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RISK MANAGEMENT
IN COMMERCIALBANKS
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ByBy
Malik DilawarMalik Dilawar
Vice President/PrincipalVice President/Principal
Senior Training Manager, North,Senior Training Manager, North,
UBL Training Centre, sla!a"ad,UBL Training Centre, sla!a"ad,
Pakistan#Pakistan#
Phone$ %%&'()*('+'%-.011#2,Phone$ %%&'()*('+'%-.011#2,
3a4$ %%&'()*('+'*)'*3a4$ %%&'()*('+'*)'*
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5isk !anage!ent "y
co!!ercial "anks (( Ti!e toha!!er o6t the chinks Financial markets the world over have
undergone far-reaching changes in the lastdecade, spurred by deregulation andliberalization, as well as rapid developments incommunication and Internet technologies.Banks in Pakistan have, however, generallynot paid enough attention to the potentialrisks and to evolve mechanisms and systemsto control and manage them in line with theglobal standards and procedures.
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5isk !anage!ent "y
co!!ercial "anks (( Ti!e to
ha!!er o6t the chinks
s the banks no longer operate in a
protected and regulated environment,there is an imperative need for them todevelop and improve their capability tounderstand the changes in their economicenvironment and other circumstances
having a critical bearing on their businessactivities.
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5isk !anage!ent "y
co!!ercial "anks (( Ti!e toha!!er o6t the chinks
!isk management is a comprehensive
process adopted by an organization thatseeks to minimize the adverse effects it ise"posed to due to various factors --economic, political or environmental,
some of them inherent to the business,others unforeseen and une"pected.
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5isk !anage!ent "y
co!!ercial "anks (( Ti!e toha!!er o6t the chinks
Present practices#situationPrevalent at commercial banksre$uires a hard look and call for agreater understanding by bank
managements and boards of therisks involved in their operations.
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What is RISK ? It is the potentia that e!ents e"pe#te$ o%
&ne"pe#te$' (a) ha!e an a$!e%se e**e#t on a
*inan#ia instit&tion+s #apita o% ea%nin,s-
Ris. is inhe%ent in a /&siness an$ *inan#ia
a#ti!ities-
The ,%eate% the RISK asso#iate$ 0ith an
a#ti!it) the ,%eate% potentia to ,ene%ate a
hi,h %et&%n- Ban.s $o ta.e RISKS The /i,,est RISK is
Not Ta.in, A RISK-
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e*initiono* Ris. Mana,e(ent
Ris. Mana,e(ent is the p%o#ess o*
identifying, measuring, monitoring and
controlling%is.s
These *o&% points a%e essentia to %is.
(ana,e(ent
This p%esentation 0i #o!e% the (aini$enti*ie$ %is.s in /an.s an$ $ete%(ine ho0
0e %is.s a%e /ein, (ana,e$-
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I$enti*)in, Ris.s
7here 5isks sho6ld "e denti1ied
Instit&tion50i$eB&siness ines
%o$ts
T%ansa#tions
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Serving the Needs of Depositor
Borrowers and Banks
Co!!ercial Bank
lending/n8est!ent in8ol8es three
parties $
2- The s&ppie%s o* *&n$s The $eposito%8
3- The &se%s o* *&n$s The /o%%o0e%s8
9- A *inan#ia inte%(e$ia%) Ban.8 s
SupplierSupplier
BankBankBorrowerBorrower
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Chaen,e in Ban.in,
:Ban.in, is an a%t o* st%i.in, a
/aan#e /et0een Ris.an$
Re!en&e-;
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T>ICAL BALANCE SEET O@ A BANK
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T>ICAL BALANCE SEET O@ A BANK
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RISK MANAGEMENT
RAGNI!ATINRis. (ana,e(ent is a $e#ent%aiFe$ p%o#ess ,&i$e$ /)
#ent%a) esta/ishe$ poi#ies an$ %&es -Senio% sta**
