Transcript Document
PRMIA- HYDERABAD CHAPTER
Uniting Risk Professionals Worldwide Financial Stability B. YERRAM RAJU REGIONAL DIRECTOR
This presentation is based on the RBI Report on Financial Stability enclosed to the RBI Bulletin April 2010.
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When and Why think of Stability?- The Crisis and Consequential instability?
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• The crisis started in summer 2007 with lightning failure of Lehman Brothers, Washington Mutual Funds and 3 Iceland Banks.
• Mistrust and fear spread among Banks.
• Four Risk environmental factors still being probed:
– Financial Risk valuation models/methods – Risk Control Functions – Risk limiting strategies and – Bonus Culture.
A Perspective on the Indian Approach on the Financial Policy Making
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• Prudential policy framework for banks addressing: – Leverage, liquidity, and counterparty concentration – Recognition of NBFCs as systemically important and extension of regulatory perimeter – An Active Capital Account management framework – Explicit regulation of key OTC derivative markets.
• Despite relatively low exposure to global markets, the contagion impact of any global shocks not ruled out.
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Healthy Banking sector
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•Tighter regulatory standards on capital, liquidity and leverage for banks; •Unregulated systematically important financial entities (NBFCs, Coops) brought under regulatory oversight •Addressing systemic risks arising from interconnectedness among financial sector entities •Regulating financial markets from a systemic risk perspective .
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Key underpinnings
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•Ensuring that – the process of being away from disintermediation is genuine – A clear, transparent capture of the risks within the prudential framework exists in the treatment of NBFCs •Credit quality robust •Share of low cost current and savings account deposits (CASA) is high •Banks are required to hold a minimum percentage of their liabilities in risk free government securities.
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•“Maintenance involves trade-offs and raises a number of challenges.” of financial (Financial stability Stability Report, RBI, April 2010)
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What is Financial Stability
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•It is “a situation in which the financial sector provides critical services to the real economy without any discontinuity.” •Absence of financial instability: ‘containment of the likelihood of failure of individual financial firms or any systemic stress and thereby limiting the associated costs to the economy.’ •Arresting the possible consequence of ‘unknown unknowns’ and realising the limitations of modeling apparatus and stress testing exercises.
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Financial Stability Board
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• Set up by G-20 in the aftermath of recession. • Mandated to – Assess vulnerabilities affecting the global financial
system
– Identify and review the regulatory, supervisory
and related actions needed to address them and their outcomes;
– Promote coordination and information exchange
among the authorities responsible for FS
– Monitor and advise market development and their
implications for regulatory policy;
– Advise and monitor best practices – Undertake joint strategic reviews of policy
development work on developing international standards
– Set guidelines for and support establishment of
supervisory colleges
– Support contingency planning for cross-border
crisis management
– Collaborate with the IMF to conduct Early Warning
System
– Undertake any other tasks members may seek to
perform.
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Central Banks and FS-Key Aspects
• Supervision of individual firms from a systemic perspective • Greater involvement of central banks where it is found wanting in supervision of systemically important entities • A collegial body of government/central bank/regulators • Reorientation of regulatory mandates of all regulators to also take into account a systemic perspective. • Monetary stability supports sound investment and sustainable growth leading to FS
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Principal Perspectives of FS
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•FS has critical influence on price stability and sustained growth •FS facilitates efficient transmission of monetary policy actions •From the regulatory and supervisory angle, FS safeguards the depositors’ interests and ensures stability of the financial system.
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Capital Account
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Buttressed through the imposition of prudential safeguards in respect of access of foreign entities to the domestic debt markets and on forex borrowings by domestic corporates. (Cap on FII investments in Corporate (US$15bn) and Government (US$5bn) bonds.
