asset & liabilities has to increased by 40531 & 21769 respectively. but in Ist quarter of 2012 both deposits and advances are reduced by 11405& 2114 respectively. from the maturity bucket we analysis that some time bank liquidity will be at risk because of negative cash flow .After analysis the credit risk result is that NPA is decreased during 2011 & ist quarter of 2012. Banks have been very successful in cleaning their balance sheet and Non- performing Assets have fallen dramatically and from ratio analysis result is that current ratio ,net profit margin ratio, is increased as compared to last years.

Suggestion
There should be thorough awareness about ALM among the staff at all levels, supportive management & dedicated teams

To develop the suggested risk management solution, it requires a strong domain expertise and efficient technical platform.

For managing the credit risk effectively banks need credit rating system. Advanced statistical techniques that were recommended by Basel-II committee should be adopted to access market risk emanating from changes in the value of market variables such as interest rate, foreign exchange rates and equity price...

Bank should move from deposit orientation to profit orientation. However, the shift in focus to profitability rather than the balance sheet doesnt mean that targeted resource mobilization and asset build up should take a back seat.

If 50% of the liabilities are maturing within 1 year but only 10% of the assets are maturing within the same period. Though the financial institution has enough assets, it may become temporarily insolvent due to a severe liquidity crisis. Thus, ALM is required to match assets & liabilities and minimize liquidity as well as market risk.

CHAPTER-6 BIBLIOGRAPHY

BIBLIOGRAPHY

Web sites
www.hdfcbank.com www.moneycontrol.com www.mbaknol.com http://www.hdfcbank.com/aboutus/awards/default.htm http://www.gkvharidwar.org/journals/gbr_7/Chapter_15.pdf http://www.hdfcbank.com/assets/pdf/Investor_Presentation.pdf http://www.wikinvest.com/stock/HDFC_Bank_LTD_Ads_(HDB)/Capital_A dequacy_Requirements

BOOKS
Punithavathy Pandian - Risk management. Vikas publication 2010 C.R Kothari-Business Research Methodology, Wiley Eastern, New Delhi.-

ANNEXURE

Managing liquidity through basket system

OUTFLOWS

1 to 14 days

15 to 28 days

29 days and upto 3 months

Over 3 months and upto 6 months 0.00 0.00

RESIDUAL MATURITY Over 6 Over 1 Over 3 year and years and upto 3 upto 5 Months years years and upto 1 year 0.00 0.00 0.00 0.00 7793.15 1117.40 3330.23 3345.52 0.00 0.00 1149.54 0.00 0.00 4569.49 1117.40 3330.023 121.86 0..00 0.00 18.48

Over 5 years

Total

1.Capital 2.Reserves & Surplus 3.Deposits (i)Current Deposits (ii)Savings Bank Deposits (iii)Term Deposits (iv) Certificates of Deposit 4.Borrowin gs 5.Other Liabilities & Provisions (i)Bills Payable (ii)Provisio ns (iii)Others 7.Unavaile d portion of Cash Credit / Overdraft / DemandLo an component

0.00 0.00 1138.04 372.47 555.04 118.76 91.77 0.00 443.96

0.00 0.00 473.53 0.00 0.00 276.38 197.15 0.00 59.17

0.00 0.00

50.00 1996.47 15877.83 1117.41 3885.27 10875.19 0.00 0.00 1779.75

50.00 1996.47 39120.4 3724.67 11100.77 18274.68 5820.31 390.00 4493.29

2589.09 2660.16 4019.11 0.00 0.00 0.00 0.00 0.00 0.00 1918.90

1178.98 639.09

1410.11 2021.07 2100.21 0.00 135.73 300.00 89.89 90.00 284.29

54.99 6.67 382.30 17.83

54.99 4.18 0.00 0.00

0.00 128.98 6.75 0.00

0.00 9.28 80.61 0.00

0.00 85.17 199.12 0.00

989.79 93.73 66.02 0.00

0.00 16.68 1.80 0.00

0.00 95.72 1684.03 0.00

1099.77 440.41 2420.72 17.83

of Working Capital 8. Lettersof Credit / Guarantees 12. Interest payable A. TOTAL OUTFLO WS

10.31 12.36

10.31 5.14

10.31 28.11

19.88 28.88

0.72 43.64

0.00 84.61 9027.30

0.00 49.61 4637.58

0.00 172.38 19876.47

51.53 424.73 50149.77

2298.23 650.39

4000.67 4343.16 5316.08

INFLOWS 1.Cash 2.Balances with RBI 3.Balances with other Banks (i)Current Account (ii) Money at Call and Short Notice, Term Deposits and other placements 4.Investments (including those under Repos but excluding Reverse Repos) 5.Advances(Perfo rming) (i)Bills Purchased and Discounted (including bills under DUPN) (ii)Cash Credits, Overdrafts and Loans repayable on demand (iii)Term Loans 6. NPAs(Advances and Investments) * 7. Fixed Assets 8. Other Assets (i)Inter-office Adjustment ii) suspense A/c (iii) Others 10. Swaps (Sell / Buy)/ maturingforwards 11. Bills Rediscounted (DUPN) 12.Interest receivable 13.Committed Lines ofCredit 14.Export Refinance from RBI. B. TOTAL INFLOWS C. MISMATCH( B

203.94 1465.9 9 336.59 61.59 275.00

0.00 24.04 0.00 0.00 0.00

0.00 131.44 0.00 0.00 0.00

0.00 135.05 0.00 0.00 0.00

0.00 204.04 0.00 0.00 0.00

0.00 395.63 0.00 0.00 0.00

0.00 231.98 0.00 0.00 0.00

0.00 806.05 0.00 0.00 0.00

203.94 3394.22 336.59 61.59 275.00

362.45

222.20

259.54

963.81

619.63

2104.16

1328.87 5214.50

11075.16

1118.7 9 296.17

702.66 37.79

1105.39 1597.58 2309.22 16097.4 6 148.05 54.33 0.32 4.37

2799.67 2765.98 0.10 53.58

28496.75 594.71

492.31

492.31

0.00

0.00

0.00

11323.0 4

0.00

0.00

12307.66

330.31 0.00

172.56 0.00

957.34 0.00

1503.02 2308.90 4400.48 0.00 0.00 0.00

2799.67 3712.40 120.49 52.61

16184.68 173.1

0.00 480.01 130 .65 349.36 0.00 578.38 0.00 0.00 0.00 794.26 5340.4 1 3042.1 8

0.00 0.54 0.00 .54 10.31 70.50 0.00 0.00 0.00 0.00

0.00 23.03 0.00

0.00 0.00 0.00

0.00 3.70 0.00

0.00 9.66 0.00 9.66 0.72 0.00 0.00 0.00 0.00 0.00

0.00 2.11 0.00 2.11 0.00 0.00 0.00 0.00 0.00 0.00

171.43 54.13 0.00 54.13 0.00 0.00 0.00 0.00 0.00 0.00

171.43 573.18 130.65 442.53 51.53 4217.18 0.00 446.97 0.00 794.6

23.03 0.00 3.70 10.31 10.31 19.88 1358.10 1286.76 923.44 0.00 157.60 0.00 0.00 0.00 289.37 0.00 0.00 0.00 0.00 0.00 0.00

1030.25 3045.41 4282.88 4079.91 18607.6 3 379.86 -955.26 -60.28 1236.17 9580.33

4483.12 10064.7 0 -154.46 -9811.77