Addressing the Risk of the Financial Sector

Risk management is a hot topic in the financial sector, especially in the light of the recent losses of some multinational companies. the British Barings Bank, the collapse of WorldCom and the 9 September incident. With rapid changes in the business environment, increasing competition, developing new products, increasing the complexity of emerging markets, cross-border transactions and transactions, the reorganization of organizations has gained new risk dimensions for financial institutions. Thus, the concept of risk is increasingly important in modern financial society.

By facilitating transactions and providing credit and other financial products, the financial sector is an essential element of private and public development. It is most widely concerned about the bank, stock exchanges and insurers, credit unions, microfinance institutions and money providers. As an effective service provider, the financial sector plays an important role in the entire economy. Various financial institutions in the financial sector include banks, DFIs, microfinance banks, leasing companies, Modarabas, trusts, investment funds, etc.

Today's operating environment requires a systematic and integrated risk management approach [19659002] Risk:

Default-loss components; insecurity and exposure. If both are not present, there is no risk. Determining the risks under the Risk Management Guidelines of the Pakistan State Bank: "The financial risk of a banking organization is that the outcome of an action or event may have adverse consequences. These consequences may either directly result in earnings / capital or restrictions that "Such risks may pose a risk as they may hinder the bank from pursuing ongoing business or take advantage of business enhancement." [19659002] Risk Types:

The adverse impact of the risks on the profitability of multiple uncertainties Define. More or less all financial institutions should address the following risk factors:

1. Credit Risk

2. Market Risk

3. Liquidity risk

4. Operational Risk

5. Country Risk

6. Legal Risks

7. Compliance risk

8. Reputational Risk

Generally speaking, the guidelines for managing the risks to the financial sector, ie credit risk, market risk, liquidity risk and operational risk, represent four risks. These risks were elaborated below:

i. Credit Risk

This is a risky risk for clients defaulting. It comes from crediting, investment activity and the purchase and sale of financial instruments on behalf of others. This risk relates to financing transactions, that is:

. The default value of the borrower's repayment and

b. It is not mandatory to make the obligations of another financial institution mandatory for syndicated agreements

The most important risk of bank risk, and one must be handled with care. This risk, which requires the most subjective judgment, despite continued efforts to improve the borrowing process and to quantify it

ii. Market Risk

Market risk is determined by the volatility of income or market value due to the underlying market factors, such as currency, interest rates or interest rate fluctuations. For commercial banks, the market risk of a stable liquidity investment portfolio derives from differences in risk profile and financing of assets. This risk includes all components of interest rate risk: equity risk, exchange rate risk and commodity risk

(iii) Liquidity risk

Liquidity risk means the risk of being unable to meet its commitments or of eliminating or counteracting an organization's position in a timely manner, as it will not be able to liquidate the assets at a reasonable cost if necessary. 19659002] iv. Operational risk

This risk stems from the insufficiencies in the planning, organization or execution of the procedures for recording events in the accounting system / information system.

Need for Risk Management and Control:

There are several reasons why risk management in the financial sector is so much emphasized every day. Some of them are: –

1. The current structure of public limited companies, where owners are not farmers, therefore the risks are increasing; therefore, appropriate means are needed to achieve the desired results by covering the risks

. Financial sector was created from simple deposit and lending function

3. The world is very complex, so financial transactions and assets

4. Increase the number of cross-border transactions that cover their own risks.

5th Emerging Markets

6. Money Transfers from Terrorism

In the financial sector, risk monitoring is extremely important and an inevitable part of risk management. Risk monitoring is important in the financial sector for the following reasons:

1. Others earn money

2. Direct Deposit of the Depositary

3. A much more risky sector than commerce and manufacturing.

4th Past / Recent Problems Between Banks, ie a Limited Portfolio with Credit Risk

5. Bankruptcy of Barings Bank due to market risk due to short-term sales / long positions

6. Operational risk has no immediate effect but is important for the continuity and progression of the organism

. The appetite of the financial institution that takes the risk is related to the fund's capital base, and thus poses a huge risk to excessive exposure.

