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and the periodic assessment of inherently changing risk.The review of a

credit risk management function is discussed under the following themes: Credit portfolio management Lending function and operations Credit portfolio management Nonperforming loan portfolio Credit risk management policies Policies to limit or reduce credit

risk Asset classification Loan loss provisioning policy ???? LIQUIDITY

RISKLiquidity is

crucial to the ongoing viability of any banking organization. Banks? capital

positions can have an effect on their ability to obtain liquidity, especially

in a crisis. Each bank must have adequate systems for measuring, monitoring and

controlling liquidity risk. Banks should evaluate the adequacy of capital given

their own liquidity profile and the liquidity of the markets in which they operate. (Refer to ?Sound

Practices for Managing Liquidity in Banking Organizations?, February 2000).

(Basel Committee on

Banking Supervision)Liquidity risk

defined as bank transforms the term of their liabilities to have different

maturities on the asset side of the balance sheet At the same time, banks must

be able to meet their commitments (such as deposits) at the point at which they

come due. The contractual inflow and outflow of funds will not necessarily be

reflected in actual plans and may vary at different times. A bank may therefore

experience liquidity mismatches, making its liquidity policies and liquidity

risk management key factors in its business strategy.Liquidity risk

means that a bank has insufficient funds on hand to meet its obligations. Net

funding includes maturing assets, existing liabilities, and standby facilities

with other institutions. Liquidity risks are normally managed by a bank?s asset

and liability committee, and approach that requires understanding of the

interrelationship between liquidity risk management and interest rate

management, as well as of the impact that repricing and credit risk have on

liquidity or cash flow risk, and vice versa.Liquidity is

necessary for banks to compensate for expected and unexpected balance sheet

fluctuations and to provide funds for growth. It represents a bank?s ability to

efficiently accommodate decreases in deposits and/or to runoff of abilities, as

well as fund increases in a loan portfolio. A bank has adequate liquidity

potential when it can obtain sufficient funds (either by increasing liabilities

or converting assets) promptly and at a reasonable cost. The price of liquidity

is a function of market conditions and the degree to which risk, including

interest rate and credit risk, is reflected in the bank?s balance sheet.??? MARKET RISKThis

assessment is based largely on the bank?s own measure of value-at-risk.

Emphasis should also be on the institution performing stress testing in

evaluating the adequacy of capital to support the trading function. (Refer to

Part B of the ?Amendment to the Capital Accord to Incorporate Market Risks?,

January 1996). (Basel

Committee on Banking Supervision)In contrast to

traditional credit risk, the market risk that banks face does not necessarily

result from the nonperformance of the issuer or seller of instruments or asset.

Market or position risk is a risk that a bank may experience a loss in on ?and

off-balance-sheet positions arising from unfavorable movements in market

prices. It belongs to the category of speculative risk, wherein price movements

can result in a profit or loss. The risk arises not only because market change,

but because of the actions taken by traders, who can take on get rid of those

risks. The increasing exposure of banks to market risk is due to the trend of

business diversification from the traditional intermediary function toward

trading and investment in financial products that provide better potential for

capital gain, but which expose banks to significantly higher risks.? Market risk

results from changes in price of equity instruments, commodities, money, and

currencies. Its major components are therefore equity position risk, interest

rate risk, and currency risk. Each component of risk includes a general market

risk aspect and specific risk aspect, which originates in the specific

portfolio structure of bank. In addition to standard instruments, such as

options, equity derivatives, or currency and interest rate derivatives.? The price

volatility of most assets held in investment and trading portfolios is often

significant. Volatility prevails even in mature markets, though it is much

higher in new or illiquid markets. The presence of large institutional

investors, such as pension funds, insurance companies, or investment funds has

also had an impact on the structure of markets and on market risk.

Institutional investors adjust their large-scale investment and trading

portfolios through large-scale trades, and in markets with rising prices,

large-scale purchases tend to push prices up. Conversely, markets with

downwards trends become more skittish when large, institutional-size blocks are

sold. Ultimately, this leads to a widening of the amplitude of price variances

and therefore to increases market risk. By its very

nature, market risk requires constant management attention adequate analysis. Prudent

managers should aware of exactly how a bank?s market risk exposure relates to

its capital. In recognition of the

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