a presentation on risk management in financial institutions
TRANSCRIPT
7/29/2019 A presentation on Risk Management in Financial Institutions
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Group Members:
M.Wasim Shahzad M10MBA041
Muhammad Bilal M10MBA048
Hafiz Raza ur Rehman M10MBA054
Muhammad Usman M10MBA062
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Managing Risk in Financial
Sector
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Sections
• Introduction
• Organizational setup for Risk Management
• Risk in Financial Institutions & their Management
• Recent Innovations in Risk measurement and
Management
• Regularity Approaches to Risk Management inFinancial Institutions
• Concluding Remarks
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Introduction
RiskDesignates any uncertainty that might trigger
losses
R-MGT in FIs comprises the entire set of R-MGT
processes, Practices, All techniques and tools requiredfor risk Management which includes Identifying,
measuring, monitoring and controlling risks.
Goal Behind Risks
Risk based policies and practices have a common goal
of enhancing the risk-return profile of the FIs portfolio.
To Maximize RAROC
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Why & When FIs started risk
Management?
Continuing increases in the scale and complexityof FIs and in the pace of their financial transactions
demand that they employ sophisticated risk
management techniques and monitor changing risk
exposures.
Bank have been practicing R-MGT ever since their
existence. The Only real change is the degree of
sophistication now required to reflect the morecomplex and fast paced environment. Even today
some simple rules continue to be critical to R-MGT.
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Organizational setup for Risk
Management
Fundamental RequirementA well constituted organizational structure defining clearly
roles and responsibilities of individuals
Different Types of Committees
oSub Committee of Board to Supervise overall R-
MGT functions
oAsset Liability Committee
oCredit Risk Management Committee
oMarket Risk Management Committee
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Organizational setup for Risk
Management
There should be
Clearly Defined Policies and Procedures
An Effective Management Information System
An Explicit Procedure to Address Deviations
A Mechanism to ensure an ongoing Review of
system
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Risks In FIs & Their Management
Risk is inherent in the business of FIs and most of the risksare generated by the common cause of mismatching. FIs are
exposed to wide range of Risks including
Credit Risk
Currency Risk Liquidity Risk
Contingent Risk
Interest Rate Risk
Market Risk
KYC Risk
Operational Risk
FIs must decide which risk is to take, which is to transfer andwhich is to avoid altogether.
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Risks In FIs & Their Management
Credit Risk ManagementCredit Risk can be defined as the potential that a bank
borrower or the counterparty will fail to meet its obligations
in accordance with the agreed terms because of unwillingness
to perform an obligation or its ability to perform suchobligation is impaired
Sound Credit Risk Management Measures
Typically Include three Kinds of Policies
Policies to Limit or Reduce Credit Risk
Asset classification
Loss Provisioning
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Risks In FIs & Their Management
Policies to Limit or Reduce Credit Risk Are made for evaluation and screening of borrower,
portfolio diversification, concentration and large exposures,
lending to connected parties, or over exposures.
Specifically, evaluation system comprises well designedcredit appraisal ,sanctioning and review procedures.
concentration limits refer to total clean finance, total
exposure, total par party limits and limits to different
economic sectors like textile, agriculture and real estate etc. Alending policy should establish the maximum maturity for
each type of credit and loan should be given with a realistic
repayment schedule.
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Risks In FIs & Their Management
Asset ClassificationThese mandate periodic evaluation of the recovery of the
portfolio of loans and other credit instruments, including any
accrued and unpaid interest, which expose a bank to credit
risk.
Loss Provisioning
The third set includes policies of loss provisioning, or the
making of allowances at a level adequate t absorb anticipated
loss not only on the loan portfolio, but also on the other assetthat are subjected to losses.
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Risks In FIs & Their Management
Liquidity Risk Liquidity Risk the potential for losses to any FI arising from
either its inability to meet its obligations. Liquidity Risk
refers to the shortage of Working Capital.
