risk management process of askari bank

8/2/2019 Risk Management Process of Askari Bank

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1.Introduction:Askari Commercial Bank Limited (ACBL) works as a Unit of Army Welfare

Trust was established for the Welfare of Army Officials. The office of Army

Welfare Trust is situated at AWT Plaza, Rawalpindi. AWT offers the AWTSaving Scheme to the army officials only. AWT has its units as under:

1. Askari Associates.

2. Askari Leasing.

3. Askari General.

4. Private Business.

5. Textile Mills.

6. Cement Industry.

7. Askari Commercial Bank.

Incorporated in Pakistan on October 09, 1991. The bank obtained business

commencement certificate on February 26, 1992 and started operations form April

1, 1992, as public limited company, and has since expanded into a nation-wide

presence of 51 branches, supported by a network of online ATMs. The Bank is

listed on the Karachi, Lahore and Islamabad Stock Exchanges and the initial public

offering was over subscribed by 16 times. Askari Commercial Bank is scheduled

Commercial Bank and is principally engaged in the business of banking as defined

in the Banking Companies Ordinance 1962.

Askari Commercial Bank limited continues to scale new heights in all areas of its

operations. The safety and security of depositors funds, high productivity andoptimum use of technology are the hallmarks of its corporate strength.

While capturing the largest market share amongst the new banks, Askari hasprovided good value to its shareholders. Share price of ACBL has remained

approximately 12% higher than the average share price of quoted banks during the

last four years.


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Askari Bank is principally engaged in the business of banking as defined in the

Banking Companies Ordinance, 1962. as at December 31, 2002 the Bank had total

assets of PKR 70.313 billion, with over 250000 banking customers.

Askari Bank is the only bank with its operational Head Office in the twin cities of

Rawalpindi-Islamabad, which have relatively limited opportunities as compared to

Karachi and Lahore. This created its own challenges and opportunities, and forced

us to evolve an outward-looking strategy in terms of our market emphasis. As a

result, we developed a geographically diversified assets base instead of a

concentration and heavy reliance on business in the major commercial centers of

Karachi and Lahore, where most other banks have their operational Head Offices.

Multan is a cotton city, so to get the export market of cotton ACBL open its branch

in Multan in December, 1994. In a short span of time this branch increases their

business remarkably. In 2001 this branch gets the trophy of highest profit for theyear 2001. This branch has highest deposits and advances as compare to other

banks working in Multan. Now recently this branch gets the trophy of highest

imports for the month of July 2003 as compare to all the branches of Askari

Commercial Bank working in Pakistan.

Askari bank was incorporated in Pakistan on October 9, 1991, as a public limited

company. It commenced its operations on April 1, 1992, and is principally engaged

in the business of banking, as defined in the banking companies ordinance, 1962.

The bank is listed on the KARACHI, LAHORE AND ISLAMABAD Stock

Exchanges and its share is currently the highest quoted from among the new

private sector banks in Pakistan.

Askari Bank has expanded into a nation wide presence of 98 Branches, and an

Offshore Banking Unit in Bahrain. A shared network of over 1,100 online ATMs

covering all major cities in Pakistan supports the delivery channels for customer

service. As on December 31, 2005, the Bank had equity of Rs. 8.6 billion and total

assets of Rs. 145.1 billion, with over 600,000 banking customers, serviced by our

2,754 employees.


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2.Loss exposure suffered most of the time:Most of the time Askari Bank suffered loss exposure from Non Performing Loans

(NPL) as compared to frauds or Treasury Investment. Askari Bank's non-

performing loans (NPLs) increased from Rs. 3.66 billion to Rs. 6.91 from 2009 to

2010.

A Non-performing loan is a loan that is in default or close to being in default.

Many loans become non-performing after being in default for 3 months, but this

can depend on the contract terms.

A loan is nonperforming when payments of interest and principal are past due by

90 days or more, or at least 90 days of interest payments have been capitalized,refinanced or delayed by agreement, or payments are less than 90 days overdue,

but there are other good reasons to doubt that payments will be made in full.

By Bank regulatory definitionnon-performing loans consist of:

other real estate owned which is that taken by foreclosure or a deed in lieu offoreclosure,

loans that are 90 days or more past due and still accruing interest, and loans which have been placed on nonaccrual (i.e., loans for which interest is

no longer accrued and posted to the income statement)

Non Performing Loans can be from:

Conventional Banking Corporate Bank Agriculture Banking Islamic Banking Macro Finance3.Identify your loss exposure:

3.1. What Loss Exposures are rated:Ideally all the credit exposures of the bank should be assigned a risk rating.

However given the element of cost, it might not be feasible for all banks to follow.

