RISK MANAGEMENT

BY
M KHYZER BIN DOST
  Risk

 Financial risk in a banking organization is

possibility that the outcome of an action or
event could bring up adverse impacts. Such
impacts could either result in a direct loss of
earnings or suffer the banking activities.
 TYPES OF LOSSES
 Expected losses are those that the bank
knows with reasonable certainty will occur
(e.g., the expected default rate of loans)

 Unexpected losses are those associated with

unforeseen events (e.g. losses experienced
by banks in the aftermath of nuclear tests,
Losses due to a sudden down turn in
economy or falling interest rates)
 RISK MANAGEMENT
 It involves identification, measurement,
monitoring and controlling risks.

 Risk management activities broadly take place

simultaneously at following different hierarchy
levels.
 Strategic level: It encompasses risk management functions
performed by senior management and BOD.
 Macro Level: Risk management activities performed by middle
management or units devoted to risk reviews fall into this category.
 Micro Level: It involves ‘On-the-line’ risk management where risks are
actually created. This is the risk management activities performed by
individuals who take risk on organization’s behalf such as front office and
loan origination functions.
RISK MANAGEMENT FRAMEWORK.
 Clearly defined risk management policies and procedures
covering risk identification, acceptance, measurement,
monitoring, reporting and control.
 A well constituted organizational structure defining
clearly roles and responsibilities of individuals involved
in risk taking as well as managing it. (who reports to
whom)
 There should be an effective management information
system that ensures flow of information from operational
level to top management and a system to address any
exceptions observed. (most volatile structure).
 The framework should have a mechanism to ensure an
ongoing review of systems, policies and procedures for
risk management and procedure to adopt changes.
EFFECTIVE RISK MANAGEMENT
 Integration of Risk Management (should be
linked together not to be done in isolation).
 Business Line Accountability (not the duty of
one department all department must do it at their own)
 Risk Evaluation/Measurement. Until and unless
risks are not assessed and measured it will not be
possible to control risks. Further a true assessment of
risk gives management a clear view of institution’s
standing and helps in deciding future action plan.
 Independent review. (Persons/ Departments
taking risk on management behalf must not be the part
of risk management team)
 Contingency planning (Disaster Management Cell)
 CREDIT RISK
 Credit risk arises from the potential that
an obligor is either unwilling to perform
on an obligation or its ability to perform
such obligation is impaired resulting in
economic loss to the bank.

 Default due to inability or unwillingness of a

customer or counter party to meet
commitments in relation to lending, trading,
settlement and other financial transactions.
 COMPONENTS OF CREDIT RISK
MANAGEMENT
 A typical Credit risk management framework
in a financial institution may be broadly
categorized into following main components.

a) Board and senior Management’s Oversight

b) Organizational structure (Management Study Domain)
c) Systems and procedures for identification,
acceptance, measurement, monitoring and control
risks.
 BOARD AND SENIOR
MANAGEMENT’S OVERSIGHT
 It is the overall responsibility of bank’s Board
to approve bank’s credit risk strategy and
significant policies relating to credit risk and
its management which should be based on
the bank’s overall business strategy.
 Ensure that bank’s overall credit risk consistent with the available
capital.
 Ensure that top management as well as individuals responsible for
credit risk management possess sound expertise and knowledge to
accomplish the risk management function.
 Ensure that the bank implements sound fundamental principles
that facilitate the identification, measurement, monitoring and
control of credit risk.
 SYSTEMS AND PROCEDURES
 the bank must make an assessment of risk
profile of the customer/transaction. This
may include:

a)Credit assessment of the borrower’s industry, and

macro economic factors.
b) The purpose of credit and source of repayment.
c) The track record / repayment history of borrower.
d) Assess/evaluate the repayment capacity of the
borrower.
e) The Proposed terms and conditions.
g) Approval from appropriate authority
 FUNCTIONS OF CREDIT ADMINISTRATION
 Documentation. It is the responsibility of credit administration to ensure
completeness of documentation (loan agreements, guarantees, transfer of
title of collaterals etc) in accordance with approved terms and conditions.
 Credit Disbursement. The credit administration function should ensure
that the loan application has proper approval before entering facility
limits into computer systems.
 Credit monitoring. After the loan is approved and draw down allowed,
the loan should be continuously watched over.
 Loan Repayment. Any exceptions such as non-payment or late payment
should be tagged and communicated to the management. Proper records
and updates should also be made after receipt.
 Maintenance of Credit Files. The credit files not only include all
correspondence with the borrower but should also contain sufficient
information necessary to assess financial health of the borrower and its
repayment performance.
 Collateral and Security Documents. Collateral and Security Documents.
Physical checks on security documents should be conducted on a regular
basis.
 MEASURING CREDIT RISK.
 Business Risk
IndustryCharacteristics
Competitive Position (e.g.
marketing/technological edge)

 Financial Risk
Financial condition (micro and macro)
Profitability
Capital Structure
Present and future Cash flows
 INTERNAL RISK RATING

 Categorizes all credits into various

classes on the basis of underlying
credit quality.
 Analysis of migration of
deteriorating credits and more
accurate computation of future loan
loss provision
 HOW TO ARRIVE AT RATINGS
 Major risk factors include borrowers financial
condition, size, industry and position in the
industry; the reliability of financial statements of
the borrower; quality of management
 Banks may vary somewhat in the particular factors they consider and the weight
they give to each factor.
 The circumstances under which deviations from criteria can take place
 The credit policy should also explicitly narrate the roles of different parties
involved in the rating process.
 The institution must ensure that adequate training is imparted to staff to ensure
uniform ratings
 External ratings and written guidelines/benchmarks serve as input.
 Institutions should take adequate measures to test and develop a risk rating
system prior to adopting one. Adequate validation testing should be conducted
during the design phase
 RATINGS REVIEW

 Continuous monitoring by those who assigned the rating.

The Relationship Managers (RMs) generally have a close
contact with the borrower and are expected to keep an
eye on the financial stability of the borrower. In the event
of any deterioration the ratings are immediately revised
/reviewed. (must review when adverse situation occur)
 Secondly the risk review functions of the bank or business
lines also conduct periodical review of ratings at the time
of risk review of credit portfolio.
 CREDIT RISK MONITORING & CONTROL
 incessant monitoring of individual credits
 overall credit portfolio of the bank
 monitor quality of the credit portfolio on
day-to-day basis and take remedial (proctors,
reactors, defenders) measures as and when
any deterioration occurs.
 The roles and responsibilities of individuals
responsible for credit risk monitoring
 The assessment procedures and analysis techniques
(for individual loans & overall portfolio)
 The frequency of monitoring
 The periodic examination of collaterals and loan
 The frequency of site visits
 The identification of any deterioration in any loan