Best tips for risk management


rmisinfo.com keyword stats



Most current MSN search phrases:

Tristar Lending Group definition "Composite risk management"

Managing Risk in Financial Sector

Risk Management is a hot topic in thethe achievement of an objective. Risk
financial sector especially in the light ofassessments is done to determine the relative
the recent losses of some multinationalpotential for loss in programs and functions
corporations e.g. collapses of Britain'sand to design the most cost-effective and
Barings Bank, WorldCom and also due to theproductive internal controls.III. Control
incident of 9/11. Rapid changes in businessActivities,Control activities mean the
condition, restructuring of organizations tostructure, policies, and procedures, which an
cope with ever increasing competition,organization establishes so that identified
development of new products, emerging marketsrisks do not prevent the organization from
and increase in cross border transactionsreaching  its  objectives.
along with complexity of transactions has
exposed Financial Institutions to new risksPolicies, procedures, and other items like
dimensions. Thus the concept of risk hasjob descriptions, organizational charts and
captured a growing importance in modernsupervisory standards, do not, of course,
financial society.By facilitatingexist only for internal control purposes.
transactions and making credit and otherThese activities are basic management
financial products available, the financialpractices.IV. Information and Communication,
sector is a crucial building block forandOrganizations must be able to obtain
private as well as public sector development.reliable information to determine their risks
In its broadest definition, it includesand communicate policies and other
everything from banks, stock exchanges, andinformation to those who need it. Information
insurers, to credit unions, microfinanceand communication, the fourth component of
institutions and moneylenders. As aninternal control, articulates this
efficient service provider, the financialfactor.V. MonitoringLife is change; internal
sector simultaneously fulfils an importantcontrols are no exception. Satisfactory
function in the overall economy. Variousinternal controls can become obsolete through
types of Financial Institutions activelychanges in external circumstances. Therefore,
working in Financial Sectors include Banks,after risks are identified, policies and
DFIs, Micro Finance Banks, Leasing Companies,procedures put into place, and information on
Modarabas, Assets Management Company, Mutualcontrol activities communicated to staff,
Funds, etc.Thus today's operating environmentsuperiors must then implement the fifth
demands systematic and more integrated riskcomponent of internal control,
management approach.Risk:Risk by default hasmonitoring.Even the best internal control
tow components; uncertainty and exposure. Ifplan will be unsuccessful if it is not
both are not present, there is no risk.followed. Monitoring allows the management to
Definition of Risk as per Guidelines on Riskidentify whether controls are being followed
Management issued by State Bank of Pakistanbefore problems occur. In the same way,
is, "Financial risk in a banking organizationmanagement must review weaknesses identified
is possibility that the outcome of an actionby audits to determine whether related
or event could bring up adverse impacts. Suchinternal controls need revision.Tools for
outcomes could either result in a direct lossMonitoring of RiskManagement Information
of earnings / capital or may result inSystemM.I.S or Management Information System
imposition of constraints on bank's abilityis the collection and analysis of data in
to meet its business objectives. Suchorder to support management's decision with
constraints pose a risk as these could hinderrespect to the achievement of objectives
a bank's ability to conduct its ongoingmentioned in the policies and procedures and
business or to take benefit of opportunitiesthe control of various risks therein.It is
to enhance its business."Types of Risks:Risksthis area i.e. M.I.S, where I.T can play a
are usually defined by the adverse impact onvital and effective role as with the help of
profitability of several distinct sources ofI.T large information may be analyzed
uncertainty. More or less all financialefficiently and with accuracy, so that
institutions have to manage the followingeffective decision may be taken by the
faces  of  risks:1.  Credit  Riskmanagement without the loss of any
time.Asset-Liability Management Committee
2.  Market  Risk(ALCO)In most cases, day-to-day risk
assessment and management is assigned to a
3.  Liquidity  Riskspecialized committee, such as an
Asset-Liability Management Committee (ALCO).
