Institute of Chartered Financial Analysts of India (ICFAI) University 2006 Certification Finance Management of Financial Institutions - II - Question Paper

RBI, in its report (2000-01) has asked banks to develop risk management strategies to avoid concentration of credit and advised banks to fix limits on their exposure to:

· Individual borrowers

· Group borrowers

· Unsecured guarantees and advances

Most simple credit derivative instrument can be taken as the Credit Linked Notes (CLNs). A simple credit derivative transaction is a negotiated contract where a protection buyer buys protection from the protection seller for a fee or premium. In case any credit event occurs the protection buyer gets compensated by the protection seller.

Caselet 3

learn the caselet carefully and ans the subsequent questions:



11. explain the fundamental flaw in the Basel I framework. Also explain about the risk weights applicable to SME sector under revised framework.

(7 marks) < ans >

12. As per the RBI guidelines issued in February, 2005 a regulatory retail portfolio should meet the 4 criteria to be assigned a risk-weight of 75%. Enumerate those criteria.

(7 marks) < ans >

Basel II continues to attract the attention of regulators, banks as well as academicians worldwide and while a few project it as the biggest fashion statement on bank risk management, a few others interpret it as only the codification of the global best practices in managing risk in banks. As such Basel II no longer remains confined only to the capital charge on risk exposures, it has become the fait accompli on robust integrated risk management in banks. In this context, the fundamental difference ranging from the role of the central bankers in the developed world and their counterparts in the Emerging Market Economies (EMEs) is that the latter have to put in place a robust integrated risk management system in their banks 1st to move over to Basel II, while the former have to basically codify the practices followed by a few of their best banks. Admittedly, the task is more challenging for the central bankers in the EMEs.

As the history of economics bears witness to it, the globalization, deregulation and the opening up of the markets led to huge balance sheet and off balance sheet risk exposure of banks in the 2nd part of the twentieth century. The oil shock, the collapse of Brettonwoods systems and the following failure in the hegemony of dollar coupled with large scale financial disintermediation led to severe banking crises, starting with the Herschedt bank failure in Germany in 1974. In many countries, like those in the Latin America, the banking crises combined with currency crisis led to economic crises at the macro level, a tragedy to be repeated in the South East Asian economies in the late 1990s. It is about that time that in 1975, the Basel Committee on Banking Supervision, a committee of supervisors from the G-10 countries took shape and which ultimately codified the 1st capital accord. At such a juncture, it was basically an attempt to safeguard the interest of international banks exposed to the risk beyond the geographical boundaries and of course various time zones, that Basel I was introduced in 1988. The norm was initially for the internationally active banks in the G-10 countries. Today, however, most of the banks in more than 100 countries subscribe to the 1st Basel accord. The said objective of the accord was, however, that this will decrease the competitive inequality among internationally active banks, create a level playing field for them and as such decrease global systemic risks.

Earning:   Approval pending.