BT Best Banks 2001: Riskier Than Thou!

BT BEST BANKS 2001: RISK MANAGEMENT IN BANKS
Riskier Than Thou!

The ability to manage risks, and manage them well distinguishes the winners from others in the banking sweepstakes. That said, the overall quality of risk management could certainly improve.

By Roshni Jayakar

The fact is that bankers are in the business of managing risk. Pure and simple, that is the business of banking.
-Walter Wriston, former Chairman, Citicorp

With due deference to Mr. Wriston-may his tribe increase-there's the question of the extent to which banks are aware of the risks they face. And that of whether they possess the controls that can mitigate these risks. The answer to both questions would be: not always. Travel through time and the landscape of the Indian banking sector over the past few months is littered with risk-flotsam, decisions that seemed to have gone horribly wrong. Like Madhavpura Co-operative Bank's capital market exposure. Like Global Trust Bank's (GTB) indiscreet loans to a few brokerages.

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Banks typically respond to suggestions that their risk management systems are faulty by battening the hatches and imitating a large flightless bird with a fondness for sand. But in the perilous 2000s, this won't help: what will, is a comprehensive overhaul of the risk management machinery. The best thing to do would be to develop an enterprise-wide risk management programme that targets all of a banks' risks: market risks, credit risks, technology risks, and operational risks. ''Risk management,'' avers Sujit Banerji, Managing Director, Area Head (India, Sri Lanka, Nepal, and Bangladesh), ''has to be part of the very culture of the organisation.''

Risk management isn't a defence mechanism in the lexicon of banking; it, believes Narayan Seshadri, Partner, Arthur Andersen, is a very real competitive advantage. ''A bank can earn higher profits than its competitors due to its ability to take on and get paid for greater risk due to its ability to manage risk better than its competitors.'' Adds Aditya Puri, CEO, HDFC Bank: ''We have a clear understanding of risk and reward. So, high or low provisioning doesn't make a difference. If the risk is high then our return must be higher.''

So, when things go wrong, it is only natural to see whether the bank in question had prudential risk management practices in place. For instance, did GTB, which found itself at the receiving end after it was revealed that the bank's exposure to broker Ketan Parekh's companies was considerable? Or was it merely an issue of overstepping some norms? The bank's just-appointed Chairman and Managing Director, R.S. Hugar, admits that it was a mix of both: ''To set this right and to put the right systems in place, the bank has now evolved a new risk management policy which is being put before the board.''

In all fairness, a report presented by the standing technical committee of the Reserve Bank of India (RBI) and the Securities and Exchange Board of India (SEBI) on April 12, 2001, to review how banks stacked up against the central bank's guidelines on financing of equities discovered nothing untoward. According to it, the total investment in securities of the 101 scheduled commercial banks aggregated Rs 6,324.11 crore on March 31, 2001, and constituted 1.42 per cent of domestic credit-well within the norm of 5 per cent of domestic credit stipulated by the RBI.

Having concluded that the problem was not universal, the RBI still went ahead and proposed, on April 23, a few amendments on bank financing of equities and bank investments in shares. These are:

The 5 per cent limit will cover direct investment by banks in equity shares, convertible debentures, and units of equity-oriented mutual funds; advances against shares and debentures; and guarantees issued on behalf of brokers

Within the overall ceiling of 5 per cent, there will be a discretionary sub-ceiling for total advances to all the stock brokers and market makers

The total fund- and non-fund-based facilities sanctioned by a bank to a single broking entity including its associates should not exceed the prudential norm of 10 per cent of the sub-ceiling

To prevent any nexus , there should be clear separation of responsibilities for making decisions with regard to actual advances against shares and surveillance and monitoring of actual advances in shares

The RBI had also suggested as far back as March 2000 that banks create a high-level risk management committee within 18 months. Some banks have always had such systems in place; others have created them in the last year. Says K.V. Hegde, General Manager, Canara Bank: ''Our bank has an active ALCO (Asset-liabilities Committee) which addresses market risks.''

Essentially, establishing an organisational structure conducive to risk management includes: defining responsibilities, assigning them, segregating conflicting duties, and putting in place adequate risk management controls. That apart, banks need to improve their understanding of the changing environment and develop credit evaluation systems. Still, the increasing complexity of risks faced by banks does require sophisticated tools. Banks across the world have adopted the risk-adjusted-return-on-capital framework for risk aggregation and allocation of capital to various product lines. There are other tools and techniques like the value at risk model. Says Asit Bhatia, Principal, Bank of America: ''Unless there are systems in place it's not possible to monitor exposure on real-time basis.''

Managing risk, despite all that's being said about it, does not require sophisticated technology. Banks can extract information from the existing executive information support system in use. Explains Narayan of Arthur Andersen: ''If the board understands the concept of risk management and asks the right questions on the bank's portfolio, that could keep the bank management on its toes.'' That's right: asking questions may be a good way to start getting a handle on risk. It is also a great way to end a composition that begins with several questions.

-Additional reporting by Dilip Maitra, Nitya Varadarajan, & E. Kumar Sharma

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