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Risk Management Program · CoreTrack
1Risk, Treasury & Financial Control
iRisk Foundations
Risk Appetite, Tolerance, Capacity…The Risk Taxonomy and UniverseRisk Register vs Risk MatrixStress TestingScenario Analysis vs Stress TestingImpact and LikelihoodLikelihoodThe Risk EventRisk Assessment
iiEnterprise Risk Management
Enterprise Risk ManagementThe Four Risk TreatmentsRisk CultureRisk MaturityRisk Monitoring
iiiRisk Governance
Risk GovernanceHow to set a…The Risk PolicyThe Risk OwnerThe Risk Committee and Its CharterThe Risk Limit FrameworkRisk EscalationHow to set a…
ivCredit and Counterparty Risk
Collateral AgreementsCollateral vs NettingProbability of DefaultExposureCounterparty ExposureConcentration Risk vs Wrong Way RiskCounterparty Risk vs Credit RiskHow to assess Counterparty ExposureHow to assess Concentration Risk
vMarket Risk
Market RiskSensitivity MeasuresThe Hedging PolicyInterest Rate Risk in the Banking BookIRRBB vs Market RiskExpected ShortfallEconomic Value of EquityVaR BacktestingOpen PositionValue at RiskValue at Risk and Expected ShortfallEconomic Value SensitivityFX ExposureValue at Risk vs Expected ShortfallEarnings at Risk vs…FX Transaction Risk vs…How to measure Interest…How to measure Foreign…
viLiquidity Risk
Liquidity Stress TestingLiquidity Gap vs Liquidity BufferMaturity MismatchThe Debt Maturity ProfileFunding ConcentrationSurvival HorizonThe Contingency Funding PlanNet Stable Funding RatioLiquidity Risk vs Funding RiskLiquidity Coverage RatioLiquidity Gap and BufferHow to run a Liquidity Gap Analysis
viiOperational Risk
Operational LossThe Loss EventRisk and Control Self AssessmentException ManagementInformation Security as a…Segregation of DutiesIssue ManagementThe Near MissRoot Cause Analysis in RiskThe Fraud TriangleCyber Risk vs Third Party RiskHow to run a…How to assess Third…
viiiRisk Reporting, Data and Model Risk
Model RiskModel Validation vs BacktestingHow to run Model ValidationData Governance in RiskModel Risk vs Data RiskKey Risk IndicatorsManagement InformationRisk ReportingRisk ScoreEarnings at RiskRisk Adjusted ReturnEarly Warning IndicatorsHow to build a KRI Dashboard
ixTreasury
Corporate TreasuryAsset Liability ManagementIntragroup FundingThe Treasury PolicyThe Treasury Management SystemThe Cash ForecastCash Pooling and ConcentrationHow to build a Cash Forecast
xFinancial Controls and Assurance
Control AssuranceThe Control LifecycleThe Assurance MapThe Audit FindingIssue RemediationInternal Financial ControlsControl Design vs Control EffectivenessHow to map Internal Financial ControlsHow to test Control…Control DeficiencyMaterial Weakness
xiOperational Resilience
Operational ResilienceBusiness Continuity and Disaster RecoveryBusiness Continuity vs Operational…Crisis ManagementDisaster RecoveryIncident Management

Concentration Risk vs Wrong Way Risk: Two Different Faults

Concentration risk and wrong way risk are two separate faults, not one idea wearing two names. Concentration is about how a book is shaped: too much piled into one borrower, one connected set of borrowers or one industry, and it is already true this morning. Wrong way risk is about a link. The amount the bank is owed swells in precisely the state that leaves the borrower least able to settle.

Two things go wrong in a lending book and they sound alike when somebody says them quickly. The first is that there is too much of something. The second is that the amount at stake gets bigger at the worst possible moment. Both get described in meetings as too much risk in one place, and that sentence is the reason the two keep getting filed together, treated with the same remedy, and reported in the same table until one of them stops being reported at all.

Both faults appear at household scale first. Each is familiar there, and at household scale the two are rarely separated. A household running entirely on one salary is the first fault. Nothing has to happen for that to be true. The fault is true on a good Tuesday, with the salary credited and the fridge full. Now take a different household: one earner, paid in rupees, with a child studying abroad and a fee bill payable in dollars. If the rupee weakens, the fee bill in rupees gets bigger at the same moment the earner's purchasing power gets smaller. The dollar fee bill is the second fault, and bill and weakness arrive together rather than one after the other.

Nobody in the second household is doing anything reckless. The salary is fine. The fee is affordable today. The fault is not in either fact; it is in the line between them, and no examination of the salary alone or the fee alone will ever find it. The first fault is a property of the shape of the thing, and the second is a property of a relationship between two things that each look perfectly ordinary on their own.

The worked case is Vindhya Commercial Bank Limited, an invented mid-sized Indian commercial bank, and its ten largest single-name exposures, numbered C1 to C10, with every figure in Rs crore. How an exposure is built from what is drawn, what is committed and undrawn, and what a derivative position is currently worth is covered separately. Standing back from one exposure to look at all ten at once is what turns up a fault that no measurement of any single exposure can find.

