Risk Management in Banking Overview
Just like any business, banks face a myriad of risks.
.There are various types of risks that a bank may face and is
important to understand how banks manage risk
.
Risk can be defined as an unplanned event with financial
consequence resulting in loss or reduced earnings
What is RISK?
It is the potential that events expected or unexpected, may have an adverse
effect on a financial institution’s capital or earnings.
Risk is inherent in all business and financial activities.
The greater the RISK associated with an activity the greater potential to
generate a high return.
Banks do take RISKS – The biggest RISK is Not Taking a RISK
RISKS
MUST BE:
01
03
Known
Quantifiable
02
Understood
04
Controllable / Accebtable
Commercial Bank lending/Investment involves
three parties :
The suppliers of funds (The depositor)
The users of funds (The borrowers)
A financial intermediary (Bank) s
Definition of Risk Management
1.
Risk management: is the process of assessing risk taking steps to reduce
risk to an acceptable level and maintaining that level of risk.
Types of risks management that face banks
Credit Risk
Banks often lend out money. The chance that a loan recipient does not pay back that
money can be measured as credit risk.
Market Risk
This refers to the risk of an investment decreasing in value as a result of market
factors (such as a recession)
Operational Risk
These are potential sources of losses that result from any sort of operational event; e.g.
poorly-trained employees, a technological breakdown, or theft of information
Reputational Risk
Let’s say a news story breaks about a bank having corruption in leadership. This may
damage their customer relationships, cause a drop in share price, give competitors an
advantage, and more.
ypes
f risk
Liquidity Risk
With any financial institution, there is always the risk that they are unable to pay back its
liabilities in a timely banner because of unexpected claims or an obligation to sell long
term assets
Foreign exchange risk
Risk may arise on account of maintenance of position in forex operation and it involves
currency rate risk transaction risk {profit and loss on transfer of earned profit due to
the time lag}and transportation risk arising out of exchange restrictions
Technological risk
This risk is associated with computers and the communication technology which is being
introduced in the banks
Interest rate risk
This arise due to fluctuation in the interest rate it can result in reduction in the revenues of
the bank due to the fluctuation in the interest rate which are dynamic and which change
differently for assets and liability
Risk Identification In Banks
Banks must create a risk identification process across the organization in order to develop a meaningful risk
management program.
Assessment & Analysis Methodology
Assessing risk in a uniform fashion is the hallmark of a healthy risk management system. It’s important to be
able to collect and analyze data to determine the likelihood of any given risk and subsequently prioritize
remediation efforts.
Mitigate
Risk mitigation is defined as the process of reducing risk exposure and minimizing the likelihood of an
incident
Monitor
Monitoring risk should be an ongoing and proactive process. It involves testing, metric collection and incidents remediation
to certify that the controls are effective
Connect
Creating relationships between risks, business units, mitigation activities and more paints a cohesive picture of the bank. This
allows for recognition of upstream and downstream dependencies, identification of systemic risks and design of centralized
controls.
Report
Presenting information about how the risk management program is going – in a clear and engaging way – demonstrates
effectiveness and can rally the support of various stakeholders at the bank
M Software for Banks
best way to begin the process of developing a sound banking risk management plan is by using enterprise risk
nagement software. Logic Manager’s risk management software for banks and unlimited advisory services provide a risked framework and methodology to accomplish all of your governance activities, while simultaneously revealing the
nections between those activities and the goals they impact.
Credit risk management
The board of directors of each bank shall be responsible for approving and periodically reviewing the credit risk strategy and
significant credit risk policies.
Building Blocks of Credit Risk Management
•Policy and strategy
•Organizational structure
•Operations / Systems
Credit risk policies : every bank should have a credit policy document approved by the board the document should include
risk identification risk measurement risk grading techniques reporting and risk control
Credit risk strategy
Each bank should develop, with the approval of its board, its own credit risk strategy or plan that establishes the objectives
guiding the bank’s credit granting activities and adopt necessary policies / procedures for conducting such as activities.
activities.
Organizational Structure
The Organizational structure is sine qua non (end result) for successful implementation of an effective credit risk
management system. being introduced or undertaken
Operations / Systems
Banks should have in place an appropriate credit administration, credit risk measurement and monitoring processes. The
credit administration process typically involves the following phases:
•Relationship management phase i.e. business development .
•Transaction management phase covers risk assessment, loan pricing, structuring the facilities, internal approvals,
documentation, loan administration, on going monitoring and risk measurement.
•Portfolio management phase entails monitoring of the portfolio at a macro level and the management of problem loans.
Interest Rate Risk (IRR) Management
What is interest rate risk?
Interest rate risk: is the risk where changes in market interest rates might adversely affect a bank’s financial condition. The
management interest rate risk should be one of the critical components of market risk management in banks.
Earnings Perspective involves analyzing the impact of changes in interest rates on accrual or reported earnings in the near
term.
Economic Value Perspective involves analysing the changing of impact interest on the expected cash flows on assets minus
the expected cash flows on liabilities plus the net cash flows on off-balance sheet items.
.
Liquidity Risk Management
What is liquidity risk ?
Liquidity risk: is the potential inability to meet the liabilities as they become due.
The liquidity risk in banks manifest in different dimensions:
•Funding Risk: need to replace net out flows due to unanticipated withdrawal / non-renewal of deposits (wholesale, and reta
•Time Risk: need to compensate for non- receipt of expected inflows of funds, i.e. performing assets turning into nonperforming assets; and
•Call Risk: due to crystallization of contingent liabilities and unable to undertake profitable business opportunities when
desirable.
How is it measured?
Liquidity measurement is quite a difficult task and can be measured through stock or cash flow approaches. The key ratios,
adopted across the banking system are:
•Loans to total assets
•Loans to core deposits
Operational Risk (OR) Management
What is operational risk ?
Operational risk: has been defined by the Basel Committee on Banking Supervisions as the risk of loss resulting from
inadequate or failed internal processes, people and system or from external events.
Measuring Operational Risk
Operational risk is more difficult to measure than market or credit risk due to the non-availability of objective data ,
redundant data, lack of knowledge of what to measure etc.
Risk Management Tools
A robust operational risk management process consists of clearly defined steps which involve identification of the risk
events, analysis, assessment of the impact , treatment and reporting.
What is AML?
ALM is a comprehensive and dynamic framework for measuring, monitoring and managing the market risk of a bank. It
is the management of structure of balance sheet (Liabilities and assets) in such a way that the net earning from interest
is maximised within the overall risk- preference (present and picture) of the institutions.