Components of the Risk Management Framework

There are five components of risk management framework work. First and foremost, the risk is identified, it is evaluated to classify, search for solution and management after assessing the rapid reaction and execution of the solution and the last phase Monitoring the progress of risk management and learn from this experience that this problem never happens again. The whole process needs to be well communicated throughout the entire risk management process if it is to be effectively addressed.

The International Organization for Standardization (ISO) for risk management is the identification, analysis, evaluation, treatment (control) of risk monitoring, review and communication. These activities can be applied systematically or ad hoc. The presumption that the systematic application of these activities results in better decision making and probably better results

Risk Management Structure

Depending on the structure and operation of the organization, financial risk management can be achieved by different paths. The risk management structure identifies the different layers of the organization where the risk is identified and managed. Although there are different layers or levels of risk management, there are three layers that are common to everyone. ie

Risk Management

There are principles for dealing with risk that each organization must follow:

1. Enterprise Policy Directives

2. Risk Management Strategy

3. Determined Policies and Procedures at Senior Leadership

4. Dissemination, Implementation and Compliance of Policies and Procedures

5. Accountability of individuals subject to different functions / business lines

6. Independent risk assessment function

7. Emergency Plans

8. Tools for Monitoring Risks

Institutions can reduce risks by simply researching them. The bank may reduce its credit risk by knowing borrowers. Brokerage firms can reduce market risk by being aware of their markets.

Functionally, there are four aspects of financial risk management. Success depends

A. A Positive Corporate Culture,

No one can handle the risk if he or she is not willing to take risks. Although the individual initiative is critical, this corporate culture promotes the process. A positive risk culture is the one that promotes individual responsibility and supports risk taking

B. Actively Respected Directives and Procedures

Used correctly, procedures are effective tools for risk management. Policies and procedures are designed to empower people. They determine how people can take the necessary steps. The success of policies and procedures is critically dependent on a positive risk culture.

C. Efficient application of technology

Risk management and communication play a primary role in risk management. Technology is used to quantify or otherwise summarize risks. It then transmits this information to decision-makers.

D. Independence or Risk Management Professionals

In order to achieve the desired outcome of risk management, risk managers must be independent of the risk taking functions within the organization. Enron's risk management experience is instructive. The company maintained its risk management function and was able to work with employees.

Internal Audits

The first paragraph on the first page of the SBP's "Internal Controls Guidelines" provides:

"Internal control involves policies and processes that are subject to and conducted by the Board of Directors management and all levels of employees and internal controls are designed to provide reasonable assurance on the achievement of organizational goals. The system of internal controls includes control of financial, operational and compliance. "

The current official definition of internal control is based on Treadway (COSO) Committee of the Commission's Sponsorship Organization. In a clear report on the internal control – integrated framework, the Commission defines internal control as follows:

"Internal control is a process carried out by the board of directors, management and other personnel of an entity

 Reliability of financial reporting

 Compliance with Applicable Legislation and Regulations

This definition reflects some basic concepts:

 Internal Audit is a Process That Ends It's Not a Self-Purpose Goal

 Internal Audit is performed by people, non-political guidelines and forms, but people within every organization. 19659002]  Internal control is expected to provide reasonable assurance and not absolute assurance to the entity's executive and board.

Internal control should help and never have Controls should be taken seriously.The well-designed internal control system is worse than worthless unless it is met, as the interception of the audit is likely to result in false assurance. Controls should not be avoided. For example, exceptional reports should be followed. The top management should be a good example of compliance with the rules. For example, senior management, like junior staff, should take into account physical access restrictions.

Components of Internal Controls

The components of internal control depend on the structure of the business unit and the nature of its operation. The COSO report describes the internal control process as consisting of five interrelated components that come from the treatment process and are integrated. The ingredients are linked together, which means that each component affects and affects the other four. These five components, which are the necessary bases for an effective internal control system, are:

I. Control environment,

The control environment, the intangible factor, and the first five components, are the basis for all other components of internal control that provide discipline and structure and include both technical competence and ethical commitment. Risk Assessments,

Organizations exist to reach a certain goal. Goals, as they are generally broad, can be divided into specific objectives commonly known as goals. The risk is all that endangers the achievement of a goal. We conduct a risk assessment to determine the relative potential of loss of programs and functions and to create the most cost-effective and effective internal controls

III. Control activities,

Control activities are the structure, policies, and procedures that are designed by the organization so that the identified risks do not hinder the organization's achievement.