#o((ittees $e*ine #%e$it #&t&%e an$ esta/ishe$ o!e%apoi#ies an$ %&es-Line (ana,e(ent $esi,ns en$in,
p%o#e$&%es an$ #ont%os %is.-
The%e a%e &s&a) *i!e (ao% o%,aniFation ,%o&ps that
pa%ti#ipate in %is. (ana,e(ent p%o#ess-These ,%o&ps a%e%esponsi/e *o% $e*inin, 'i(pe(entation 'an$Ho% %e!ie0in,
%is. (ana,e(ent poi#ies'%&es an$ p%o#e$&%es 0ithin the
/an.-
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Banking Risk
Ta.in, %is.s #an a(ost /e sai$ to /e the/&siness o* /an. (ana,e(ent-A /an. that is
%&n on the p%in#ipe o* a!oi$in, a %is.s o% as
(an) o* the( as possi/e' 0i /e a sta,nantinstit&tion 'an$ 0i not a$e&ate) se%!e the
e,iti(ate #%e$it nee$s o* its so#iet)-On the
othe% han$ a /an. that ta.es e"#essi!e %is.s o%
#%e$it is (o%e i.e) 'ta.es the( 0itho&t
%e#o,niFin, thei% e"tent o% thei% e"isten#e 0i
s&%e) %&n into $i**i#&t)-
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9ll "6siness in8ol8es so!e type o1 risk and
"anking is no e4ception#
Credit risk is !a:or category o1 risk o1 the
"ank#t occ6rs whene8er there is a possi"ility
that is the c6sto!er cannot !eet contract6alo"ligations to the "ank in ter! o1 $
5 The $ei!e%) o* $o#&(ents o% #o((o$ities
0he%e the /an. /ea%s the 0hoe %is. 05
5 The pa)(ent o* p%in#ipa 'inte%est '*ees o%
#o((issions-
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The o!e%a o/e#ti!e o* Ris. Mana,e(ent is to in#%ease
ente%p%ise !a&e
INCREASE VALUE BY
Providing
AppropriateLeveland
Allocationof Capital
IncreasingReturn on
Capital
ImprovingConsistencyof Earnings
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1
The best way to reach thisobjective is to understandthe fullrisk environment within which you operate...
ExternalEnvironment
;cono!ic
Conditions
Co!petition
Nat6ral Catastrophes
Social/LegalTrends
Political/
5eg6latory
Cli!ate Technology
;4pansion/
Di8ersi1ication
People
C6lt6re
Distri"6tion
Processes
5isk 9ppetite
InternalEnvironment
3inancial 5isk
9sset 5isk
0perational 5isk
Lia"ility 5isk
B6siness 5isk
;8ent 5isk
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and the completeset of strategies that are available to you...
FinancialStrategies
Pricing
Sec6ritisation
Capital
Str6ct6re
Prod6ct Mi4
9sset
9llocation
OperationalStrategies
ncenti8e Progra!s
Technology
nternal Controls
Distri"6tion
Prod6cts
C6sto!er Ser8ice
Market Strategy
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2
and to apply this knowledge
in a holisticrisk management framework, to drive value
Holisticallyanage
Financial andOperational
Ris!s
Optimise Financialand OperationalStrategies
"nderstand InternalandExternal Environment
Capital
Return
Consisten
cy
Increase #alue
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To accomplish all this in a consistent manner, it is necessary to implement a
continual management process
$evelop
%estStrategies
Implement
Strategies
onitor
Performance andEnvironment
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In s&((a%)' Ente%p%ise Ris. Mana,e(ent
Ao0s )o& to $ete%(ine the ne#essa%) #apitae!e' $epo) &nnee$e$ #apita an$ i(p%o!e
%et&%n on #apita
En#o&%a,es p%ope% ao#ation o* #apita to
se,(ents an$ s&ppo%ts pe%*o%(an#e t%a#.in,
%o!i$es a (etho$ *o% ens&%in, that
ente%p%ise o0ne%s %e#ei!e p%ope%
#o(pensation *o% %is.s ass&(e$
Provides Competitive Advantage
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RISKS
MST BE
5 KNOWN
5 NERSTOO5 JANTI@IABLE
5 CONTROLLABLE H ACCETABLE H
BANKABLE
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5S=S 39C;D B> B9N=S
CREIT RISK
MARKET RISK
INTEREST RISKLIJIIT> RISK
OERATIONAL RISK
CONTR> RISKOWNERSI H MANAGEMENT RISK
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CREIT RISK
THE R!" TH#T THE $%&'$R (%$RR$)ER* )&&
+$T %E #%&E T$ RE#- THE E%T (&$#+* /+ER
THE TER0! $1 THE $R'+#& #'REE0E+T (&$#+
#'REE0E+T*.