Liquidity Risk Management Techniques
Generally Banks have following choices to manage Liquidity
Risk
Sale of Their Liquid Assets
Borrowings from Inter Bank Market
Central Bank Rediscount Window
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Muhammad Wasim Shahzad
M10MBA041
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Risks In FIs & Their Management
Sale of Liquid AssetsBanks can make outright sale of their short term highly liquid
assets like treasury bills or if they do not want to lose their
assets and want to lesson their cost of borrowing, they can
make repurchase agreements in the inter bank market to meettheir urgent liquidity requirements.
Borrowings from Inter Bank Market
Depending on their goodwill, banks can borrow from inter
bank market, if liquidity problems seem to be protracted theycan lengthen term of their inter bank liabilities for three or six
months
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Risks In FIs & Their Management
Central Bank’s Rediscount Window Central bank’s rediscount window is the most traditional and
dependable source to meet liquidity shortages. Banks can
rediscount their assets with central bank or can place these
assets as collateral to get short term loans.
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Risks In FIs & Their Management
Market Risk
Is a risk that a FI may experience a loss in on and off
balance sheet positions arising from unfavorable movements
in the market prices e.g. prices of equity instruments,
commodities, money and currencies. Its major components
are therefore equity positions, commodities risk, interest rate
risk and currency risk
Market Risk Management Policies
Marking to Market
This refers to reprising bank’s portfolio to reflect changes in
asset prices due to market price movements.
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Risks In FIs & Their Management
Market Risk Management PoliciesPosition Limits
A market risk management policies provides for limits on
long, short and net position, bearing in mind the liquidity
risk.
Loss Provisions
This relate to a predetermined loss exposure limit based on bank’s capital structure, earnings trends and overall risk
profile
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Risks In FIs & Their Management
Interest Rate Risk ManagementInterest Rate Risk
Interest rate risk is the risk of a decline in earnings due to
movements of interest rates.
Goal
To maintain interest rate risk exposure with in self imposed
parameters over a range of possible change in interest rates.
Controlling instruments
Variable rate lending
Interest rate swap
Financial future
options
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Risks In FIs & Their Management
Currency Risk ManagementThis risk arise because of fluctuation in exchange rate, change
the value of currency held by banks
Policies
•Risk exposure limit
•Concentration
•Derivatives etc
Contingent Risk The risk arise due to commitment to provide fund in specified
circumstances. guaranties and bank acceptance are traditional
contingent liabilities
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Risks In FIs & Their Management
Operational RisksOperational Risk is associated with human error, system
failures and inadequate procedures and controls. It is the risk
of loss or reputation problem arising from inadequate
information system, breaches in internal controls, fraud orunforeseen catastrophes.
Techniques to control
•Internal control and internal audit
•Insurance
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Risks In FIs & Their Management
KYC Risks ManagementSound KYC policies and procedures not only
contribute to bank overall safety and soundness they also
protect the integrity of banking system by reducing unlawful
activities.Basel committee essential elements
a)Customer Acceptance Policy
b)Customer Identification
c)On-going Monitoring of high risk accounts
d)Risk Management
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Muhammad Usman
M10MBA062
R t I ti I Ri k
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Recent Innovations In Risk
Measurement And Management
Major FIs are using sophisticated Model to Measure risk, andto manage risk innovative techniques like derivatives, asset
securitization and loan sales are being used
Measuring Risk
A number of techniques are available for measuring theinterest rate risk from simple techniques like
maturity/repricing schedule to static simulations using current
holdings to highly sophisticated dynamic modeling
techniques that reflect potential future business decisions. Inrecent years, leading banks have also devoted increased
attention to measuring credit risk and made important gains
by employing innovative risk modeling techniques like option
theory and estimating probability that a borrower will default.
R t I ti I Ri k
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Recent Innovations In Risk
Measurement And Management
Stress TestingA systemic methodology to prepare for financial crises.
