1️⃣ What is Risk Management?

• Definition:
  Risk Management = Identifying, assessing, and controlling risks that may affect achievement of an organisation’s objectives.
• Objective:
  ✔ Minimise losses
  ✔ Maximise opportunities / returns

Risk Management = Think in advance + Prepare + Control

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2️⃣ Types of Risks in Banking & Finance

2.1 Credit Risk

• Meaning:
  Risk of loss if borrower fails to repay loan or meet contractual obligations.
• Examples (Banking):
  • Loan default
  • EMI not paid
  • NPA formation
• Mitigation:
  • ✔ Credit appraisal (CIBIL, income, financials)
  • ✔ Collateral / security
  • ✔ Diversification of loan portfolio

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2.2 Market Risk

• Meaning:
  Risk of loss due to changes in market prices, such as:
  • Interest rates
  • Foreign exchange rates
  • Equity / commodity prices
• Examples (Banking):
  • Fall in bond price when interest rates rise
  • Loss in forex position due to INR depreciation
• Mitigation:
  • ✔ Hedging using derivatives
  • ✔ Asset allocation
  • ✔ Diversification

🔹 Hedging – Very Important Concept

Hedging = Protection / Insurance against price movement risk.

Common Hedging Strategies:

• Diversification
  ➡ Spread investments across assets / sectors
  ➡ Example: Invest in IT + Pharma + FMCG instead of only IT.
• Using Derivatives:
  1. Futures Contracts
     • Agreement to buy/sell in future at fixed price
     • Example: Airline locks fuel price using oil futures.
  2. Options Contracts
     • Right (not obligation) to buy/sell at specific price.
     • Call Option – Right to buy
     • Put Option – Right to sell
     • Example: Investor buys put option to protect against fall in stock price.
  3. Forwards
     • Customised future contract (OTC, not exchange-traded).
     • Example: Bank and exporter fix USD-INR rate for future date.
  4. Swaps
     • Exchange of cash flows
     • Example: Interest Rate Swap – fixed rate ↔ floating rate.

Mnemonic – Derivatives Types:

FOPS = Futures, Options, Forwards, Swaps

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2.3 Operational Risk

• Meaning:
  Risk of loss from failed internal processes, people, systems, or external events.
• Examples:
  • System failure
  • Fraud by staff
  • Wrong posting of entries
  • Cyber-attack
• Mitigation:
  • ✔ Strong internal controls
  • ✔ Segregation of duties (maker–checker)
  • ✔ IT security, backups
  • ✔ Employee training, SOPs

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2.4 Liquidity Risk

• Meaning:
  Risk that bank/organisation cannot meet short-term obligations because it can’t convert assets into cash quickly.
• Examples (Banking):
  • Bank has long-term loans but must repay short-term deposits.
  • Sudden deposit withdrawal.
• Mitigation:
  • ✔ Maintain adequate liquid assets (CRR, SLR, HQLA)
  • ✔ Gap analysis, Liquidity Coverage Ratio (LCR)
  • ✔ Contingency funding plan

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2.5 Interest Rate Risk

• Meaning:
  Risk of loss due to interest rate changes impacting assets/liabilities.
• Examples:
  • Bank holding fixed-rate bonds loses when market interest rate increases.
  • Mismatch between rate-sensitive loans and deposits.
• Mitigation:
  • ✔ Interest rate swaps, futures, options
  • ✔ Duration management
  • ✔ Asset-Liability Management (ALM)

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2.6 Foreign Exchange (Forex) Risk

• Meaning:
  Risk of loss due to movement in exchange rates.
• Examples:
  • Importer must pay USD; if USD/INR rises, cost increases.
  • Bank holding USD assets loses when USD falls.
• Mitigation:
  • ✔ Currency hedging (forwards, options, swaps)
  • ✔ Matching assets & liabilities in same currency
  • ✔ Diversification in currency exposure

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2.7 Reputational Risk

• Meaning:
  Risk of damage to organisation’s image, leading to loss of customers / investors.
• Causes:
  • AML / fraud incidents
  • Mis-selling
  • Poor customer service
• Mitigation:
  • ✔ Ethical practices
  • ✔ Transparent communication
  • ✔ Quick and effective crisis management

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3️⃣ Risk Management Framework – Step by Step

3.1 Risk Identification

• Meaning: Find all possible risks.
• Methods:
  ✔ Brainstorming
  ✔ Risk workshops
  ✔ Internal audits
  ✔ Study past incidents / loss data

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3.2 Risk Assessment

Assess = How likely + How big?