The banks may decide on their own which exposure needs to be rated. The


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decision to rate a particular loan could be based on factors such as exposure

amount, business line or both. Generally corporate and commercial exposures are

subject to internal ratings and banks use scoring models for consumer / retail loans.

The credit loss exposure involves both the probability of Default (PD) and loss in

the event of default or loss given default (LGD). The former is specific to borrowerwhile the later corresponds to the facility. The product of PD and LGD is the

expected loss. In addition the rating and loan analysis process while being separate

are intertwined. The process of assigning a rating and its approval / confirmation

goes along with the initiation of a credit proposal and its approval.

3.2. Loss exposure identifies in term of: Frauds:

Sanction loans on wrong documents or mortgage illegal property.

Non Performing Loan:Loans those are not ended with natural maturity.

Credit/Treasury losses:Foreign Exchange Rates/Stock Exchange Investments.

Frauds Identifies through:

Fraud identifies itself Report or Complaints Audit

o Internal Audito External Audit

Normal activity/Daily activity

NPL Identifies through:

Repayments stop Loan overdueCredit/Treasury losses:

These types of losses occurred after they incurred. Investment that does not give

profitable return can bear a loss for the bank.Board and executive management


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should recognize, understand and have defined all categories of investment risk

applicable to the institution. Furthermore, they should ensure that their

investment management framework adequately covers all of these categories of

market risk, including those that do not readily lend themselves to

measurement.

SAM (Special Asset Management) is also made by Askari Bank to identify

and monitor Loss Exposures. SAM is a Watch list Department made other than

Risk Management Division.

4.Analyses loss exposure base on loss frequency and severityFrom the below methods Banks can analyze about the risk of loss and severity.

These methods give the exact situation about the loss exposure and give the

guideline for the future regarding that loss.

Bank analyzes loss exposure as:

Doubtful:

When 90 days overdue with maximum 25% of outstanding amounts. These losses

float when the payment is not made from last 90 days. Bank feels doubt and

marked it as doubtful for loss exposure.

Sub-standard:

When 180 days overdue with maximum 50% of outstanding amounts. These losses

float when the payment is not made from last 180 days. Bank feels doubt and

marked it as sub-standard for loss exposure.

Loss:

When 360 days overdue with maximum 100% of outstanding amounts. These

losses float when the payment is not made from last 360 days. Bank feels doubtand marked it as loss in loss exposure.

From the above methods Banks can analyze about the risk of loss and severity.

These methods give the exact situation about the loss exposure and give the

guideline for the future regarding that loss.


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According to their 2010 Balance Sheet they have following loss exposures:

Loss Exposure based on loss frequency:

Askari Commercial Bank 2010

Rupees in 000

Classified Advances Provision Required Provision Held

Category of classification Domestic Overseas Total Domestic Overseas Total Domestic Overseas Total

Other Assets Especially

Mentioned - note 54,779 - 54,779 - - - - - -

Substandard 1,155,321 - 1,155,321 257,673 - 257,673 257,673 - 257,673

Doubtful 2,484,033 - 2,484,033 684,625 - 684,625 684,625 - 684,625

Loss 17,904,515 - 17,904,515 14,280,500 - 14,280,500 14,280,500 -

14,280,500

21,598,648 - 21,598,648 15,222,798 - 15,222,798 15,222,798 - 15,222,798

Business Exposure:

Industry Characteristics Competitive Position (e.g. marketing/technological edge) Management

Financial Exposure:

Financial condition Profitability Capital Structure Present and future Cash flows

Audit:

Banks need to review and validate each step of market risk measurement process.

This review function can be performed by a number of units in the organization

including internal audit/control department or ALCO support staff. In small banks,

external auditors or consultants can perform the function.


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Contingency Funding Plans:

In order to develop a comprehensive liquidity risk management framework,

institutions should have way out plans for stress scenarios. Such a plan commonly

known as Contingency Funding Plan (CFP) is a set of policies and procedures thatserves as a blue print for a bank to meet its funding needs in a timely manner and

at a reasonable cost. A CFP is a projection of future cash flows and funding

sources of a bank under market scenarios including aggressive asset growth or

rapid liability erosion. To be effective it is important that a CFP should represent

managements best estimate of balance sheet changes that may result from a

liquidity or credit event. A CFP can provide a useful framework for managing

liquidity risk both short term and in the long term. Further it helps ensure that a

financial institution can prudently and efficiently manage routine and extraordinary

fluctuations in liquidity.

