Banks in the process of financial intermediation are confronted with various kinds of financial and non-financial risks viz., credit, interest rate, foreign exchange rate, liquidity, equity price, commodity price, legal, regulatory, reputational, operational, etc. These risks are highly interdependent and events that affect one area of risk can have ramifications for a range of other risk categories. It therefore becomes very essential for top management of banks to attach considerable importance to improve the ability to identify, measure, monitor and control the overall level of risks undertaken. This is a new development in Indian Banking. All these decades before the advent of Reforms the exercise of risk assessment and risk management were never seriosly considered or attempted , as the banks were operating in a captive economy.

With liberalisation in Indian financial markets over the last few years and growing integration of domestic markets and with external markets, the risks associated with banks' operations have become complex and large, requiring strategic management. Banks are now operating in a fairly deregulated environment and are required to determine on their own, interest rates on deposits and advance in both domestic and foreign currencies on a dynamic basis. The interest rates on banks' investments in government and other securities are also now market related. Intense competition for business involving both the assets and liabilities, together with increasing volatility in the domestic interest rates as well as foreign exchange rates, has brought pressure on the management of banks to maintain a good balance among spreads, profitability and long-term viability. Imprudent liquidity management can put banks' earnings and reputation at great risk. These pressures call for structured and comprehensive measures and not just ad hoc action. The Management of banks has to base their business decisions on a dynamic and integrated risk management system and process, driven by corporate strategy. Banks are exposed to several major risks in the course of their business - credit risk, interest rate risk, foreign exchange risk, equity / commodity price risk , liquidity risk and operational risk. It is, therefore, important that banks introduce effective risk management systems that address the issues related to interest rate, currency and liquidity risks.

Since the year 1998 RBI have been giving serious efforts and attention towards evolving suitable and comprehensive models for Risk-management by the Banks and to integrate this new discipline in the working systems of the Banks.

RBI has defined that the broad parameters of risk management function should encompass:

1. organisational structure;

2. comprehensive risk measurement approach;

3. risk management policies approved by the Board which should be consistent with the broader business strategies, capital strength, management expertise and overall willingness to assume risk;

4. guidelines and other parameters used to govern risk taking including detailed structure of prudential limits;

5. strong MIS for reporting, monitoring and controlling risks;

6. well laid out procedures, effective control and comprehensive risk reporting framework;

7. separate risk management framework independent of operational Departments and with clear delineation of levels of responsibility for management of risk; and

8. periodical review and evaluation

In terms of this objective to provide risk-management tools and strategies to the commercial banks, RBI has been formulating a number guidelines since 1998, to cover each type of risk, like Asset Liability Risk, Credit Risk, Market Risk, Country Risk etc.

First in the series was guidelines issued on ALM. These were firsty issued in the form of draft guidelines by RBI vide circular DBOD No. BP. BC. 94/ 21. 04. 098/ 98 dated September 10, 1998. Subsequently a review of thse guidelines were conducted in a seminar organised at Bankers Training College and also at the Review Meeting of the Chairmen/Chief Executive Officers of banks. Based on the feedback/suggestions RBI finalised the Guidelines and circulated to the Banks vide circular DBOD No. BP. BC. 8/21.04.098/99. The guidelines in detail are incorporated on this website.

In the same year 1999, as a further measure RBI circulated guidelines to evolve a comprehensive risk management approach vide circular DBOD.BP.SC. 98/21.04.103/99 dated October 7, 1999. These guidelines, together with the guidelines on Asset-Liability Management were purported to serve as benchmark to those banks, which have not established integrated risk management systems. RBI has since evolved seperate Guidelines for each broad segment of risk, viz. credit risk, market risk and country risk. Hence these guidelines are not relevant now.

As a step towards enhancing and fine-tuning the existing risk management practices in banks, two Working Groups were constituted in Reserve Bank of India in the year 2001 drawing experts from select banks and FIs for preparing detailed Guidance Notes on Credit Risk and Market Risk management by banks. The Working Groups have identified further steps which are required to be taken by banks for Improving their existing risk management framework, suiting to Indian conditions. On the basis of feedback received from the members of the Working Group, a draft Guidance Notes on both Credit Risk and market riks has been placed on the website of RBI for comments by banks and other market participants. These have since been finalised and approved Guidelines have been circulated by RBI, with instruction to place them at the Board Meetings of respective banks.