4.  Operational  RiskDuties pertaining to key elements of the risk
management process should be adequately
5.  Country  Riskseparated to avoid potential conflicts of
interest - in other words, a financial
6.  Legal  Risksinstitution's risk monitoring and control
functions should be sufficiently independent
7.  Compliance  Riskfrom its risk-taking functions. Larger or
more complex institutions often have a
8. Reputational RiskBroadly speaking theredesignated, independent unit responsible for
are four risks as per Risk Managementthe design and administration of balance
Guidelines which surround Financial Sectorsheet management, including interest rate
i.e. Credit Risk, Market Risk, Liquidity Riskrisk. Given today's widespread innovation in
and Operational Risk. These risk arebanking and the dynamics of markets, banks
elaborated here under:i. Credit RiskThis isshould identify any risks inherent in a new
the risk incurred in case of a counter-partyproduct or service before it is introduced,
default. It arises from lending activities,and ensure that these risks are promptly
investing activities and from buying andconsidered in the assessment and management
selling financial assets on behalf of others.process.Corporate Governance
This risk is associated with financingPrinciplesCorporate governance relates to the
transactions i.e.:a. Default in repayment bymanner in which the business of the
the  borrower  andorganization is governed, including setting
corporate objectives and a institution's risk
b. Default in obliging the commitment byprofile, aligning corporate activities and
another Financial Institution in case ofbehaviors with the expectation that the
syndicated arrangements.It is the mostmanagement will operate in a safe and sound
critical risk in banking and one that must bemanner, running day-to-day operations within
managed carefully. It is also the risk thatan established risk profile, while protecting
requires the most subjective judgment despitethe interests of depositors and other
constant efforts to improve and quantify thestakeholders. It is defined by a set of
credit decision process.ii. Market RiskMarketrelationships between the institution's
risk is defined as the volatility of incomemanagement, its board, its shareholders, and
or market value due to fluctuations inother stakeholders.The key elements of sound
underlying market factors such as currency,corporate governance in a bank include:a) A
interest rates, or credit spreads. Forwell-articulated corporate strategy against
commercial banks, the market risk of thewhich the overall success and the
stable liquidity investment portfolio arisescontribution of individuals can be
from mismatches between the risk profile ofmeasured.b) Setting and enforcing clear
the assets and their funding. This riskassignment of responsibilities,
involves interest rate risk in all of itsdecision-making authority and
components: equity risk, exchange risk andaccountabilities that are appropriate for the
commodity risk.iii. Liquidity RiskThebank's risk profile.c) A strong financial
liquidity risk is defined as the risk of notrisk management function (independent of
being able to meet its commitments or notbusiness lines), adequate internal control
being able to unwind or offset a position bysystems (including internal and external
an organization in a timely fashion becauseaudit functions), and functional process
it cannot liquidate assets at reasonabledesign with the necessary checks and
prices when required.iv. Operational RiskThisbalances.d) Corporate values, codes of
risk results from inadequacies in theconduct and other standards of appropriate
conception, organization, or implementationbehavior, and effective systems used to
of procedures for recording any eventsensure compliance. This includes special
concerning bank's operations in themonitoring of a bank's risk exposures where
accounting system/information systems.Needconflicts of interest are expected to appear
for Risk Management and Monitoring:There are(e.g., relationships with affiliated
a number of reasons as to why there is soparties).e) Financial and managerial
much emphasis given to Risk Management inincentives to act in an appropriate manner
Financial Sector now a day. Some of them areoffered to the board, management and
listed below: -1. Present structure of jointemployees, including compensation, promotion
stock companies, wherein owners are not theand penalties. (i.e., compensation should be
mangers, hence risks increase; thereforeconsistent with the bank's objectives,
proper tools are required to achieve theperformance, and ethical values).f)
desired  results  by  covering  the  risks.Transparency and appropriate information
flows internally and to the public.Tools
2. The financial sector has come out ofmentioned above can be utilized in
simple  deposit  and  lending  function.identifying and managing different risks in
the following manner:I. Credit RiskIt is
3. The world has become very complex so themanaged by setting prudent limits for
financial  transactions  and  instruments.exposures to individual transaction,
counterparties and portfolios. Credits limits
4. Increase in the number of cross borderare set by reference to credit rating
transactions  which  caries  its  own  risks.established by Credit Rating Agencies,