Concentration is defined in full first, on this bank's own figures, with nothing said about the other fault. Then wrong way risk is defined in full, on the same bank's figures, with nothing said about the first. Only after both have been built separately do the two get laid against each other, on six criteria, and then measured against one common figure so their sizes can be compared honestly. Contrasting two things before defining either is how the two collapse into one blurred idea.

What is concentration risk, before any comparison at all?

Concentration riskToo much exposure in one name, one group, one sector or one anything, which is a fact about the shape of a book today. is the risk that too much of a book sits in one place. A single failure then takes an amount out of the bank that the bank cannot comfortably absorb. Three words in that sentence do the work. Take too much first. No absolute quantity is wrong on its own, and the judgement is always against a capacity. Then one place. The place can be a name, a set of connected names, a sector, a geography, a currency, a maturity or a source of funding. Then sits. The exposure is already there. Nobody has to do anything for the fault to exist.

The word sits is what most readers underrate, so hold on to it. Concentration is a fact about the book as it stands this morning, and it does not wait for any event to become true. If a bank has a quarter of its lending in one sector, that is true on the calmest day of the year. The failure that would hurt has not happened and may never happen, but the concentration is not a forecast of the failure; it is a measurement of what the book would lose if the failure came. Concentration can be computed with a list and a calculator, and no view about the world is needed at all.

So how is it found? By counting. Every exposure is taken, a decision is made about what to group it by, the groups are added up, and each total is compared with a limit. There is nothing clever in it, and that plainness is the point: any person holding the exposure list can reproduce the answer, and two people doing it independently get the same number. The hard parts of concentration are entirely in the definitions. The definitions are set out below, and they are where the fault hides.

Concentration at this bank, at three levels

Vindhya Commercial Bank Limited measures concentration at three levels and the case gives all three. At the level of one name, limit L1 caps exposure to a single counterparty at Rs 2,640 crore, and the largest name in the book, C1, Nirjhar Industries Limited, an invented steel and alloys maker, carries a reported total of Rs 2,496 crore. C1 runs at 94.5 per cent of the single name limitA cap on exposure to one counterparty, here limit L1, and this invented bank's own figure rather than a published requirement. and it is within.

At the level of connected names, limit L2 caps exposure to one borrower groupA parent and the entities it controls, treated as one exposure because they tend to fail together. at Rs 3,960 crore. Nirjhar Alloys Private Limited, a subsidiary wholly held by C1, carries a total of Rs 672 crore of its own. Add the two and the exposure to the Nirjhar group is 2,496 plus 672, being Rs 3,168 crore. The group total runs at 80.0 per cent of limit L2 and is also within.

At the level of a sector, limit L3 caps any one sector at Rs 7,056 crore, being 12.0 per cent of this bank's gross advances of Rs 58,800 crore. The infrastructure and power sector carries Rs 7,644 crore, being 13.0 per cent of gross advances and 108.3 per cent of the limit. The sector total is over, it is recorded as breach B1, it was first crossed in month 5, and at month 12 it is still open. It is the largest of this bank's three live limit breaches and it is the reason concentration is not an abstraction here.

Notice what the three levels do to each other. Read only the single-name level and the book looks tight but fine. Add the group level and a further Rs 672 crore appears that the first level could not see. Add the sector level and a figure three times larger than the largest single name comes into view, and that one is over its cap. Each level catches something the level below it is structurally unable to see. A bank that measures concentration at one level only has not measured concentration.

CONCENTRATION IS NOT ONE MEASUREMENT, IT IS THREE Each track runs from zero to 120 per cent of that level's own limit. The upright line is the limit. ONE NAME, LIMIT L1 C1 at Rs 2,496 crore cap Rs 2,640 crore ONE GROUP, LIMIT L2 Nirjhar group at Rs 3,168 crore cap Rs 3,960 crore ONE SECTOR, LIMIT L3 infrastructure and power Rs 7,644 crore, cap Rs 7,056 crore THE LIMIT 94.5% 80.0% 108.3% WITHIN WITHIN BREACH B1 Nothing has to happen for any of these three readings to be true. They were true last month as well. Every limit here belongs to the invented bank. None of the three is a published requirement.
Read from the top down and the book looks disciplined until the third track, where a sector total larger than three times the biggest borrower sits past its own cap and has done since month 5.
LevelWhat is measuredRs croreLimit, Rs croreUtilisation
One nameC1, the largest borrower2,496L1 2,64094.5%
One groupC1 plus Nirjhar Alloys Private Limited3,168L2 3,96080.0%
One sectorInfrastructure and power7,644L3 7,056108.3%

Two of those three rows are comfortable and the third is a live breachA limit crossed and still crossed, here breach B1 on limit L3, open since month 5 and accepted with a dated plan.. And the whole of that assessment was produced by adding numbers in a list and dividing by three caps somebody set in advance. No scenario was used, no view about interest rates or the rupee was needed, and nobody had to imagine a future. The signature of concentration risk is arithmetic on what is already there.