Market Risk Management provides a comprehensive and dynamic framework for measuring, monitoring and managing liquidity, interest rate, foreign exchange and equity and commodity price risks of a bank that needs to be closely integrated with the bank's business strategy. Market Risk may be defined as the possibility of loss to a bank caused by changes in the market variables. The BIS defines market risk as " the risk that the value of on-or off-balance-sheet positions will be adversely affected by movements in equity and interest rate markets, currency exchange rates and commodity prices". Thus, Market Risk is the risk to the bank's earnings and capital due to changes in the market level of interest rates or prices of securities, foreign exchange and equities, as well as the volatilities of those prices. An effective market risk management framework in a bank comprises risk identification, setting up of limits and triggers, risk monitoring, models of analysis that value positions or measure market risk, risk reporting, etc. These aspects are elaborately discussed in the guidelines issued by RBI along with their circular DBOD. No. BP. 520 /21.04.103/2002-03 Date: Oct 12, 2002 . In the guidelines relating to Market Risk RBI covered the following types of risk.

1. Guidelines for evolving a risk-management structure

2. Credit Risk (including credit risk in investment banking and off-balance sheet exposure)

3. Inter-bank Exposure and Country Risk

4. Market Risk

5. Liquidity Risk

6. Interest Rate Risk (IRR)

7. Foreign Exchange (Forex) Risk

8. Operational Risk

RBI guidelines on Market Risk Management are incorporated on this website

In terms of paragraphs 123 and 124 of the Statement on Monetary and Credit Policy for the year 2002-03 RBI has indicated therein that with a view to moving further in complying with the Core Principles for Effective Banking Supervision drawn up by the Basle Committee on Banking Supervision, RBI would be issuing guidelines on country risk management and provisioning therefor, in consultation with banks. These guidelines were issued by RBI vide circular No. DBOD. BP. BC. 71 / 21.04.103 / 2002- 03 dated February 19, 2003. The CRM policy should address the issues of identifying, measuring, monitoring and controlling country exposure risks. The Policy should specify the responsibility and accountability of the various levels for the country risk management decisions. Banks should also put in place procedures for ensuring that necessary steps are taken in accordance with the CRM policy

1. in the case of direct lending, that funds will not be repaid;

2. in the case of guarantees or letters of credit, that funds will not be forthcoming from the customer upon crystallization of the liability under the contract;

3. in the case of treasury products, that the payment or series of payments due from the counterparty under the respective contracts is not forthcoming or ceases;

4. in the case of securities trading businesses, that settlement will not be effected;

5. in the case of cross-border exposure, that the availability and free transfer of currency is restricted or ceases.

Credit risk management enables banks to identify, assess, manage proactively, and optimise their credit risk at an individual level or at an entity level or at the level of a country. Given the fast changing, dynamic world scenario experiencing the pressures of globalisation, liberalization, consolidation and disintermediation, it is important that banks have a robust credit risk management policies and procedures which is sensitive and responsive to these changes.

RBI guidelines on Credit Risk Management was issued to the Banks under covedr of their circular No.DBOD. No. BP. 520 /21.04.103/2002-03 Date: Oct 12, 2002. These guidelines are incorporated on this website

A sound internal audit function plays an important role in contributing to the effectiveness of the internal control system. The audit function should provide high quality counsel to management on the effectiveness of risk management and internal controls including regulatory compliance by the bank. Historically, the internal audit system in banks has been concentrating on transaction testing, testing of accuracy and reliability of accounting records and financial reports, integrity, reliability and timeliness of control reports, and adherence to legal and regulatory requirements. However, in the changing scenario such testing by itself would not be sufficient. There is a need for widening as well as redirecting the scope of internal audit to evaluate the adequacy and effectiveness of risk management procedures and internal control systems in the banks.

To achieve these objectives, banks will have to gradually move towards risk-based internal audit which will include, in addition to selective transaction testing, an evaluation of the risk management systems and control procedures prevailing in various areas of a bank's operations. The implementation of risk-based internal audit would mean that greater emphasis is placed on the internal auditor's role in mitigating risks. While focusing on effective risk management and controls, in addition to appropriate transaction testing, the risk-based internal audit would not only offer suggestions for mitigating current risks but also anticipate areas of potential risks and play an important role in protecting the bank from various risks. The guidelines issued by RBI on this subject are included on this website

It has been stated by the Governor RBI that the Reserve Bank would be developing an overall plan for moving towards Risk-based Supervision (RBS) with the assistance of international consultants. Accordingly, Pricewaterhouse Coopers (PwC), a firm of consultants based in London, were engaged to undertake a review of the current regulatory and supervisory regime and prepare the blue print for the transition to a more sophisticated system of RBS incorporating international best practices.

As per the discussion paper submitted by PWC and approved by RBI, the Reserve Bank would focus its supervisory attention on the banks in accordance with the risk each bank poses to itself as well as to the system. The risk profile of each bank would determine the supervisory programme comprising off-site surveillance, targeted on-site inspections, structured meetings with banks, commissioned external audits, specific supervisory directions and new policy notices in conjunction with close monitoring through a Monitorable Action Plan (MAP) followed by enforcement action, as warranted. The guidelines issued by RBI on this subject are included on this website