This document discusses key concepts in risk management for banks. It outlines the main types of risks banks face, including market, credit, operational and strategic risks. It describes the risk management process as identifying, analyzing, managing and assessing risks. It distinguishes between expected and unexpected losses. It provides a roadmap for risk management including setting risk appetite, mapping risks, operationalizing limits, and re-evaluating regularly. Key risk management tools and principles of corporate governance for banks are also outlined.
This document discusses key concepts in risk management for banks. It outlines the main types of risks banks face, including market, credit, operational and strategic risks. It describes the risk management process as identifying, analyzing, managing and assessing risks. It distinguishes between expected and unexpected losses. It provides a roadmap for risk management including setting risk appetite, mapping risks, operationalizing limits, and re-evaluating regularly. Key risk management tools and principles of corporate governance for banks are also outlined.
This document discusses key concepts in risk management for banks. It outlines the main types of risks banks face, including market, credit, operational and strategic risks. It describes the risk management process as identifying, analyzing, managing and assessing risks. It distinguishes between expected and unexpected losses. It provides a roadmap for risk management including setting risk appetite, mapping risks, operationalizing limits, and re-evaluating regularly. Key risk management tools and principles of corporate governance for banks are also outlined.
This document discusses key concepts in risk management for banks. It outlines the main types of risks banks face, including market, credit, operational and strategic risks. It describes the risk management process as identifying, analyzing, managing and assessing risks. It distinguishes between expected and unexpected losses. It provides a roadmap for risk management including setting risk appetite, mapping risks, operationalizing limits, and re-evaluating regularly. Key risk management tools and principles of corporate governance for banks are also outlined.
Distinction between Expected and Unexpected Losses
Expected losses: Average losses that can be ascertained with a high degree of confidence Expected ELloss is *covered = PD through provisions LGD * EAD
Unexpected loss is covered by setting aside capital
Implement Choose instruments to manage risks. Make day to day decisions. Establish oversight.
Re-evaluate regularly It is a continuous and dynamic process. As business evolves, risks change...New risks emerge, old ones may no longer have same impact.
Risk Appetite Amount and types or risk a firm is willing to accept. It is the amount of risk a firm is happy to bear an any point in time. Detailed risk appetite statement is an internal document that is subject to board approval
Risk Capacity Maximum amount of risk a firm can absorb
Risk Tolerance Defines boundaries or limits of risk which the firm is willing to accept
Risk Management Toolbox Instrument Type Defining Features Forward Tailored agreement to exchange a specific quantity of underlying at a pre agreed price at a future date. Either physically delivered or cash settled Future Exchange listed forward with standardized terms, subject to margining and MTM Swap Agreement to exchange cash flows linked to an underlying index/benchmark. Fixed vs floating IRS Call Option Buyer has right to buy the underlying asset at the strike price at a certain rate in future or a window period. Pays premium to get that right Put Option Buyer has right to sell the underlying asset at the strike price at a certain date in future or a window period. Pays premium to get that right Exotic Option Example: Barrier options, Binary options, Lookback options, Compound options Swaption It is an option to enter into a swap at a later date
Board has ultimate responsibility of bank’s strategic objectives, governance
Boards overall Responsibilities framework and corporate culture
Boards Qualification and Compensation Board members should be qualified, individually and collectively
Board’s Own Structure and Practices Composition of independent, executive directors, etc. Senior Management Should act under oversight of board and report accurately Governance of Group structures Board of parent firm has ultimate responsibility Risk Management function Independent function headed by CRO
Risk Identification, Monitoring, Controlling Risks should be measured and monitored continuously
Risk Communication Important within departments and between senior managements and board Compliance Board should establish a compliance function Internal Audit Should provide independent assurance to board Compensation Compensation should facilitate sound corporate governance
Disclosure and Transparency Disclosures to concerned stakeholders should be accurate, timely and complete
Responsible for comprehensive evaluation. Regular interaction with board and
Self-Reinforcing Securitization Chain Loan Origination Compensation was tied to high loan volumes and high commission mortgages, not subsequent loan performance or suitability
Investors Securitization As monetary policy turned High fee earning, complex highly accommodative, and opaque product investors started chasing issuance soared requiring yields advanced financial engineering and large quantities of underlying loans Credit Rating Agencies Some securitized products were awarded ratings higher than fundamentals suggested
Risk viewed in business line, risk-type and functional silos Risk viewed across business lines, functions, risk types looking at diversification and concentration Risk Managers work in isolation Risk team integrated using global risk management committee and CRO Many different risk Metrics that cannot be compared Development of rational risk management frameworks and cross-risk universal metrics Risk aggregated, if at all, within business lines and risk Tools and integrated frameworks make it possible to more types. Difficulty seeing the aggregate risk picture accurately measure and track enterprise risk
Each risk type managed using risk specific transfer Possibility of cutting risk transfer costs firm wide and mechanisms integrated instruments
Each risk management approach Each risk management approach is viewed as one (avoid/retain/mitigate/transfer) often treated separately, component of a total cost of risk, ideally measured in a with strategy rarely being optimized single currency
Impossible to integrate the management and transfer of Risk management is increasingly integrated with balance risk with balance sheet management and financing sheet management, capital management and financing strategies strategies