Try it out

Where does the Rs 3,168 crore of exposure to the Nirjhar group appear on the bank's list of ten largest single names?

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What is wrong way risk, before any comparison at all?

Wrong way riskExposure that grows in exactly the state of the world that makes the counterparty less able to pay. is the risk that the amount a counterparty owes the bank grows in exactly the state of the world that makes that counterparty less able to pay. The whole idea sits in the word exactly. The fault is not that a bad thing happens to both. One single movement in the world does both jobs at once. The same movement pushes the number up and pushes the payer down.

The opposite arrangement has a name too, and knowing it makes the first one easier to see. Right way riskThe opposite relationship, where the exposure shrinks in the state that weakens the counterparty, which is the case nobody worries about. is where the exposure shrinks in the state that weakens the counterparty. A bank that is owed more by a gold miner when gold prices rise, and less when they fall, has a position that gets smaller exactly when the miner is under pressure. Nobody loses sleep over that one. Same two ingredients, opposite sign on the link between them, completely different night's sleep.

So wrong way risk is not a quantity. Wrong way risk is the sign of a relationship, and a relationship needs two things and a state of the world before it exists at all. That is why it cannot be read off a list of exposures however carefully the list is drawn: a list has one row per counterparty, and this fault lives in a line drawn between a row and something that is not on the list.

Wrong way risk at this bank, at counterparty C7

Counterparty C7 is Wainganga Textiles Limited, an invented textile maker, and it is an importerA business that buys in a foreign currency, whose costs rise when its own currency weakens.. C7 sits at internal grade 6, it carries funded exposure of Rs 840 crore and a total reported exposure of Rs 1,056 crore, and it holds a US dollar forward against the bank whose current exposure is Rs 36 crore. Each part is unremarkable and the fault is not in any of them, so take the parts one at a time.

The borrower first. A textile maker at grade 6 with Rs 840 crore of funded exposure is the seventh largest name on this bank's published list and the second weakest grade in the top ten. C7 is not the biggest exposure, it is not the worst rated, and nothing about it would stop a reviewer's eye. The Rs 840 crore here is counterparty C7's funded exposure and nothing else. The same case also carries a Rs 840 crore economic value of equity change on limit L8, a different object entirely that belongs to the interest rate work.

The contract second. The definition of a forward belongs to the derivatives subject area, so the forward is named here and taken as a settled object rather than explained. One property of the forward matters. The contract is worth more to the bank when the rupee weakens against the US dollar. Today it is worth Rs 36 crore to the bank, and that Rs 36 crore is C7's derivative current exposure specifically. The same Rs 36 crore carries three other meanings in this case, including the negative leg inside C1's netting pair and the excess in the month 9 foreign exchange breach B2. Four different objects wear one number, and Rs 36 crore means nothing until the object behind it is named.

Now draw the line between them. A weaker rupee makes every consignment C7 imports more expensive in the currency C7 earns in. So a weaker rupee raises C7's import bill, squeezes its margin and weakens its ability to pay anybody, including this bank. And the same weaker rupee is what makes the forward worth more to the bank. The exposure grows in the same state of the world that weakens the counterparty, and that sentence is the entire definition of the fault, written on one real position.

The size of the position today is Rs 36 crore against C7's total of Rs 1,056 crore, being 3.4 per cent of one counterparty, and against the top ten total exposure of Rs 13,068 crore it is 0.3 per cent. On any measure, it is nothing. The smallness of the position is the single most important fact about wrong way risk, and it comes back below with force.

TWO ORDINARY FACTS, AND THE FAULT IS THE LINE BETWEEN THEM FACT ONE, THE BORROWER C7 Wainganga Textiles Limited Textiles, and an importer Internal grade 6, funded Rs 840 crore Total exposure Rs 1,056 crore UNREMARKABLE ON ITS OWN FACT TWO, THE CONTRACT A US dollar forward against the bank Worth more to the bank when the rupee weakens Current exposure Rs 36 crore SMALL ON ITS OWN ONE MOVEMENT DOES BOTH JOBS AT ONCE A weaker rupee raises C7's import bill and grows what C7 owes this bank, in the same moment WHAT EACH REVIEW SEES A REVIEW OF THE NAME A grade 6 textile borrower. Nothing to flag. A REVIEW OF THE TRADE Rs 36 crore, being 3.4 per cent of C7. Nothing to flag. A REVIEW OF THE LINK Finds it. No other review in this guide can.
With either box covered, the remaining panel reports a clean position, which is why a control built out of name reviews and trade reviews can run for years without once looking at the join.
Try it out

C7 is an importer holding a contract that pays the bank when the rupee weakens. What makes that wrong way risk rather than an ordinary open position?

So what actually separates the two faults?

Concentration and wrong way risk each stand on their own now. Lay them against each other on six criteria. The second criterion sorts all the others, so take that one slowly.