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Liquidity Management
Exposure Norms for Commercial Banks Exposure to Limit 1, Single borrower 2. Group Borrowers 3. NBFC 4. NBFC-AFC 5. Indian Joint venture /wholly owned subsidiaries abroad/overseas step down subsidiaries of Indian corporates 15% of capital fund (Additional 5% on infrastructural component) 40% of capital fund (Additional 10% on infrastructure exposure) 10% on capital fund 15% on capital fund 20% on capital fund 12
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Liquidity Management (contd)
Exposure Norms for Commercial Banks Exposure to Limit 6. Capital Market Exposure (a) (b) (c) (d) (e) (f) Banks holding shares in any Co.
The lesser of 30% of paid up share capital of the Co., or 30% of the paid up cap of banks 40% of its net worth Banks’ aggregate exposure (solo basis) Group basis Banks’ direct exposure (solo) Banks’ direct exposure (group) Gross holding of capital among banks/FIIs 40% of its consolidated net worth 20% of net worth 20% of net worth 10% of capital fund
Source: RBI FSR-2010 p 8
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What made us distinct?
• The counter-cyclical regulations applied ahead of the global crisis
helped us cushion against systemic instability.
• Significant reduction in risk and rebound in market activity • Pressures on banking sector liquidity during the crisis together with
extraordinary measures taken led to shortening of the maturity profile of bank liabilities
• Banks facing large refinancing needs in the following years • Management of funding risks skillfully • More stable customer deposits • Sovereign and corporate CDS spreads broadly stabilised in Q2-2009 • Corrections in equity prices in Emerging Market economies witnessed
largely declines in the range of 30-67 percent.
• Gains started only in the Q3-2009 • Stimulus measures significantly increased global liquidity. • Forex markets – RBI’s presence in the market helped manage
volatility –Forward Premia in Indian forex markets lower than the rate dictated by interest differential.
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Regulatory Counter-cyclical Measures
Date Capital Mkt Housing Other Retail Comm Real Estate NBFC-ND-SI Risk wt Pro vision Risk Wt Pro vision Risk Wt Pro vision Risk wt Pro vision Risk Wt Pro vision Dec 04 Jul 05 Nov 05 May-06 Jan-07 May- 07 May-08 Nov- 08 Nov-09 125 125 125 125 125 125 125 125 100 0.25
1.0
2.0
75 0.25
75 0.40
75 75 75 0.25
0.25
0.40
1.0
1.0
2.0
2.0
0.40
0.40
50-75 1.0
50 100 50 100 50 100 1.0
0.40
0.40
125 125 125 125 125 125 125 125 125 1.0
2.0
2.0
2.0
0.25
0.25
0.40
0.40
0.40
100 0.25
100 125 0.25
100 125 0.40
100 150 150 150 150 1.0
2.0
2.0
2.0
100 125 125 125 100 0.40
125 100 1.00
100 0.25
0.25
0.40
0.40
2.00
2.00
2.00
0.40
0.40
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GDP Outlook
• Increasing business cycle correlation between developed and developing economies that enabled India’s current and capital a/c flows more than doubled from les than half of the country’s GDP in 1991 to over 100% of GDP in the last two years.
• Indian economy continued to be driven largely by domestic demand notwithstanding increasing globalization.
• Overall macro economic conditions affected by adverse shocks in farm sector growth – deficient monsoon;associated drought and flood in certain parts of the country; decline in kharif production of food grains and oil seeds.
GDP Outlook Contd..
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• Tangible recovery since April 2009 in industry and services • Upward bias strengthened due to – Recovery in industry & core infrastructure – Upturn in business & consumer confidence reflected in revival of consumption and investment demand – Revival in exports and capital flows – Recovery in stock market – Higher resource mobilization thru public issues and private placements • RBI’s growth forecast revised to 7.5% in 09-10
Exit Process had begun
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•SLR restored to 25% - on May 26 reduced to 24.5% to provide more liquidity in the wake of 3-G cash requirements of Telecom Companies.
•Export Credit refinance back to 15% •Non-standard refinance facilities to commercial banks discontinued •Jan 2010- CRR hiked by 75 basis points to 5.75% •Repo and Reverse Repo hiked by 25 basis points.
