Introduction to Market Risk:
Market Risk may be defined as the possibility of loss to bank caused by the changes in the market
variables. It is the risk that the value of on-/off-balance sheet positions will be adversely affected by movements
in equity and interest rate markets, currency exchange rates and commodity prices. Market risk is the risk to the
bank’s earnings and capital due to changes in the market level of interest rates or prices of securities, foreign
exchange and equities, as well as the volatilities, of those prices. Market Risk Management provides a
comprehensive and dynamic frame work for measuring, monitoring and managing liquidity, interest rate,
foreign exchange and equity as well as commodity price risk of a bank that needs to be closely integrated with
the bank’s business strategy.
Scenario analysis and stress testing is yet another tool used to assess areas of potential problems in a
given portfolio. Identification of future changes in economic conditions like – economic/industry overturns,
market risk events, liquidity conditions etc. that could have unfavorable effect on bank’s portfolio is a condition
precedent for carrying out stress testing. As the underlying assumption keep changing from time to time, output
of the test should be reviewed periodically as market risk management system should be responsive and
sensitive to the happenings in the market.