1. 1 Banking Risks Management Chapter 8 Issues in Bank Management

2. 2 General Risk Management How risk management function is handled within the banking organisation and the importance of the function influencing the effectiveness and efficiency. System & Process - allocation of resources - governance issues - record keeping - communications with organisation - Internal audit

3. 3 General Risk Management Risk measurement deals with the quantification of risk exposures Risk management deals with overall process that a financial institution follows to define a business strategy, To identify the risks it is exposed To quantify those risks To understand and control the nature of risks

4. 4 General Risk Management Main objectives of bank risk managers:- Shareholders wealth maximisation Trade off between risk and return

5. 5 General Risk Management How to set appropriate targets for a banks returns and risks taken Assess individual banks and group of banks risk/return decisions. Compare among banks performance Set reasonable objectives against a banks historic performance and peers.

6. 6 General Risk Management Bank targets are also based on a.Stock market expectations b.Trend analysis of past performance c.External environment – macroeconomic - Regulatory Deregulation, globalisation and Internationalisation increased the degree of competition in banking markets requiring banks to achieve satisfactory returns

7. 7 General Risk Management Banks should run in a safe and sound manner. They should achieve a good CAMELS rating C – adequate Capital A – good Asset quality M – competent Management E – good Earnings L – sufficient Liquidity S – Sensitivity to market risks

8. 8 Credit Risk Management Establishing an appropriate credit risk environment Operating under a sound credit granting process Maintaining an appropriate credit administration, measurement and monitoring process. Ensuring adequate controls over credit risk

9. 9 Managing Lending Function Size of the loan commitments Bad corporate loans – serious for banks Retail and Individual loans defaults Banks being overexposed to a particular sector of the economy.

10. 10 Retail Lending 1.Interest rate on the loan 2.Fees relating to the loan 3.Credit risk premium on the loan 4.Collateral backing of the loan 5.Other non price terms, clauses and conditions on the use of the loan.

11. 11 Credit Checking and Scoring Credit checking – Credit reference agencies holds information on retail customers and allows lender to check individuals past credit History Credit scoring – Qualitative approach, involves questions on applicant employment history, accounts held, personal address, income etc.

12. 12 Credit Checking and Scoring Personal judgment of loan officers based of 5 Cs’ Character Cash flow Capital Collateral Conditions

13. 13 Credit Checking and Scoring Using statistical program, creditors can Calculate the probability of default. Compare credit performance of consumers Awards points for each factor helps to predict who is most likely to repay a debt. Helps how creditworthy the applicant

14. 14 Managing Interest Rate risks Changes in interest rate risk affect banks economic value. Value of banks assets, liabilities and balance sheets is affected by change in rates. Gap Analysis – best known interest rate risk management technique.

15. 15 Managing Interest Rate risks Gap – refers to the difference between interest rate sensitive assets and interest rate sensitive liabilities over a specific time horizon. If interest rate sensitive liabilities are greater than the interest rate sensitive assets, than an increase in interest rates will reduce a banks profit and vice versa. Focus on maturity of the rate sensitive assets and liabilities.

16. 16 Managing Liquidity risk Reassures creditors that the bank is safe and able to meet its liabilities Signals to the market that the bank is prudent and well managed Ensures that all lending commitments can be met Avoid forced sale of the banks assets Avoids having to pay excessive borrowing costs in the inter-bank markets Avoids central bank borrowing

17. 17 Managing Operational risk The Basic Approach The Standardised Approach The Internal Measurement Approach

18. 18 Managing Operational risk Basic approach – allocates capital using a single indicator (Gross Income) as a proxy for a banks overall operational risk exposure. Standardised approach – Bank activities are divided into a number of standardised business units and business lines, etc: corporate finance, trading and sales, retail banking, commercial banking, retail brokerage, asset management and payment and settlement.

19. 19 Managing Operational risk Internal measurement approach – allows individual banks to use internal loss data, the methods for calculating the capital charge would be determined by the regulators. Encouraging banks to better manage operational risk in order to reduce the exposure, frequency and severity of loss. One technique is importance of he use of insurance to cover specific operational risk exposures.

20. 20 International risk assessment Banks are engaged in international activities and face risks, among others are foreign currency risks, regulatory risks, and reputation risks. Have to evaluate the country risk associated with their investments or overseas operation.

21. 21 Managing country Risk Effective oversight by senior managers Appropriate risk management policies and procedures An accurate system for reporting change in country risk and potential exposures. An effective process for analysing country risk A country risk rating system Regular monitoring of country conditions.