Institute of Chartered Financial Analysts of India (ICFAI) University 2006 Certification Finance International and Trade – II - Question Paper

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7. On the risk management front, the benefits as expected have been enormous. Multilateral net settlement with closely controlled processes has virtually eliminated all principal risks other than for the net US dollar sale position of the participants. This element of risk has also been kept restricted to acceptable amounts in respect of all participating entities by setting Exposure Limits and is also additionally covered by the margins collected for the principal risk element (varying from 3% for highly rated entities to 8.5% for the least rated entities allowed into the system). Moreover, the ability created to claw back the counter-value Indian rupee funds from the principal account of any defaulting entity with RBI has further reinforced the system.

Furthermore, from the 3 days in the Spot Window (CASH, TOM and SPOT), principal risk is kept confined to only the CASH date by ensuring that in case of a default, no payout happens on the following days to the account of any defaulting entity without receipt of the counter-value funds. Market risk in the system is taken care of by adding a market risk factor, for collection of margin, in respect of every settlement date. Thus market risk cover is also available for almost all positions of the participants for all settlement dates.

The process, apart from causing huge reduction of risk to the individual settlement participant has also caused huge reduction of total risk to the system as a whole. In absence of a settlement system like the system run by CCIL, the maximum possible reduction in counterparty exposures could have been to reach such level of bilateral exposures. Moreover, for a bank, even US dollar sale position creates exposure as it is not possible for it to ensure receipt of counter-value Indian rupee funds before release of the US dollar payments. Thus, at bilateral level, both US dollar sale and US dollar buy positions create exposures Indian rupee exposure in case of US dollar sale and US dollar exposure in case of US dollar Buy. The counterparty wise net bilateral exposures, irrespective of whether those were US dollar Buy positions or US dollar Sale positions, were therefore summed up for every settlement date to arrive at the total bilateral exposures of the settlement participants for such settlement date.

For the identical settlement dates, total exposures of the settlement participants for settlement through CCIL were arrived at by taking the sum of net US dollar payable amounts for the respective settlement dates. As against such huge number of transactions, the settlement through CCIL's settlement system caused the number of payment transactions for the settlement participants to come down The enormous cost reduction and reduction in operational risk due to the decreased number of settlement is thus evident. It also made the system robust and significantly more reliable.

Earning:   Approval pending.