Policies, procedures and other elements, such as job descriptions, organizational charts, and supervisory standards, of course, do not only exist for internal audit purposes. These activities are management practices.

IV. Information and Communication, and

Organizations must be able to obtain reliable information for identifying their risks and communicating policies and other information to those who need it. Information and communication, the fourth component of internal control, articulates this factor. Monitoring

Life Changes; internal controls are no exception. Sufficient internal controls may be out of date due to external circumstances. Therefore, the identification of risks, the introduction of policies and procedures and information on control activities should be carried out for higher education practitioners following the implementation of the fifth component of internal auditing.

Even the best internal audit plan will be unsuccessful if they do not follow. Monitoring allows management to identify whether checks are to be made before problems are implemented. In the same way, the management must review the weaknesses identified by the audits to determine whether the related internal controls become unnecessary.

Management Information System

Management Information System

MIS or Management Information System for Collecting and Analyzing Data to Support Management's Decision on Obtaining Goals for Policies and Procedures and Controlling Different Risks

This area, namely MIS, where IT can play a vital and effective role, high IT information can be efficiently and accurately analyzed so that management can make an effective decision without losing it at any time.

Asset Liability Committee (ALCO)

In most cases daily The daily risk assessment and management is assigned to a commission, such as the Liability Insurance Committee (ALCO). Tasks on the key elements of the risk management process should be appropriately separated to avoid potential conflicts of interest, so the financial institution's risk monitoring and control functions should be sufficiently independent of its risk taking functions. Larger or more complex institutions often have a designated, independent unit responsible for planning and managing balance sheet management, including interest rate risk. Given the widespread banking innovation and market dynamics, banks must identify the risks inherent in any new product or service before they are introduced and ensure that these risks are immediately taken into account in the assessment and management process.

[19659002] Corporate governance is aimed at the way the organization operates, including the definition of company and corporate risk profile, aligning corporate activities and behaviors with the expectation that management can safely and reliably run its daily operations within a defined risk profile while protecting the interests of depositors and other stakeholders. Relations between the management of the institution, its board of directors, shareholders and other stakeholders.

One of the key elements of responsible corporate governance in the Bank is the following:

(a) A well-organized corporate strategy that allows total success and individual contribution can be measured

(b) Responsibility, decision-making authority and bank risk profile (19659002) (c) Strong financial risk (including internal and external audit functions) and planning of functional processes with the necessary controls and balances

(d) Corporate Values, Code of Conduct and other Standards for Good Behavior , and the effective systems used to ensure compliance. This includes special monitoring of the bank's exposure to exposures where conflicts of interest are likely to occur (eg Affiliated Affiliates)

(e) Financial and management incentives to offer the body, administration and employees in an appropriate manner, including compensation, promotion and the penalties. (ie compensation must be consistent with the Bank's objectives, performance and ethical values)

(f) Transparency and flow of relevant information to the public and the public

The above tools can be used to identify and manage different risks in the following way :

I. Credit Risk

We deal with the prudence of exposures to individual transactions, customers and portfolios. Credit limit limits were set for credit rating by credit rating agencies, the methodologies established by regulators and to the board of directors.

o Supervision of Group Exposure

o Supervision of Bank Exposure Contingent Liabilities

o Bank Exposure in Clean Facilities

o Analysis of Bank's Exposure Product

o The Bank Concentration of Exposure in Different Business Segments

o Product Productivity Reports

II. Market

Financial institutions should have an adequate internal control system to monitor the interest rate risk management process. An essential element of such a system is a systematic, independent review and evaluation that will ensure the effectiveness of the system and, where appropriate, make suggestions for modifications or improvements.

