Risk Management in Cotton Industries : Opportunities and Challenges

Md. Nazrul Islam, CERM

Joint Director Banking Regulation and Policy

DepartmentBangladesh Bank –the central Bank

of Bangladesh

Outline

Risk

Risk Management Process

Risk Measureme

nt

Risk Management Strategies

Shareholders Value

1. Who is Risk Taker ? First one , Second one or Both ?

What is Risk ?

A risk is a ‘hazard, danger, chances of loss or injury, degree of probability of loss, Person, factor or thing likely to cause danger, to incur the chances of unfortunate consequences by doing something’

-The Chambers Dictionary

What is Risk ?R=ʄ(hazard*vulnerability )

Hazard is probabilistic

Vulnerability is non-probabilistic

Thus Risk is Probabilistic

As Exposure to uncertain Events

Strike in Shipment Ports Flood Drought In Cotton Growing AreasDefault on Contractual obligation by a buyer or supplier Fire in Cotton WarehousePoor Quality of Cotton CropSharp Increase in cotton price

Factors associated with term RISK

Uncertainty Cause of loss and

Level of Loss

Frequency and

severity

A Ship is safe in harbor…………….

Necessity Knows no law

Risk Management Process

Monitor and R

eview

Identify Risk

Analyze Risks

Evaluate Risks

Establish Context

Treat Risk

Risk Assessment

Com

municate and C

onsult

Strategic Process Commit and

Mandate Communicate and Train

Structure and Accountability Review and

Improve

Stra

tegi

c Pr

oces

s

Stra

tegi

c Pr

oces

s

Strategic Process

Risk Map

Seve

rity

Probability

High

High

Low

Source Risk

Country Risk Exchang

e Risk

Price Volatility

Risk Counter

Party Risk

Global Economic Slowdown Interest

Rate Risk

Operational Risk

(Knowledge Gap)

Covenant Risk

Reputational Risk

The Process for effective Risk Management

Transfer

Better Cost Control

Collateral Management

Purchase of Insurance

Manage /Internalize Avoid /Transfer

Accept Share/ Transfer

Objectives

1. Risk Analysis

Severity Probability

High

High

Low

2. Mitigation

Retain

Transfer3.

Monitor4. Review

Negative

Positive

Internal

External

Environmental Assessment and Strategic move : SWOT Analysis

Strength•Skilled and Lower Wage Human Resources• Export Contribution- 81.70% and GDP-13.10%•Forward looking Govt. & Banking Policy • Reputed Entrepreneurship •Advanced Technology•Prompt Customer Services•Innovative Products•increased mobile and Online Banking service

Weaknesses• Practice of commodity Market and Associated Risk • Non-availability of Risk Management Tools• Less Local Production of Cotton (2% of Total)• Interest rate Risk • Poor Infrastructure and Red tapes •Unrest Political situation

Opportunities• Overseas New Cotton Market • New product development• Highly market focused •High Demand of Finished Product

Threats• Cotton Source Risk • Sustainable Cotton Trading • Volatility of Raw Cotton Price •Country risk- new act & law by government•Exchange rate risk•Economic slowdown or global recession Identify

SupportCapitalize

Invest

12

Types of Corporate Risk Faced

Business Risk

• a) Commodity Risk:

• Price Risk: Price Fluctuations

• Quantitative Risk : Natural Calamity, weather etc.

• b) Concentration Risk :

• c) International Operations Risk

Financial Risk

• a) Credit Risk

• b) For-ex Risk

Operational Risks

Commodity Risk

Reasons Change in inventory Value

Inflation Leading to – Increase in Production –infrastructure cost and production raw materials cost

Change in selling price fluctuations

Commodity Risk Countering the Risk : Hedging

Making an Investment to reduce the risk of adverse price movement in an asset

Prediction: A farmer predicts price will go down from Tk. 72/kg (Spot price-oct) to tk. 65/kg(spot price dec)

Hence, the farmer sells a december 20th futures contract at tk.72/kg

Present Price tk.

72/kg

Future Tk. 65/kg

Buy Futures of dec@65

Turnover: 65

+7=72

Future Tk. 80/kg

Buy Futures of dec@80

Turnover: 80-8=72

Spot 1st Decemb

er

Bangladesh Bank Policy: Foreign Exchange Guidelines Vol-1Sec-3

Hedging the price risk of Commodities

AD can hedge the price risk of commodities that are traded on the exchanges or OTC

Subject to prior Approval No Speculation is permitted AD must have ability to monitor credit

or market risk

Counterparty risk

Non performing of Contract

Cotton Supplier not shipping when cotton prices increase sharply

Customers not opening L/C when cotton prices dropCotton

Industry and its

associates

Operational risk

People

Unexpected losses due to physical catastrophe

Fraud , Documentation

Reputation

Failure of management

Internal process errors

Unforeseeable external events.

Cotton Industry and its

associates

1.Field

Risk : supply chain of cotton

4.Port

5.Warehouse6.Buyer (PTS-Spinner/Rotor)

3.Warehouse2.Ginn

Risk Measurement

Methods •Measure uncertainty or Volatility based on historical Data

•VAR is for measuring Market risk (price, Basis, currency )

Methods

•Stress Testing•Back testing

Insurance Options

Cotton Traders

Property All Risks

Money In

Transit

Non-delivery or Non Paymen

t War at Sea or on land or

terrorism

Comprehensive Cargo

Insurance

Strike or Riot, Civil commotio

n or Malicious Damage

Risk Framework

Identification of risk Risk Control Process and ProceduresRisk Limits and Risk Cap Allocation Risk Capture, Measurement and reporting Aligning System-PMS & Annual Incentives

Governance Structure

Segregation of Duties

Bangladesh Bank Initiatives

Business Process InnovationAnd As per Foreign Exchange Guidelines (Ch-7)-34 Payment of Import Liability

Show Cause/Imposing Fine for Delay Payment –Punitive Action including

revocation of AD licence by BB

Exit Plan has been asked to submit by 31 January, 2017.

Major Risk Management Strategies

•Gain Knowledge in International Trading Practices' and risk Management

•To operate ICA rules and by laws. •Work with International Org.(WTO, ICA, ICAC)

Sustainability in Cotton Trading and sanctity of

contracts

•Backward linkage and efficient worker Cost Reduction Strategy, Labor Productivity

Improvement New Market or

Product development Strategy

•Research on new product , Development and Market

Product & Market Diversification

Strategy

Diversify Product effectively Diversify Market efficiently

•People Ask Difficult questions •People Admit Ignorance •Whistle Blowing( Public

interest disclosure) is encouraged

•Performance evaluation of business and people are based on Risk Adjusted Returns and not on absolute profit levels

Developing Risk Culture

•Implement Sound Risk management & Risk Governance

•Maximization of Share Holders Value Sound Risk

Management and

Governance

Risk Management Strategies cont.

Reference

1. Export Promotion Bureau , Bangladesh 2. The Financial Express, 08 October, 20123. www. bgmea.com.bd4. Cotton Exporters Guide August 2013, ITC4. www.mckinsey.com

Q/A ?

Thank youMd. Nazrul Islam

Joint DirectorBanking Regulation and Policy Department

Bangladesh Bank, Dhaka-1000.

Email: mdnazrul.islam@bb.org.bdwebsite: www.nazrulin.com

Contact No. 88-01552494409