5.Technique for treating loss exposure:Treating loss exposure/Stress Testing:

The importance of better understanding of potential risk n harms in the financial

system and the measures to assess these risks n harms for both the regulators and

the managers can hardly be over highlight especially due to increasing volatilities

in the financial markets. The regulators and managers of the financial systemaround the globe have developed a number of quantitative techniques to assess the

potential risks to the individual institutions as well as financial system.

A range of quantitative techniques that could serve the purpose is widely known as

stress testing.

Stress testing is a process, which provides information on the behavior of the

financial system under a set of exceptional, but reasonable assumptions. At

institutional level, stress testing techniques provide a way to quantify the impact ofchanges in a number of risk factors on the assets and liabilities of the institution.

For instance, a portfolio stress test makes a rough estimate of the value of portfolio

using a set of exceptional but reasonable assumptions. However, one of the

limitations of this technique is that stress tests do not account for the probability of

occurrence of these exceptional events. For this purpose, other techniques, for


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example VAR models etc, are used to supplement the stress tests. These tests help

in managing risk within a financial institution to ensure optimum allocation of

capital across its risk profile.

At the system level, stress tests are primarily designed to quantify the impact ofpossible changes in economic environment on the financial system. The system

level stress tests also complement the institutional level stress testing by providing

information about the sensitivity of the overall financial system to a number of risk

factors. These tests help the regulators to identify structural vulnerabilities and the

overall risk exposure that could cause disruption of financial markets. Its

prominence is on potential externalities and market failures.

5.1. Techniques for Stress Testing/ treating loss exposure: Simple Sensitivity Analysis measures the change in the value of portfolio

for shocks of various degrees to different independent risk factors while the

underlying relationships among the risk factors are not considered. For

example, the shock might be the adverse movement of interest rate by 100

basis points and 200 basis points. Its impact will be measured only on the

dependent variable i.e. capital in this case, while the impact of this change in

interest rate on NPLs or exchange rate or any other risk factor is not

considered.

Scenario Analysis encompasses the situation where a change in one riskfactor affects a number of other risk factors or there is a simultaneous movein a group of risk factors. Scenarios can be designed to encompass both

movements in a group of risk factors and the changes in the underlying

relationships between these variables (for example correlations and

volatilities). Stress testing can be based on the historical scenarios, a

backward looking approach, or the hypothetical scenario, a forward-looking

approach.

Extreme Value/ Maximum Shock scenario measures the change in the riskfactor in the worst-case scenario, i.e. the level of shock which entirely wipes

out the capital.

Stress test shall be carried out assuming three different hypothetical

scenarios:


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Minor Level Shocks: These represent small shocks to the risk

factors. The level for different risk factors can, however, vary.

Moderate Level Shocks: It have a mental picture of medium level

of shocks and the level is defined in each risk factor separately.

Major Level Shocks: It involves big shocks to all the risk factors

and is also defined separately for each risk factor.

Assumptions behind each Scenario:

The stress test at this stage is only a single factor sensitivity analysis. Each of the

five risk factors has been given shocks of three different levels. The magnitude of

shock has been defined separately for each risk factor for all the three levels of

shocks.

Scope of Stress Test:

As a starting point the scope of the stress test is limited to simple sensitivity

analysis. Five different risk factors namely; interest rate, forced sale value of

collateral, non-performing loans (NPLs), stock prices and foreign exchange rate

have been identified and used for the stress testing. Moreover, the liquidity

position of the institutions has also been stressed separately. Though the decision

of creating different scenarios for stress testing is a difficult one, however, to startwith, certain levels of shocks to the individual risk components have been specified

considering the historical as well as hypothetical movement in the risk factors.

5.2. Methodology and Calibration of Shocks: Interest Rate Risk:

Interest rate risk is the potential that the value of the on-balance sheet and the off-

balance sheet positions of the bank/DFI would be negatively affected with the

change in the interest rates. The vulnerability of an institution towards the adverse

movements of the interest rate can be gauged by using duration GAP analysis.