It is based on the old military saying the more you sweat in
peace the less you bleed in war.
It consist of assessing the attributes of a portfolio,assessing the scenarios that are likely to occur.
A bank can alter the composition of portfolio If preset stress
loss limits are exceeded during a stress test.
Fairly common for market portfolio but are still not widely
used to assess stress loss of credit portfolio particularly loan
portfolio.
R t I ti I Ri k
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Recent Innovations In Risk
Measurement And Management
DerivativesDerivative contracts allow a FI to hedge its interest
rate, foreign exchange and credit risk exposures. but
Misused of derivatives can increase the risk of FI’sinsolvency.
Following derivative instruments are useful for the
FIs to manage their risks.
Currency And Interest Rate Swaps
Financial Futures and Forwards
Options
Credit Derivatives
Recent Inno ations In Risk
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Recent Innovations In Risk
Measurement And Management
Currency Swaprefers to the transaction in which two parties exchange
specified amount of two different currencies at the beginning
and repay at future time according to the terms and conditions
agreed upon.No actual principle amount is exchanged but on the basis of
notional principle amount, interest payment streams of
differing character are exchanged according to predetermined
conditions.
Recent Innovations In Risk
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Recent Innovations In Risk
Measurement And Management
Financial Futures and Forwards Is an agreement to buy or sell an asset at a certain
time in future for certain price
They are standardized financial Instruments toHedge risk on organized exchange.
Forward contracts are similar to future contracts
but unlike future contracts they are not traded on
exchange and are marked to market daily.They are over-the – counter agreement between
two FIS
Recent Innovations In Risk
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Recent Innovations In Risk
Measurement And Management
OptionsContract involves the buyer of the option to pay a premium to
writer of the options for the right to buy(call option) or the
right to sell(put option),a specific financial instrument at a
specified price within specified time period.Credit Derivatives
Instrument allow FIs to hedge credit risk and, in some cases,
interest rate risk. It can be used to hedge credit risk on the
individual loans are bonds are on portfolio of loans andbonds.
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Hafiz Raza Ur Rehman
M10MBA054
Recent Innovations In Risk
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Recent Innovations In Risk
Measurement And Management
Asset securitizationA mechanism that financial institution used to hedge their
interest rate risk exposure gap.
The process of transforming illiquid financial assets into
marketable capital market securities.
Loan sales
A financial contract by which a bank agrees to sell
expected future returns from an underline bank loan to a third
party with or without recourse
Large banks sells loans primarily to domestic and foreign
banks and non bank financial institutions.
Regulatory Approaches to Risk
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Regulatory Approaches to Risk
Management
Capital Adequacy RequirementCapital is one of the key indicators which determines safety
and soundness of a bank
Regulatory authorities have introduced minimum capitaladequacy requirements of 8% for risk weighted assets of
banks under Basel Accord in 1988
A significant innovation of the revised framework is thegreater use of assessments of risk provided by bank’s internal
systems as inputs to capital calculations
Regularity Approaches to Risk
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Regularity Approaches to Risk Management in FIs
Prudential Regulations and Risk ManagementGuidelines
Bank regulators have issued comprehensive prudential
regulations to control risk appetite of banks by way of putting
limits on the exposure of banks to various risks
Regulators in some countries have issued guidelines on risk
management which provide a comprehensive risk
management framework for financial institutions
Regularity Approaches to Risk
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Regularity Approaches to Risk
Management in FIs
Consumer Credit BureauReliable source of information about the credit history of the
potential borrower
It helps the FIs to mitigate the Credit Risk
The availability of timely and reliable credit information is
vital in bank’s decision to grant or sustain credit facility
Banks receive credit information about the credit worthiness
of their retail customers
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Conclusion
All FIs must take advantage of new technology and keeppace with market innovations
Adhering to fundamental principles and adopting sound
practices
Each firm should have clear procedure for assessing risk
and evaluating performance
There must be adequate accountability, clear line of
authority and separation of duties
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