SIX CRITERIA, AND ONE OF THEM DECIDES THE OTHER FIVE CONCENTRATION RISK WRONG WAY RISK WC1 A statement about what kind of thing is it The shape of a book: too much sitting in one place A dependence between two things that are each fine WC2 Needs a state of the world? THE SHARPEST OF THE SIX NO. It is true this morning. Nothing has to happen. YES. It needs one particular tomorrow. WC3 How it is detected what the search looks like Rank the list, sum the groups, compare each with its cap Ask what grows it, then ask who that same thing hurts WC4 Measured against what it is compared with A limit in rupees: L1, L2 and L3 at this invented bank A scenario, and there is no natural cap for a slope WC5 Why it stays hidden where it goes missing In the ranking basis and the definition of a group Both sides of it look fine when examined separately WC6 What reduces it the remedy that works Sell it, syndicate it, or stop lending to the name Change the contract, or take security that moves the other way
The highlighted row, answered for any exposure, settles the other five, which is the practical use of a table that otherwise looks like six unrelated distinctions.

Criterion WC1 asks what kind of statement each one is. Concentration is a statement about a shape. Wrong way risk is a statement about a dependence. A shape and a dependence are different categories of thing, in the way that a person's height and a person's allergy are different categories of thing, and no amount of measuring one yields the other.

Criterion WC2 is the one that decides the rest. Does the fault need something to happen before it is a problem? For concentration the answer is no, for the reason already given: Rs 7,644 crore sits in one sector this morning and breach B1 has been open since month 5 with no event of any kind required. For wrong way risk the answer is yes, and the state is named: a weakening rupee. Today the fault at C7 costs the bank exactly nothing, and that is not a defence of it, it is the definition of it.

Try it out

A bank has 22.0 per cent of its lending in one sector. Which fault is that, on criterion WC2?

Criterion WC3 asks how the search is run, and the two searches have nothing in common. Finding concentration is a matter of ranking and summing. The search takes the exposure list, a decision about what to group by, and the caps. Concentration is clerical work in the best sense, being reproducible, checkable, and equally available to anybody holding the same file. Finding wrong way risk takes two questions in sequence, and neither of them is answerable from the list. First: what state of the world makes this exposure bigger? Second: does that same state make this counterparty less able to pay? If the answer to both is the same event, the fault is there. If the second answer is no, the arrangement is right way risk instead, and nothing to worry about.

TWO SEARCHES THAT SHARE NOT ONE STEP LOOKING FOR CONCENTRATION LOOKING FOR WRONG WAY RISK STEP 1 Take the exposure list exactly as it stands STEP 2 Choose what to group by: name, group, sector STEP 3 Sum each group, compare each with its own cap ANYBODY HOLDING THE FILE GETS THE SAME ANSWER QUESTION 1 What state of the world makes this exposure bigger than it is today? QUESTION 2 Does that same state weaken this counterparty and its ability to pay? NEITHER ANSWER IS ANYWHERE IN THE FILE Both come from outside it, and both are judgements A monthly process built only out of the left column will produce a clean pack forever and never run the right one.
Put the two columns beside each other and the reason one fault gets measured every month while the other never does stops being a mystery about diligence and becomes a fact about where the answers live.

The second search has a shape worth keeping. The search starts at the contract and walks outwards to the world, then walks back in to the borrower from a different direction. Concentration never leaves the file. Wrong way risk cannot be completed inside the file at all. A bank whose whole assessment machinery is built on reports will produce a beautiful concentration pack every month and never once record this fault.

Recording it has a fixed shape too, and it is worth stating because at this bank the record is incomplete in a way that matters. A usable entry has four parts: the counterparty, the state of the world that grows the exposure, the reason that same state weakens the counterparty, and what the exposure actually becomes in that state. Three of those four are on file for C7. The fourth has never been computed. An entry missing the fourth part holds nothing anybody can disagree with, so nobody can review it.

A WRONG WAY ENTRY HAS FOUR PARTS. THIS ONE HAS THREE. The record at the invented bank, for counterparty C7, read straight down. PART 1 the counterparty C7 Wainganga Textiles Limited, textiles, internal grade 6 ON FILE PART 2 the state that grows the exposure A weakening rupee against the US dollar ON FILE PART 3 why that state also weakens the payer C7 imports, so its bill rises in the currency it earns in ON FILE PART 4 what the exposure becomes in that state NOT COMPUTED No notional, no rupee scenario, no view on what a weaker rupee does here The first three parts are description. Only the fourth is a measurement, and only a measurement can be argued with. The fourth was never made.
Three green rows can make an entry look complete at a glance, and a register reviewed at a glance will pass this one every quarter while the only row carrying a number stays empty.
Try it out

How is the search for wrong way risk run, as against the search for concentration?