The banks and DFIs shall follow the following steps in carrying out the interest

rate stress tests.


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Estimate the market value of all on-balance sheet rate sensitive assets andliabilities of the bank/DFI to arrive at market value of equity

Calculate the durations of each class of asset and the liability of the on-balance sheet portfolio

Arrive at the aggregate weighted average duration of assets and liabilities Calculate the duration GAP by subtracting aggregate duration of liabilities

from that of assets

Estimate the changes in the economic value of equity due to change ininterest rates on on-balance sheet positions along the three interest rate

changes

Calculate surplus/(deficit) on off-balance sheet items under the assumptionof three different interest rate changes i.e. 1%, 2%, and 5%

Estimate the impact of the net change (both for on-balance sheet and off-balance sheet) in the market value of equity on the capital adequacy ratio

(CAR)

Market value of the asset or liability shall be assessed by calculating its present

value discounted at the prevailing interest rate. The outstanding balances of the

assets and liabilities should be taken along with their respective maturity or

reprising period, whichever is earlier.

Duration GAP & Price Sensitivity:Duration is the measure of a portfolios price sensitivity to changes in interest

rates. Longer the duration, larger the changes in the price for a given change in

the interest rates. Larger the coupon, lower would be the duration and smaller

would be the change in the price for a given change in the interest rates.

Exchange Rate Risk:

The stress test for exchange rate assesses the impact of change in exchange rate onthe value of equity. To model direct foreign exchange risk only the overall net

open position of the bank/DFI including the on-balance sheet and off-balance sheet

exposures shall be given an adverse shocks of 5%, 10% and 15% for minor,

moderate and major levels respectively. The overall net open position is measured

by aggregating the sum of net short positions or the sum of net long positions;


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whichever is greater regardless of sign. For example, the bank may have net long

position of Rs500 million in Yen, Euro and USD and the net short position in GBP

and Australian dollar of Rs600 million. The total exposure will be the greater of

the two i.e. sum of the short positions of Rs600 million. The impact of the

respective shocks will be calibrated in terms of the CAR. The tax-adjusted lossarising from the shocked position will be adjusted from the capital. The revised

CAR will then be calculated after adjusting total loss from the risk-weighted assets

of the bank/DFI.

Credit Risk:

The stress test for credit risk assesses the impact of increase in the level of non-

performing loans of the bank/DFI. This involves three types of shocks:

The one deals with the increase in the NPLs and the respective provisioning.The three scenarios shall explain the impact of 5%, 10% and 20% increase

in the total NPLs directly downgraded to loss category having 100%

provisioning requirement. The tax-adjusted impact will be calibrated in the

CAR of the bank/DFI for each of the scenarios.

The second deals with the negative shift in the NPLs categories and hencethe increase in respective provisioning. The three scenarios shall explain the

impact of 50%, 80% and 100% downward shift in the NPLs categories. For

example, for the first level of shock 50% of the OAEM shall be categorized

under substandard, 50% of the substandard shall be categorized under

doubtful and 50% of the doubtful shall be added to the loss category. The

tax-adjusted impact of the increased provisioning will be calibrated in the

CAR of the bank/DFI for each of the scenarios.

The third deals with the fall in the forced sale value (FSV) of mortgagedcollateral. The forced sale values of the collateral shall be given shocks of

10%, 20% and 40% decline in the forced sale value of mortgaged collateral

for all the three scenarios respectively. The tax-adjusted impact of theadditional required provision will be calibrated in the CAR for each of the

scenario.

Equity Price Risk:


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The stress test for equity price risk assesses the impact of the fall in the stock

market index. The current market value of all the on balance sheet and off balance

sheet securities listed on the stock exchanges including shares, NIT units, mutual

funds etc. shall be given shocks of 10%, 20% and 40% fall in their value for all the

three scenarios respectively. The impact of resultant loss will be calibrated in theCAR.

Liquidity Risk:

The stress test for liquidity risk evaluates the resilience of the banks towards the

fall in liquid liabilities. The ratio liquid assets to liquid liabilities shall be

calculated before and after the shocks by dividing the liquid assets with liquid

liabilities. Liquid assets are the assets that are easily and cheaply turned into cash.

They include cash and balances with banks, call money lending, lending underrepo and investment in government securities. Liquid liabilities include the

deposits and the borrowings. The liquid liabilities should be given shocks of 10%,

20% and 30% fall. The equivalent amount should be deducted from the liquid

assets assuming the fall in liquid liabilities is met by the corresponding fall in the

liquid assets. The ratio of liquid assets to liquid liabilities shall be re-calculated

under each scenario.

