Porus Mistry in India

Porus Mistry in India

Porus Mistry in India

Porus Mistry s Update : Managing Risk at the Macro Level

Ultimately, risk, and all other bank functions, are overseen by the bank's board of directors. The board I urged to take risk by the shareholders who want high returns. Balancing the shareholders, the board is limited in its risk taking by debt holders, rating agencies, regulators, and bank's own desire to stay in business. The result can be seen as a constrained maximization in which the institution is allowed to take the limited amount of risk and tries to maximize the returns on that risk.

The board oversees one key risk management function:

Deciding the target debit rating

Deciding the target debit rating

The debt rating is a measure of the bank's creditworthiness and corresponds to the bank's probability of default. A high debt rating corresponds to a low probability of default. The bank's creditworthiness is determined by the amount of risks it takes compared to the amount of capital held.

Capital is the difference in value between the bank's assets and liabilities. It can be viewed as the current net worth of the bank.

If the bank has a small amount of capital and takes a large amount of risk, there is a high probability that the losses will be greater than the capital, and the bank will go bankrupt. If the bank wants a high rating, it must hold a large amount of capital in relation to its risk.

Although the board sets the credit rating goal, the active ratings are granted by independent agencies that use quantitative and qualitative tools to assess a bank's strengths. These agencies include Standard & Poor's (S&P), Moody's and Fitch.

A low target debt rating has the advantage that the bank can take on many risks and expect to earn a high rate of return for the shareholders. However, a low debt rating means that the debt holders will charge higher interest rates to lend to the more risky bank.

The debt rating is also important to the bank's customers. For example, retail customers do not want to give their savings to a bank that is likely to go bankrupt. Similarly, corporations who are considering buying derivatives want to modify their market risk positions and do not want to be exposed to the credit risk of a lowly rated counterparty. Therefore, corporations buying derivatives would not deal with lowly rated banks.

The highest S&P rating is "AAA" most international bank are rated "AA", and national and regional banks tend to be rated "A" or "BBB"/

Once the board has decided to target debt rating, it must align the risks that it allows the bank to take with the amount of capital available.

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