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Financial markets the world over have undergone far-reaching changes in
the last decade, spurred by deregulation and liberalization, as well as rapid
developments in communication and Internet technologies. Financial
institutions have generally not paid enough attention to the potential risks
and to evolve mechanisms and systems to control and manage them in line
with the global standards and procedures.
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Risk management by financial institutions
Time to hammer out the chinks
As the Financial institutions no longer operate in a protected and regulated
environment, there is an imperative need for them to develop and improve
their capability to understand the changes in their economic environment and
other circumstances having a critical bearing on their business activities.
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Risk management is a comprehensive process adopted by an organization
that seeks to minimize the adverse effects it is exposed to due to various
factors -- economic, political or environmental, some of them inherent to the
business, others unforeseen and unexpected.
Present practices/situation Prevalent at financial institutions requires a hard
look and call for a greater understanding by bank managements and boards of
the risks involved in their operations
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What is RISK ?
It is the potential that events expected or unexpected, may have an adverseeffect on a financial institutions capital or earnings.
Risk is inherent in all business and financial activities.
The greater the RISK associated with an activity the greater potential to
generate a high return.
Financial institutions do take RISKS The biggest RISK is Not Taking A
RISK.
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What is RISK ?
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Definition of Risk Management
Risk Management is the process of identifying, measuring, monitoring andcontrollingrisks
These four points are essential to risk management
This presentation will cover the main identified risks in Financial institutions
and determine how well risks are being managed.
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Identifying Risks
Where Risks should be Identified Institution-wide Business lines
Products
Transactions
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Bank lending/Investment involves three parties :o The suppliers of funds (The depositor)
o The users of funds (The borrowers)
o
A financial intermediary (Bank)s
SupplierSupplier BankBank BorrowerBorrower
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Risk management is a decentralized process guided by centrally established
policies and rules .Senior staff committees define credit culture and established
overall policies and rules. Line management designs lending procedures and
controls risk.
There are usually five major organization groups that participate in risk
management process. These groups are responsible for defining
implementation ,and/or reviewing risk management policies, rules and
procedures within the bank.
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Taking risks can almost be said to be the business of bank management. A bank
that is run on the principle of avoiding all risks or as many of them as possible, will
be a stagnant institution ,and will not adequately serve the legitimate credit needs
of its society. On the other hand a bank that takes excessive risks or credit is
more likely, takes them without recognizing their extent or their existence will
surely run into difficulty.
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All business involves some type of risk and banking is no exception.
Credit risk is major category of risk of the bank. It occurs whenever there is a
possibility that is the customer cannot meet contractual obligations to the bank
in term of :
-The delivery of documents or commodities where the bank bears the
whole risk OR
- The payment of principal, interest, fees or commissions.
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The overall objective of Risk Management is to
increase enterprise value
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INCREASE VALUE BY
Providing
AppropriateLeveland
Allocationof Capital
Providing
AppropriateLeveland
Allocationof Capital
IncreasingReturn on
Capital
IncreasingReturn on
Capital
ImprovingConsistencyof Earnings
ImprovingConsistencyof Earnings
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The best way to reach this objective is to understand
the full risk environment within which you operate...
External
Environment
Economic
Conditions
Competition
Natural Catastrophes
Social/Legal
Trends
Political/
Regulatory
Climate Technology
Expansion/
Diversification
People
Culture
Distribution
Processes
Risk Appetite
Internal
Environment
Financial Risk
Asset Risk
Operational Risk
Liability Risk
Business Risk
Event Risk
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and the complete set of strategies that are available to
you...
FinancialStrategies
Pricing
Securitisation
Capital
Structure
Product Mix
Asset
Allocation
OperationalStrategies
Incentive Programs
Technology
Internal Controls
Distribution
Products
Customer Service
Market Strategy
Hiring/Training
Asset Risk
Liability Risk
Business Risk
Event Risk
Financial Risk
Operational Risk
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and to apply this knowledge
in a holisticrisk management framework, to drive value
Holistically
ManageFinancial andOperational
Risks
Holistically
ManageFinancial andOperational
Risks
Optimise Financialand Operational
Strategies
Understand Internaland
External Environment
Cap
ital
Re
turn
Cons
ist
en
cy
Increase Value
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To accomplish all this in a consistent manner, it is necessary to
implement a continual management process
Develop
BestStrategie
s
Develop
BestStrategie
s
ImplementStrategies
ImplementStrategies
Monitor
Performance andEnvironment
Monitor
Performance andEnvironment
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In summary, Enterprise Risk Management:
Allows you to determine the necessary capital level, deploy unneeded capital
and improve return on capital
Encourages proper allocation of capital to segments and supports
performance tracking
Provides a method for ensuring that enterprise owners receive proper
compensation for risks assumed
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Provides Competitive AdvantageProvides Competitive Advantage
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RISKS
MUST BE:
KNOWN
UNDERSTOOD
QUANTIFIABLE
CONTROLLABLE / ACCEPTABLE / BANKABLE
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RISKS FACED BY Financial institutions
CREDIT RISK
MARKET RISK
INTEREST RISK
LIQUIDITY RISK
OPERATIONAL RISK
COUNTRY RISK
OWNERSIP / MANAGEMENT RISK
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THE RISK THAT THE OBLIGOR (BORROWER) WILL NOT BE ABLE TOREPAY THE DEBT (LOAN) UNDER THE TERMS OF THE ORIGINAL
AGREEMENT (LOAN AGREEMENT).
