a presentation on risk management in financial institutions

7/29/2019 A presentation on Risk Management in Financial Institutions

http://slidepdf.com/reader/full/a-presentation-on-risk-management-in-financial-institutions 1/37



Group Members:

M.Wasim Shahzad M10MBA041

Muhammad Bilal M10MBA048

Hafiz Raza ur Rehman M10MBA054

Muhammad Usman M10MBA062



Managing Risk in Financial

Sector



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



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



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.



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



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



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.




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




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.




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.




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



Muhammad Wasim Shahzad

M10MBA041




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




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.




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.




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




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




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




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




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



Muhammad Usman

M10MBA062

R t I ti I Ri k



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





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





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





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.






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






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.



Hafiz Raza Ur Rehman

M10MBA054






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



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



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





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



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

a presentation on risk management in financial institutions

Documents