Interest rate risk shall be aggregated, including the exposure of subsidiaries. The board of directors assumes ultimate responsibility for managing interest rate risk. The Board approves business strategies that determine the degree of risk exposure and provides guidance on the institution's acceptable level of interest rate risk, risk exposure policies, procedures, powers and accountability in relation to risk management. The Management Board should systematically review the risk so that it can fully understand the level of risk exposure and assess management's performance in monitoring and controlling risks, in line with the management policies. Top management reporting should include aggregated information and appropriate level support details that facilitate risk level, bank sensitivity to changing market conditions and substantive evaluation of other relevant factors.

The Asset and Responsibility Committee ALCO plays a key role in overseeing and coordinating market risk management. ALCOs meet each month. Investment Orders and Risk Limits are regularly reviewed, usually reviewed annually to ensure they continue to be valid

Risk Management and Risk Frameworks

The risk budget establishes the margin of tolerance of income or capital loss for the Management Board or its delegates over a given horizon, typically one year due to the accounting cycle. (Institutions that are not sensitive to annual income requirements may provide greater freedom for portfolio management in the longer term.) After establishing the annual risk budget, a risk-limiting system should be introduced to protect against actual or potential losses exceeding the risk budget. There are two types of risks and both are necessary to limit the losses to the required level (risk budget).

The first type is the stop-loss constraints that control cumulative losses from the market's existing positions relative to the reference value. The second is the constraints on positions that control potential losses from future adverse changes in market prices. Stop-loss limits are set against the general risk budget. The division of risk budgets into different types of risks is the same art as science and the methodology used depends on the setting up of individual investment processes. Some of the risk-sharing issues are as follows:

* What are the significant market risk of the portfolio?

* What is the correlation with these risks?

* How many risk takers are there?

* How is expected to be used over a year?

Keeping stop-loss restrictions is frequent if you do not need daily performance metrics. Performance is the overall return on the portfolio, less than the full return on the reference value. Performance Measurement is a critical statistic for monitoring the use of risk budgets and controlling compliance with stop-loss limits. Position limits are also determined in relation to the general risk budget and are subject to the considerations discussed above. However, the function of the position boundaries is to limit the potential losses resulting from future adverse changes in prices or yields

III. Liquidity Risk

The Basel Committee established certain quantitative standards for internal models when used in the capital adequacy context

a. Allocating capital for various types of business after taking account of operational risks, ie disruption of business, which has increased in particular due to excessive EDP use

b. The distribution of capital is based on different products, ie long-term, short-term, consumer, corporate, etc. Products are taken into account taking into account the risks inherent in each product and their life cycle in order to avoid the liquidity crisis for which a gap analysis is made. This is the work of ALCO

. For example, contingent liabilities corresponding to tenfold capital,

d. Up to 6-fold base on capital

e. Capital Market Operations Up to 1 Capital Requirement

f. However, these limit values ​​may not exceed the rules.

g. Control Parameters

o Regulatory Requirements

o Governance Guidelines

o Prudent Practices

Liquidity management organizations are forced to hold reserves for unexpected liquidity needs. ALCO is responsible for establishing and verifying liquidity risk limits. These limits are governed by the governing bodies and the board, keeping in mind market conditions and past experience.

The Basel Convention includes the definition of solvency margin, risk exposures and capital level in relation to these risks. It introduced a de facto capital adequacy standard based on the risk-weighted composition of bank assets and off-balance sheet exposures, which ensures that sufficient capital and reserves are maintained to safeguard solvency. The 1988 Basel Convention was primarily concerned with deposit and lending (commercial banking activities under US law), so the credit risk was the focus of it.

In the early 1990s, the Basel Committee decided on capital requirements for market risks.

= Level I, Level 2 + Level 3 – 8%

Weighted Asset + (Market Risk Capital Fee x 12.5)

IV . Operational Risk

Risk-documented policies and procedures are developed. In addition, they provide regular training to ensure that staff are well-acquainted with the objective statutory requirements of the organization.

o Significant / unusual / exceptional transactions reported by KYC and anti-money laundering measures

o Analysis of System Problems

Source by sbobet

Leave a Reply

Your email address will not be published. Required fields are marked *