(A) Risk Matrix

• Two Axis Tool:
  • Likelihood (Low / Medium / High)
  • Impact (Low / Medium / High)
• Risks plotted as:
  • ✅ Green – Low risk
  • ⚠️ Yellow – Medium risk
  • 🔴 Red – High risk
• Example: Cyber-attack with high likelihood + high impact → Red zone.

(B) Scenario Analysis

• “What if” technique
• Steps:
  1. Choose a risk (e.g. economic slowdown)
  2. Build scenarios (10% drop, 20% drop in sales)
  3. Check impact on profit, capital, liquidity
• Widely used for stress testing in banks.

(C) Qualitative vs Quantitative

Type	Basis	Example
Qualitative	Non-numeric, judgement-based	“High / Medium / Low” risk rating
Quantitative	Numbers, probability, value	Expected loss = Probability × Impact

Example (Quantitative):

• 20% chance of loss of ₹10 lakh → Expected loss = ₹2 lakh

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3.3 Risk Control (Treatment)

Main strategies: Avoid, Reduce, Transfer, Accept

Strategy	Meaning	Example
Avoid	Change plan to avoid risk	Bank avoids lending to banned sectors
Mitigate	Reduce probability/impact	Extra security checks in Internet banking
Transfer	Shift risk to others	Insurance, outsourcing, hedging
Accept	Bear minor risk	Small FX variation tolerated

Mnemonic – ARTA:

Avoid, Reduce, Transfer, Accept

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3.4 Risk Monitoring

• Continuous tracking of:
  • KRIs (Key Risk Indicators)
  • Loss events
  • Policy breaches
• Tools:
  ✔ Dashboards
  ✔ Regular risk reports
  ✔ Internal audits

Examples of KRIs (Banking):

• NPA Ratio
• Loan default rate
• Capital Adequacy Ratio (CAR)
• Number of fraud cases

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3.5 Risk Reporting

• Purpose: Inform management / Board / regulators.
• Format:
  • MIS reports
  • Dashboard charts
  • ALCO reports (for ALM)
  • Regulatory reports to RBI / SEBI etc.

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4️⃣ Risk Management Tools

4.1 Risk Matrix

➡ Already covered – used for prioritisation of risks.

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4.2 Scenario Analysis & Stress Testing

• Scenario Analysis → normal + extreme conditions
• Stress Testing → extreme but plausible shocks
  • Example:
    • 3% increase in interest rate
    • 30% fall in stock market
    • Large deposit withdrawal

Basel norms require regular stress tests for banks.

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4.3 Hedging (Recap)

• Hedging = Insurance for Market / FX / Interest Rate Risk.
• Tools: Futures, Options, Forwards, Swaps, Diversification

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4.4 Risk Register

• Definition:
  A live document recording all major risks and how they are being handled.
• Typical Columns:
  • Risk ID
  • Risk Description
  • Category (credit/market/operational…)
  • Likelihood (H/M/L)
  • Impact (H/M/L)
  • Risk Score (= L × I)
  • Risk Owner
  • Mitigation Plan
  • Status (Active / Closed / Monitoring)

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4.5 Treasury Risk Measures (Bank Treasury)

1. Value at Risk (VaR)
   • Meaning: Maximum possible loss in a portfolio over a period, at a given confidence level.
   • Example: VaR = ₹1 crore at 99% for 1 day → loss will not exceed ₹1 crore on 99% of days.
2. Duration & Duration Gap
   • Duration: Sensitivity of bond price to interest rate change.
   • Duration Gap: Duration of Assets – Duration of Liabilities
   • Used for interest rate risk in banking book.

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5️⃣ Risk Management in Banks & Treasury

5.1 Basel Accords (I, II, III) – Overview

• Global regulatory framework for banks’ risk management.
• Key focus areas:
  • Capital Adequacy (protects against credit, market, operational risk)
  • Stress Testing
  • Risk Disclosure & Governance
• Basel III:
  • Higher quantity and quality of capital (CET1)
  • Capital buffers
  • Liquidity standards:
    • LCR – Liquidity Coverage Ratio
    • NSFR – Net Stable Funding Ratio

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5.2 Treasury Risks

• Market Risk:
  • Price / yield change in G-Secs, corporate bonds, forex.
• Credit Risk:
  • Counterparty fails in inter-bank / derivative deals.
• Liquidity Risk:
  • Mismatch between short-term borrowing and long-term investments.
• Interest Rate Risk:
  • Mismatch in rate-sensitive assets & liabilities.

