Risk Mangmt[1] - Bilal Khalid

8/6/2019 Risk Mangmt[1] - Bilal Khalid

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Project Progress Report

RISK MANAGEMENT IN BANKS

Introduction:

Risk management in banking companies, includes risk identification, risk measurement and risk

assessment. The objective of risk management in banking companies is to reduce the negative

effects of risks that could affect the financial results and capital of banks. Banks are oftenconfronted with banks and other financial institutions with the risks that are mostly of a financial

nature. These institutions must balance these risks as well as returns. Bank has a large consumer

base, and must offer loan products that are reasonable enough. However, if the interest rate on

loan products is very low, the bank suffers losses. In terms of justice, the banks should haveenough amount of capital reserves, but not too much that is missing the return on investment, and

not too little that in itself lead to financial instability and the risk of regulatory non-compliance.

In the past decade has seen significant losses in the banking industry. Companies that wereperforming well suddenly announced large losses due to credit risk which has turned bitter, and

the positions taken in the interest rate, or derivative exposure that may or may not be assumedthat the hedge risk budget. In response to this, it was almost universally started building

commercial banks to raise the level of risk management and control systems.

The purpose of this study is to determine the different risks that can be encountered in the banksand the measures that can be taken to mitigate these risks to some extent as all risks cannot be

avoided. These risks can be divided into six general types such as systematic or market risk,

credit risk and counterparty risk, liquidity risk and operational risk and legal risk. The bankingindustry has long been considered the problem of managing the risks and the need to control four

of the above risks, which constitute most, if not all, of the exposure to risk, i.e., credit, interestrate and foreign exchange and liquidity risk. While they are aware of the dangers of thecounterparty, legal, and they view them as less central to the concerns of the risk is not contained

in the Bank's major activities, namely, those involving its own budget and its core business of

lending and borrowing, and miss all of the bank itself. In many cases, the institution to remove ormitigate the financial risks associated with treatment by sound business practices, and in other

cases, it will shift the risk to other parties through a combination of product design and pricing.

Oldfield and Santomero (1997), has been said that the risks faced by all financial institutions can

be divided into three types of separation, from a management point of view. These are thedangers that can be eliminated or avoided through simple business practices, and the risks that

can be transferred to other participants, and the risks that must be actively managed at the firm

level.

The construction of investment portfolios that benefit from diversification across borrowers and

that reduce the effects of any experience is another another. The implementation of incentive-compatible contracts with the Department of the institution to require that contract staff is held

accountable. This point has been made in a different context by both and Santomero Trester

(1997) and Berger and Udell (1993). In each case, the goal is to get rid of the risks that the


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company was not necessary in the financial services provided, or just to absorb the optimum

amount for a particular type of risk.

There are also some risks that can be eliminated, or at least significantly reduced by the transfer

of technical risks. There is no market in many of the risks borne by the banking company. Bank

Can transfer interest rate risk by-products such as interest rate swaps or other derivatives. It canchange the terms of borrowing for a change in duration. The bank may purchase or sale of

financial claims to diversify or focus on the risks that lead to service its customer base. The

extent to which the understanding the financial risks of the assets created by the company in themarket, can be sold these assets at their fair value.

According to standard economic theory, the company must maximize the value of corporate

managers to maximize the expected profit regardless of the variation around its expected value.

However, there is now a growing literature on the causes of risk management including the latestwork of Stulz (1984), Smith, Smithson and Wolford (1990), and Froot Sharfstein, and Stein

(1993), for example, a few of the more notable contributions. Management banking company

relies on a series of steps to implement risk management system.

Litrature Review:

It seems appropriate to discuss any measures to manage the risk that why these companies do

risk management. According to standard economic theory, it must maximize the value of

corporate managers to maximize the expected profit regardless of the variation around its

expected value. However, there is now a growing literature on the causes of risk managementincluding the latest work of Stulz (1984), Smith, Smithson and Wolford (1990), and Froot

Sharfstein, and Stein (1993), for example, a few of the more notable contributions.

In fact, according to a review of modern risk management in Santomero (1995) lists dozens ofcontributions in the region and at least four distinct justifications provided for active risk

management. These include self interest administrative, and non-linear structure of taxes and the

costs of financial distress, and the presence of capital market imperfections. Any one of thesecompanies justify the concern over the volatility of return, as the book mentioned above

demonstrate. The bank can report the quality of loan portfolio at any time, like Moody's (1996)

and Santomero, Babel (1997) for evidence on the relationship between credit rating and defaultrates.