methodologies established by Regulators and
5.  Emerging  marketsas per Board's direction.- Monitoring of per
party  exposure
6. Terrorism RemittancesRisk monitoring in
financial sector is very crucial and an-  Monitoring  of  group  exposure
inevitable part of risk management. Risk
Monitoring is important in the financial- Monitoring of bank's exposure in
sector due to the following reasons:1. Dealscontingent  liabilities
in  others'  money
-  Bank's  exposure  in  clean  facilities
2.  Direct  stake  of  deposit  holder.
-  Analysis  of bank's exposure product wise
3. Much riskier sector than trading and
manufacturing.- Analysis of concentration of bank's
exposure  in  various  segments  of  economy
4. Previous / Recent problems faced by banks
i.e.  stuck  portfolio  that  is credit risk.- Product profitability
reportsII. MarketFinancial Institutions
5. Bankruptcy of Barings Bank due to shortshould also have an adequate system of
selling  / long position that is market risk.internal controls to oversee the interest
rate risk management process. A fundamental
6. Operational risk does not has immediatecomponent of such a system is a regular,
impact, but important for continuity andindependent review and evaluation to ensure
progress  of  organization.the system's effectiveness and, when
appropriate, to recommend revisions or
7. Appetite of a financial institution toenhancements.Interest rate risk should be
take risk is related with the capital base ofmonitored on a consolidated basis, including
the institute so it caries a huge risk ofthe exposure of subsidiaries. The
over exposure.Components of Risk Managementinstitution's board of directors has ultimate
Frame WorkRisk Management Frame Work has fiveresponsibility for the management of interest
components. First of all risk is Identified,rate risk. The board approves the business
then it is Assessed to classify, seekstrategies that determine the degree of
solution and management, after assessingexposure to risk and provides guidance on the
quick Response and implementation of solutionlevel of interest rate risk that is
and the last phase is Monitoring of the riskacceptable to the institution, on the
management progress and Learning from thispolicies that limit risk exposure, and on the
experience that such problem never occurprocedures, lines of authority, and
again. Whole process is to be wellaccountability related to risk management.
Communicated during the entire process ofThe board also should systematically review
risk management if it is to be managedrisk, in such a way as to fully understand
efficiently.The International Organizationthe level of risk exposure and to assess the
for Standardization (ISO) has defined riskperformance of management in monitoring and
management as the identification, analysis,controlling risks in compliance with board
evaluation, treatment (control), monitoring,policies. Reports to senior management should
review and communication of risk. Theseprovide aggregate information and a
activities can be applied in a systematic orsufficient level of supporting detail to
ad hoc manner. The presumption is thatfacilitate a meaningful evaluation of the
systematic application of these activitieslevel of risk, the sensitivity of the bank to
will result in improved decision-making and,changing market conditions, and other
most likely, improved outcomes.Structure ofrelevant factors.The Asset and Liability
Risk ManagementDepending upon the structureCommittee (ALCO) plays a key role in the
and operations of organization, financialoversight and coordinated management of
risk management can be implemented inmarket risk. ALCOs meet monthly. Investment
different ways. Risk management structuremandates and risk limits are reviewed on a
defines the different layers of anregular basis, usually annually to ensure
organization at which risk is identified andthat they remain valid.Risk Management and
managed. Although there are different layersRisk BudgetsA risk budget establishes the
or level at which risk is managed but theretolerance of the board or its delegates to
are three layers which are common to all.income or capital loss due to market risk
i.e.Risk ManagementFor managing risk thereover a given horizon, typically one year
are certain basic principles which are to bebecause of the accounting cycle.
followed by every organization:1. Corporate(Institutions that are not sensitive to
level  Policiesannual income requirements may have a longer
horizon, which would also allow for a greater
2.  Risk  management  strategydegree of freedom in portfolio management.).
Once an annual risk budget has been
3. Well-defined policies and procedures byestablished, a system of risk limits needs to
senior  managementbe put in place to guard against actual or
potential losses exceeding the risk budget.