Internal Controls in Treasury:

• ✔ Limits on deal size, open position
• ✔ Stop-loss limits
• ✔ Separation of Front Office (deals), Mid Office (risk), Back Office (settlement)

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5.3 Asset-Liability Management (ALM) & ALCO

• ALM:
  Managing liquidity and interest rate risk by matching assets and liabilities.
• ALCO (Asset-Liability Committee):
  • Senior-level committee in bank
  • Decides interest rate policy, liquidity strategy, maturity profile
  • Works closely with Treasury.

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6️⃣ Key Terms

• Risk Appetite:
  Level of risk organisation is willing to accept.
• Risk Tolerance:
  Acceptable variation from expected risk level.
• Risk Exposure:
  Extent to which entity is vulnerable to a risk.
• Residual Risk:
  Risk remaining after applying controls/mitigation.

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🔥 Most Important

1. Definition:
   ➡ Risk = possibility of loss; Risk Management = identify + assess + control.
2. Main Types (Banking):
   ➡ Credit, Market, Operational, Liquidity, Interest Rate, Forex, Reputational
3. 3 Stages in Risk Process:
   ➡ Identify → Assess → Control → (Monitor & Report)
4. Risk Treatment Mnemonic – ARTA:
   ➡ Avoid, Reduce, Transfer, Accept
5. Risk Matrix = Likelihood vs Impact
6. Qualitative vs Quantitative Risk Assessment
7. VaR – potential portfolio loss at given confidence level & time.
8. Duration Gap used for interest rate risk.
9. Basel III = capital adequacy + liquidity + stress testing.
10. ALM & ALCO – key for liquidity & interest rate risk management in banks.
11. KRIs – early warning signals like NPA ratio, CAR, default rate.
12. Hedging tools: Futures, Options, Forwards, Swaps (FOPS).

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📊 Visual Summary

Area	Key Point	Example / Tool
Definition	RM = Identify + Assess + Control risk	Bank credit policy
Credit Risk	Borrower default	NPA formation
Market Risk	Price/Rate changes	Bond price fall
Operational Risk	Process/System failure	Fraud / system crash
Liquidity Risk	Cannot meet obligations	Deposit run
Interest Rate Risk	Rate change impact	Fixed bond loss
Forex Risk	FX rate movement	USD/INR volatility
Tools	Risk Matrix, Scenario, VaR, Duration, Risk Register
Mitigation	ARTA – Avoid, Reduce, Transfer, Accept	Insurance, Hedging
Basel III	Capital + Liquidity + Stress Test	LCR, NSFR
ALM / ALCO	Manage liquidity & rate risk	Gap analysis
Treasury Controls	Limits, stop-loss, segregation	Front/Mid/Back Office

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⏳ 2-Minute Quick Revision Sheet

✅ Core Concepts

• Risk: Chance of loss or adverse outcome.
• Risk Management: Identify ➡ Assess ➡ Control ➡ Monitor ➡ Report. (ACMR)

✅ Main Risk Types (Banking)

• Credit Risk – borrower default → NPA
• Market Risk – price, interest rate, FX movements
• Operational Risk – people, process, system failures
• Liquidity Risk – can’t meet short-term obligations
• Interest Rate Risk – mismatch in rate-sensitive items
• Forex Risk – currency movement
• Reputational Risk – loss of trust

Mnemonic:

C-MO-LIR-FR = Credit, Market, Operational, Liquidity, Interest Rate, Forex, Reputational

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✅ Risk Management Steps

1. Risk Identification – list risks
2. Risk Assessment – Likelihood + Impact (Risk Matrix)
3. Risk Control – ARTA: Avoid, Reduce, Transfer, Accept
4. Risk Monitoring – KRIs, dashboards
5. Risk Reporting – MIS to management / regulators

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✅ Assessment Tools

• Risk Matrix: Likelihood vs Impact → Green / Yellow / Red
• Scenario Analysis: Best / Worst / Most-likely
• Quantitative: Expected loss = Probability × Impact
• VaR: Max loss with given confidence
• Duration Gap: Interest rate sensitivity of assets vs liabilities
• Risk Register: Table of all major risks & actions

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✅ Banking & Treasury Focus

• Basel III: Capital, liquidity (LCR/NSFR), stress testing.
• ALM: Manage liquidity + interest rate risk.
• ALCO: Committee for ALM & pricing.
• Treasury Risks: Market, credit, liquidity, interest rate.
• Controls: Limits, stop-loss, segregation of duties.

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✅ One-Line Memory Hooks

• RM Formula: Think Risk → Measure Risk → Control Risk
• Hedging Tools: FOPS – Futures, Options, Forwards, Swaps
• Treatment: ARTA – Avoid, Reduce, Transfer, Accept
• VaR: How much can I lose at worst (with X% confidence)?

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