Credit Risk in Off Balance Sheet Exposures (including risks involved with derivative products)
Similar mechanics are used for the evaluating, managing and monitoring credit risk involved with our contingent exposures including trade related, guarantee, foreign exchange, interest rate, swap and option products as part of our overall customer credit approval limit setting and monitoring procedures.
Many of these products involve a myriad of interrelated credit, market and operational risks including the contingent exposure to market risk in the event of a counterparty default. These are all evaluated by the authority approving the credit after considering all the risk and mitigants. Current and potential credit exposures are measured and reviewed on a regular basis to evaluate the impact of changes in market conditions on the value of counterparty positions, which are quantified on the basis of market prices or in the case of derivatives by obtaining the current replacement cost or unwinding cost from a market maker or a major international counterparty. All derivative product risks are approved and regularly reviewed by ALCO. Commercial Bank has fully hedged the market risk of its derivative exposures with major correspondent international banks and these exposures are reported monthly to the Central Bank in accordance with their regulations.
The years preceding the current market turmoil were characterised by low levels of volatility and it was on this basis that we established credit risk limits for foreign exchange and commodity derivative products. The greatly increased volatility in 2008 have caused exposures for a few customers to exceed these limits but these still remain well within the Bank’s overall limits for single borrower exposures.
Market Risk
Market Risk has received significant additional management attention during 2008 to assess the potential impacts of the unprecedented volatility in financial markets worldwide on our business.
The Bank has clearly defined the division of responsibility for managing market risks, which are centralised in the Bank’s Treasury and funding centre. The Heads of Global Markets and Global Treasury who manage the overall Treasury business report to Managing Director, the Back Office Treasury which records the transactions and activities of the Treasury reports to the Chief Financial Officer. The Middle Office Treasury was established during 2008 and independently and continuously monitors, measures and analyses the foreign exchange risks and other risks managed by the Treasury and reports to Deputy Chief Risk Officer.
Market Risk arises due to mismatches or changes of value as a result of the Bank’s exposure to:
Asset and Liability Products.
Foreign Exchange Positions
Investments in Shares and Bonds
Derivative Products
The main types of Market Risk faced by the Bank are Interest Rate Risk, Liquidity Risk and Foreign Exchange Risk is described below.
Interest Rate Risk
Interest Rate Risk (IRR), is a major source of Market Risk in Commercial Bank and is unavoidable in any financial institution where the re-pricing of assets and liabilities are not identically matched. The ALCO manages the potential impact which might be caused by the volatility of changes in market interest rates and yield curves in order to optimize net interest income commensurate with IRR.
The ALM Unit of the Risk Management Department undertakes scenario analysis considering various financial/profitability outcomes which would create rate shocks to the Balance Sheet. This assists the ALCO to device strategies to manage and ensure the financial stability of the Bank in the event of drastic changes in market conditions. The ALCO uses Gap Analysis as a tool for monitoring the risks which arise when re-pricing maturities of assets and liabilities do not coincide and carefully monitors the potential impact on our profitability.
Liquidity Risk
Liquidity Risk Management has become a much higher priority in Commercial Bank during 2008 due to volatile funding conditions both in
Sri Lankan and Global Markets.
Up to 3
3 to 12
1 to 3
3 to 5
More than
Total as at
Total as at
months
months
years
years
5 years
31.12.2008
31.12.2007
Bank
Rs. Mn
Rs. Mn
Rs. Mn
Rs. Mn
Rs. Mn
Rs. Mn
Rs. Mn
Interest earning assets
121,382
46,073
52,550
17,679
16,322
254,006
240,883
Non-Interest earning assets
19,827
2,112
277
186
4,806
27,208
27,107
Total Assets
141,209
48,185
52,827
17,865
21,128
281,214
267,940
Interest bearing liabilities
150,043
51,974
10,215
5,207
7,517
224,956
212,143
Non-Interest bearing liabilities
28,077
1,748
543
–
25,890
56,258
55,797
Total Liabilities
178,120
53,722
10,758
5,207
33,407
281,214
267,940
Maturity Gap
(36,911)
(5,537)
42,069
12,658
(12,279)
–
–
Cumulative Gap
(36,911)
(42,448)
(379)
12,279
–
–
–
Liquidity Risk is the risk that the Bank cannot fulfill its payment commitments on a given due date due to unforeseen factors or be forced to borrow funds on unfavourable terms. Liquidity acts as an important buffer in all banks to compensate for planned and unplanned balance sheet fluctuations and to provide a means for growth. Liquidity Risk is managed by the ALCO within the overall liquidity and funding framework of the Bank and in response to market conditions. This also helps to pre-empt having to restructure or acquire additional liabilities at high cost under adverse market conditions to meet any unforeseen liquidity needs.
Commercial Bank places considerable importance on maintaining the stability of its Current, Savings and other core deposits and aims to minimise reliance on interbank or other wholesale funding which is mainly price driven. The ALCO carefully monitors funding concentrations and has succeeded in ensuring that these are satisfactorily diversified. Stability depends on maintaining the high level of depositor confidence that we have achieved through fair, competitive and transparent deposit pricing policies. We closely monitor our advances to deposit ratio as a key indicator of liquidity risk and limit growth of our lending portfolio commensurate with our growth of reliable core deposits.
Maturities
0-1 Month
Rs. Mn
1-3 Months
Rs. Mn
3-6 Months
Rs. Mn
6-12 Months
Rs. Mn
1-3 Years
Rs. Mn
Rs. Mn
3-5 Years
Rs. Mn
Rs. Mn
>5 Years
Rs. Mn
Not
Applicable
Rs. Mn
Total as at
31.12.2008
Rs. Mn
Total as at
31.12.2007
Rs. Mn
Rate Sensitive Assets
101,775
52,771
17,944
20,744
31,383
13,995
12,497
–
251,109
240,833
Non-Rate Sensitive Assets
–
–
–
–
–
–
–
30,105
30,105
27,107
Total Assets
101,775
52,771
17,944
20,744
31,383
13,995
12,497
30,105
281,214
267,940
Rate Sensitive Liabilities
124,640
37,930
15,151
28,215
7,333
5,066
6,800
–
225,135
212,143
Non-Rate Sensitive Liabilities
–
–
–
–
–
–
–
56,078
56,078
55,997
Total Liabilities
124,640
37,930
15,151
28,215
7,333
5,066
6,800
56,078
281,214
267,940
Net Rate Sensitive Assets/(Liabilities)
(22,865)
14,841
2,793
(7,470)
24,049
8,929
5,696
–
–
–
Rate Sensitive Ratio*
81.66
139.13
118.44
73.52
427.95
276.26
183.77
–
–
–
* Ratio of rate sensitive assets to rate sensitive liabilities.
The ALCO reviews local and foreign currency liquidity separately and analyses the various scenarios which could cause a bank specific or market-wide liquidity shortfall taking into account projections for deposit withdrawals and drawdowns of committed lending facilities and reviews liquidity contingency plans to manage serious disruptions to the liquidity structure. Additionally the Bank continuously complies with a statutory requirement to maintain a 20% Statutory Liquid Asset Ratio (SLR) on a daily basis within both the Domestic Banking Unit and the Off-shore Banking Unit.