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Key Fiscal Indicators (Centre and States)
(per cent to GDP)
Year
2003-04 2004-05 2005-06 2006-07 2007-08 2008-09 RE 2009-10 BE
Primary Deficit Revenue Deficit
2.1 1.3
1.0
0.0
-1.1
3.4
4.3
5.8
3.5
2.7
1.3
0.2
4.1
5.1
Gross Fiscal Deficit
8.5
7.2
6.5
5.4
4.1
8.5
9.7
Outstanding Liabilities
81.1
78.6
77.2
74.3
72.0
71.6
73.2
RE: Revised Estimates. BE: Budget Estimates.
NOTE: Negative sign indicates surplus.
Source: Budget Documents.
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Movements in Monetary Policy Instruments and BPLRs Phase Monetary Tightening Phase Monetary Easing Phase CRR Repo Rate Reverse Repo Rate Bench mark Prime Lending rates Public Sector Banks Private Banks Foreign Banks (Mar 2004 – Sep 2008) 450 300 150 325-350 225 – 375 100 – (-)150 (Sep 2008 – Nov 2009) (-)400 (-)425 (-)275 (-)125 – (-)275 (-)100 – (-)125 (+)50 – 0 Source: RBI Report of the Working Group on Benchmark Prime Lending Rate, October 2009
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Liquidity ratios
Liquidity Ratios Mar 05 Mar 06 Mar 07 Mar 08 Mar 09 Sep 09 Dec 09
1 2 (Volatile Liabilities – Temporary assets)/ (Earning Assets Temporary Assets) – (%) Core Deposits/Total Assets – (%) 34.7
53.8
38.4
53.9
3 4 (Loans + Mandatory CRR + Mandatory SLR + Fixed Assets)/Total Assets – (%) [Loans +Mandatory CRR + Mandatory SLR + Fixed Assets]/Core Deposits 75.0
1.4
79.9
1.5
5 Temporary Assets/Total Assets – (%) 28.8
30.3
6 Temporary Assets/Volatile Liabilities 0.54
Source: RBI Supervisory Returns 0.53
41.4
43.9
43.9
45.7
52.2
49.3
48.4
51.0
83.4
85.9
79.6
81.4
1.6
1.7
1.6
1.6
43.4
52.0
47.6
39.9
0.65
0.71
0.69
0.61
45.1
52.0
83.3
1.6
40.0
0.61
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Liquidity Ratios
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NO
1
Ratio Components Significance
(Volatile liabilities – Temporary Assets)/(Earnin g Assets – Temporary Assets)
Volatile Liabilities:
(Deposits + borrowing bills payable upto 1 year) Letters of credit – full outstanding Component Wise CCF of other contingent credit and commitments Swap funds (buy/sell) upto one year As per extant norms, 15 per cent of current deposits (CA) and 10 per cent of savings deposits (SA) are to be treated as volatile and shown in 1 14 days time bucket; remainder in 1-3 years bucket. Hence CASA deposits reported by banks as payable within one year are included under volatile liabilities Borrowings include from RBI, call, other institutions and refinance
Temporary assets:
Cash Excess CRR balances with RBI Balances with banks Bills purchased/discounted upto 1 year Investments upto one year Swap funds (sell/buy) upto one year
Earning Assets:
Total assets – (Fixed assets + Balances in current accounts with other banks + Other assets excl. leasing + Intangible assets) Measures the extent to which hot money supports bank’s basic earning assets. Since the numerator represents short term, interest sensitive funds, a high and positive number implies some risk of illiquidity.
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No Ratio Components
4 (Loans + mandatory SLR + mandatory CRR + Fixed Assets)/Core deposits Advances Required SLR Required CRR Fixed assets
Significance
2 3 Core deposits/Total Assets (Loans + mandatory SLR + mandatory CRR + Fixed Assets)/Total Assets
Core deposits:
All deposits (including CASA) above I year + net worth Total Assets: Balance sheet footing Measures the extent to which assets are funded through stable deposit base.
