Management of market risk should be the major concern of top management of banks. The Boards should clearly articulate market risk management policies, procedures, prudential risk limits, review mechanisms and reporting and auditing systems. The policies should address the bank's exposure on a consolidated basis and clearly articulate the risk measurement systems that capture all material sources of market risk and assess the effects on the bank. The operating prudential limits and the accountability of the line management should also be clearly defined. The Asset-Liability Management Committee (ALCO) should function as the top operational unit for managing the balance sheet within the performance/ risk parameters laid down by the Board.

Successful implementation of any risk management process has to emanate from the top management in the bank with the demonstration of its strong commitment to integrate basic operations and strategic decision making with risk management. Ideally, the organization set up for Market Risk Management should be as under :-

1. The Board of Directors

2. The Risk Management Committee

3. The Asset-Liability Management Committee (ALCO)

The Board of Directors should have the overall responsibility for management of risks. The Board should decide the risk management policy of the bank and set limits for liquidity, interest rate, foreign exchange and equity price risks.

The Risk Management Committee will be a Board level Sub committee including CEO and heads of Credit, Market and Operational Risk Management Committees. It will decide the policy and strategy for integrated risk management containing various risk exposures of the bank including the market risk

The responsibilities of Risk Management Committee with regard to market risk management aspects include:

• Setting policies and guidelines for market risk measurement, management and reporting

• Ensuring that market risk management processes (including people, systems, operations, limits and controls) satisfy bank's policy

• Reviewing and approving market risk limits, including triggers or stop-losses for traded and accrual portfolios

• Ensuring robustness of financial models, and the effectiveness of all systems used to calculate market ris

• Appointment of qualified and competent staff; Ensuring posting of qualified and competent staff and of independent market risk manager/s, etc.

The Asset-Liability Management Committee, popularly known as ALCO should be responsible for ensuring adherence to the limits set by the Board as well as for deciding the business strategy of the bank in line with bank's budget and decided risk management objectives. The role of the ALCO should include, inter alia, the following :-

• Product pricing for deposits and advances

• Deciding on desired maturity profile and mix of incremental assets and liabilities

• Articulating interest rate view of the bank and deciding on the future business strategy

• Reviewing and articulating funding policy

• Decide the transfer pricing policy of the bank

• Reviewing economic and political impact on the balance sheet

The size (number of members) of ALCO would depend on the size of each institution, business mix and organisational complexity. To ensure commitment of the Top Management and timely response to market dynamics, the CEO/CMD or the ED should head the Committee. The Chiefs of Investment, Credit, Resources Management or Planning, Funds Management / Treasury (forex and domestic), International Banking and Economic Research can be members of the Committee. In addition, the Head of the Technology Division should also be an invitee for building up of MIS and related computerisation. Some banks may even have Sub-committees and Support Groups.

The ALM Support Groups consisting of operating staff should be responsible for analysing, monitoring and reporting the risk profiles to the ALCO. The Risk management group should prepare forecasts (simulations) showing the effects of various possible changes in market conditions related to the balance sheet and recommend the action needed to adhere to bank's internal limits, etc.

The Middle Office is responsible for the critical functions of independent market risk monitoring, measurement, analysis and reporting for the bank's ALCO. Ideally this is a full time function reporting to, or encompassing the responsibility for, acting as ALCO's secretariat. An effective Middle Office provides the independent risk assessment which is critical to ALCO's key-function of controlling and managing market risks in accordance with the mandate established by the Board/Risk Management Committee. It is a highly specialised function and must include trained and competent staff, expert in market risk concepts. The methodology of analysis and reporting will vary from bank to bank depending on their degree of sophistication and exposure to market risks. These same criteria will govern the reporting requirements demanded of the Middle Office, which may vary from simple gap analysis to computerised VaR modelling. Middle Office staff may prepare forecasts (simulations) showing the effects of various possible changes in market conditions related to risk exposures. Banks using VaR or modelling methodologies should ensure that its ALCO are aware of and understand the nature of the output, how it is derived, assumptions and variables used in generating the outcome and any shortcomings of the methodology employed. Segregation of duties should be evident in the middle office which must report to ALCO independently of the treasury function. In respect of banks without a formal Middle Office, it should be ensured that risk control and analysis should rest with a department with clear reporting independence from Treasury or risk taking units, until formal Middle Office frameworks are established

The Dealing Room

The Treasury Dealing Room within a bank is generally the clearing house for matching, managing and controlling market risks. It may provide funding, liquidity and investment support for the assets and liabilities generated by regular business of the bank. The Dealing Room is responsible for the proper management and control of market risks in accordance with the authorities granted to it by the bank's Risk Management Committee. The Dealing Room also is responsible for meeting the needs of business units in pricing market risks for application to its products and services. The Dealing Room acts as the bank's interface to international and domestic financial markets and generally bears responsibility for managing market risks in accordance with instructions received from the bank's Risk Management Committee.

