Unisa risk analysis


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Unisa risk analysis

  1. 1. Risk Analysis and Bank Financial Statements Hennie van Greuning World Bank Treasury FirstRand Board of Directors
  2. 2. Outline – key messages <ul><li>Discuss the common causes of financial crisis and failure. </li></ul><ul><li>K ey lessons learned from the financial crisis </li></ul><ul><li>Proposed regulatory reforms and risk enhancements as a result of the financial crisis. </li></ul><ul><li>Basic risk analysis </li></ul>
  3. 3. 1. Credit Crises – Common Causes <ul><li>“… all consequential events in human history have come from unexpected, rare occurrences” Nassim Nicholas Taleb </li></ul><ul><li>Unusual Times </li></ul>
  4. 4. 1. Financial / Banking Sector Crises – Common Causes <ul><li>Business strategies flawed </li></ul><ul><li>Poor governance oversight & risk management </li></ul><ul><li>Balance sheets structurally weak </li></ul><ul><li>Excessive gearing </li></ul><ul><li>Excessive credit risk </li></ul><ul><ul><li>Weak credit terms </li></ul></ul><ul><ul><li>Risky products </li></ul></ul><ul><li>Liquidity risk not well understood </li></ul><ul><li>Risks taken at lower levels not understood by senior management </li></ul><ul><li>Recent bank failures – generic causes </li></ul>
  5. 5. 1. Financial Crises – Common Causes <ul><li>Global imbalances have built up over years </li></ul>CA balances Financial
  6. 6. 1. Financial Crises – Common Causes <ul><li>“ Debt can be viewed as sustainable as long as the debt to GDP ratio is non-increasing”* </li></ul>US Private Sector Debt to GDP Source: US Federal Reserve *Nouriel Roubini (2001) Debt Sustainability: How to Assess Whether a Country is Insolvent, Stern School of Business, NYU 0% 50% 100% 150% 200% 250% 300% 350% 400% 1916 1926 1936 1946 1956 1966 1976 1986 1996 2006
  7. 7. 1. Financial Crises – Common Causes <ul><li>US Housing Market Fundamentals </li></ul><ul><li>Source: OFHEO and US Federal Reserve </li></ul>
  8. 8. 1. Financial Crises – Common Causes Unrestrained asset (derivative) growth – CDS market growth Source: ISDA, The World Bank, US Bureau of Economic Analysis and US Treasury
  9. 9. 1. Financial Crises – Common Causes <ul><li>South Africa’s macro economic imbalances monitor </li></ul>Current account balance Household debt to disposable income House prices Inflation
  10. 10. 1. Financial Crises – Common Causes <ul><li>Consequences of macro economic imbalances </li></ul>Global financial sector crisis Global macroeconomic crisis Bank share prices Global growth
  11. 11. Financial Crises – Common Causes <ul><li>Bank Failures Statistics </li></ul>Source: http://investingcontrarian.com/global/us-1800-bank-failures-tsunami-on-horizon/ 2010 began with a whimper for Bank Failures as the first week almost gave us the illusion that maybe and just maybe, the problem might just have solved itself as zero failures were reported. It was never going to be that easy, was it? As the graph, shows,  a few weeks into 2010, the number of failures curve has already picked up steam and we see the red curve blasting away. May 20 Failures – 72 so far this year Problems - 775 institutions with aggregate assets of $431 billion 8,384 FDIC insured banks
  12. 12. Key Lessons Learned <ul><li>“ I spent too much time out of the office with clients and trusted other people to manage the risk – I am sorry.” Dick Fuld, ex-Lehman CEO.12 September 2009 </li></ul><ul><li>“ We strive to have a balance in our team and I will use the analogy of the soccer team. A balanced team has good forwards, sweepers, backs and a goalie. If too many goals are let in, you must strengthen your defense. However to score goals you must have good strikers. You can’t win matches with 11 goalies and nor can you win with 11 strikers . We have improved our defensive line but not at the expense of our forward line.” SA banker - September 2009 </li></ul><ul><li>Remember, models are only as effective as the assumptions on which they’re built and the inputs they’re provided </li></ul><ul><li>“ Human beings, who are almost unique in having the ability to learn from the experience of others, are also remarkable for their apparent disinclination to do so.” Douglas Adams </li></ul><ul><li>What did management learn? </li></ul>
