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Risk Management in Banking Sectors.
- 1. RISK MANAGEMENT IN BANKING SECTORS BY:RUPESH NYAUPANE
- 2. Risk Management The MajorRisks Banks Face: 1. Liquidity risk 2. Interest risk 3. Market risk 4. Credit risk 5. Off-balance sheet risk 6. Foreign exchange risk 7. Operating risk
- 3. Cont……………… Liquidity Risk Definition: Riskof not being able to honor bank’s financial commitments promptly It arises from an uncertainty of the timing of cash flows Liability-side risk results from unexpectedly high rates of deposit redemption Asset-side risk results from borrowers unexpectedly drawing down loan commitment
- 4. Cont…………. Useful measurements The net liquidity position, which measures sources and uses of liquidity Peer group financial ratios The financing gap, which show the degree to which loans are not financed by core fund
- 5. Cont…….. Liquidity risk managementis carried out at both the retail and wholesale level 1. Demand deposit 2. Term deposit 3. Purchased money 4. Interbank borrowing 5. Repos
- 6. Cont….. Liquidity Management Utilizeliquidity monitoring tools through normal and stress periods Analytics rely on management’s judgment about ability to liquidate assets or use them as collateral for borrowings Funding plan: use a variety of both short-term and long-term instruments (including deposits, repurchase agreements, commercial paper, bank notes, medium- and long-term debt,)
- 7. Cont………. Interest Risk Definition:is the impact on banks earnings and market value of equity of changes in interest rates Refinancing risk Reinvestment risk
- 8. Cont….. Interest Risk (measurements) Gap analysis Duration analysis Simulation model
- 9. Cont…. Matching averagelife of assets and liabilities reduces interest rate risk, but it is not perfect hedge Immunization requires dynamic rebalancing of the portfolio, which may be costly
- 10. Cont… Market Risk Definition:The risk of bank losses from movement of market prices on its trading inventory.
- 11. Cont…. Market Risk Measurement Value-at-Risk Measure the dollar amount of potential loss from adverse market moves in an ordinary market environment Used to compare risks across businesses, to monitor limits and to allocate economic capital Back-testing of VAR against actual financial results to evaluate the soundness of the model.
- 12. Cont…. Stress-testing: Capture exposureto unlikely but plausible events in abnormal markets (VAR – loss due to unlikely events in normal markets) VAR and stress-testing are important determinants in capital allocation for market risk
- 13. Cont… Credit Risk Definition:The risk of loss due to the failure of a borrower, endorser, guarantor or counterparty to repay a loan or honor another predetermined financial obligation
- 14. Cont…. Credit Risk Measurement Traditional approach Available collaterals Quantitative approach Customers creditworthiness
- 15. Cont… Credit Risk Management Ensure that credit risks are accurately assessed, properly approved, continually monitored and actively managed Assess on- or off-balance sheet exposures including loans, derivative receivables and lending-related commitments To measure these risks, estimates are made of both expected and unexpected losses for each segment of the portfolio using statistical techniques Credit Policy Guideline
- 16. Cont… Credit Risk Policy Formulate credit policies, limits, allowance adequacy and guidelines Independent from the groups that approve and support credit activities Manage problem credits
- 17. Cont… Sound Practices forManaging Credit Risk a) Establish an appropriate credit risk environment. b) Operate under a sound credit-granting process. c) Maintain an appropriate credit administration, measurement and monitoring process. d) Ensure adequate controls over credit risk. Board of Directors should review credit risk strategy periodically. Senior management should implement credit risk strategy approved by the Board.
- 18. Cont… Off-balance Sheet Risk Definition of off-balance sheet activities: activities that do not appear on the current balance sheet because it does not concern holding a currency primary claim(asset) or issuing a current secondary(liability) Two categories: 1) Credit substitutes 2) Derivatives
- 19. Foreign ExchangeRisk The potential adverse impact on a bank’s earning and value of its equity from foreign exchange rate movement Operating Risk It is business risk which includes organizational behavior, technological systems and legal aspects of managing a bank • Operational Risk arises as a result of failure of operating system in the bank due certain reasons like fraudulent activities, natural disaster, human error, omission or sabotage etc.
- 20. Operational RisksInclude Internal Fraud. External Fraud. Employment Practices and Workplace Safety. Clients, Products and Business Practices. Damage to Physical Assets. Business Disruption and System Failures. Execution, Delivery and Process Management.
- 21. Internal Fraud Unauthorized Activity. Transactions not reported. Transaction type unauthorized. Mismarking of position. Theft and Fraud. Fraud/credit fraud/worthless deposits. Theft/extortion/embezzlement/robbery. Misappropriation of assets. Forgery. Account take-over/impersonation. Bribes/kickbacks. Insider trading. Money laundering. Willful blindness.
- 22. External Fraud Theft and Fraud. Theft/robbery. Forgery. Check kiting. Identity theft. Systems Security. Hacking damage. Theft of information (with monetary loss).
- 23. Operational RiskManagement Maintain a system of comprehensive policies and a control framework designed to provide a sound and well-controlled operational environment Reputational risk: put in place an additional structure to take account of the potential for adverse reputational impact of transactions with clients.
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