Criterion WC4 asks what each fault is measured against, and here the asymmetry becomes uncomfortable. Concentration is measured against a limit, in rupees, and this bank has three of them on this subject: L1, L2 and L3. A limit is a good instrument for a quantity that already exists. Wrong way risk has no quantity to cap, so it is measured against a scenario instead. A slope cannot be capped. The only available question is what the exposure becomes when the named state arrives, and that question needs the state described and the position sized in it.

Criterion WC5 asks what makes each fault invisible, and the two answers are as different as everything else. Concentration goes missing inside definitions: which column the list was sorted on and where somebody drew the edge of a group. Both of those are addressed in the next section, on this bank's own list, and the result is startling. Wrong way risk goes missing for a completely different reason. Both halves of it are unremarkable when read alone, so the fault survives every review that examines the borrower and the trade one at a time. Nearly every review there is works that way.

Criterion WC6 asks what reduces each fault, and this is where getting the classification wrong stops being an intellectual matter and starts costing something. Because the two are reduced by unrelated actions, a fault filed under the wrong heading receives a remedy that does not touch it, and the remedy will be reported as complete.

EACH REMEDY WORKS ON ONE FAULT AND DOES NOTHING TO THE OTHER AGAINST CONCENTRATION AGAINST WRONG WAY RISK REMEDY A Sell it down, syndicate part of it, or stop lending to the name WORKS Every rupee sold comes straight off the Rs 588 crore by which the sector is over limit L3. DOES NOTHING The Rs 36 crore was never the problem. Selling a small position leaves the link intact. REMEDY B Change the contract, or take security that holds value in that state DOES NOTHING No contract term changes the sector total. Breach B1 is the same size the next morning. WORKS It breaks the link, or puts something behind it that holds up in the named state. The two green cells sit on a diagonal. A remedy chosen from the wrong row lands in a red cell and still gets reported as an action taken, which is how a fault survives being addressed.
The useful thing here is the red diagonal rather than the green one, because a bank only ever lands in a red cell by classifying the fault wrongly first and then acting decisively on the classification.
Try it out

A committee responds to the wrong way risk at C7 by setting a limit on it. What is wrong with that response?

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Why does the list of the ten largest exposures depend on who drew it?

Concentration was described above as arithmetic on what is already there, and that is true. The arithmetic sits on top of two decisions somebody made before the counting began, and both decisions change the answer. The first is the ranking basisThe column a list is sorted on, which changes the list, which is why a top ten with no basis named is not a list of anything.. The second is where the edge of a group was drawn. Take them in that order, on this bank's own ten names.

Vindhya Commercial Bank Limited publishes its ten largest single-name exposures ranked by funded exposure, meaning the money actually drawn. On that basis the order runs C1 at Rs 1,680 crore down to C10 at Rs 540 crore. Now rank the same ten names on the same day by total exposure, meaning drawn plus the undrawn committed line plus what the derivative positions are currently worth. Nothing about the book has changed. Not one rupee has moved. And three of the ten change place while a fourth leaves the list altogether.

C6, Manjeera Housing Finance Limited, carries a Rs 300 crore undrawn line against C5's Rs 120 crore, so C6 rises from sixth to fifth. C5 falls from fifth to sixth for the same reason read the other way. C10, Betwa Speciality Chemicals Limited, rises from tenth to ninth, carrying Rs 180 crore undrawn and Rs 60 crore of derivative current exposure against C9's Rs 60 crore undrawn and none at all. And on the total basis a name the published list does not carry pushes past C9, Lohit Valley Tea Estates Limited. C9 leaves the ten altogether.

The name is Nirjhar Alloys Private Limited, the subsidiary of C1 met earlier, whose total exposure of Rs 672 crore would place it tenth. On the funded basis it would place ninth, at Rs 660 crore, and push C10 out instead. So the subsidiary is ninth on the funded basis, tenth on the total basis, and nowhere at all on the published list. The bank reports it inside the group line rather than as a single name. Note the trap in those two figures: Rs 660 crore is Nirjhar Alloys' funded exposure and it is also C9's total exposure, two different objects wearing one number in the same case.

ONE BOOK, ONE DAY, TWO SORT COLUMNS, TWO DIFFERENT LISTS RANKED BY FUNDED EXPOSURE the money drawn, and this bank's own published basis RANKED BY TOTAL EXPOSURE drawn plus undrawn plus derivative current exposure 1 C1 steel 1,680 2 C2 power 1,440 3 C3 ports 1,200 4 C4 cement 1,080 5 C5 agro 960 6 C6 housing 900 7 C7 textiles 840 8 C8 auto 720 9 C9 tea 600 10 C10 chemicals 540 1 C1 steel 2,496 2 C2 power 1,920 3 C3 ports 1,584 4 C4 cement 1,320 5 C6 housing 1,200 6 C5 agro 1,092 7 C7 textiles 1,056 8 C8 auto 960 9 C10 chemicals 780 10 Nirjhar Alloys 672 LEFT OUT OF THIS ONE Nirjhar Alloys, funded Rs 660 crore, would enter at 9 and push C10 off the ten. LEFT OUT OF THIS ONE C9, total Rs 660 crore, sits eleventh and falls off the ten altogether. Bars are scaled inside their own panel. Read positions across the two panels and lengths only within one. Three of the published ten change place and a fourth leaves the ten, on one sort column.
Neither panel is wrong and neither is the true list, which is the uncomfortable part: a reader handed one of them without being told which column it was sorted on cannot recover the other.
Rank by fundedCounterpartyFundedUndrawnDerivativeTotal
1C1 Nirjhar Industries Limited1,680720962,496
2C2 Sahyadri Power Transmission Limited1,44048001,920
3C3 Kalinga Port Services Limited1,200360241,584
4C4 Marudhar Cements Limited1,08024001,320
5C5 Tapti Agro Processing Limited960120121,092
6C6 Manjeera Housing Finance Limited90030001,200
7C7 Wainganga Textiles Limited840180361,056
8C8 Palar Auto Components Limited7202400960
9C9 Lohit Valley Tea Estates Limited600600660
10C10 Betwa Speciality Chemicals Limited54018060780
not listedNirjhar Alloys Private Limited660120672