The Dealing Room may also have allocated to it by Risk Management Committee, a discretionary limit within which it may take market risk on a proprietary basis. For these reasons effective control and supervision of bank's Dealing Room activities is critical to its effectiveness in managing and controlling market risks.

Critical to a Dealing Room's effective functioning is dealers' access to a comprehensive Dealing Room manual covering all aspects of their day-today activities. All dealers active in day-to-day trading activities must acknowledge familiarity with and provide an undertaking in writing to adhere to the bank's dealing guidelines and procedures. A Dealing Room procedures manual should be comprehensive in nature covering operating procedures for all the bank's trading activities in which the Dealing Room is involved and in particular must cover the bank's requirements in respect of:

1. Code of Conduct - all dealers active in day-to-day trading activities in the lndian market must acknowledge familiarity with and provide an undertaking to adhere to FEDAI code of conduct (and FIMMDA when available).

2. Adherence to Internal Limits - All dealers must be aware of, acknowledge and provide an undertaking to adhere to the limits governing their authority to commit the bank to risk exposures as they apply to their own particular risk responsibilities and level of seniority.

3. Adherence to RBI limits and guidelines - All dealers must acknowledge and provide an undertaking to adhere to their responsibility to remain within RBI limits and guidelines in their area of activity.

4. Dealing with Brokers: All dealers should be aware of, acknowledge and provide an undertaking to remain within the guidelines governing the bank's activities with brokers including conducting business only with brokers authorised by bank's Risk Management Committee on the bank's Brokers Panel.

5. Ensuring their activities with brokers do not allow for the brokers to act as principals in transactions, but remain strictly in their authorised role as market intermediaries.

6. Requiring brokers to provide all broker notes and confirmations of transactions before close of business each day (or exceptionally by the beginning of the next business day, in which case the note must be prominently marked by the broker as having been transacted the previous day, and the Back Office must recast the previous night's position against limits reports) to the bank's Back Office for reconciliation with transaction data.

7. Ensuring all brokerage payments and statements are received, reconciled and paid by the bank's Back Office department and under no circumstances authorised or any payment released by dealers.

8. Prohibiting the acceptance by dealers of gifts, gratifications or other favours from brokers, instances of which should be reported in detail to RBI's Department of Banking Supervision indicating the nature of the case

9. Prohibiting dealers from nominating a broker in transactions not done through that broker.

10. Rules for the prompt investigation of complaints against dealers and malpractices by brokers and reporting to FEDAI and RBI's Department of Banking Supervision.

11. Dealing Hours: All Dealers should be aware of the bank's normal trading hours, cut off time for overnight positions and rules governing after hours and off-site trading (if allowed by the bank)

12. Security and Confidentiality: All dealers should be aware of the bank's requirements in respect of maintaining confidentiality over its own and its customers' trading activities as well as the responsibility for secure maintenance of access media, keys, Staff Rotation and leave requirements: All dealers should be aware of the requirement to take at lea

The key controls over market risk activities, and particularly over Dealing Room activities, exist in the Back Office. It is critical that both a clear segregation of duties and reporting lines is maintained between Dealing Room staff and Back Office staff, as well as clearly defined physical and systems access between the two areas. It is essential that critical Back Office controls are executed diligently and completely at all times including.

• The control over confirmations both inward and outward: All confirmations for transactions concluded by the Dealing Room must be issued and received by the Back Office only. Discrepancies in transaction details, non-receipts and receipts of confirmations without application must be resolved promptly to avoid instances of unrecorded risk exposure.

• The control over dealing accounts (vostros and nostros: Prompt reconciliation of all dealing accounts is an essential control to ensure accurate identification of risk exposures. Discrepancies, non-receipts and receipts of funds without application must be resolved promptly to avoid instances of unrecorded risk exposure. Unreconciled items and discrepancies in these accounts must be kept under heightened management supervision as such discrepancies may at times have significant liquidity impacts, represent unrecognised risk exposures, or at worst represent collusion or fraud.

• Revaluations and marking-to-market of market risk exposures: All market rates used by the bank for marking risk exposures to market, used to revalue assets or for risk analysis models such as Value at Risk analysis, must be sourced independently of the Dealing Room to provide an independent risk and performance assessment. If the bank has an established and independent Middle Office function, this responsibility may properly pass to the Middle Office.

• Monitoring and reporting of risk limits and usag:: Reporting of usage of risk against limits established by the Risk Management Committee (as well as Credit Department for Counterparty risk limits) should be maintained by the Back Office independently of the Dealing Room. The Back Office must also undertake maintenance of all limit systems and access to limit systems (such as counterparty limits, overnight limits etc.) must be secure to avoid unauthorised access and tampering. If the bank has an established and independent Middle Office function, this responsibility may properly pass to the Middle Office.

• Control over payments systems: The procedures and systems for making payments must be under at least dual control in the Back Office independent from the dealing function. Payments systems should be at all times secure from access or tampering by unauthorised personnel.