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Market Risk
Market Risk in Banking
Market risk is the risk of losses arising out of adverse inmarket prices. This is a risk to bank's financial condition resulting from adverse movements in the level or volatility of market prices of Interest rate instruments, Equities, commodities, and currencies.
Market risk is usually measured as the potential loss or gain in a position or portfolio that is associated with the price movement of a given probability over a specified time horizon. This is also typically known as VALUE AT RISK.
Market risk gained a high profile when Basle committee on banking supervision came out with SUPERVISORY TREATMENT OF MARKET RISKS IN 1993.
This proposal is important in as much as it sought for the first time to extend 1998 Capital accord for credit risks to cover market risk also. In 1996 the Basle committee pronounced capital charge for the Market risk also indicating that Banks can use:
1. Standard approach
2. Internal model approach to measure the market risk
The proposed capital allocation is as under:
1. Tier 1 (Consisting of Equity and retained earnings)
2. Tier 2 (as per present 1988 accord such as debentures etc.)
3. Tier 3(consisting of short term subordinated debt subject to:)
A. Original maturity being not less than 2 years and limited to 250% of Tier 1 capital.
B. This capital is eligible to cover only market risk including forex and commodity risk.
C. In so far as the overall limits under 1988 accord are not breached, Tier 2 elements may be substituted for Tier 3 up to the same limit of 250%.
D. This capital funds are subjected to a Lock-in that neither the principal nor the interest may be paid if such payment means that the overall capital would then amount to less than the minimum capital requirement.
Banks are expected to assess the market risk by capturing all material sources of market risk and aggregate the total exposure assumed by them at any given point of time. With well laid Market risk movement policies, procedures, prudential risk limits, review mechanism, sound accounting and audit system, effective Asset-Liability management, such aggregation should not be difficult.