Now the second decision, the edge of a group, and it is the larger of the two. Add C1's Rs 2,496 crore to Nirjhar Alloys' Rs 672 crore and the exposure to one borrower group is Rs 3,168 crore. The Rs 3,168 crore does not appear on the list above. The group total does not appear on the funded version of the list, or the total version, or in any cell of the table. The group exposure exists only once somebody connects the parent and the subsidiary, and forcing exactly that connection is what limit L2 was created for. Against L2's Rs 3,960 crore it runs at 80.0 per cent, which is comfortable, and it would have been invisible without the definition.

Put the two decisions together and the shape of the concentration problem changes. The difficulty is not that the counting is hard. The counting is trivial. The counting sits on a sort column and a group definition, both chosen upstream, and anybody handed the output without being told either has been handed a number that cannot be checked. A list of ten largest exposures with no basis stated is not a list of the ten largest anything.

Try it out

A paper shows the bank's ten largest exposures and does not say what they are ranked on. What has been lost?

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How big is each fault, measured on one common figure?

Two faults measured in different units cannot be compared. Concentration has been in rupees against a cap. Wrong way risk has been in dependence, and a dependence has no unit at all. So put them both into rupees, and do it in the only way that is honest: measure each one by how far it is from where it should be.

For concentration that distance is already on record. The infrastructure and power sector carries Rs 7,644 crore against limit L3's Rs 7,056 crore, so it is over by 7,644 less 7,056, being Rs 588 crore. Nothing has to happen for that Rs 588 crore to exist. The excess existed last month. Rs 7,644 crore in this case is also the sum of grade 1 and grade 2 exposures, being 2,940 plus 4,704, so the object needs care. The best-rated two grades and the sector in breach share a number and nothing else.

For wrong way risk the level today is not the fault, so the distance is a growth rather than a level. C7's derivative current exposure is Rs 36 crore. If a weaker rupee multiplies it by some figure, call the figure w, the growth in it is 36 times w less 1. Setting that growth equal to Rs 588 crore gives 36 times w less 1 equals 588, so w less 1 is 16.33 and w is 17.33. The contract exposure at C7 would have to grow more than seventeen times before its growth reached the amount by which one sector is already over its cap this morning.

THE ONLY HONEST COMPARISON: BOTH FAULTS IN RS CRORE Each bar is the distance from where the figure should be. The scale runs from zero to Rs 700 crore. THE CONCENTRATION FAULT sector over limit L3, breach B1, open since month 5 Rs 588 crore, already there THE WRONG WAY FAULT TODAY growth in C7's derivative current exposure at w of 1 Rs 0 crore, nothing at all THE WRONG WAY FAULT AT A MULTIPLE OF 17.33 the growth it would take Rs 588 crore, if the rupee moves that far Rs 588 crore The top bar needed no state of the world. The bottom bar needs the contract exposure to grow more than seventeen times, and nobody at this invented bank has estimated how likely that is.
Two bars of identical length carry completely different weight, because one of them is a measured fact about this morning and the other is a condition that has to be met before it means anything.
Try it out

C7's derivative current exposure is Rs 36 crore against a total exposure of Rs 1,056 crore. Before looking: what share is that?

Commit to an answer before the control below moves. Expectation and arithmetic sit a long way apart on this one.

Try it out

The sector is Rs 588 crore over limit L3 today. How many times would C7's Rs 36 crore contract exposure have to grow for its growth to match that?

Play with it

Grow the contract exposure and watch where it gets to

One control, two panels. Drag w, the multiple by which C7's derivative current exposure of Rs 36 crore grows in the weakening-rupee state that also weakens C7. The upper panel plots C7's credit-equivalent exposure, being funded Rs 840 crore plus 50.0 per cent of the Rs 180 crore undrawn line, being Rs 90 crore, plus 36 times w. The lower panel plots the growth alone, being 36 times w less 1, against the Rs 588 crore by which the infrastructure and power sector already exceeds limit L3. Both counterparties in the upper panel are measured the same way. Comparing one name on one basis with another name on a different basis compares nothing at all.