Generally accepted accounting principles require such monitoring. The credit portfolio is subject

to fair value accounting standards, which emphasized recently by the Financial Accounting

Standards Board (FASB). Requests from commercial banks have loan loss reserve account (acontra asset) by Altman (1993) to discuss the financial accounting standards on both the

standards and methods used to assess the level of the reserve account. Estimating loan losses

accurately report quality of the loan is, in fact, it is very difficult because of the limitedinformation available to the bank in loan losses in the future, and the change in the quality of the

loan with the passage of time. To see how we can use the statistical properties of the time series

evaluations loan to obtain estimates of credit losses, Kim and Santomero (1993) accuratelyrepresents the diminution in market value of credit losses known or estimated. As an industry,

and banks generally sought estimates of the expected loss using the two-step process, including

the possibility of default, and an estimate of the loss given default. Absent from the debate and is

thus far no systematic analysis of the risks contained in the portfolio.


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Traditionally mutual funds and merchant banks have taken them under cosideration of risk

exposure but commercial banking sector did not do so. It seems that this change in the light ofthe large losses that have occurred recently in real estate and similar losses is not too distant past

in the field of petrochemicals. Accordingly, many banks are beginning to develop reports focus,

pointing to the formation of industry in the loan portfolio. This process was initially in a weakposition by the lack of a simple industry index. Recently, however, developed and Moody's

industrial cluster system 34 which can be used to report concentrations. The report refers to the

ratio portfolio by sector, as well as commitments to various industries. Real Estate Investments,have also been reported on geography, while this may not be sufficient to capture the total

geographic concentration, it is a beginning. Investment management community, and is

generally measured concentrations against some indicators of the market, mutual funds and

generally report not only the percentage of absolute concentration of the industry, but also theirpositions relative to market indices and broad. Unfortunately, there is no similar standard to the

loan portfolio. Accordingly, companies must weigh the pros and cons of specialization and focus

by industry group and setting limits on self-exposure in general.

This is usually done with all of the guidelines and limits set by senior management. This report is

not the result of any analytical process to assess the potential losses the negative side, it is a self-assessment of tolerance management, based on the recollections of minutes instead of previous

downturns. In addition, the emergence of portfolio manager to monitor the loan portfolio and the

degree of focus and exposure to both types of concentration of risk should be there.

Most of the organizations focus of the report and also by individual counterparty. To bemeaningful, however, this should be bankwide exposure and include all of the relevant

companies. Not all of these requirements are easily satisfied. For large organizations, it is

necessary to set the key relationship manager to ensure that the overall exposure of banks to aparticular client is captured and monitored. This level of accumulation of data is never easy,

especially across time zones. However, it is needed to report such a relationship to take a

different activity from many parts of the West Bank. Treatment with affiliated companies needsto be collected and maintained in close to real time.

It shows all the different lending. In addition, the current credit lines, both of which uses theopen, must be notified as well. Typically, this type of exposure to credit risk or the report focuses

on both the upper and lower limits so that the value is recorded concentrations just above the

minimum size, lack of exposure to credit risk than one predetermined limits. The monitoring of

the latter, for example, the second method of risk management and by the Credit Committee ofthe relationship as a whole.

On the analytical level, the total risk exposure has increased scrutiny. To do so, however, requirecollection of different types of risks mentioned above. This is accomplished in two distinct,

Salomon Brothers (1993) and Wei and Lee (1995) for the public the most complete information

on the bankers.

a system of risk analysis is RAROC pioneered by Bankers Trust. In this approach, risk is

measured in terms of the volatility of the outcome. Where possible, the estimated frequency

distribution of the proceeds, from historical data, the estimated standard deviation of this


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distribution. Capital is allocated to activities as a function of these risks or measuring volatility.

Then, required a risky position to carry the expected rate of return on capital for a company that

compensates for the additional risks associated with them. Dimensions of each risk in terms ofallocation of loss, and the allocation of capital from the vagaries of the proposed activity, the

risk-pooling and the price is one and the same process.

The second approach is similar to RAROC, but rely less on capital and the allocation system

more on cash flow or earnings effects of the position is fraught with risks implied. This is

referred to as earning at risk in the methodology of the risks mentioned above, when he workedfor the analysis of interest rate risk. When used market values, approaches become identical to

the value at risk exposure of the business. this method can be used to analyze the total firm-level

risk in a manner similar to the system RAROC. Again, the distribution of frequencies can be

estimated from the proceeds of any one type of risk from historical data. The results can then beestimated from the extreme tail of the distribution. Either used in the worst cases, for example,

historical for this purpose, or is one or two of the results, the standard deviation. Because of the

negative consequences associated with any position of danger, restricts the company offered

even in the worst case scenario, the bank does not lose more than a certain percentage of currentincome or market value. Therefore, instead of moving from the volatility of the value of the

capital, this approach goes directly to the effects of current profits from a position fraught withdanger.

This approach, however, it has two shortcomings very clearly. If used the EAR, and the cash

flow to, rather than the market value paid. In any case, it does not directly measure the volatilityof total possible outcomes through the distribution of the prior specifications. Instead, based on a

pre-defined self-risky environments, to push the worst-case scenario. Measures, however,

attempt to address the issue of trade-offs between risk, using a standard methodology to convertthe specific risks of exposure at the corporate level. In addition, it can consider the relevance of

each of the different risks, and the extent of what can, or should be seen as an interview. In

practice, however, most, if not all, of these models do not look at this group of risk as a problemportfolio standard. Instead, they reside on each unit of risk exposure and the total aggregate and

in addition to this is simple.

