Risks in Banking Operations Banking Finance and Insurance Institute of Nepal Ltd. (BFIN) Conference on Transformation of Human Capital for a Digital World Risks in Banking Operations Narayan Prasad Paudel December 23, 2018 Kathmandu

Risk: General Types Risk Specific characteristics Business Risk The nature of business Financial Risk Use of greater debt in the capital structure Credit Risk The probability of being default Liquidity Risk Inability to sell assets quickly for cash Interest Rate Risk The unfavorable effects of interest rate Management Risk Risk associated with managerial decisions. Purchasing Power Risk Inflationary effect on the rate return Legal Risk Failure to comply with statutory or regulatory obligations  Sovereign risk Risk of investment in a particular country Reputational Risk Risk of loss resulting from damages to an organization’s reputation

Financial and Non- Financial Risks Financial Risk Non-Financial Risks Interest Rate Risk Operational Risk Exchange Rate Risk Legal Risk Market Risk Reputational Risk Credit Risk Strategic and Policy Risk Liquidity Risk Country Risk

Risk Governance Framework Risk Governance Structure: - The Board of Directors - Board Level Risk Committee - Board Level Audit Committee Risk Management Structure: - Business Areas ( First Line of Defense - Risk Managing) - Risk Management Department (Second Line of Defense - Risk Monitoring) - Audit Department

Risk Management Framework An effective risk management framework includes: Clearly defined risk management policies and procedures covering risk identification, acceptance, measurement, monitoring, reporting and control. A well constituted organizational structure defining clearly roles and responsibilities of individuals involved in risk taking as well as managing it. Banks, in addition to risk management functions for various risk categories may institute a setup that supervises overall risk management at the bank. Such a setup could be in the form of a separate department or bank’s Risk Management Committee (RMC) could perform such function. There should be an effective management information system that ensures flow of information from operational level to top management and a system to address any exceptions observed. There should be an explicit procedure regarding measures to be taken to address such deviations. The framework should have a mechanism to ensure an ongoing review of systems, policies and procedures for risk management and procedure to adopt changes.

Risk Management Risk Management is a discipline at the core of every bank and encompasses all activities that affect its risk profile. It involves identification, measurement, monitoring and controlling risks Became the hot topic after the 2008 financial crisis A sound risk management system should have the following elements: Active board and senior management oversight Adequate policies, procedures and limits Adequate risk measurement, monitoring and management information system; and Comprehensive internal controls.

Risk Management Functions Identifying current and emerging risks; Developing risk assessment and measurement systems; Establishing policies, practices and other control mechanisms to manage risks; Developing risk tolerance limits for Senior Management and Board approval; Monitoring positions against approved risk tolerance limits; and Reporting results of risk monitoring to Senior Management and the Board.

Directive on Risk Management (Directive No. 5) Credit risk Operational risk Liquidity risk Market Interest rate risk Foreign Exchange risk Other risk (Reputational, strategic, AML/CFT)

Risk Based Supervision Six Major Inherent Risks: Credit Liquidity Market Interest Rate Foreign Exchange Operation

Banking Risks Liquidity risk Operational risk Credit risk Market risk FX risk Interest rate risk

Risk Based Supervision Quantity of Risk: High Moderate Low Quality of Risk Management: Strong Acceptable Weak

Risk Based Supervision Aggregate Risk Matrix: Quantity of Risk Low Moderate High Quality of Risk Management Strong Acceptable Weak

Risk Based Supervision Direction of Risk: Decreasing Stable Increasing

Risk Based Supervision: Recommended Supervisory Regime Matrix: Aggregate Risk Low Moderate High Direction of Risk Decreasing Normal Regime Closely Monitor and/ or Supervisory Action Stable Closely Monitor Increasing Supervisory Action

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