6. Risk Management:Risk Management is a discipline at the core of every financial institution and

encompasses all the activities that affect its risk profile. It involves identification,

measurement, monitoring and controlling risks to ensure that :

a) The individuals who take or manage risks clearly understand it.

b) The organizations Risk exposure is within the limits established by Board of

Directors.

c) Risk taking Decisions are in line with the business strategy and objectives setby BOD.

d) The expected payoffs compensate for the risks taken

e) Risk taking decisions are explicit and clear.


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f) Sufficient capital as a buffer is available to take risk

The acceptance and management of financial risk is inherent to the business of

banking and banks roles as financial intermediaries. Risk management as

commonly perceived does not mean minimizing risk; rather the goal of riskmanagement is to optimize risk -reward trade -off. Notwithstanding the fact that

banks are in the business of taking risk, it should be recognized that an institution

need not engage in business in a manner that unnecessarily imposes risk upon it:

nor it should absorb risk that can be transferred to other participants. Rather it

should accept those risks that are uniquely part of the array of banks services.

In every financial institution, risk management activities broadly take place

Simultaneously at following different hierarchy levels.

a) Strategic level: It encompasses risk management functions performed by

senior management and BOD. For instance definition of risks, ascertaining

institutions risk appetite, formulating strategy and policies for managing risks and

establish adequate systems and controls to ensure that overall risk remain within

acceptable level and the reward compensate for the risk taken.

b) Macro Level: It encompasses risk management within a business area or

across business lines. Generally the risk management activities performed by

middle management or units devoted to risk reviews fall into this category.

c) Micro Level:It involves On-the-line risk management where risks are

actually created. This is the risk management activities performed by individuals

who take risk on organizations behalf such as front office and loan origination

functions. The risk management in those areas is confined to following operational

procedures and guidelines set by management.

Expanding business arenas, deregulation and globalization of financial activities

emergence of new financial products and increased level of competition hasnecessitated a need for an effective and structured risk management in financial

institutions. A banks ability to measure, monitor, and steer risks comprehensively

is becoming a decisive parameter for its strategic positioning. The risk

management framework and sophistication of the process, and internal controls,

used to manage risks, depends on the nature, size and complexity of institutions


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activities. Nevertheless, there are some basic principles that apply to all financial

institutions irrespective of their size and complexity of business and are reflective

of the strength of an individual bank's risk management practices.

Board and senior Management oversight:

a) To be effective, the concern and tone for risk management must start at the top.

While the overall responsibility of risk management rests with the BOD, it is the

duty of senior management to transform strategic direction set by board in the

shape of policies and procedures and to institute an effective hierarchy to execute

and implement those policies. To ensure that the policies are consistent with the

risk tolerances of shareholders the same should be approved from board.

b) The formulation of policies relating to risk management only would not solve

the purpose unless these are clear and communicated down the line. Senior

management has to ensure that these policies are embedded in the culture of

organization. Risk tolerances relating to quantifiable risks are generally

communicated as limits or sub-limits to those who accept risks on behalf of

organization. However not all risks are quantifiable. Qualitative risk measures

could be communicated as guidelines and inferred from management business

decisions.

c) To ensure that risk taking remains within limits set by seniormanagement/BOD, any material exception to the risk management policies and

tolerances should be reported to the senior management/board that in turn must

trigger appropriate corrective measures. These exceptions also serve as an input to

judge the appropriateness of systems and procedures relating to risk management.

d) To keep these policies in line with significant changes in internal and external

environment, BOD is expected to review these policies and make appropriate

changes as and when deemed necessary. While a major change in internal or

external factor may require frequent review, in absence of any unevencircumstances it is expected that BOD re-evaluate these policies every year.

6.1. Risk Management framework.


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A risk management framework encompasses the scope of risks to be managed, the

process/systems and procedures to manage risk and the roles and responsibilities of

individuals involved in risk management. The framework should be

comprehensive enough to capture all risks a bank is exposed to and have flexibility

to accommodate any change in business activities. An effective risk managementframework includes

a) Clearly defined risk management policies and procedures covering risk

identification, acceptance, measurement, monitoring, reporting and control.

b) 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 setupcould be in the form of a separate department or banks Risk Management

Committee (RMC) could perform such function. The structure should be such

that ensures effective monitoring and control over risks being taken. The

individuals responsible for review function (Risk review, internal audit,

compliance etc) should be independent from risk taking units and report directly to

board or senior management who are also not involved in risk taking.

c) 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.

d) The framework should have a mechanism to ensure an ongoing review of

systems, policies and procedures for risk management and procedure to adopt

changes.

