Commercial Bank Management Risk Analysis of ICICI Bank

Submitted by: Himanshu Porwal (PGP01/015)

As a financial intermediary, ICICI Bank is primarily exposed to credit risk, market risk, liquidity risk, operational risk and legal risk. ICICI Bank has a central Risk, Compliance and Audit Group with a mandate to identify, assess, monitor and manage all of ICICI Banks principal risks in accordance with well-defined policies and procedures. The Head of the Risk, Compliance and Audit Group reports to the Executive Director responsible for the Corporate Centre, which does not include any business groups, and is thus independent from ICICI Banks business units. The Risk, Compliance and Audit Group coordinate with representatives of the business units to implement ICICI Banks risk methodologies. As shown in the following chart, the Risk, Compliance and Audit Group is organized into six subgroups: Credit Risk Management, Market Risk Management, Analytics, Internal Audit, Retail Risk Management and Credit Policies and Reserve Bank of India Inspection. The Analytics Unit develops proprietary quantitative techniques and models for risk measurement

Managing Director& CEO

Audit/Risk/Credit/Agriculture & Small Enterprises Business Committee of the Board

Executive Director, Corporate Centre

Head, Risk, Compliance and Audit Group

Credit Risk Management C

Market Risk Management

Analytics

Internal Audit (Including Subsidiaries)

Retail Risk Management

Credit Policies, Reserve Bank of India Inspection

Credit Risk:
Credit risk is the risk of loss that may occur from the failure of any party to abide by the terms and conditions of any financial contract with institution, principally the failure to make required payments on loans due to bank. Credit risk arises whenever a borrower is expecting to use future cash flows to pay a current debt. Investors are compensated for assuming credit risk by way of interest payments from the borrower or issuer of a debt obligation. In order to assess the credit risk associated with any financing proposal, ICICI Bank assesses a variety of risks relating to the borrower and the relevant industry. Borrower risk is evaluated by considering the financial position of the borrower by analyzing the quality of its financial statements, its past financial performance, its financial flexibility in terms of ability to raise capital and its cash flow adequacy the borrower's relative market position and operating efficiency; and the quality of management by analyzing their track record, payment record and financial conservatism. Industry risk is evaluated by considering: certain industry characteristics, such as the importance of the industry to the economy, its growth outlook, cyclicality and government policies relating to the industry; the competitiveness of the industry; and Certain industry financials, including return on capital employed, operating margins and earnings stability.

After conducting an analysis of a specific borrower's risk, the Credit Risk Management Group assigns a credit rating to the borrower. ICICI Bank has a scale of 10 ratings ranging from AAA to B and an additional default rating of D. Credit rating is a critical input for the credit approval process. ICICI Bank determines the desired credit risk spread over its cost of funds by considering the borrower's credit rating and the default pattern corresponding to the credit rating. The approval process for non-fund facilities is similar to that for fund based facilities. The credit rating for every borrower is reviewed at least annually and is typically reviewed on a more frequent basis for higher risk credits and large exposures. ICICI Bank also 63 reviews the ratings of all borrowers in a particular industry upon the occurrence of any significant event impacting that industry. Working capital loans are generally approved for a period of 12 months. At the end of 12 months, ICICI Bank reviews the loan arrangement and the credit rating of the borrower and takes a decision on continuation of the arrangement and changes in the loan covenants as may be necessary.

Market Risk:
Market risk is the possibility of loss arising from changes in the value of a financial instrument as a result of changes in market variables such as interest rates, exchange rates and other asset prices. The prime source of market risk for the Bank is the interest rate risk; ICICI Bank is exposed to as a financial intermediary which arises on account of ICICI Bank asset liability management activities. In addition to interest rate risk, ICICI Bank are exposed to other elements of market risk such as liquidity or funding risk, price risk on trading portfolios, exchange rate risk on foreign currency positions and credit spread risk.

Market risk: i) Liquidity risk: Risk arising on account of lack of secondary market to provide ready exit options to the investors/participants. ii) Interest rate/currency risk: Mark to market risks arising on account of interest rate/currency fluctuations. Market Risk Management Procedures: The board of directors of ICICI Bank reviews and approves the policies for the management of market risk. The board has delegated the responsibility for market risk management on the banking book to the Asset Liability Management Committee and the trading book to the Committee of Directors, under the Risk Committee of the Board. The Asset Liability Management Committee is responsible for approving policies and managing interest rate risk on the banking book and liquidity risks reflected in the balance sheet. The Committee of Directors is responsible for setting policies and approving risk controls for the trading portfolio.

Interest Rate Risk:

Since ICICI Banks balance sheet consists predominantly of rupee assets and liabilities, movements in domestic interest rates constitute the main source of interest rate risk. Our portfolio of traded and other debt securities and ICICI Bank loan portfolio are negatively impacted by an increase in interest rates. Exposure to fluctuations in interest rates is measured primarily by way of gap analysis, providing a static view of the maturity and re-pricing characteristics of balance sheet positions. An interest rate gap report is prepared by classifying all assets and liabilities into various time period categories according to contracted maturities or anticipated repricing date. The difference in the amount of assets and liabilities maturing or being repriced in any time period category, would then give an indication of the extent of exposure to the risk of potential changes in the margins on new or re-priced assets and liabilities. ICICI Bank prepared interest rate risk reports on a fortnightly basis in fiscal 2003. The same were reported to the Reserve Bank of India on a monthly basis. Interest rate risk is further monitored through interest rate risk limits approved by the Asset Liability Management Committee. ICICI Bank has a mix of floating and fixed interest rate assets. The loans generally are repaid more gradually, with principal repayments being made over the life of the loan. Housing loans are primarily floating rate loans where the rates are reset every quarter. ICICI Bank seeks to eliminate interest rate risk on undisbursed commitments by fixing interest rates on rupee loans at the time of loan disbursement. In contrast to ICICI Bank rupee loans, a large proportion of ICICI Bank foreign currency loans are floating rate loans. These loans are generally funded with floating rate foreign currency funds. ICICI Bank use the duration of ICICI Bank government securities portfolio as a key variable for interest rate risk management. ICICI Bank increase or decrease the duration of government securities portfolio to increase or decrease ICICI Bank interest rate risk exposure.

