Risk Management
What the exam tests
Risk management tests identification, measurement and mitigation of credit, market, liquidity, operational and concentration risks in a DFI. Expect expected-loss arithmetic, limits, ALM and stress testing.
Core rules and concepts
- Credit risk: PD, LGD, EAD and expected loss = PD × LGD × EAD. Unexpected loss is covered by capital; expected loss by pricing and provisions.
- DFI-specific risks: construction risk, completion risk, offtake concentration, long-tenor interest-rate risk, currency mismatch, refinancing risk and regulatory change.
- ALM: match asset and liability tenors and repricing; monitor duration gap, liquidity gap and contingency funding.
- Risk governance: board risk committee, three lines of defense, risk appetite statement, sector/borrower/group limits, and independent credit review.
- Stress testing: apply GDP, tariff, exchange rate, delay and default shocks; link results to capital and liquidity plans.
Worked example
Exposure EAD ₹800 crore; PD 1.5%; LGD 40%. Expected loss = 0.015 × 0.40 × 800 = ₹4.8 crore. If fee and interest income is ₹72 crore and operating cost is ₹20 crore, risk-adjusted income before capital = ₹47.2 crore. Allocate ₹80 crore economic capital; RAROC = 47.2/80 = 59%. If a stress raises PD to 4%, EL becomes ₹12.8 crore and RAROC falls to 49%, so the limit and pricing need review.
Traps
Do not treat a guarantee or credit enhancement as risk-free. Do not ignore construction risk because a project has a long-term offtake contract. Do not double-count collateral in LGD and again in exposure. Do not compare risk metrics without checking exposure definition and time horizon.