Creation of a Bank The Risk Managment of a fictitious bank

1. “A LEADER FOR A NEW WORLD”
RISK MANAGEMENT REPORT

2.  Presented By:
 Gavyn

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.  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.  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. 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

8.  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.

10.  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.

11. 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

13.  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.

15.  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.

16.  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.

18.  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.

19. Minimum Capital
Requirements
Supervisory
Review
Market
Discipline

20.  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.

21.  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).

22.  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.

24. 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

25. Capital
Requirements
Leverage
Ratio
Liquidity
Requirements

26. 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.

27. 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

28. 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.

29. 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.

30.  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

31.  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.

33.  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

34.  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

35. ◦ 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

36.  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

37.  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

38.  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

39. 1) Screening & monitoring
2) Long-term Customer Relationships
3) Loan Commitments
4) Collateral
5) Compensating Balances
6) Credit Rationing
7) On-Balance Sheet Netting

40.  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.

41.  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.

42.  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

43. Minimum
Capital
Requirement
Three Basic Pillars
Supervisory
Review Process
Market
Discipline
Requirements

44.  Standardized approach
(External Ratings)
 Internal ratings-based approach
 Foundation approach
 Advanced approach
 Credit risk modeling
(Sophisticated banks in the future)
Minimum
Capital
Requirement

45.  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.

47.  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.

48.  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.

49. “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

50.  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.

51.  Funding Requirements
 Limits on the net Cumulative Funding
Mismatch
 Intra-group Liquidity
 Fund Concentration
 Funding Capacity
 Cash flows denominated in individual
currencies

52. 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

53.  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;

54. • 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.

55.  “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.

57. Market Risk
arising from movement in market prices
 Interest Rate Risk,
 Exchange Rate Risk,
 Commodities Price risk
 Equity Price Risk.

58. 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.

59. • 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

60. 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

61. 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

62.  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.

63. “ 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. “

64.  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.

65.  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

66.  SObrun
SOobrayen
SEhudaheen
BhAyro
-
SoSeBa Bank