SoSeBa Bank - Risk Managment of a fictitious Bank


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Creation of a Bank
The Risk Managment of a fictitious bank

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SoSeBa Bank - Risk Managment of a fictitious Bank

  2. 2.  Presented By:  Gavyn
  3. 3.  Introducing SoSeBa Bank in Mauritius  Issues involved:  Basel Core Principles  Risks: Credit, Liquidity, Market  How to measure them?  How to manage them?  Illustration
  4. 4.  23 banks for a population of 1,295,000. 2 latest additions (Warwyck Private Bank Limited and Richemont Limited) last week  Wide range of banking facilities.  Banks regulated by the Bank of Mauritius  Adherence to Core Principles for Effective Banking Supervision set by the Basel Committee on Banking Supervision
  5. 5.  Target: working class population  Our mission: To provide a diverse range of services to the working class population of Mauritius  Our vision: To emerge as a leading bank in Mauritius in the medium term.  Our values: Integrity, reliability, efficiency
  6. 6. Relevant Laws  Assets Recovery Act 2011  Banking Act 2004  Bank of Mauritius Act 2004  Borrower Protection Act 2007  Companies Act 2001  Financial Intelligence and Anti Money Laundering Act 2002 (FIAMLA)  Financial Services Act 2007  Insurance Act 2005  Insolvency Act 2009 + Bank of Mauritius Guidelines
  7. 7.  Banking regulations are a form of government regulation which subject banks to certain requirements, restrictions and guidelines.  Banking regulation has advanced noticeably since the 2008 financial crisis, with considerable progress achieved in 2013.  There is a need for regulations since banks like to take risks.
  8. 8.  Established in 1930 in the context of Young Plan.  Main purpose is to make monetary policy more predictable.  The BIS sets "requirements on two categories of capital, tier 1 capital and total capital.
  9. 9. Tier 1 Capital Tier 2 Capital It is a term used to describe the capital adequacy of a bank It refers to as the equity tier one ratio. It consists of only one equity and retained profits. Tier 2 Capital also known as Supplementary Capital Include a number of important and legitimate constituents of bank’s capital base Tier 2 capital can be said to be subordinate Capital
  10. 10.  The Basel Committee under the banking supervision established by the central bank governors of the group of 10 countries in 1974.  Its objective is to enhance understanding of key supervisory issues and improve the quality of banking supervision worldwide.
  11. 11.  Basel Capital Accord (Basel 1) was approved by the G10 governors and released to banks in July 1988.  Basel 1 helps to strengthen the stability of international banking system.  Basel 1 is a set minimum capital standards for banks.
  12. 12.  Limited differentiation of credit risk.  No recognition of term-structure of credit risk.  Static measure of default risk.  Simplified calculation of potential future counterparty risk.  Lack of recognition of portfolio diversification effects.
  13. 13.  Basel II is the second of the Basel Accords.  Basel II, initially published in June 2004, was intended to create an international standard for banking regulators to control how much capital banks need to put aside to guard against the types of financial and operational risks banks (and the whole economy) face.
  14. 14. Minimum Capital Requirements Supervisory Review Market Discipline
  15. 15.  The first pillar deals with minimum capital requirements in respect of credit, market and operational risk.  Each of which has to be calculated using an approach which is suitable and sufficient for the individual bank.
  16. 16.  Pillar 2 requires the banks to have procedures for the evaluation and assurance of an adequate capitalisation in relation to the risk profile as well as of a strategy concerning the preservation of the level of own funds (Internal Capital Adequacy Assessment Process – ICAAP).
  17. 17.  Pillar 3 aims to increase market transparency by providing information on the scope of application, regulatory capital, risk positions, risk measurement approaches equity, risk positions, the IRB-Approach and as a result the capital requirements of a bank.