Gross Advances Required SLR Required CRR Fixed assets Loans including mandatory cash reserves and statutory liquidity investments are least liquid and hence a high ratio signifies the degree of ‘illiquidity’ embedded in the balance sheet.
Measure the extent to which illiquid assets are financed out of core deposits.
Greater than 1 (purchased liquidity) Less than 1 (stored liquidity)
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No
5 6
Ratio
Temporary Assets/Total Assets Temporary Assets/Volatile Assets
Components Significance
Measures the extent of available liquid assets. A higher ratio could impinge on the asset utilisation of banking system in terms of opportunity cost of holding liquidity Measures the cover of liquid investments relative to volatile liabilities.
7 8 Volatile liabilities/Total Assets (Market value of Non – SLR Securities + Excess SLR Securities) / (Book Value of Non – SLR Securities + Excess SLR Securities) Item 5 divided by item 6 A ratio of less than 1 indicates the possibility of a liquidity problem.
Measures the extent to which volatile liabilities fund the balance sheet.
Measures the market value of non – SLR securities and excess SLR securities relative to their book value. A ratio exceeding 1 reflects that a bank stands to gain if it sells off its saleable portfolio Source: Report of the Committee on Financial Sector Assessment.
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Rating Outlook of Banks (Long term Instrument) Rating as on March 31,2009 Rating as on November 30,2009 (hybrid Instruments) Rating as on March 31,2009 Rating as on November 30,2009
No. of Banks assessed 25 26 No. of Banks assessed 25 25 Positive Stable Negative Source:CRISIL 01 19 05 - Positive 25 Stable 1 Negative 18 07 01 23 1
25
Rating as on March 31,2009 Rating as on November 30’2009
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Banks assessed Long Term rating Positive Stable Negative 27 0 24 3 28 3 20 5 Note: The numbers pertain to long – term instruments only (both national and international), Hybrid ratings where assigned, carry a lower rating but the same outlook as the bank’s long – term rating.
Source: Fitch
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Definition NPA norm Asset classification norm Provisioning Norms
Different Regulatory Norms of UCBs Tier I bank
Deposits less than Rs.100 crore 180 days loan delinquency norm for loan accounts till March 2009 The 12 month period for classification of a substandard asset in doubtful category is effective from April 1, 2009 Standard Assets:0.25%
Tier II bank
Other cooperative banks 90 days loan delinquency The 12 month period for classification of a substandard asset in doubtful category has been effective from April 1, 2005 Standard Asset: 0.25% to 0.40%depending on loan category. Fresh accretion Doubtful Asset for more than three years March 31,2007 – 50% March 31,2008 – 60% March 31,2009 – 75% March 31,2010 – 100% Doubtful assets outstanding for more than three years 100% from March 31,2007 Source: Reserve Bank of India
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Deposits Advances and Investments of SUCBs
(Growth per cent)
Mar 2008 over Mar 2007 Sep 2008 over Sep 2007 Mar 2009 over Mar 2008
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Total Assets Capital &Reserves Deposits Borrowings SLR Investments Non SLR Investments Gross loans & Advances Source: RBI on Trends and Progress 17.2
29.8
19.7
7.9
17.0
39.5
16.1
14.9
17.5
16.6
-2.5
12.8
23.9
18.8
13.2
25.9
13.6
15.2
13.3
19.9
13.7
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1.
2.
3.
4.
5.
Major Sources of Funds of NBFCs – ND - SI Source of Fund March 2008 (Percentage to total liabilities) March 2009 (Percentage to total liabilities)
Debentures Commercial Paper Borrowing from Banks and Fis Inter – corporate Loans Others 21.7
4.9
19.8
5.4
14.1
28.3
4.5
18.5
2.8
15.2
Source: RBI Report on Trend & Progress of Banks.
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S.
No Approach
a.
b.
c.
d.