  13. 13. Key Lessons Learned <ul><li>If things appear too good to be true, they probably are (“If something cannot go on forever, it won’t”) – know where profits come from </li></ul><ul><li>Back to basics – use common sense approach to risk management: Risk management is about quality of people, experience, judgment and coordination </li></ul><ul><li>Pro-active, holistic and forward looking analysis , through e.g. robust stress testing and a combination of quantitative and qualitative risk information </li></ul><ul><li>Align risk, capital, funding and strategy – and incorporate it in a dynamic risk appetite process </li></ul><ul><li>Escalate clearly and early – to avoid surprises </li></ul>“ The last time anybody made a list of the top hundred character attributes of New Yorkers, “common sense” snuck in at number 79.” Douglas Adams “ Nothing travels faster than the speed of light with the possible exception of bad news, which obeys its own special laws.” Douglas Adams, &quot;The Hitchhiker's Guide to the Galaxy&quot;
  14. 14. Financial Failure - Nothing New ? Themes Lehman Brothers Kidder, Peabody & Co Barings Bank Orange County Societe Generale Dick Fuld Joseph Jett Nick Leesam Bob Citron Jerome Kerviel Board failure Management failure Failure in Internal controls Weak risk management Accounting failure Corporate Governance failure Regulatory failure IT Compensation
  15. 15. <ul><li>Disconnect between risk and controls: “These are stories of what happens when the desire for excess returns overrides risk controls” . </li></ul><ul><li>The person in charge (in each case) showed excellent results in the beginning , and thus was allowed to transact without proper supervision and controls.” Beware of star performer who is unconstrained by lack of supervision. </li></ul><ul><li>If returns are too good to be true, there is likelihood of elevated risk </li></ul><ul><li>Poor understanding of business and investment strategies by senior management and Board </li></ul><ul><li>Fractured (and not always competent) oversight mechanisms: internal and external </li></ul><ul><li>GREED </li></ul><ul><li>History: Analysis from Kidder Peabody to the present crisis </li></ul>
  16. 16. 3. Regulatory reform
  17. 17. 3. Regulatory Reform <ul><li>Some emerging market countries way ahead of the governance & regulatory curve – already implemented many items the world is still debating </li></ul><ul><li>The crisis provides a unique opportunity to make significant internal improvements in organizations </li></ul><ul><li>Good time to foster a culture of risk and transparency </li></ul><ul><li>Flexibility: Those better able to adapt have an advantage in the market going forward </li></ul><ul><li>Building-up infrastructure and capacity takes commitment and resources. </li></ul><ul><li>Not everything is bad news... </li></ul>
  18. 18. 4. Key stakeholders - Accountability Key stakeholders Accountability A. Regulators Set regulatory framework, including risk exposures limits and other risk management parameters, which will optimize risk management in the banking sector A. Supervisors Monitor financial viability and effectiveness of risk management. Check compliance with regulations. B. Shareholders Appoint “fit and proper” boards, management, and auditors C. Board of directors Set risk management and other bank policies. Ultimate responsibility for the entity D. Executive management Create systems to implement board policies, including risk management, in day-to-day operations E. Risk Committee and ERM Monitoring of risk management practices F. Audit Committee and Internal Audit Test compliance with board policies and provide assurance regarding corporate governance, control systems, and risk management processes G. External Audit Express opinion and evaluate risk management policies <ul><ul><li>H. External stakeholders (depositors, customers, investment analysts, rating agencies, financial press, NGO's) </li></ul></ul>Insist on transparency and full disclosure
  19. 19. 4. Risk information not directly reflected in AFS <ul><li>Summary of risk types </li></ul>Financial risks Operational risks Business risks Event risks Balance sheet structure Internal fraud Macro policy Political Income statement structure External fraud Financial infrastructure Contagion Capital adequacy Employment practices Legal infrastructure Banking crisis Credit Clients, products and business Legal liability Other exogenous Liquidity Damage to physical assets Regulatory compliance Market Business disruption and system failures Reputational and fiduciary Interest rate Execution, delivery and process Country risk Currency Strategic issues