Two crossings are solved in advance and the control lands on both. At w of 3.33 C7's credit-equivalent exposure of Rs 1,050 crore draws level with C6, Manjeera Housing Finance Limited. C6 stands at Rs 900 crore funded plus Rs 150 crore and carries no derivative exposure at all. At w of 17.33 the growth alone reaches Rs 588 crore. There is no crossing with C1. Reaching C1's credit-equivalent exposure of Rs 2,136 crore, being 1,680 plus 360 plus 96, would need w of 33.5, past the end of this dial. The three concentration figures stand still throughout: C1 at 94.5 per cent of limit L1, the Nirjhar group at 80.0 per cent of limit L2, and the sector at 108.3 per cent of limit L3.

w, the multiple
1.00
C7 credit-equivalent, Rs crore
966.0
Growth in the derivative, Rs crore
0.0
Still short of Rs 588 crore by
588.0

At w of 1, which is where the book stands today, C7's credit-equivalent exposure is Rs 966.0 crore and the growth in its contract exposure is Rs 0.0 crore, against a sector already Rs 588 crore over limit L3 with nothing having happened.

PANEL A: C7 CREDIT-EQUIVALENT EXPOSURE, RS CRORE 1,700 1,500 1,300 1,100 900 C1 sits at Rs 2,136 crore on this same basis and needs w of 33.5, past the end of this dial C6 at Rs 1,050 crore, and it carries no derivative exposure at all C7 draws level with C6 at w of 3.33 PANEL B: GROWTH IN C7'S DERIVATIVE EXPOSURE ALONE, RS CRORE 600 400 200 0 THE SECTOR IS ALREADY Rs 588 CRORE OVER LIMIT L3 the growth reaches it at w of 17.33 1 5 10 15 20 w, the multiple by which C7's derivative current exposure grows in the weakening-rupee state

Educational illustration. Every figure in the instrument is Vindhya Commercial Bank Limited's own: the Rs 36 crore derivative current exposure at C7, the Rs 840 crore funded and Rs 180 crore undrawn, the 50.0 per cent drawdown assumption, and limits L1, L2 and L3. None of them is a supervisory requirement and none is published by anybody. The multiple w is set on the dial and is not a figure from the case: this record carries no notional for C7's contract and no rupee scenario, so nobody at this invented bank has estimated how far the exposure would actually travel.

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Where does the distinction between the two actually break down?

The distinction breaks in one specific place, and it breaks quietly. Both faults sound like too much of something, so somebody classifies wrong way risk as a kind of concentration. Once it is filed there, it receives what everything in that file receives: a limit, a utilisation percentage, and a row in the monthly pack.

The wrong way position at C7 is given a limit, reports green every month, and the fault never appears again

Work through what happens. A limit counts what is there. At C7 there is Rs 36 crore of derivative current exposure, being 3.4 per cent of that one counterparty and 0.3 per cent of the Rs 13,068 crore of total exposure across the ten largest names. Set any cap a committee would actually set, and this position passes it comfortably. The position passes this month and it will pass next month, and on the day the rupee moves far enough to matter, it will still have been passing right up to that morning.

The failure is not that the limit was set too high. The failure is that the measurement answers a different question from the one the fault poses. A limit asks how big a thing is. Wrong way risk asks what a thing becomes when one named event happens. How big and what it becomes are not the same question, and no calibration of the first ever turns it into the second.

And what would it take to answer the real question at this bank? Three things, and the record carries none of them. A scenario for the rupee, saying how far it moves and over what period. A notional for C7's contract, without which no growth in its value can be computed. And an estimate of what a weaker rupee actually does to a textile importer's ability to pay, a credit judgement rather than a market one. The measurement was therefore never made. Producing a figure from three missing inputs is how a scenario becomes a number nobody can defend and everybody quotes.

Try it out

What would this bank need before it could put a number on the wrong way risk at C7?

Credit Exposure and How It Is Reduced teaches you to measure counterparty exposure and to know what netting and collateral actually do to it.

When does the difference between them change a decision?

Four people read the same two faults and act on them in four unrelated ways. Watching the four is the quickest test of whether the distinction is real or academic.

The credit officer inside the bank has to choose an action, and the choice is decided entirely by the classification. On the sector she can act today. The Rs 588 crore excess is a quantity, quantities can be sold, syndicated or allowed to run off, and breach B1 already carries an accepted remediation plan running to month 18 with a named risk owner in the governance record. On C7 there is nothing to sell that would help. The only actions that touch a dependence are changing the contract, taking security that holds its value in the state that hurts, or pricing the dependence, and none of them looks like reducing an exposure.

The analyst outside the bank cannot recompute any of this, and does not need to. Three questions cost nothing and separate a bank that has thought about the problem from one that has not. On what basis is the top ten ranked? A list with no basis is not a list of anything. How is a borrower group defined and where was the edge drawn? The Rs 3,168 crore at Nirjhar exists only after that definition is applied. And are any exposures recorded as wrong way, with the state of the world named. A pack with three concentration tables and no answer to the third question has measured the fault that is easy to measure.