20$!T 3RT3#& R!" + %#+"+'
2RE4/RE! 0$!T !/%5E3T6E 5/'E0E+T
20/!T %E 0#+#'E 3#RE1/&&-
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MARKET RISK
3H#+'E! + 0#R"ET R#TE! #+ R3E! )&&
0#R #+ $%&'$R7! #%&T- T$ ER1$R0
/+ER THE 3$+TR#3T +E'$T#TE %ET)EE+THE #RTE!.
2+EE! 0$+T$R+' $1 3H#+'E! + R3E!$1
3$00$TE!, RE#& E!T#TE, ET3.
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INTEREST RATE RISK
+TERE!T R#TE R!" ! THE E8$!/RE $1 #+
+!TT/T$+9! 1+#+3#& 3$+T$+ T$ #6ER!E
0$6E0E+T! + +TERE!T R#TE!, )HETHER
$0E!T3 $R )$R&:)E.
2 #+$THER 3RT3#& R!"
2 RE:R3+'; 0!0#T3HE! +EE T$ %E #RE!!E
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2
LIJIIT> RISK
THE R!" TH#T # %#+" )&& %E /+#%&E T$
#33$00$#TE E3RE#!E! + %&TE! $R
T$ 1/+ +3RE#!E! + #!!ET!. !/3H R!"!
#R!E )HE+ THE RER3+' $R 0#T/RTE! $1
#!!ET! $ +$T 0#T3H TH$!E $1 %&TE!.
2 3RT3#& R!"
2 0#T/RT- 0!0#T3HE!
2 %#!E $+ 0#R"ET 3$+T$+! < ER3ET$+!
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OERATIONAL RISK
TIS RISK ARISES @ROM TE LACK O@
E@@ECTIE INTERNAL CONTROLS AN AITING
ROCERES- ARTICLARL> IMORTANT IS
TAT TE BANK SOL AE GOO INTERNAL
CONTROLS
Ris. o* a *ai&%e in the /an.+s p%o#e$&%es
0hethe% *%o( e"te%na #a&ses o% as a %es&t
o* e%%o% o% *%a&$ 0ithin the instit&tion-
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CONTR> RISK
R!" #!!$3#TE )TH THE E3$+$03,
!$3#& #+ $&T3#& E+6R$+0E+T $1 THE
%$RR$)ER7! 3$/+TR-. 3$/+TR- R!" !0$!T ##RE+T )HE+ &E++' T$ 1$RE'+
'$6ER+0E+T!; THER #'E+3E! #+ $THER
3/!T$0ER!.
2 %#+"7! H#6+' '&$%#& RE!E+3E
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OWNERSI RISK
THE R!" TH#T $)+ER! ; !H#REH$&ER!,
RE3T$R! $R !E+$R 0#+#'E0E+T 0'HT %E
/+1T 1$R THER RE!E3T6E R$&E! $R THE-
#RE #3T/#&&- !H$+E!T.
2 #&!$ # 3RT3#& R!"
