DBOD.No.BP.BC. 64/21.04.103/2002-03

January 29, 2003

All Scheduled Commercial Banks
(excluding RRBs and LABs)

Dear Sir,

Risk Management Systems in Banks

As you are aware, the RBI guidelines on asset-liability management in banks were issued vide circular DBOD.No.BP.BC.8/ 21.04.098/ 99 dated February 10, 1999. These guidelines broadly covered management of liquidity and interest rate risks by banks, prescribed the reporting systems for capturing the above two risks and also prescribed the prudential limits for liquidity mismatches. Subsequently, the guidelines on risk management systems in banks were issued by RBI vide circular DBOD.No. BP(SC).BC.98 /21.04.103/99 dated October 7, 1999 to serve as a benchmark to banks which were yet to establish integrated risk management system and covered management of credit risks, management of market risks and development of risk management structure.

2. As a step towards further enhancing and fine-tuning risk management systems in banks, draft Guidance Notes on Credit Risk Management and Market Risk Management were issued and placed on the RBI website for wider discussion among banks, financial institutions and other market participants. The Guidance Notes were based on the recommendations of two Working Groups constituted in Reserve Bank of India drawing experts from banks and FIs. The draft Guidance Notes were revised in the light of comments / feedback received from a wide spectrum of banks, financial institutions, rating agencies and other market participants and the revised Guidance Notes were issued vide DBOD.No. BP. 520/ 21.04.103 / 2002-03 dated October 12, 2002, and banks were advised to use these Guidance Notes for upgrading their risk management systems. The revised Guidance Notes for management of credit risk and market risk were also placed on the RBI website for greater dissemination.

3. With a view to involving banks in the process of transition to risk based supervision (RBS), a discussion paper on "Move towards Risk Based Supervision of banks" was issued vide DBS.CO/RBS/58/36.01.002 dated 13^th August 2001 to all commercial banks advising banks to initiate action to prepare themselves for RBS in five specific areas. Detailed risk profile templates were sent to banks vide DBS. No. DBS/CO/89/36.01.03/2002-03 dated July 12, 2002 with a view to enabling them to understand the technicalities of the risk profiling exercise and re-orienting their management systems to meet the requirements of RBS. Since risk based internal audit is an important component of the RBS process, guidelines on risk based internal audit were issued to banks vide circular DBS. CO. PP. BC.10/ 11.01.005/ 2002-03 dated 27^th December 2002. On-site inspection of banks under Risk Based Supervision will initially be taken up by RBI shortly on a pilot basis and thereafter the process will be fine tuned and extended to all commercial banks on the basis of the experience gained. With a view to enhancing the risk management functions in the banks and their preparedness for RBS, it will be necessary for banks to adapt their risk management systems and put in place appropriate structures/ systems in tune with the above guidelines at the earliest.

4. In this connection, it would also be pertinent to mention that the proposed New capital adequacy framework aims at moving over to an enhanced level of risk sensitivity in the capital allocation processes and captures all the major risks inherent in a bank’s operations viz. credit risk, market risk and operational risk, and envisages enhancement of risk sensitivity with mutually reinforcing pillars which would collectively contribute to safety and soundness of the financial system.

5. In the above background, with a view to moving over to integrated risk management systems which would further equip banks to identify, measure, monitor and control the various types of risks assumed by them to ensure a smooth transition to the new capital adequacy framework, banks are advised to critically evaluate the risk management systems already in place with reference to the above referred guidelines and guidance notes issued by RBI. Banks should, in particular, ensure that their risk management framework is oriented towards their requirements dictated by the size and complexity of business, risk philosophy, market perception and expected level of capital. The risk management systems should be adaptable to changes in business size, market dynamics and introduction of innovative products by banks in future. As the primary responsibility of laying down risk parameters and establishing an integrated risk management and control system rests with the Board of Directors, the note assessing the risk management systems should be placed before the Board. On the basis of such evaluation banks should initiate appropriate steps, with the approval of their Board, to eliminate the gaps in compliance with the risk management guidelines issued by RBI and ensure that they have efficient and robust risk management systems in place.

6. Please acknowledge receipt.

Yours faithfully,

( C.R.Muralidharan )
Chief General Manager