Risk Management

Introduction : Banks in the financial services industry are facing various challenges attributable to increased competition and expansion of diversified business network. With a view to managing various risks in a prudent manner, scheduled banks are hereby follow `Risk Management Guidelines for Banks issued by Bangladesh Bank vide DOS Circular No-02 dt. 15/02/12. Bangladesh Bank advised the banking industry to identify the risk factors associated with their business and to take effective measures in the financial process to minimize and control the risks in the area of lending, internal control, liquidity and treasury management. Risk management guidelines should be treated as supplement to, and not a substitute for, existing core risks guidelines. Banks have to prepare a risk management paper and must place the same in the monthly meeting of the Risk Management Unit. The minutes of the meetings should contain specific decisions based on the analysis/recommendations made in the risk management paper. Banks have to submit risk management papers (hard & soft copies for successive months of each quarter) along with the minutes of the meetings within 10 days of each quarter end to the Department of Offsite Supervision. Bangladesh Bank has already issued sets of guidelines for capital adequacy in accordance with Basel II, including stress testing, and there are the mandatory Core Risk Guidelines which are : i. Internal Control and Compliance Risk ii. Foreign Exchange Risk iii. Credit Risk iv. Asset Liability Management Risk v. Money Laundering Risk vi. Information & Communication Technology Security Risk

Definition of Risk : Risk is the possibility of something unusual, unexpected or

adverse happening. Risk is the potential to loose assets by an unexpected event.

Definition of Risk Management: Risk Management is a process to i dentify,

evaluate/measure, control and monitor major risks inherent in banking business. Objectives of Sound Risk Management : The objectives of a sound risk management is consequences. Principles of Sound Risk Management :
1. Organizational Context: Every organization is affected to varying degrees by various factors in its environment (Political, Social, Legal, and Technological, Societal etc). 2. Involvement of Stakeholders: The risk management process should involve the stakeholders at each and every step of decision making. They should remain aware of even the smallest decision made. 3. Organizational Objectives: When dealing with a risk it is important to keep the organizational objectives in mind. The risk management process should explicitly address the uncertainty. This calls for being systematic and structured and keeping the big picture in mind. 4. Reporting: In risk management communication is the key. The authenticity of the information has to be ascertained. 5. Roles and Responsibilities: Risk Management has to be transparent and inclusive. 6. Early Warning Indicators: Keep track of early signs of a risk translating into an active problem. This is achieved through continual communication by one and all at each level. 7. Review Cycle: Keep evaluating inputs at each step of the risk management process - Identify, assess, respond and review. 8. Supportive Culture: Brainstorm and enable a culture of questioning, discussing. This will motivate people to participate more. 9. Continual Improvement: Be capable of improving and enhancing risk management strategies and tactics.

to identify and analyze risks and manage their

Guidelines on Managing Core Risk in banking: Bangladesh Bank issued the `Risk Management Guidelines for Banks to provide a structured way of identifying and analyzing potential risks and devising and implementing responses appropriate to their impact. This guidelines includes policies and procedures for risk management activities. Policies :

1. Designing organizational structure of Risk Management Unit (RMU) 2. Formulation/Establishing overall risk assessment and management policies; 3. Reviewing and updating all risks on a systematic basis; 4. Setting portfolio objectives and tolerance limits/parameters; 5. Setting and establishing strategies and different models; 6. Developing information system/MIS inflow process and data management capabilities.

Risk Management Process :

1. Collecting all relevant data from different models and information system; 2. Assessing the quality, completeness and correctness of all relevant data; 3. Highlighting risky portfolios and deficiencies; 4. Analyzing data/information through preparation of paper, 5. Identifying, evaluation/measuring, controlling and monitoring major risks, 6. Reviewing market conditions and taking precautionary measures; 9. Analyzing the bank's own resilience capacity; 10. Taking necessary steps to bring the position within limit and also assess and measure volatility of market and vulnerability of investment. Risk Measurement, Monitoring & Management Reporting System. Risk Appetite : Risk appetite is the level and type of risk a bank is able and willing to assume in its exposures and business activities, given its business objectives and obligations to shareholders. It is stated in terms of the potential impact on profitability, capital and liquidity.

Risk Management Unit :

a. Risk Management Committee Banks should have a Risk Management Committee headed by CEO and MD . Senior executives will be the members of the committee. Committee will meet monthly meeting. b. Risk management sub-committee : Bank should have different subcommittees to assess and mitigation the risk in six core risk areas. c. Credit Committee

Role & Responsibilities of the Board and Senior Management:

a. Defining the risk appetite.
b. Designing the organizational structure to manage risk within the bank. c. Understanding the inherent risks of the bank. d. Reviewing and approving risk management policies and re-reviewing at least annually. e. Enforcing and using adequate recordkeeping and reporting systems. f. Reviewing and approving limits and re-reviewing at least annually. g. Monitoring compliance with overall risk management policies and limits.

Capital Management :
a. To define the goals of capital management
b. To prepare a set of policies and internal rules with regard to capital management. c. To integrate capital management into the banks strategic plan. d. To review the policies and specific measures for developing and establishing an adequate capital management system. e. Disseminate the capital management policies throughout the bank. f. To analyze present as well as future capital needs of the bank and adopt suitable capital raising methods. g. To ensure consistency of the capital management system, with the banks risk profile and the competing business environment. h. To set an appropriate level of capital target for the short-term, medium-term and long-term and develop a capital plan to achieve the target.