MOST CRITICAL RISK IN BANKING
REQUIRES MOST SUBJECTIVE JUDGEMENT
MUST BE MANAGED CAREFULLY
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CHANGES IN MARKET RATES AND PRICES WILL IMPAIR AN
OBLIGORS ABILITY TO PERFORM UNDER THE CONTRACT
NEGOTIATED BETWEEN THE PARTIES.
NEEDS MONITORING OF CHANGES IN PRICES OF COMMODITIES,
REAL ESTATE, ETC.
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INTEREST RATE RISK IS THE EXPOSURE OF AN INSTITUTION'S
FINANCIAL CONDITION TO ADVERSE MOVEMENTS IN INTEREST RATES,
WHETHER DOMESTIC OR WORLD-WIDE.
ANOTHER CRITICAL RISK
RE-PRICING/ MISMATCHES NEED TO BE ADDRESSED.
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THE RISK THAT A BANK WILL BE UNABLE TO ACCOMMODATE
DECREASES IN LIABILITIES OR TO FUND INCREASES IN ASSETS. SUCH
RISKS ARISE WHEN THE REPRICING OR MATURITIES OF ASSETS DO
NOT MATCH THOSE OF LIABILITIES.
CRITICAL RISK
MATURITY MISMATCHES
BASED ON MARKET CONDITIONS & PERCEPTIONS
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OPERATIONAL RISK
THIS RISK ARISES FROM THE LACK OF EFFECTIVE INTERNAL CONTROLS AND AUDITING
PROCEDURES. PARTICULARLY IMPORTANT IS THAT THE BANK SHOULD HAVE GOOD
INTERNAL CONTROLS
Risk of a failure in the banks procedures whether from externalcauses or as a result of error or fraud within the institution.
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RISK ASSOCIATED WITH THE ECONOMIC, SOCIAL AND POLITICAL
ENVIRONMENT OF THE BORROWERS COUNTRY. COUNTRY RISK IS
MOST APPARENT WHEN LENDING TO FOREIGN GOVERNMENTS/ THEIR
AGENCIES AND OTHER CUSTOMERS.
BANKS HAVING GLOBAL PRESENCE
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THE RISK THAT OWNERS / SHAREHOLDERS, DIRECTORS OR SENIOR
MANAGEMENT MIGHT BE UNFIT FOR THEIR RESPECTIVE ROLES OR THEY
ARE ACTUALLY DISHONEST.
ALSO A CRITICAL RISK
THE BEST WAY TO ROB A BANK IS TO OWN IT
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RISK MANAGEMENT
Familiarisation of Management with Risks
Implementation of Internal Controls
Sound Internal Audit System
Efficient MIS in Place
Competent Group of Risk Managers
Prompt Action & Monitoring
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Risk Quantification
Risk quantification techniques becoming important to determine capital
requirementsMore reliance on Financial institutions own systems for identifying and
managing risk
Not only quantitative; also processes and culture:
scrutiny of model design
data integrity risk management resources validation independent audit management understanding
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DEPOSITS IN A BANK REPRESENTS WHAT ?
financial institutions support a mountain of RISK on a slender capital base.
The bulk of their liabilities is redeemable at PAR and on DEMAND, with
depositors regarding their money as perfectly safe.
Yet bank assets are subject to credit risk, market risk, and settlement risk.
With international lending, there is foreign exchange risk and transfer risk.
Also there is management risk and risk of fraud.
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GENERAL
Many of The Risks Overlap. Need To Be Evaluated In The Context Of Individual Institution With On-site
Presence.
Evaluation of Risks Requires An Understanding of The Bank, its Customer
Mix, its Assets & Liabilities And The Economic And Competitive
Environment.
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INTERNAL CONTROLS
RISK RATING SYSTEM FOR CREDITS
CLOSE MONITORING OF OPERATIONS
COMPETENT CREDIT MANAGERS
DUAL CONTROLS
SYSTEM TO STUDY THE INDUSTRIAL AND ECONOMIC DEVELOPMENT FOR ESTABLISHING TARGET AREAS
OF INVESTMENT
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Once the management system is in place, supervisors can determine that the
systems are working properly by testing the systems. If the systems are
inadequate, the scope of the inspection can be expanded so that risks are
properly identified, quantified and corrective action initiated.
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Reliance on Internal Control ?
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Segregation of duties
Dual control
Rotation of assignments or duties
Two weeks continuous vacation
Adequate Compensation
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Principles of Control
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INTERNAL AUDIT SYSTEM
IMPLEMENTATION OF INTERNAL CONTROLS
PROVIDES SECONDARY RISK REVIEW
INDEPENDENC.
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The overall objective of internal auditing is to assist all members of
management in the effective discharge of their responsibilities by furnishing
them with objective analysis, appraisals, recommendations and pertinent
comments concerning the activities reviewed. The internal auditor, therefore,
should be concerned with any phase of banking activity wherein he can be
any service to management
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Objective of Internal Audit
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Procedures for Internal Auditors WorkOrganizational Structure of the Audit Department
Independence of the Audit Function
Auditors Qualifications
Audit Staff Qualifications
Content and Utilization of the Audit Frequency and Scope Schedule
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MIS
AN ADEQUATE MIS HELPS IN TIMELY IDENTIFICATION OF RISKS
REPORTS ON MATURITY OR INTEREST RATE MISMATCHES
REPORTS ON PROBLEM CREDITS
REPORTS ON CREDITS SHOWING DETERIORATING TREND IN RISK
RATING
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Questions