Post on 12-Jun-2015
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04/13/23 SBP Risk Guidelines 1
Risk Management Guidelines
For Commercial Banks
04/13/23 SBP Risk Guidelines 2
Risk Management Clear understanding Within established limits In line with business strategy and
objectives Expected pay-offs compensates for risks
taken Not minimizing rather optimizing risk reward
trade-off Decisions are explicit and clear Sufficient capital as buffer
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Hierarchy levels Strategic Level
Senior Management (SM) & Board of Directors (BOD) Ascertaining risk appetite Formulating strategy Policies, systems and controls
Macro level Risk manager within business area
Risk review Micro Level
Front office, loan originations function Risk created here
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BOD & SM Oversight Concern and tone must start at the
top Responsibility rest with BOD SM transforms the strategic
direction through policies and procedures
BOD approves the policies Policies and procedure must
communicate down the line Embedded in the organization
culture Material exceptions to be reported
to SM Triggers appropriate corrective
measures BOD to review policies when
deemed necessary
BOD
Division Head1 Division Head2 Division Head3
Unit Head1 Unit Head2 Unit Head3
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Risk Management Framework Scope of risk to be managed
Identification, measurement, monitoring and control
Process/ systems and procedures Management information systems (MIS) Procedure to address deviations
Roles and responsibilities Separate setup like RMC Risk review independent of risk originating role
Ongoing review of policies and procedures
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Risk Evaluation Aggregate exposure of institute
Risk Type Business line Short and Long run impact
Quantitative or qualitative measures quantitative techniques/model, as good as
underlying assumptions the rigor and robustness of analytical methodologies the controls surrounding data inputs and
applications
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Contingency Planning Disaster Recovery Public Relations damage control Litigation strategy Regulatory criticism Plans should be tested for
Appropriateness of response Escalation channels Impact on other parts of institution
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CREDIT RISK MANAGEMENT
Potential that an obligor is either unwilling to
perform on an obligation or its ability to perform such obligation is
impairedresulting in economic loss to the
bank.
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Specific Areas of Oversight Define risk Tolerance
Client segments, products, economic sectors, currency and maturity
Preferred level of diversification Pricing strategy
Risk exposure at prudent levels and consistent with capital
Policy should include Detailed and formalized evaluation process Approval authority at various hierarchy Risk acceptance criteria Credit origination, administration and documentation Guidelines on management of NPL
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Organization Structure Credit Risk Management Committee (CRMC)
Head of credit risk Credit Department Treasury
Responsible for: Implementation of policy Monitor risk and ensure limits compliance Recommend policies to board Decide delegation of powers, standards of loan
collaterals, loan review mechanism, risk concentrations, provisioning and regulatory compliance
Credit Risk Management Department (CRMD) Assists the committee in running day to day oversight.
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Systems and Procedures Banks must make an assessment based on
Borrower industry and economic conditions Purpose for credit and source of re-payment Track record and re-payment history and current capacity Adequacy and enforceability of collaterals Required approvals
Name lending should be discouraged Price to cover economic costs, terms to cover bank
interest Credit use as per intended purpose, conduct
assessment on group basis (where necessary) Syndicate participants must do independent analysis
and review Must not over rely on collaterals
Buffers are considered protection provision
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Systems and Procedures Size of limits should be based on
Strengths of obligor Genuine requirements Economic conditions and Risk tolerance
Impose restrictions if frequent sharing of limits among associated group of companies
Limits should be reviewed at least annually Credit administration unit performs following
Documentation including correspondences Disbursement Monitoring Repayment reminders Collaterals under dual control and fire proof safes with
regular physical checks and insurance coverage
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Systems and Procedures Banks are advised to device internal risk ratings to help
them in Selection, exposure, tenure and price Analysis of migration of deteriorating credits Accurate computation of loan provisions
Corporate and commercial exposures are subject to internal rating Consume/retail loans are subject to scoring models
Risk rating framework may, incorporate Business risk
Industry characteristics Competitive position (marketing/ technological) Management structure and capability
Financial risk Financial condition and Profitability Present and future cash flows
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Systems and Procedures Dedicated remedial process for NPL Specialized work out section improves collection
results Proactive efforts prevent litigation and loan losses Remedial strategies improve repayment capacities
Restructuring Enhancements in limits Reduction in interest rates
These measures need to be applied with caution, so that it does not encourage others to default intentionally
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MANAGING MARKET RISK
Risk that the value of on and off-balance sheet positions of a financial institution will be adversely affected by movements in market rates or prices such as interest rates, foreign exchange rates, equity prices, credit spreads and/or commodity prices resulting in a loss to earnings and capital
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Specific Areas of Oversight Define risk Tolerance
Market risk appetite Ensure prudent risk exposure levels and
are consistent with capital Needs to consider
Economic conditions and its effects Ability to identify and profit in specific
markets Review based on financial results
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Organization Structure The risk management committee (RMC)
Ensure adequate risk management resources Review and approve limits Ensuring the robustness and effectiveness of systems
calculating risk Asset Liability management committee (ALCO)
Observe composition of banks assets and liabilities Required maturity profile Articulate interest rate view and funding policy Evaluate risk in new product launch
The Middle Office – reports to ALCO Treasury operations and resp. risk review on day to day
basis Reporting may vary from simple gap analysis to VaR
modeling Prepare forecast analysis
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Risk Measurement Assess all material risk factors
GAPtimeband = IS (Asset–Liabilities+OBS exposure) If ISA > ISL --> Positive GAP IS Ratio = ISA/ISL
Utilize generally accepted financial concepts Have well documented assumptions and
parameters, clearly under stood at all levels For traded portfolios banks should use
valuation approach. Encouraged to use VaR Models Expected to adopt maturity mismatches,
sensitivity analysis as a minimum
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Risk Measurement Review and validate each step of the process
for Appropriateness of system Accuracy or integrity of data used in risk model Reasonableness of scenarios and assumptions
Set limits based on Trading desk Products Instruments Markets Industries Regions
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MANAGING LIQUIDITY RISK
Potential for loss to an institution arising from either its
inability to meet its obligations or to fund increases in assets as they fall duewithout incurring unacceptable cost or
losses.
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Specific Areas of Oversight Concentrations Deterioration in portfolio credit quality Decline in earnings/ performance Rapid asset growth funded by large volatile
deposit Large OBS exposure Deteriorating 3rd party evaluation about bank Identifying funding markets bank has access to
Nature of those markets Current and future use of those markets Monitor signs of confidence erosion
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Organization Structure
Responsibility should lie with a particular group e.g., ALCO
ALCO should interact frequently with risk managers and strategic planners
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Risk Measurement Timeliness should be preferred over
accuracy Liquidity is affected by large aggregate cash
flows Fund flow analysis and Continuous funding
plan reports Set of policies and procedures to meet funding
in a timely manner and reasonable cost Useful for both short and long term
Should include asset and liability side Asset: liquidate surplus money market assets Liability: Use of SBP discount window
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Risk Monitoring Net deficit or surplus over a time horizon Maturity ladder Liquidity Ratios, in conjunction with more
qualitative information Likelihood of increased withdrawals Decease in credit lines Shortening of term funds
Liability concentration ratio: prevents relying on too few providers/ funding sources
Limit exceptions early indicators of excessive risk
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MANAGING OPERATIONAL RISK
Risk of loss resulting from inadequate or failed
internal processes, people and system or from external
events.
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Risk Assessment Systematically record on individual loss
event Frequency Severity Other related information
Adequacy of counter measures for effectiveness in Reducing the probability of risk Reducing the impact should it occur