4. Dissemination, implementation andThere are two types of risk limits, and both
compliance  of  policies  and  proceduresare necessary to constrain losses to within
the prescribed level (the risk budget).The
5. Accountability of individuals headingfirst type is stop-loss limits, which control
various  functions/  business  linescumulative losses from the mark-to-market of
existing positions relative to the benchmark.
6.  Independent  Risk  review  functionThe second is position limits, which control
potential losses that could arise from future
7.  Contingency  plansadverse changes in market prices. Stop-loss
limits are set relative to the overall risk
8. Tools to monitor risksInstitutions canbudget. The allocation of the risk budget to
reduce some risks simply by researching them.different types of risk is as much an art as
A bank can reduce its credit risk by gettingit is a science, and the methodology used
to know its borrowers. A brokerage firm canwill depend on the set-up of the individual
reduce market risk by being knowledgeableinvestment process. Some of the questions
about the markets it operatesthat affect the risk allocation include the
in.Functionally, there are four aspects offollowing:* What are the significant market
financial risk management. Success dependsrisks  of  the  portfolio?
uponA. A positive corporate culture,No one
can manage risk if they are not prepared to* What is the correlation among these risks?
take risk. While individual initiative is
critical, it is the corporate culture which*  How  many  risk  takers  are  there?
facilitates the process. A positive risk
culture is one which promotes individual* How is the risk expected to be used over
responsibility and is supportive of riskthe course of a year?Compliance with
taking.B. Actively observed policies andstop-loss limits requires frequent, if not
proceduresUsed correctly, procedures aredaily, performance measurement. Performance
powerful tool of risk management. The purposeis the total return of the portfolio less the
of policies and procedures is to empowertotal return of the benchmark. The
people. They specify how people canmeasurement of performance is a critical
accomplish what needs to be done. The successstatistic for monitoring the usage of the
of policies and procedures depends criticallyrisk budget and compliance with stop-loss
upon a positive risk culture.C. Effective uselimits. Position limits also are set relative
of technologyThe primary role technologyto the overall risk budget, and are subject
plays in risk management is risk assessmentto the same considerations discussed above.
and communication. Technology is employed toThe function of position limits, however, is
quantify or otherwise summarize risks as theyto constrain potential losses from future
are being taken. It then communicates thisadverse changes in prices or
information to decision makers, asyields.III. Liquidity RiskThe Basel Committee
appropriate.D. Independence or riskhas established certain quantitative
management professionalsTo get the desiredstandards for internal models when they are
outcome from risk management, risk managersused in the capital adequacy
must be independent of risk taking functionscontext.a. Allocation of capital into various
within the organization. Enron's experiencetypes of business after taking into account
with risk management is instructive. The firmthe operational risks i.e. disruption of
maintained a risk management function staffedbusiness activity, which has especially
with capable employees. Lines of reportingincreased  due  to  excessive  EDP  usage
were reasonably independent in theory, but
less so in practice.Internal ControlsPara oneb. Allocation of the capital is also made
on first page of the 'Guidelines on Internalamongst various products i.e. long term,
Controls' issued by SBP provides:"Internalshort term, consumer, corporate etc.
Control refers to policies, plans andconsidering the risks involved in each
processes as affected by the Board ofproduct and its life cycle to avoid any
Directors and performed on continuous basisliquidity crunch for which gap analysis is
by the senior management and all levels ofmade.  This  is  the  job  of  ALCO
employees within the bank. These internal
controls are used to provide reasonablec. For instance Contingent liabilities not
assurance regarding the achievement ofmore  than  10  times  of  capital,
organizational objectives. The system of
internal controls includes financial,d. Fund based not more than 6 times of
operational and compliance controls."Thecapital
current official definition of internal
control was developed by the Committee ofe. Capital market operations not more than 1
Sponsoring Organization (COSO) of thetime  of  capital
Treadway Commission. In its influential
report, Internal Control - Integratedf. However these limits cannot exceed the
Framework, the Commission defines internalregulations.
