Volume 20, Number 3 Article by Malay Bhattacharyya September, 2008
Contemporary Financial Risk Management: The Role of Value at Risk - VAR Models :
Managing risk has become crucial to organisations. The management of risk is intrinsically related to the measurement of risk. Most organisations today recognise that measuring risk is a complex task involving complicated mathematical models. Prof Malay Bhattacharyya's introductory note presents an overview of contemporary risk management issues and of the Value at Risk VaR models presently used to measure risk and comes up with questions for both members of the academia and practitioners pertaining to the best way to measure risk data requirement issues an integrated way to measure risk for the entire firm and the need to address categories of risk other than market and credit risk such as operational business and systemic risk.
In this context, IIMB Management Review invited a panel of experts from industry and academia to share perspectives on various aspects of contemporary financial risk management.
Prof Rajeev S, Visiting Faculty at IIM Bangalore, demonstrated how effectively technology could be used in fraud management and risk identification. Technology based on a combination of rules devised on the basis of prior experience, techniques of artificial intelligence such as neural networks, and data mining leading to pattern recognition, complemented by human judgement, can significantly increase fraud detection. Prof Rajeev illustrated these functionalities by describing a software programme currently in use in a few banks.
Mr Vijay Sharma, Head of i-flex Consulting at i - flex Solutions, focused on operational risk or 'the risk of loss resulting from inadequate or failed internal processes, people and systems, or from external events's as defined by the Basel Committee on Banking Supervision. Operational risk, unlike market risk and credit risk, cuts across departments and functions and requires an enterprise - wide approach, with a defined risk function incorporating different frameworks and data sharing across departments. Some banks have now begun measuring operational risk to comply with regulatory requirements and incorporating measurement in their decision making process. Organisations have begun to look at risk and compliance in a larger framework of governance.
Explicating the need for effective regulation of markets, Prof P C Narayan, IIM Bangalore, discussed the interconnection between credit and market risk. In the absence of effective regulation of all participants, the adverse outcomes arising from credit and market risk ultimately devolve on the financial intermediaries or banks, which most often end up bearing the brunt of financial market losses, as can be seen from several financial crises in the recent past.
Mr Siddhartha Roy, Chief Risk Officer, The Clearing Corporation of India Ltd (CCIL), discussed settlement risk from the point of view of the clearing house. Settlement risk, in the case of transactions between financial service providers, can be managed by bilateral netting but a multilateral approach to netting using a central counter party (CCP) is more effective in risk reduction in certain types of transactions. CCIL provides guaranteed settlement of over-the-counter (OTC) trades of wholesale market participants in the money, debt and forex markets as a CCP, and seeks to be an efficient and cost effective vehicle for risk mitigation for its members. CCIL's other risk management services include provision of liquidity and risk based margining. It serves as a form of regulation and provides information, as also guarding against systemic failure in the markets.
All the panelists were agreed that risk assessment and management should be embedded into the process of decision making and here, a Chief Risk Officer could play a pivotal role. The potential for clearing houses like CCIL to take the lead globally and the change in mindset required to develop and strengthen the Indian financial markets were discussed.
Reprint No 08304a