Risk Management Reporting :

Quarterly Annual Reporting

Capital Management & Relationship with Risk Management .

Role & Responsibilities of Board & Senior Management. Capital Management Unit.

Credit Risk Management Credit Strategy Credit Policy Credit Procedure Delegation of Authority Credit Limits Measuring Credit Risk (CRG) Credit Risk Monitoring & Control Credit Concentration Market Risk Management

Interest Rate Risk Foreign Exchange Risk Foreign Exchange Settlement Risk Equity Price(Share price) Risk Portfolio Concentration Security Analysis

Stress Testing
Stress Testing is a risk management technique used to evaluate the potential effects on an institutions financial condition of a specific event and/or movement in a set of financial variables. It measures the shock absorbing capacity of the bank. Stress Testing shows the effect of shock on capital adequacy. Stress Test ascertains the magnitude of shock in different areas as under: 1. 2. 3. 4. 5. Credit Risk Interest Rate Risk Exchange Rate Risk Equity Price Risk Liquidity Risk

Various Risk factors if turn into reality then what would be the impact on Banks Capital. Three Shocks are anticipated : (i) (ii) (iii) Minor Shock Moderate Shock Major Shock

Parameter of Different shocks :

Sl. Risk Factor Minor Shock Moderate Major No Shock Shock 1. Credit Risk: Increase in NPLs 3% 9% 15% Increase in NPLs due to default of top ten 3 7 10 large borrowers borrowers borrowers borrowers Fall in the forced sale value of mortgage 10% 20% 40% collaterals Negative shift in the NPLs categories 5% 10% 15% Increase of NPLs in particular 2 sectors 3% 9% 15% 2. Interest Rate Risk (change in interest rates) 1% 2% 3% 3. Exchange Rate Risk (change in exchange 5% 10% 15% rates) 4. Equity Price Risk (fall in the stock market 10% 20% 40% index ) 5. Liquidity Risk (excess of banks normal 2% 4% 6% withdrawal)

Liquidity Risk Management

Liquidity Policy, Procedure & Limit Liquidity Management Structure Liquidity Risk Management Process MIS / Periodic Review Contingency Funding Plans

Operational Risk Management

Operational risk is defined as the risk of unexpected losses due to physical catastrophe, technical failure and human error in the operation of a bank, including fraud, failure of management, internal process errors and unforeseeable external events.
Operational Risk Operational strategic risk
The risk of choosing an inappropriate strategy in response to environmental factors, such as Political Government Regulation Taxation Societal Competition, etc.

Operational failure risk

The risk encountered in the pursuit of a particular strategy due to People Process Technology

Operational Risk Management Principles

Operational Risk Management Framework Risk Monitoring Reporting Contingency Planning

Strategic Risk Management

Policies, Procedures & Limit Identification, Measurement & Monitoring MIS Board Oversight Senior Management Oversight Strategic Plan
Strategic risk is the current or prospective risk to earnings and capital arising from adverse business decisions, improper implementation of decisions, or lack of responsiveness to changes in the business environment, both internal and external. Such factors include: a) Competition: A strategic plan and business plan must be in line with current and anticipated future competition. Competitive factors must be taken into consideration in the bank's pricing practices and when developing new products. b) Change of target customers: Changes in demographics and consumer profiles may affect the customer base, earnings and capital funding of a bank. c) Technological changes: A bank may face risks from changing technology because its competitors can develop more efficient systems or services at lower costs. The bank should ensure that the level of technology in use is sufficient to retain its customer base. d)...Economic factors: Global, regional or national economic conditions affect the level of profits of a bank. Thus, continual assessment and monitoring of economic trends and forecasts are needed. e) Regulations: Changes in laws and regulations of the supervisor, tax authorities, local authorities and other authorized agencies may affect the implementation of strategic and business plans established to meet the bank's goals; and may require adjustments to the plans in order to ensure compliance.

Compliance Risk Management

Compliance risk is the current or prospective risk to earnings and capital arising from violations or non-compliance with laws, rules, regulations, agreements, prescribed practices, or ethical standards, as well as from the possibility of incorrect interpretation of effective laws or regulations.

Reputation Risk

Reputation risk may arise from the possibility that negative publicity regarding the bank and its business practices, in the territory or elsewhere through related entities, and whether accurate or not, will adversely impact the operations and position of the bank.

Money Laundering Risk

A definition of what constitutes the offence of money laundering under Bangladesh law is set out in Section 2 (Tha) of the Prevention of Money Laundering Act 2002 (Act No. 7 of 2002) which is reads as follows: "Money Laundering means: (Au) Properties acquired or earned directly or indirectly through illegal means; (Aa) Illegal transfer, conversion, concealment of location or assistance in the above act of the properties acquired or earned directly or indirectly through legal or illegal means;" Management Action : (i) Management fully understands the aspects of AML risk and exhibits strong commitment to compliance; (ii) When deficiencies are identified, management promptly implements meaningful corrective action; (iii) The Board has approved an AML compliance program that includes adequate policies, procedures, controls, and information systems;