Group Members:

M.Wasim Shahzad M10MBA041

Muhammad Bilal
Hafiz Raza ur Rehman Muhammad Usman

M10MBA048
M10MBA054 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 in Financial Institutions Concluding Remarks

Introduction
Risk
Designates any uncertainty that might trigger
losses R-MGT in FIs comprises the entire set of R-MGT processes, Practices, All techniques and tools required for 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 complexity of 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 more complex and fast paced environment. Even today some simple rules continue to be critical to R-MGT.

Organizational setup for Risk Management

Fundamental Requirement
A well constituted organizational structure defining clearly roles and responsibilities of individuals

Different Types of Committees oSub Committee of Board to Supervise overall RMGT 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 risks are 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 and which is to avoid altogether.

Risks In FIs & Their Management

Credit Risk Management Credit 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 such obligation is impaired

Sound Credit Risk Management Measures

Typically Include three Kinds of Policies

Policies to Limit or Reduce Credit Risk Asset classification Loss Provisioning

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 designed credit 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. A lending policy should establish the maximum maturity for each type of credit and loan should be given with a realistic repayment schedule.

Risks In FIs & Their Management

Asset Classification
These 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 asset that are subjected to losses.

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

Muhammad Wasim Shahzad M10MBA041

Risks In FIs & Their Management

Sale of Liquid Assets
Banks 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 meet their 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 they can lengthen term of their inter bank liabilities for three or six months

Risks In FIs & Their Management

Central Banks Rediscount Window
Central banks 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.

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 banks portfolio to reflect changes in asset prices due to market price movements.

Risks In FIs & Their Management

Market Risk Management Policies Position 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 banks capital structure, earnings trends and overall risk profile

Risks In FIs & Their Management

Interest Rate Risk Management Interest 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

Risks In FIs & Their Management

Currency Risk Management
This 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

Risks In FIs & Their Management

Operational Risks
Operational 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 or unforeseen catastrophes.

Techniques to control
Internal control and internal audit Insurance

Risks In FIs & Their Management

KYC Risks Management
Sound 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

Recent Innovations In Risk Measurement And Management

Major FIs are using sophisticated Model to Measure risk, and to manage risk innovative techniques like derivatives, asset securitization and loan sales are being used

Measuring Risk
A number of techniques are available for measuring the interest 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. In recent 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.

Recent Innovations In Risk Measurement And Management

Stress Testing
A 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.

Recent Innovations In Risk Measurement And Management

Derivatives Derivative contracts allow a FI to hedge its interest rate, foreign exchange and credit risk exposures. but Misused of derivatives can increase the risk of FIs insolvency. 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 Innovations In Risk Measurement And Management

Currency Swap
refers 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 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 to Hedge 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 Measurement And Management

Options
Contract 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 and bonds.

Hafiz Raza Ur Rehman M10MBA054

Recent Innovations In Risk Measurement And Management

Asset securitization
A 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 Management

Capital Adequacy Requirement
Capital is one of the key indicators which determines safety and soundness of a bank
Regulatory authorities have introduced minimum capital adequacy requirements of 8% for risk weighted assets of banks under Basel Accord in 1988

A significant innovation of the revised framework is the greater use of assessments of risk provided by banks internal systems as inputs to capital calculations

Regularity Approaches to Risk Management in FIs

Prudential Regulations and Risk Management Guidelines
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 Management in FIs

Consumer Credit Bureau
Reliable 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 banks 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 keep pace 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