Type Of Risks The Bank Could Be Faced:

Risks associated with the provision of banking services vary by type of service provided. Of the

sector as a whole, however, risks can be divided into six major types: systematic risk or marketrisk and credit risk and counterparty risk, liquidity risk and operational risk and legal risk.

systematic risk the risk of asset value change associated with systematic factors. Indicated that insome cases, and market risk, which is in fact the words are incorrect to some extent. By its very

nature, it can be covered from this danger, but can not be diversified away completely. In fact,

can be thought of systematic risk and the risk of undiversifiable.

All investors tolerate this type of risk, and the more assets that are owned or claims of that could

change in value due to economic factors and wide. In this way, systemic risk comes in many


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forms. Of the banking sector, however, these are the most troubling, the differences in the

overall level of interest rates and the relative value of currencies.

Because of the bank's dependency on these factors, methodology, and most try to estimate the

impact of these risks, in particular on the methodology of performance, and trying to hedge

against it, and thus reduce the sensitivity to changes in factors undiversifiable. Accordingly, mostof the path of interest rate risk closely. The managers try to measure and manage the Company's

exposure to interest rate differential, although they can not do just that. At the same time, with

the positions of major international banks in the currency closely the risk of foreign exchangeand try to manage, as well as limit, of being subjected to it.

Credit risk arises from the failure/inability of paying back of the borrower. It can be arised from

the inability or unwillingness to perform in the manner that was committed prior to the contract.This can affect the lender holding the loan contract, as well as other lenders to the creditor.

Therefore, the financial situation of the borrower, as well as the current value of any basic

guarantees are of great interest to the bank. The real danger is the deviation of the credit portfolio

performance for its expected value.

Accordingly, credit risk is diversifiable, but it is difficult to eliminate it completely. In addition,the nature of the doctrinal part of this loss is still a problem for creditors in spite of the positive

impact of diversification on the full certainty. This is particularly true for banks that lend in local

markets and those that take on illiquid assets to a large extent. In such cases, it is not credit risk

transfer easily, and accurate estimates of the losses is difficult to obtain.

Counterparty risk comes from the non-performance business partner. May arise from non-

performance of the party's refusal to return to perform because of the presence of adverse pricemovement caused by systematic factors, or from some other restrictions of political or legal is

not anticipated by school administrators. Diversification is a key tool to control the risks

nonsystematic return.

The Counterparty risk such as credit risk, but is generally regarded as a financial risk more

transient . Associated with the trading record of creditor default risk. In addition, failure of thecounterparty for the settlement of trade arising from other factors beyond the problem of credit.

Liquidity riskcan best be described as the risk of a funding crisis The best way to describeliquidity risk is the risk of a funding crisis. While some will include the need to plan for growth

and expansion is not expected of the credit, and risk is considered here is more correctly as

possible to the funding crisis. Inevitably be associated with this case an unforeseen event, such asoff a heavy charge, and loss of confidence, or a national crisis such as the proportion of the

currency crisis.

In any case, risk management centers here on the liquidity facilities and the structure of the

portfolio. Recognize the risk of liquidity lead the West to recognize the same liquidity as an

asset, and portfolio design in the face of liquidity concerns as a challenge.


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Operational risks associated with the problems of accurately processing, settling, and taking orMaking deliveries in the trades in exchange for cash. It also arise in the record-keeping,

processing of system failure and to comply with different rules. In this way, and operating

problems of individual events is possible for small organizations that have well-managedcompany, but it displays the results may be very expensive.

Legal risks are common in the field of contracting and finance separate from the legalconsequences of the credit, and the counterparty, and operational risk. New regulations, and tax

legislation, can put transactions previously established in a dispute even when they were

previously performed by all parties to be adequately and fully able to do in the future. For

example, you may have had a radical environmental regulations real estate values for older properties and impose serious risks to lending institutions in this area.

A second type of legal risk arises from the activities of the Department or institution staff.

Possible fraud and violation of regulations or laws, and other actions leading to the loss, as

shown by recent examples in the savings industry.

All financial institutions are to face all these risks to some extent. Non-core activity, or agencyinvolved in the operational risk in the first place. Because the institutions in this case do not have

the underlying assets in trade and methodology, credit and counterparty risk accumulates directly

to the owner of the assets. If the latter was facing a financial loss, however, is often an attempt to

go to court against the agent in these activities, managers must decide how much of the businessthat arise, how to finance, how to sell, and to what extent the contracting agents. In doing so, one

must weigh both the return and the risks inherent in the portfolio. Managers must measure the

expected profits and assess the wisdom of the various risks mentioned to make sure that theresult achieves the stated goal of maximizing shareholder value.

Type Of Risks Being Measured In The Banks

(working on this)

Risk Mangmt[1] - Bilal Khalid

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