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IN
Briefing session on
RISK MANAGEMENT
IN COMMERCIAL
BANKS
By
Malik Dilawar
Vice President/Principal
Senior Training Manager, North,
UBL Training Centre, Islamabad,
Pakistan.
Phone: 0092-51-2820674(Off.),
Fax: 0092-51-2821521
Risk management by
commercial banks -- Time to
hammer out the chinks
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.
Banks in Pakistan have, however, 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.
Risk management by
commercial banks -- Time to
hammer out the chinks
As the banks 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.
Risk management by
commercial banks -- Time to
hammer out the chinks
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.
Risk management by
commercial banks -- Time to
hammer out the chinks
Present practices/situation
Prevalent at commercial banks
requires a hard look and call for a
greater understanding by bank
managements and boards of the
risks involved in their operations.
What is RISK ?
It is the potential that events expected or
unexpected, may have an adverse effect on a
financial institution’s 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.
Banks do take RISKS – The biggest RISK is
Not Taking A RISK.
Definition of Risk Management
Business lines
Products
Transactions
Serving the Needs of Depositor
Borrowers and Banks
Commercial Bank
lending/Investment involves three
parties :
2. The suppliers of funds (The depositor)
3. The users of funds (The borrowers)
4. A financial intermediary (Bank) s
Revenue.”
[Swiss Banking Corporation’s Credit Manual]
TYPICAL BALANCE SHEET OF A BANK
[Amounts in millions USD]
Liabilities
Deposits & Other Accounts 4,720 84.92
Borrowings from other Banks, Agents 391 7.03
Bills Payable 90 1.62
Other Liabilities 144 2.59
TOTAL LIABILITIES 5,345 96.16
NET ASSETS [ 1] 213 3.83
Represented By:
Share Capital 203 3.64
Reserves 106 1.91
Other Tier 1 Capital 136 2.45
Accumulated Loss 284 5.11
Surplus on revaluation of Fixed Assets 52 0.94
NET ASSETS [1] 213 3.83
RISK MANAGEMENT
ORAGNIZATION
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.
Banking Risk
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.
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.
The overall objective of Risk Management is to increase
enterprise value
INCREASE VALUE BY
Providing
Appropriate Increasing
Level Improving
Return on
and Consistency
Capital
Allocation of Earnings
of Capital
The best way to reach this objective is to understand
the full risk environment within which you operate...
External Internal
Environment Environment
Financial Operational
Strategies Strategies
Hiring/Training
Financial Risk Capital
Structure
Incentive Programs
Asset Risk
Asset
Allocation Internal Controls
Liability Risk
Products
Pricing
Technology
Business Risk
Product Mix Customer Service
Event Risk
Market Strategy
Increase Value
Return
Consisten
Capital
cy
Understand Internal Holistically Optimise Financial
and Manage and Operational
External Environment Strategies
Financial and
Operational
Risks
To accomplish all this in a consistent manner, it is necessary to implement a
continual management process
Develop
Best Implement
Strategie Strategies
s
Monitor
Performance and
Environment
In summary, Enterprise Risk Management:
• CRITICAL RISK
• MATURITY MISMATCHES
• BASED ON MARKET CONDITIONS & PERCEPTIONS
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 bank’s procedures
whether from external causes or as a result
of error or fraud within the institution.
COUNTRY RISK
RISK ASSOCIATED WITH THE ECONOMIC,
SOCIAL AND POLITICAL ENVIRONMENT OF THE
BORROWER’S COUNTRY. COUNTRY RISK IS
MOST APPARENT WHEN LENDING TO FOREIGN
GOVERNMENTS/ THEIR AGENCIES AND OTHER
CUSTOMERS.
• BANK’S HAVING GLOBAL PRESENCE
OWNERSHIP RISK
THE RISK THAT OWNERS / SHAREHOLDERS,
DIRECTORS OR SENIOR MANAGEMENT MIGHT BE
UNFIT FOR THEIR RESPECTIVE ROLES OR THEY
ARE ACTUALLY DISHONEST.
02/05/09
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.
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
Reliance on Internal Control ?
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,
Principles of Control
• Segregation of duties
• Dual control
• Rotation of assignments or duties
• Two weeks continuous vacation
• Adequate Compensation
INTERNAL AUDIT SYSTEM
IMPLEMENTATION OF INTERNAL
CONTROLS
PROVIDES SECONDARY RISK REVIEW
INDEPENDENC.
Objective of Internal Audit
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
Inspection Procedures for
Internal Auditors Work
Organizational 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
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
RISK MANAGERS
QUALIFIED
OBJECTIVE
ENJOY ADEQUATE AUTHORITY
ABILITY TO CORRECTLY ANALYSE FOR
CURRENT ACTION AND FUTURE
PREDICTIONS
PROMPT IN ACTION