  20. 20. 4. Risk information not directly reflected in AFS <ul><li>Risk in the context of a Bank Balance Sheet </li></ul>Assets Liabilities Credit risk +Interest Rate in the banking book +Liquidity Market risk + Banking book hedges Investment risk + Liquidity risk + Market risk Liquidity risk Liquidity & Funding risk + Interest rate in the banking book Market risk + Banking book hedges Market risk Capital risk Funding risk High level allocation to key risk types Note: figures are provisional
  21. 21. Financial Analysis – Principles <ul><li>Questions to consider… </li></ul><ul><li>What is the purpose of the analysis? </li></ul><ul><li>What level of detail will be needed? </li></ul><ul><li>What factors or relationships (context) will influence the analysis? </li></ul><ul><li>What are the analytical limitations, and will these limitations have the potential to impair the analysis? </li></ul><ul><li>What data is available? </li></ul><ul><li>How will data be processed? </li></ul><ul><li>What methodologies will be used to interpret the data? </li></ul><ul><li>How will conclusions and recommendations be communicated? </li></ul>
  22. 22. Financial Analysis – Principles <ul><li>What happened? </li></ul><ul><li>Why did it happen? </li></ul><ul><li>What is the Impact of event? </li></ul><ul><li>Action plan going forward </li></ul><ul><ul><li>Accountability </li></ul></ul><ul><ul><li>Target date </li></ul></ul><ul><li>What is Financial Analysis? </li></ul>
  23. 23. Financial Analysis – Tools and techniques Tools Techniques <ul><ul><li>Questionnaires </li></ul></ul><ul><ul><li>Group response to answers per risk category </li></ul></ul><ul><ul><li>Data input tables (excel, etc) </li></ul></ul>Manipulate the data to facilitate analysis <ul><ul><li>Manipulated data </li></ul></ul><ul><ul><ul><li>Structure of the balance sheet </li></ul></ul></ul><ul><ul><ul><li>Structure of the income statement </li></ul></ul></ul><ul><li>Common-Size analysis </li></ul><ul><li>Cross-Sectional / comparative analysis </li></ul><ul><li>Ratios </li></ul><ul><ul><li>Graphs & charts </li></ul></ul><ul><ul><li>Pie, Bar, Trend Analysis, etc </li></ul></ul><ul><ul><li>Structural change in the business </li></ul></ul><ul><ul><ul><li>Annual growth (from year-to-year) </li></ul></ul></ul><ul><ul><ul><li>Cumulative growth (base to current year) </li></ul></ul></ul><ul><ul><li>Ratios </li></ul></ul><ul><ul><li>Ratio analysis </li></ul></ul><ul><ul><li>Regression analysis </li></ul></ul>
  24. 24. Balance Sheet Overview 4. Regulatory Returns Analytical Value
  25. 25. 4. Regulatory Returns Analytical Value Composition of Assets : Structural Change & Growth
  26. 26. 4. Regulatory Returns Analytical Value Asset Growth Over Time SARB -2008 Annual Bank Supervision Report
  27. 27. Financial Analysis – Tools and techniques <ul><li>Trend analysis – Asset Growth: cumulative from a base period </li></ul>Source: 2009 ABACUS
  28. 28. 6. Financial Analysis – Tools and techniques <ul><li>Trend analysis: Total Assets, Gross Loans and Advances </li></ul>SARB – 2008 Annual Bank Supervision Report
  29. 29. Financial Analysis – Tools and techniques <ul><li>Common Size Analysis - “Vertical” Analysis </li></ul>Period 1 (%) Period 2 (%) Revenue source: Service A 30 45 Revenue source: Service B 23 20 Revenue source: Service C 30 30 Revenue source: Service D 17 5 Total Revenue: 100 100 Operating expenses (excluding depreciation) Salaries and employee benefits 15 25 Administrative expenses 22 20 Rent expense 10 10 Earnings before interest, tax, depreciation (EBITDA) 53 45 Depreciation and amortization 4 4 Earnings before interest and tax (EBIT) 49 41 Interest paid 7 7 Earnings before tax (EBT) 42 34 Income tax provision 15 8 Net Income 27 26
  30. 30. Assets Vs Income: Energy Applied Vs Income Earned Regulatory Returns Analytical Value Income Assets
  31. 31. Cost-to-Income Ratios of Individual banks Categorized by Asset Value of Each Bank SARB – 2008 Annual Bank Supervision Report 4. Regulatory Returns Analytical Value
  32. 32. Composition of Income Statement - Multi Year Trend SARB – 2006 Annual Bank Supervision Report Regulatory Returns Analytical Value
  33. 33. Financial Analysis – Tools and techniques <ul><li>Ratio Analysis: Liquidity statistics </li></ul>0% 50% 100% 150% 200% 250% Period 1 Period 2 Period 3 Period 4 Current Period Customer loans as % of customer deposits Interbank loans as % of interbank deposits Readily marketable assets as % of total assets Volatile liabilities as % of total liabilities Volatility coverage (readily marketable assets as % of volatile liabilities) Bank run (readily marketable assets as % of all deposits type)
  34. 34. Financial Analysis – Tools and techniques <ul><li>Correlation: Total Banking-Sector Assets to GDP </li></ul>SARB – 2008 Annual Bank Supervision Report