  18. 18. Basel III (or the Third Basel Accord) is a global, voluntary regulatory standard on bank capital adequacy, stress testing and market liquidity risk. It was agreed upon by the members of the Basel Committee on Banking Supervision in 2010–11. It was scheduled to be introduced from 2013 until 2015; however, changes from 1 April 2013 extended implementation until 31 March 2018
  19. 19. Capital Requirements Leverage Ratio Liquidity Requirements
  20. 20. Capital Requirements Basel III introduced "additional capital buffers", (i) a "mandatory capital conservation buffer" of 2.5% and (ii) a "discretionary counter-cyclical buffer", which would allow national regulators to require up to another 2.5% of capital during periods of high credit growth.
  21. 21. Leverage Ratio The leverage ratio was calculated by dividing Tier 1 capital by the bank's average total consolidated assets. The banks were expected to maintain a leverage ratio in excess of 3% under Basel III
  22. 22. Liquidity Requirements The "Liquidity Coverage Ratio" was supposed to require a bank to hold sufficient high-quality liquid assets to cover its total net cash outflows over 30 days. The Net Stable Funding Ratio was to require the available amount of stable funding to exceed the required amount of stable funding over a one-year period of extended stress.
  23. 23. Unlike Basel I and Basel II which are primarily related to the required level of bank loss reserves that must be held by banks for various classes of loans and other investments and assets that they have, Basel III is primarily related to the risks for the banks of a run on the bank by requiring differing levels of reserves for different forms of bank deposits and other borrowings.
  24. 24.  Due to inherent risks in the accepting of deposits from people with an excess of money to granting loans to those in deficit of it.  Need to manage risks : Credit/ Liquidity/ Market  Risk management -a four-step process  Identifying  Measuring ( quantifying)  Managing  Monitoring and reviewing
  25. 25.  Regulatory response ◦ Prudential norms ◦ Stringent Provisioning norms ◦ Corporate governance norms  Market response-introduce new products ◦ Equity futures ◦ Foreign currency futures ◦ Currency swaps ◦ Options As a newly established bank, SoSeBa expects to distinguish itself by its intelligent risk management.
  26. 26.  Areas covered ◦ Credit Risk ◦ Liquidity Risk ◦ Market Risk  Credit risk is defined as “the potential that a borrower or counter-party will fail to meet its obligations in accordance with agreed terms”  It is the probability of loss from a credit transaction
  27. 27.  Working Capital Finance ◦ Extended to meet day-to-day short term operational requirements  Loan for setting up new project, expansion and diversification of existing project etc. ◦ Short term or medium term
  28. 28. ◦ Pre-Sanction appraisal  Financial data of past and projected working results  Detailed credit report is compiled on the borrower / surety  Market reports  Final / audited accounts  Income tax and other tax returns / assessments ◦ Post-Sanction control  Documentation of the facility and ‘after care’ follow- up  Supervision through monitoring of transactions in loan amount  Physical inspection of securities and books of accounts of the borrower  Periodical reviews
  29. 29.  Use of credit rating models and credit rating analysts  Credit quality of facilities to individuals or small businesses assessed through credit scoring based on a standard formulae which incorporates relevant variables like annual income, repayment capacity, and exposure limits.  Afrasia’s banking software: CRISIL & CRESS
  30. 30.  Bank generally sets an exposure credit limit for each counterparty to which it has credit exposure  Prudential limits: not more than 15% of capital to individual borrower and not more than 40% of capital to a group borrower.  Threshold limits set are dependent upon : ◦ Credit rating of the borrower ◦ Past financial records ◦ Willingness and ability to repay ◦ Borrower’s future cash flow projections
  31. 31.  Credit risk models used by banks: Altman’s Z Score Model  95 % accuracy of prediction of bankruptcy up to two years prior to failure on non- manufacturing firms as well. Credit Metrics Model  Tool for assessing portfolio risk due to changes in debt value caused by changes in obligor credit quality Value at Risk Model  Constructs a probability distribution of the portfolio values over a given time horizon
  32. 32. 1) Screening & monitoring 2) Long-term Customer Relationships 3) Loan Commitments 4) Collateral 5) Compensating Balances 6) Credit Rationing 7) On-Balance Sheet Netting
  33. 33.  Despite all these measure, the banking sphere experienced crises like  Enron (2001)  Washington Mutual (2008)  Why?  Maintained a risk management function.  Lines of reporting were reasonably independent.  Few career risk managers.