6.2. Integration of Financial Risk Management:

Risks must not be viewed and assessed in isolation, not only because a single

transaction might have a number of risks but also one type of risk can trigger other

risks. Since interaction of various risks could result in diminution or increase in

risk, the risk management process should recognize and reflect risk interactions in

all business activities as appropriate. While assessing and managing risk the


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management should have an overall view of risks the institution is exposed to. This

requires having a structure in place to look at risk interrelationships across the

organization.

6.3.

Risk Evaluation/Measurement.

Until and unless risks are not assessed and measured it will not be possible to

control risks. Further a true assessment of risk gives management a clear view of

institutions standing and helps in deciding future action plan. To adequately

capture institutions risk exposure, risk measurement should represent aggregate

exposure of institution both risk type and business line and encompass short run as

well as long run impact on institution. To the maximum possible extent institutions

should establish systems / models that quantify their risk profile, however, in some

risk categories such as operational risk, quantification is quite difficult andcomplex. Wherever it is not possible to quantify risks, qualitative measures should

be adopted to capture those risks. Whilst quantitative measurement systems

support effective decision-making, better measurement does not obviate the need

for well-informed, qualitative judgment. Consequently the importance of staff

having relevant knowledge and expertise cannot be undermined. Finally any risk

measurement framework, especially those which employ quantitative

techniques/model, is only as good as its underlying assumptions, the rigor and

robustness of its analytical methodologies, the controls surrounding data inputs andits appropriate application

o Independent review:One of the most important aspects in risk management philosophy is to

make sure that those who take or accept risk on behalf of the institution are

not the ones who measure, monitor and evaluate the risks. Again the

managerial structure and hierarchy of risk review function may vary across

banks depending upon their size and nature of the business, the key is

independence.

o Contingency planning:Institutions should have a mechanism to identify stress situations ahead of

time and plans to deal with such unusual situations in a timely and effective


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manner. Stress situations to which this principle applies include all risks of

all types. For instance contingency planning activities include disaster

recovery planning, public relations damage control, litigation strategy,

responding to regulatory criticism etc. Contingency plans should be

reviewed regularly to ensure they encompass reasonably probable eventsthat could impact the organization.

o Credit Origination:Banks must operate within a sound and well-defined criteria for new

credits as well as the expansion of existing credits. Credits should be

extended within the target markets and lending strategy of the

institution. Before allowing a credit facility, the bank must make an

assessment of risk profile of the customer/transaction. This mayinclude

o Limit setting:An important element of risk management is to establish exposure

limits for single obligors and group of connected obligors. Institutions

are expected to develop their own limit structure while remaining

within the exposure limits set by State Bank of Pakistan. The size of

the limits should be based on the credit strength of the obligor,genuine requirement of credit, economic conditions and the

institutions risk tolerance. Appropriate limits should be set for

respective products and activities. Institutions may establish limits for

a specific industry, economic sector or geographic regions to avoid

concentration risk.

o Administration:Ongoing administration of the credit portfolio is an essential part of the creditprocess. Credit administration function is basically a back office activity that

support and control extension and maintenance of credit. A typical credit

administration unit performs following functions:

a. Documentation. It is the responsibility of credit administration to

ensure completeness of documentation (loan agreements, guarantees, transfer of


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title of collaterals etc) in accordance with approved terms and conditions.

Outstanding documents should be tracked and followed up to ensure execution and

receipt.

b. Credit Disbursement. The credit administration function shouldensure that the loan application has proper approval before entering facility limits

into computer systems. Disbursement should be effected only after completion of

covenants, and receipt of collateral holdings. In case of exceptions necessary

approval should be obtained from competent authorities.

c. Credit monitoring. After the loan is approved and draw down

allowed, the loan should be continuously watched over. These include keeping

track of borrowers compliance with credit terms, identifying early signs of

irregularity, conducting periodic valuation of collateral and monitoring timelyrepayments.