The board committee reads the two as different kinds of business. A limit breach is a decision to be made: accept it with a dated plan, as this bank has done with B1, or act on it. A dependence with no measurement is a gap in the machinery, and the correct instruction is not a limit but a body of work: name the scenario, get the notional, form the credit view.

The mechanism is identical at every scale, so take the household version too. A person with all their savings in one employer's shares carries the first fault, and it is true today whether or not that employer ever stumbles. A person whose salary comes from that same employer as well carries the second fault. The state of the world that destroys the savings is the same state that ends the income. The first is fixed by selling some shares; the second is not fixed by selling shares at all, and telling the two apart is what decides whether the remedy does anything.

What happens when a concentration and a severe state arrive together?

One more figure, and it is handed forward rather than worked here. Vindhya Commercial Bank Limited's own loss capacity is Rs 2,400 crore, being the loss that reaches its own capital floor, and that floor is the bank's own figure rather than anybody's requirement. 6,000 times 0.40 is 2,400, so at its assumed 40.0 per cent loss given default a loss of Rs 2,400 crore needs Rs 6,000 crore of exposure to default. And Rs 6,000 crore is 78.5 per cent of the infrastructure and power sector's Rs 7,644 crore, being the sector that is already in breach.

Read that slowly. The entire path from a comfortable book to the bank's own capital floor lies inside one sector that has been over its cap since month 5. When a state of the world does finally arrive, the fault that needed nothing to happen becomes the channel through which the loss arrives. Working backwards from a loss to the state that produces it is a reverse stress test, and the method for it is set out under reverse stress testing, alongside the full step-by-step assessment of concentration. Note the object once more before leaving it. The Rs 2,400 crore here is this bank's loss capacity, and the same figure appears in this case as tier 2 subordinated bonds and as a liquidity bucket gap, two different things entirely.

Where do the rules on large exposures and wrong way risk come from?

The order of the sources matters. The idea of capping exposure to a single counterparty and to connected counterparties, and the treatment of wrong way risk as a named category inside the counterparty credit risk framework, originate with the Basel Committee on Banking Supervision at the Bank for International Settlements, bis.org. The Basel Committee is where the reasoning is set out and where the definitions were first written down.

A global standard is not what binds an Indian bank, and naming only the first source is a confident and common error. What actually binds on large exposures, on how a borrower group is defined for that purpose, and on sector exposure comes from the Reserve Bank of India at rbi.org.in. Name the standard, then name what binds, then send the reader to the text of both. State no figure from either.

India

What is named here, and where the binding version lives

Limits L1, L2 and L3, the Rs 2,640 crore single name cap, the Rs 3,960 crore group cap, the 12.0 per cent sector cap and its Rs 7,056 crore, the 50.0 per cent drawdown assumption, the 40.0 per cent loss given default, the internal grades and every counterparty figure are Vindhya Commercial Bank Limited's own choices. None of them is a supervisory requirement and none is published by anybody.

The large exposures framework, and wrong way risk as a defined category within counterparty credit risk, originate with the Basel Committee on Banking Supervision at the Bank for International Settlements, bis.org. The Reserve Bank of India at rbi.org.in sets what an Indian bank is actually held to on large exposures, on the definition of a borrower group and on sector exposure, and the binding text lives there.

The authoritative figures for large exposure limits, group definition thresholds, sector caps, risk weights, minimum ratios and effective dates are the ones published at source.

Collateral, netting, the probability of default and the build-up of exposure at default are each covered separately and used here as facts. The full step-by-step method for assessing concentration, and the reverse stress test whose result is named above, are covered under concentration assessment and under reverse stress testing. How limit L3 was set, how breach B1 was accepted with a dated remediation plan, who the risk owner is and how an escalation runs belong to the governance work. How a foreign exchange open position is measured, what a rupee move does to a trading book and what value at risk is belong to the market risk work. What a forward is belongs to the derivatives subject area, and it appears here only as a named contract that pays one side when a rate moves.

Sources

SourceDocumentSite
Bank for International SettlementsThe Basel Committee large exposures standard, and wrong way risk as a defined category within the counterparty credit risk frameworkbis.org
Reserve Bank of IndiaWhat actually binds an Indian bank on large exposures, on how a borrower group is defined for that purpose, and on sector exposurerbi.org.in

Vindhya Commercial Bank Limited, Nirjhar Industries Limited, Nirjhar Alloys Private Limited, Sahyadri Power Transmission Limited, Kalinga Port Services Limited, Marudhar Cements Limited, Tapti Agro Processing Limited, Manjeera Housing Finance Limited, Wainganga Textiles Limited, Palar Auto Components Limited, Lohit Valley Tea Estates Limited and Betwa Speciality Chemicals Limited are invented.
Educational material. Not advice on any investment, tax, budget or market position.

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