  34. 34.  Effective management of funding liquidity, capital & balance sheet ( contingency plans).  Senior Management role in understanding and acting on existing and emerging risks is extremely important.
  35. 35.  A positive corporate culture.  Actively observed policies and procedures.  Effective use of technology.  Independence of risk management professionals. Overall risk should always be lower than overall economic capital
  36. 36. Minimum Capital Requirement Three Basic Pillars Supervisory Review Process Market Discipline Requirements
  37. 37.  Standardized approach (External Ratings)  Internal ratings-based approach  Foundation approach  Advanced approach  Credit risk modeling (Sophisticated banks in the future) Minimum Capital Requirement
  38. 38.  Since the 2008 financial crisis and its recent ramifications, liquidity risk management has become a focal point for banks and regulators.  Liquidity risk for SOSEBA is centrally managed by a dedicated liquidity risk management team in Group Treasury.  It is this central function’s responsibility to ensure that the liquidity risk management framework is implemented appropriately.
  39. 39.  Liquidity risk is one of the major risks faced by financial intermediaries and banks in particular.  Liquidity in banking is conventionally defined as the ability to meet its obligations as they become due.  The Bank may encounter liquidity risks – the inability to meet its liquidity needs because of bank-specific problems or because of a market liquidity shortage in times of a financial crisis.
  40. 40.  Funding liquidity tends to manifest as a credit risk: inability to fund liabilities produces defaults.  Market liquidity risk manifests as market risk: inability to sell an asset drives its market price down, or worse, renders the market price indecipherable.  Market liquidity risk is a problem created by the interaction of the seller and buyers in the marketplace. If the seller's position is large relative to the market, this is called endogenous liquidity risk (a feature of the seller). If the marketplace has withdrawn buyers, this is called exogenous liquidity risk (a characteristic of the market which is a collection of buyers); a typical indicator here is an abnormally wide bid-ask spread.
  41. 41. “Principles for Sound Liquidity Risk Management and Supervision”, by providing more guidance on the following.  Liquidity risk tolerance  Maintaining adequate levels of liquidity  Allocating liquidity costs, benefits and risks to business  Identification and measurement of contingent liquidity risks  Design and use of severe stress test scenarios  A contingency funding plan  Public disclosure in promoting market discipline
  42. 42.  As per the Bank of Mauritius, the liquidity risk Guidelines are issued under the authority of Section 50 of the Bank of Mauritius Act 2004 and Section 100 of the Banking Act 2004.  As per Bank of Mauritius, SOSEBA shall manage liquidity risk in a sound manner  shall establish a robust liquidity risk management framework that ensures it maintains sufficient liquidity, including a cushion of unencumbered, high quality liquid assets, to ZSwithstand a range of stress events, including those involving the loss or impairment of both unsecured and secured funding sources.
  43. 43.  Funding Requirements  Limits on the net Cumulative Funding Mismatch  Intra-group Liquidity  Fund Concentration  Funding Capacity  Cash flows denominated in individual currencies
  44. 44. Risk Management Policies  Liquidity Risk Tolerance  Strategy  Composition of assets and liabilities  Diversification and Stability of Liabilities  Access to Inter bank and Other Wholesale Markets  Management of Liquidity in Different Currencies  Management of Intra-group Liquidity  Translation of Liquidity strategy into Policies
  45. 45.  senior management has set up a structure of responsibilities and controls for managing liquidity risk and for overseeing the liquidity positions of all legal entities, branches and subsidiaries;  senior management has a thorough understanding of the close links between funding liquidity risk and market liquidity risk  the liquidity risk strategy, key policies for implementing the strategy and liquidity management structure be communicated throughout the organization by senior management;  senior management should have an oversight process with efficient and effective internal controls to ensure the enforcement of policies and procedures  senior management implements changes in a timely manner when significant changes impact on the effectiveness of controls and revisions or enhancements to internal controls are warranted;
  46. 46. • internal audit reviews the implementation and effectiveness of the agreed framework for controlling liquidity at the periodicity as determined by it; • senior management closely monitors current trends and potential market developments that may present significant, unprecedented and complex challenges for managing liquidity risk so that they can make appropriate and timely changes to the liquidity strategy as needed. • senior management provides regular feedback through a formal system of reporting; • senior management takes appropriate remedial actions within the least delay to address the above concerns.