2 =THE %E!T )#- T$ R$% # %#+" ! T$ $)+ T=
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5S= M9N9?;M;NT@a(iia%isation o* Mana,e(ent 0ithRis.s
I(pe(entation o* Inte%na Cont%osSo&n$ Inte%na A&$it S)ste(
E**i#ient MIS in a#e
Co(petent G%o&p o* Ris. Mana,e%s%o(pt A#tion D Monito%in,
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Ris. J&anti*i#ation
Ris. &anti*i#ation te#hni&es /e#o(in,i(po%tant to $ete%(ine #apita %e&i%e(ents
Mo%e %eian#e on /an.s+ o0n s)ste(s *o%
i$enti*)in, an$ (ana,in, %is.
Not on) &antitati!e aso p%o#esses an$
#&t&%e+ s#%&tin) o* (o$e $esi,n
$ata inte,%it)
%is. (ana,e(ent %eso&%#es
!ai$ation
in$epen$ent a&$it
(ana,e(ent &n$e%stan$in,
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EOSITS IN A BANK
RERESENTS WAT ? :Co((e%#ia Ban.s s&ppo%t a (o&ntain o* RISK
on a sen$e% #apita /ase- The /&. o* thei%ia/iities is %e$ee(a/e at AR an$ onEMAN' 0ith $eposito%s %e,a%$in, thei% (one)as pe%*e#t) sa*e-;
:>et /an. assets a%e s&/e#t to #%e$it %is.'(a%.et %is.' an$ sette(ent %is.- With
inte%nationa en$in,' the%e is *o%ei,n e"#han,e%is. an$ t%ans*e% %is.- Aso the%e is (ana,e(ent%is. an$ %is. o* *%a&$-;
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GENERAL
Man) o* The Ris.s O!e%ap-
Nee$ To Be E!a&ate$ In The Conte"t O*
In$i!i$&a Instit&tion With On5site %esen#e-
E!a&ation o* Ris.s Re&i%es An
n$e%stan$in, o* The Ban.' its C&sto(e%
Mi"' its Assets D Lia/iities An$ The
E#ono(i# An$ Co(petiti!e En!i%on(ent-
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NT;5N9L C0NT50LS RISK RATING S>STEM @OR CREITS
CLOSE MONITORING O@ OERATIONS
COMETENT CREIT MANAGERS
AL CONTROLS
S>STEM TO ST> TE INSTRIAL
AN ECONOMIC EELOMENT @OR
ESTABLISING TARGET AREAS O@INESTMENT
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Reliance on Internal Control &
Once the management system is
in place, supervisors can
determine that the systems areworking properly by testing the
systems. If the systems are
inadequate, the scope of the
inspection can be expanded so
that risks are properly identified,
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Principles of Control
Segregation of duties
Dual control
otation of assignments or duties
!wo weeks continuous vacation
"dequate #ompensation
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NT;5N9L 9UDT S>ST;M IMLEMENTATION O@ INTERNAL
CONTROLS
ROIES SECONAR> RISK REIEW INEENENC-
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O'(ective of Internal Audit
!he overall ob$ective of internalauditing is to assist all members ofmanagement in the effective
discharge of their responsibilities byfurnishing them with ob$ectiveanalysis, appraisals,recommendations and pertinentcomments concerning the activitiesreviewed. !he internal auditor,therefore, should be concerned with
any phase of banking activity
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Inspection Procedures for
Internal Auditors )or!Organi%ational Structure of the "udit
Department
Independence of the "udit &unction
"uditors 'ualifications
"udit Staff 'ualifications#ontent and (tili%ation of the "udit
&requency and Scope Schedule
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MS
AN AEJATE :MIS; ELS IN TIMEL>
IENTI@ICATION O@ RISKS
REORTS ON MATRIT> OR INTEREST
RATE MISMATCES REORTS ON ROBLEM CREITS
REORTS ON CREITS SOWING
ETERIORATING TREN IN RISK RATING
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5S= M9N9?;5S
JALI@IE
OBECTIE
ENO> AEJATE ATORIT>ABILIT> TO CORRECTL> ANAL>SE @OR
CRRENT ACTION AN @TRE
REICTIONS
ROMT IN ACTION
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