Maturity Pattern: Maturity pattern of assets and liabilities of the Bank at March 31, 2012.

Maturity Bucket Day 1 2 to 7 days 8 to 14 days 15 to 28 days 29 days to 3 months 3 to 6 months 6 months to 1 year 1 year to 3 year 3 year to 5 year Above 5 years

Loans and advances 7,738.50 13,041.40 13,191.00 39,001.70 1,42,209.30 1,88,828.50 3,36,379.40 10,43,883.50 3,88,469.10 3,64,534.20

Investment Securities 35,284.90 2,17,729.60 49,505.70 95,723.50 77,392.40 87,627.90 1,49,466.70 2,45,544.20 1,52,923.00 4,84,702.50

Deposits 19,792.90 44,612.60 54,744.20 97,134.40

Borrowings 1,74,543.10 2,543.60 26,841.40

Gap

Net Interest Margin Squeeze if

-11,615.30 -5,408.90 -10,749.40 1,34,467.70 1,53,404.70 1,89,889.10 -4,25,780.60 -1,15,695.80 -61,809.30

Interest Rate increases Interest Rate increases Interest Rate increases Interest Rate decreases Interest Rate decreases Interest Rate decreases Interest Rate increases Interest Rate increases Interest Rate increases

2,73,131.80 80,937.60 2,88,254.60 1,41,606.50 4,52,112.80 2,23,622.40 6,90,126.60 1,73,520.50 2,28,550.30 1,97,146.00 4,06,539.40 3,80,888.00

Exchange Rate Risk:

ICICI Bank offer foreign currency hedge instruments like swaps, forwards, and currency options to clients, which are primarily banks and highly rated corporate customers. ICICI Bank actively use cross currency swaps, forwards, and options to hedge against exchange risks arising out of these transactions. Trading activities in the foreign currency markets expose ICICI Bank to exchange rate risks. This risk is mitigated by setting counterparty limits, stipulating daily and cumulative stop-loss limits, and engaging in exception reporting.

Liquidity Risk:
Liquidity risk is the risk of inability to meet financial commitments as they fall due, through available cash flows or through sale of assets at fair market value. It is the current and prospective risk to the Banks earnings and equity arising out of inability to meet the obligations as and when they become due. It includes both, the risk of unexpected increases in the cost of funding an asset portfolio at appropriate maturities as well as the risk of being unable to liquidate a position in a timely manner at a reasonable price. Liquidity risk arises in the funding of lending, trading and investment activities and in the management of trading positions. The goal of liquidity management is to be able, even

under adverse conditions, to meet all liability repayments on time, to meet contingent liabilities, and fund all investment opportunities. ICICI Bank maintains diverse sources of liquidity to facilitate flexibility in meeting funding requirements. ICICI Bank operations are funded principally by accepting deposits from retail and corporate depositors and through public issuance of bonds. ICICI Bank also borrows in the short-term inter-bank market. Loan maturities, securitization of assets and loans, and sale of investments also provide liquidity.

Operating results:
Following table represents the operational result of the bank for the year 2011-12: Fiscal 2011 259.74 169.57 90.17 Fiscal 2012 335.42 228.08 107.34 % change 29.1% 34.5 19.0

Interest income Interest expense Net interest income Non-interest income Fee income Treasury income Lease and other income Operating income Operating profit Profit after tax

64.19 (2.15) 4.44 156.65 90.48 51.51

67.07 (0.13) 8.08 182.36 103.86 64.65

4.5 (94.0) 82.0 16.4 14.8 25.5%

Net interest income and spread analysis:

Following is the Interest income and Spread for the bank Fiscal 2011 Fiscal 2012 % change

Average interest-earning assets Average interest-bearing liabilities Net interest margin Interest spread

3,418.59 3,168.26 2.64% 2.25%

3,932.59 3,603.51 2.73% 2.20%

15.0 13.7%

Interest margin increased from 2.64% in fiscal 2011 to 2.73% in fiscal 2012. The higher increase in average interest-earning assets compared to increase in average interestbearing liabilities led to an increase in net interest margin. Net interest margin of overseas branches improved from 0.88% for fiscal 2011 to 1.23% for fiscal 2012 primarily due to increase in yield on overseas advances.

Capital adequacy ratios: At 31 March 2012

Tier I capital Tier II capital Total Capital Credit risk-Risk weighted assets(RWA) Market Risk RWA Operational Risk-RWA Total RWA Total capital adequacy ratio Tier I capital adequacy ratio Tier II capital adequacy ratio

in Rs. Billion
505.18 232.95 738.13 3468.74 268.66 248.46 3985.86 18.5% 12.7% 5.8%

Capital Requirement for Risk:

Minimum capital required to be held at 9.00% for credit, market and operational risks

In Rs. Billion
I. Capital required for credit risk for portfolio subject to standardised approach for securitisation exposure II. Capital required for market risk for interest rate risk for foreign exchange (including gold) risk for equity position risk III. Capital required for operational risk Total capital requirement (I+II+III) Total capital funds of the Bank Total risk weighted assets Capital adequacy ratio 339.19 338.08 1.11 31.96 26.06 0.87 5.03 26.19 397.34 865.19 4414.88 19.60%