  47. 47.  “Knowledge has to be improved, challenged and increased constantly or it vanishes” Peter Drucker  It is the risk that the value of on and off- balance sheet positions of a financial institution will be adversely affected by movements in market rates or prices such as interest rates, foreign exchange rates, equity prices, credit spreads and/or commodity prices resulting in a loss to earnings and capital.
  48. 48. Market Risk arising from movement in market prices  Interest Rate Risk,  Exchange Rate Risk,  Commodities Price risk  Equity Price Risk.
  49. 49. MARKET RISK-CONTINUED  Basel-I focused only on credit risk excluding the market risk  Risk brought vide amendments in 1996  usually measured with a Value-at-Risk method and on daily basis  capital charge should be either the previous day’s VaR or three times the average of the daily VaR for the preceding 60 working days.
  50. 50. • Convergence of Economies • Easy and faster flow of information • Skill Enhancement • Increasing Market activity • Increased Volatility • Need for measuring and managing Market Risks • Regulatory focus • Profiting from Risk Leading to
  51. 51. Time Sophistication Mark to Market Duration Value at Risk Stress Testing Use of Statistical analysis to determine maximum losses Use of ‘What if’ scenarios to determine losses in extreme eventsCashflow analysis to measure the sensitivity of fixed income instruments Revaluation of the portfolio to measure notional P/L TimeTime Sophistication Mark to Market Duration Value at Risk Stress Testing Use of statistical analysis to determine maximum losses Use of ‘What if’ scenarios to determine losses in extreme eventsCashflow analysis to measure the sensitivity of fixed income instruments Revaluation of the portfolio to measure notional P/L Market Risk – Advanced Risk Measurement Techniques enables Bank to effectively control the amount of market risk it assumes and allocate capital for the same Measurement Techniques  Marking to Market  Duration, Convexity  Price Value of a Basis Point  VaR - Forex (Spot & Forward)  Stress Testing  Scenario Analysis  Duration Limits  VaR Limits  Stop Loss Limits  Counterparty Exposure Limits  Country Exposure Limits  Standardized Model  Internal Model ‘Know’ your risks Allocate Capital Control Measures
  52. 52. Value-at-Risk is a measure of Market Risk, which measures the maximum loss in the market value of a portfolio with a given confidence VaR is denominated in units of a currency or as a percentage of portfolio holdings It is a probability of occurrence and hence is a statistical measure of risk exposure
  53. 53.  Value at risk (VAR) is a probabilistic method of measuring the potentional loss in portfolio value over a given time period and confidence level.  The VAR measure used by regulators for market risk is the loss on the trading book that can be expected to occur over a 10-day period 1% of the time  The value at risk is $1 million means that the bank is 99% confident that there will not be a loss greater than $1 million over the next 10 days.
  54. 54. “ The way that risk is managed in any particular institution reflects its position in the marketplace, the products it delivers and perhaps, above all, its culture. “
  55. 55.  Trading book  Banking book  The main differences are: 1. Assets that are held for trading are put in the trading book, assets that are held to maturity are held in the banking book 2. Assets in the trading book are marked-to-market daily, assets in the banking book are held at historic cost 3. The value-at-risk for assets in the trading book is calculated at a 99% confidence level based on a 10-day time horizon. The value-at-risk for assets in the banking book are calculated at a 99.9% confidence level on a one- year horizon.
  56. 56.  Effective Management of Risk benefits the bank..  Efficient allocation of capital to exploit different risk / reward pattern across business  Better Product Pricing  Early warning signals on potential events impacting business  Reduced earnings Volatility  Increased Shareholder Value
  57. 57.  SObrun SOobrayen SEhudaheen BhAyro - SoSeBa Bank