control as follows:"Internal control is a
process, effected by an entity's Board ofg.  Parameters  of  controls
Directors, management and other personnel,
designed to provide reasonable assurance-  Regulatory  Requirements
regarding the achievement of objectives in
the following-  Board's  directions
categories: Effectiveness and
efficiency  of  operations.- Prudent practicesFor liquidity management
organizations are compelled to hold reserves
 Reliability of financial reporting.for unexpected liquidity demands. The ALCO
has responsibility for setting and monitoring
 Compliance with applicable laws andliquidity risk limits. These limits are set
regulations.This definition reflects certainby Regulatory Bodies and under Board's
fundamental concepts: Internaldirections keeping in mind the market
control is a process. It is a means to ancondition and past experience.The Basel
end,  not  an  end  in  itself.Accord comprises a definition of regulatory
capital, measures of risk exposure, and rules
 Internal control is effected byspecifying the level of capital to be
people. It is not policy manuals and forms,maintained in relation to these risks. It
but people at every level of an organization.introduced a de facto capital adequacy
standard, based on the risk-weighted
 Internal control can be expected tocomposition of a bank's assets and
provide only reasonable assurance, notoff-balance-sheet exposures that ensures that
absolute assurance, to an entity's managementan adequate amount of capital and reserves is
and board.Internal control should assist andmaintained to safeguard solvency. The 1988
never impede management and staff fromBasel Accord primarily addressed banking in
achieving their objectives. Control must bethe sense of deposit taking and lending
taken seriously. A well-designed system of(commercial banking under US law), so its
internal control is worse than worthlessfocus was credit risk.In the early 1990s, the
unless it is complied with, since theBasel Committee decided to update the 1988
assemblance of control will be likely toaccord to include bank capital requirements
convey a false sense of assurance. Controlsfor market risk. This would have implications
are there to be kept, not avoided. Forfor non-bank securities firms.Thus, the
instance, exception reports should beformula for determining capital adequacy can
followed up. Senior management should set abe illustrated as follows:= Tier
good example about control compliance. ForI + Tier 2 + Tier 3 *- 8%
instance, physical access restrictions to.Risk-weighted Assets + (Market Risk
secure areas should be observed equally byCapital Charge x 12.5)IV. Operational RiskTo
senior management as by juniormanage this risk documented policies and
personnel.Components of Internalprocedures are established. In addition,
ControlsComponents of internal control alsoregular training is provided to ensure that
depend upon the structure of the businessstaffs are well aware of organization's
unit and nature of its operation. The COSOobjective, statutory requirements.- Reporting
Report describes the internal control processof major/ unusual/ exceptional transactions
as consisting of five interrelated componentswith respect to ensuring the compliance of
that are derived from and integrated with thethe principles of KYC and Anti-money
management process. The components arelaundering  measure
interrelated, which means that each component
affects and is affected by the other four.- Analysis of system problemsConclusionFor
These five components, which are theany business to grow and stay in the market
necessary foundation for an effectivemanagement style is a key and Risk management
internal control system, include:I. Controlis basically the management style of managing
Environment,Control environment, anthe risks.It is so important and that State
intangible factor and the first of the fiveBank of Pakistan plans to replace Prudential
components, is the foundation for all otherRegulations with Risk management guidelines,
components of internal control, providingwhich will be adopted by banks according to
discipline and structure and encompassingtheir size and complexity of operations.Risk
both technical competence and ethicalis inherent in every business and every
commitment.II. Risk Assessments,Organizationsorganization has to manage it according to
exist to achieve some purpose or goal. Goals,its size and nature of operation because
because they tend to be broad, are usuallywithout it no organization no organization
divided into specific targets known ascan survive in long run.
objectives. A risk is anything that endangers



1 A B C D 62 63 64 65 66 67 68 69 70 71 72 73 74 75 76 77 78 79 80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 100 101 102 103 104 105 106 107 108 109 110 111 112