Internal Models Approach (IMA) for Market Risk The Standardised Approach (TSA) for Operational Risk Advanced Measurement Approach (AMA) for Operational Risk Internal Ratings – Based (IRB) Approaches for Credit Risk (Foundation – as well as Advanced IRB)
The earliest date of making application by banks to the RBI Likely date of approval by the RBI
April 1, 2010 April 1, 2010 April 1, 2012 April 1, 2012 March 31, 2011 September 30, 2010 March 31, 2014 March 31, 2014 Source: Reserve Bank of India
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Macro Economic Environment
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• Global activity contraction of 0.8% in 2009 expected to recover by about 3.9% in 2010 (IMF-World Economic Outlook Jan) • Global inflation remained subdued slipped into negative territory • Anaemic aggregate demand, sharp decline in oil prices since mid 2008 • Major corrections of agricultural commodity prices and metals • Decline in capacity utilization • Transfer of financial risks to sovereign balance sheets and higher public debt levels added to financial stability risks and complicated the stimulus-exit process
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Soren Ramdhan Research Findings
• Financial Crisis started in summer 2007 with the lightning failure of Lehman Bros and Washington Mutual Funds and 3 Iceland Banks • It spread mistrust and fear among Banks and FIs • Four Risk Environmental Factors still being probed: – Financial Risk valuation models/methods – Risk Control Functions – Risk limiting strategies and – Bonus culture • Empirical evidence shows that financial risk performance was related with the factors: financial risk valuation models/methods and risk control functions. The factor risk control functions with the financial risk performance have a stronger relation than the factor financial risk valuation models/methods with financial risk performance. • Remarkably, no evidence is found to support the relation between financial risk performance and the factors: risk-limiting strategies and bonus culture.
• Financial institutions can achieve better financial risk
performance by emphasizing more on the risk environmental conditions related with financial risk valuation models/methods and risk control functions.
Introduction (1)
Background/sc ope Risk Scope of the environmental conditions research Underestimated financial risk crisis Financial crisis Started in 2007 Risk environmental conditions
Professionals
Perfectly estimated financial risk
Worldwide
Risk environmental factors Financial risk performance Researc h objectiv e
To identify the relation between financial risk performance of the last years and risk environmental factors influencing the performance.
MRQ1
What were the risk environmental factors behind the financial risk performance?
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Introduction (1)
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Need Challeng e Perspecti ve Reason Effective financial risk management in the future.
Learning from the past can be a solution for the future To identify the significant REC’s.
Risk practitioners, it is their performance.
Opportun ity To re-engineer the risk matrix and spread risk culture seamlessly integrating with the Business of the organization
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Introduction (2)
The research model and questions To what extent was financial risk performance The independent variables Financial risk valuation models and methods
Professionals
H 1 0 To what extent was financial risk performance risk control functions?
The dependent variable Risk control functions Risk-limiting strategies H 0 2 H 3 0 Financial risk performance (Estimated financial risk ) H 0 Bonus culture 4 To what extent was financial risk performance related with risk-limiting strategies?
To what extent was financial risk performance related with bonus culture?
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Conclusions
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Financial risk performance (FRP) was related with financial risk valuation models/methods.
The beta of 0.331 is the extent of the relation
FRP was related with risk control functions (highest significant predictor).
The beta of 0.381 is the extent of the relation.
FRP was not related with risk-limiting strategies.
FRP was not related with bonus culture Overall risk management failed due to:
1) Underdeveloped financial risk valuation models/methods, 2) Poor performance of risk control functions
The determinants of FRP are RISK DRIVERS related with the following 13 REC’s:
Data, market variables, qualitative valuation methods, tail loss, stress test, and group-wide risk, system risk, solvability and integrity, strategic risk decision, day to-day operational risk activities, and traders’ risk awareness.
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Recommendations (1)
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Financial institutions risk drivers.
must emphasize more on the risk drivers related with the (13) REC’s by ensuring proper governance around the Regulators must extend their control activities among the risk drivers related with the (13) REC’s to ensure that a proper governance is applied among FI’s Management of Risk Evaluation Controls holds the key
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