Bank of baroda

Market Risk
Market risk is another risk that is inevitably faced by an entity operating in the financial services industry. It is the risk that
exposure to price movements of financial instruments arising as a result of changes in market variables, such as interest

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BANK OF BARODA
rates, exchange rates and other asset prices, will result in loss to us. The objective of market risk management is to avoid
excessive exposure of our earnings and equity to loss and to reduce our exposure to the volatility inherent in financial
instruments such as securities, foreign exchange contracts, equity and derivative instruments, as well as balance sheet or
structural positions.
The primary risk that arises for us as a financial intermediary is interest rate risk due to our asset- liabilities management
activities. Other market related risks to which we are exposed to a lesser extent are foreign exchange risk on foreign
currency positions, liquidity, or funding risk, and price risk on trading portfolios.
We have a clearly articulated integrated treasury management policy and asset liability management policy to address
market risk. These policies are comprised of management policies, procedures, prudential risk limits, review mechanisms
and reporting systems. These policies are revised periodically in tune with changes in financial and market conditions.
Asset Liability Management Committee
We have formed an Asset Liability Management Committee (ALMC) which reports to a sub-committee of the Board,
comprising of experienced senior general managers with Chairman & Managing Director as Chairman and Executive
Director as Vice-Chairman to oversee market risk management and implement strategies to address market risk in
accordance with the parameters set by the Board.
The responsibilities of the ALMC include:
formulating product pricing for deposits and advances;
determining the maturity profile and mix of incremental assets and liabilities;
articulating the interest rate outlook for the purposes of the our future business strategy;
devising an effective transfer pricing policy; and
monitoring our return on asset ratios.
Reporting to the ALMC is the Asset Liability Management Cell (ALM Cell) whose role is to identify measure, monitor and
control our market risk exposure. The ALM Cell provides a number of valuable risk management mechanisms:
a state of the art ALM information system;
fortnightly reviews of structural liquidity, gap reports to review our liquidity position and dynamic liquidity statements;
monthly interest rate sensitivity and earnings at risk reviews;
quarterly reviews of residual maturity of advances; and
fortnightly reviews of residual maturity of borrowings, deposits, investments, call lending and term lending
Since October 2001, we have had in place a Specialized Integrated Treasury Branch (SITB) in Mumbai that is equipped
with the latest technology to co-ordinate our money market, investment and foreign exchange functions as well as
monitor interest rate risk and implement strategies to address market risk in line with prudential guidelines of RBI. The
various responsibilities of the SITB include:
ensuring full compliance with various regulatory and prudential requirements;
managing liquidity;
improving the efficiency of delivery channels;
being a major player in the debt market; and
being one of the leading market makers in the foreign exchange market.
The SITB managed to get a yield of 8.45% on coupon bearing securities for the six months ended September 30, 2005,
whilst at the same time, reducing our portfolio’s risk and volatility. This is evident in the reduction in modified duration (a
measurement of risk and volatility) from 4.05 to 2.90 during the half-year ended September 30, 2005. Further, we have an
investment fluctuation reserve of Rs. 10,425 million as of September 30, 2005, which is more than the prescribed level of
5%.

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Foreign Exchange Risk
We conduct extensive foreign exchange operations including trading and taking positions in various currencies, both
proprietary and on behalf of clients. In this regard, part of the market risk we are exposed to are foreign exchange risks
as a result of adverse exchange rate movements during a period in which we may have an open position in any
combination of foreign currencies.
Risk and Return Based Performance Management Framework
In order to manage and monitor our overall market risk exposure, we have in place a system of fundamental methods
that we apply to manage foreign exchange risks arising from our foreign exchange trading activities. The risk management
methods fall within a risk and return based performance management framework designed to optimize gains in our
foreign exchange portfolio in view of the corresponding risk taken. In this sense, we adopt a risk adjusted performance
measurement framework that seeks to optimize our risk-return profile.
In determining our risk-return profile, we also pay particular attention to:
the complexity of foreign exchange products available to us;
the proportion of foreign exchange risks compared to our overall risk profile;
our stakeholders’ expectations in terms of the level of growth and volatility; and
any of our on and off balance sheet strategies that are designed to manage and reduce our overall risk exposure.
Organizational Control Over Management of Foreign Exchange Risk
Clear definition of authority for foreign exchange risk management activities and appropriate separation from foreign
exchange trading activities help ensure the integrity, accuracy and reasonableness of our foreign exchange operations.
Our Board bears the responsibility of instituting a foreign exchange policy that clearly sets out the risk-taking activities
and operations that our employees are permitted to engage in. Furthermore, our Board periodically reviews the effectiveness
of our foreign exchange risk management policies in light of developments of the global foreign exchange market and
approves any necessary changes.
In addition to the review by our Board, independent reviews of our foreign exchange risk management activities are
carried out periodically. At these internal audits, the auditor will independently review foreign exchange risk management
policies, focusing particularly on the compliance by our management with the policies, any significant changes on the
policies, and the appropriateness and effectiveness of the policies given the nature, scope and complexity of our foreign
exchange operations and activities.
Measuring the Market Risk Exposure from Foreign Exchange Operations
To determine our market risk position as a result of our foreign exchange operations, we utilize a combination of
measurement techniques that enable static and dynamic analyses.
Static analysis
Static analysis measures the market risk exposure of our foreign exchange product positions by computing the value at
risk (VaR) of positions both individually and on a portfolio basis. The VaR method is used to assess potential losses that
could crystallize on trading positions due to variations in currency exchange rates and interest rates, for a given confidence
level within a defined period of time.
We seek to manage our foreign exchange market risk exposure by computing VaR at 95%, 97.5% and 99% confidence
level for 1-day and 10-day time horizons. Relying on past data and historically observed correlations, our goal is to be
able to effective monitor our VaR over a defined period of time.
Dynamic analysis
Dynamic analysis measures the market risk exposure of our foreign exchange products by calculating our potential future
profit and loss, capturing the effect of both the current and future events that could happen in the planning horizon.
Through the stress testing analysis of a series of potential stress scenarios, we are able to estimate our market rate risk
exposure. Each of the stress scenarios we adopt takes into account our business strategy and likely changes in the
external environment such as global economic changes, supply constraints caused by wars and other sanctions.

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