d. Loan Repayment. The obligators should be communicated ahead of

time as and when the principal/markup installment becomes due. Any exceptions

such as non-payment or late payment should be tagged and communicated to the

management. Proper records and updates should also be made after receipt.

e. Maintenance of Credit Files. Institutions should devise procedural

guidelines and standards for maintenance of credit files. The credit files not onlyinclude all correspondence with the borrower but should also contain sufficient

information necessary to assess financial health of the borrower and its repayment

performance. It need not mention that information should be filed in organized way

so that external / internal auditors or SBP inspector could review it easily.

f. Collateral and Security Documents. Institutions should ensure that

all security documents are kept in a fireproof safe under dual control. Registers for

documents should be maintained to keep track of their movement. Procedures

should also be established to track and review relevant insurance coverage forcertain facilities/collateral. Physical checks on security documents should be

conducted on a regular basis.

Risk Monitoring & Control:


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Credit risk monitoring refers to incessant monitoring of individual credits inclusive

of Off-Balance sheet exposures to obligors as well as overall credit portfolio of the

bank. Banks need to enunciate a system that enables them to monitor quality of the

credit portfolio on day-to-day basis and take remedial measures as and when any

deterioration occurs. Such a system would enable a bank to ascertain whether loansare being serviced as per facility terms, the adequacy of provisions, the overall risk

profile is within limits established by management and compliance of regulatory

limits. Establishing an efficient and effective credit monitoring system would help

senior management to monitor the overall quality of the total credit portfolio and

its trends. Consequently the management could fine tune or reassess its credit

strategy /policy accordingly before encountering any major setback. The banks

credit policy should explicitly provide procedural guideline relating to credit risk

monitoring.

6.4. Elements of Risk management:o Board and senior Management Oversighto Organizational Structure6.5. Risk Management should include:o The Risk Management Committeeo The Asset-Liability Management Committee (ALCO)o The Middle Officeo Risk Management Committee:

It is generally a board level subcommittee constituted to supervise overall

risk management functions of the bank. The structure of the committee may

vary in banks depending upon the size and volume of the business.

Generally it could include heads of Credit, Market and operational risk

Management Committees. It will decide the policy and strategy for

integrated risk management containing various risk exposures of the bank

including the market risk.

o Asset-Liability Committee:Popularly known as ALCO, is senior management level committeeresponsible for supervision / management of Market Risk (mainly interest

rate and Liquidity risks). The committee generally comprises of senior

managers from treasury, Chief Financial Officer, business heads generating

and using the funds of the bank, credit, and individuals from the departments


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having direct link with Interest rate and liquidity risks. The CEO or some

senior person nominated by CEO should be head of the committee. The size

as well as composition of ALCO could depend on the size of each

institution, business mix and organizational complexity. To be effective

ALCO should have members from each area of the bank that significantlyinfluences liquidity risk. In addition, the head of the Information system

Department (if any) may be an invitee for building up of MIS and related

computerization. ALCO should ensure that risk management is not confined

to collection of data. Rather, it will ensure that detailed analysis of assets and

liabilities is carried out so as to assess the overall balance sheet structure and

risk profile of the bank. The ALCO should cover the entire balance

sheet/business of the bank while carrying out the periodic analysis.

o Middle Office:The risk management functions relating to treasury operations are mainlyperformed by middle office. The concept of middle office has recently been

introduced so as to independently monitor measure and analyze risks

inherent in treasury operations of banks. Besides the unit also prepares

reports for the information of senior management as well as banks ALCO.

Basically the middle office performs risk review function of day-to-day

activities. Being a highly specialized function, it should be staffed by people

who have relevant expertise and knowledge. The methodology of analysis

and reporting may vary from bank to bank depending on their degree of

sophistication and exposure to market risks. These same criteria will govern

the reporting requirements demanded of the Middle Office, which may vary

from simple gap analysis to computerized VAR modeling. Middle Office

staff may prepare forecasts (simulations) showing the effects of various

possible changes in market conditions related to risk exposures. Banks using

VAR or modeling methodologies should ensure that its ALCO is aware of

and understand the nature of the output, how it is derived, assumptions and

variables used in generating the outcome and any shortcomings of the

methodology employed. Segregation of duties should be evident in the

middle office, which must report to ALCO independently of the treasury

function. In respect of banks without a formal Middle Office, it should be

ensured that risk control and analysis should rest with a department with


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clear reporting independence from Treasury or risk taking units, until normal

Middle Office framework is established.