Professional Documents
Culture Documents
What is Risk?
Risk, in traditional terms, is viewed as a negative. Websters dictionary, for instance, defines risk as exposing to danger or hazard. The Chinese give a much better description of risk >The first is the symbol for danger, while >the second is the symbol for opportunity, making risk a mix of danger and opportunity.
Risk Management
Risk management is present in all aspects of life; It is about the everyday trade-off between an expected reward an a potential danger. We, in the business world, often associate risk with some variability in financial outcomes. However, the notion of risk is much larger. It is universal, in the sense that it refers to human behavior in the decision making process. Risk management is an attempt to identify, to measure, to monitor and to manage uncertainty.
Enable bank to proactively manage loan portfolios in order to minimize losses and earn an acceptable level of return.
2. Only lend what the Customer has the capacity and ability to repay
Risk Management
.
Strategic
Macro
Micro Level
On-line risk performed by individual who on behalf of bank take calculated risk and manages it at their best, eg front office or loan originators.
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Credit Risk
Credit risk refers to the risk that a counter party or borrower may default on contractual obligations or agreements
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Credit Risk is the risk that the other party to a transaction involving a financial instrument will fail to perform according to the terms & conditions of the contract.
Credit Risk
Market Risk
Operational Risk
Credit Risk
Prudent credit risk management framework for bank ensures strategic fit between business targets, laid-down policy and environment with a view to improve quality of credit decisions & subsequent monitoring of risk assets.
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Type of Capital
Economic Capital (EC) or Risk Capital.
estimate of the level of capital that a firm requires to operate its business Regulatory Capital (RC).
capital that a bank is required to hold by regulators in order to operate Bank Capital (BC)
An
The
CAPITAL
Bank Capital
Economic Capital
Regulatory Capital
Economic Capital is the amount of capital that the firm has put at risk to cover potential losses* under extreme market conditions
* Arising from all kind of risks
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CAPITAL
Unexpected Losses
PROVISIONS
Expected / Known Losses
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Economic Capital
Economic capital acts as a buffer that provides protection against all the credit, market, operational and business risks faced by an institution. EC is set at a confidence level that is less than 100% since it would be too costly to operate at the 100% level.
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Probability
EL
Cost
UL
Economic Capital = Difference 2,000
2,500
Total Loss incurred at x% confidence level
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Risk Appetite
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Comparison
Basel I
Focus on a single risk measure
Basel 2
More emphasis on banks internal methodologies, supervisory review and market discipline Flexibility, menu of approaches. Provides incentives for better risk management Introduces approaches for Credit risk and Operational risk in addition to Market risk introduced earlier. More risk sensitivity
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Objectives
The objective of the New Basel Capital accord (Basel II) is:
1.
2. 3.
4. 5.
To promote safety and soundness in the financial system To continue to enhance complete equality To constitute a more comprehensive approach to addressing risks To render capital adequacy more risk-sensitive To provide incentives for banks to enhance their risk measurement capabilities
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Criteria Minimum Paid Up Capital Requirements for New Entrants/Setting up a new Commercial Bank* Minimum Paid Up Capital Requirement for Foreign Banks commencing business in branch mode with 5 branches Minimum Paid Up Capital Requirement for Foreign Banks commencing business in branch mode with 6 to 50 branches
Requirement
PKR 10 Billion
PKR 3 Billion
PKR 6 Billion PKR 10 Billion by December 2013 To be raised in the following manner PKR 7 Billion by Dec 2010 PKR 8 Billion by December 2011 PKR 9 Billion by December 2012 PKR 10 Billion by December 2013
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Minimum Paid Up Capital Requirements for banks with more than 50 branches
CAMELS-S
31.12.2008
31.12.2009
1&2 3 4 5
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Pillar I
Minimum Capital Requirements
Establishes minimum standards for management of capital on a more risk sensitive basis: Credit Risk Operational Risk Market Risk
Pillar II
Supervisory Review Process
Increases the responsibilities and levels of discretion for supervisory reviews and controls covering: Evaluate Banks Capital Adequacy Strategies Certify Internal Models Level of capital charge Proactive monitoring of capital levels and ensuring remedial action
Pillar III
Market Discipline
Bank will be required to increase their information disclosure, especially on the measurement of credit and operational risks. Expands the content and improves the transparency of financial disclosures to the market.
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Objectives
Continue to promote safety and soundness in the banking system
Market disclosure
What and how should banks disclose to external parties?
Issue
Better align regulatory capital with economic risk Evolutionary approach to assessing credit risk - Standardised (external factors) - Foundation Internal Ratings Based (IRB) - Advanced IRB Evolutionary approach to operational risk - Basic indicator - Standardised - Adv. Measurement
Internal process for assessing capital in relation to risk profile Supervisors to review and evaluate banks internal processes Supervisors to require banks to hold capital in excess of minimum to cover other risks, e.g. strategic risk Supervisors seek to intervene and ensure compliance
Effective disclosure of: - Banks risk profiles - Adequacy of capital positions Specific qualitative and quantitative disclosures - Scope of application - Composition of capital - Risk exposure assessment - Capital adequacy
Principle
Pillar 1
Pillar 2
Pillar 3
Score Card
Standardized Approach Advanced Measurement Approach (AMA)
Standardized Approach
Foundation
Internal Ratings Based (IRB)
Advanced
Standard Model
Internal Model
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Maturity (M)
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Banks
Mortgage
Retail
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Bank Portfolio
Retail Portfolio
Exposure to individual, small business in the form of revolving credits and lines of credit (including credit cards and overdrafts), personal term loans and leases (e.g. instalment loans, auto loans and leases, student and educational loans, personal finance) and small business facilities. To be eligible the total exposure to a single person should not be more than Rs 75 million in case of consumer loans and small business loans. Mortgage loans are not included in this category.
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Loans to individuals for the purchase or construction of residential house / apartment or making improvements in house / apartment / land irrespective of the amount of finance Staff housing finance qualifying as Residential Mortgage Finance be treated as residential mortgage. Other staff loans shall be treated as Retail or in any other categories provided respective requirements are fulfilled.
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Staff Finance
Commitments
The New Regulations require Bank should be able to determine the amount of loan committed by the bank to be disbursed The amount of such committed exposure not yet disbursed by the bank at any cut off date Example may include Running finance line approved for Rs 10 million but current outstanding is Rs 4 million and therefore Rs 6 million is banks commitment not yet disbursed by the bank.
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Commitments
Limit amount Outstanding Un-utilized
Commitment
No commitment
Conditions where un-utilized will not be a commitment Where the bank can unconditionally cancel the limit at any time without notice
Where the limit is automatically cancelable due to deterioration in a borrowers creditworthiness In cases where the above conditions are not present, the un-utilized amount will represent commitment.
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assessments (ratings) Least sophisticated capital calculations; generally highest capital burden
determined inputs of probability of default (PD) and inputs fixed by regulators of loss given default (LGD), exposure at default (EAD) and maturity (M). More risk sensitive capital requirements inputs of PD, LGD, EAD and M Most risk-sensitive (although not always lowest) capital requirements management systems and data
Under Basel II, banks have strong incentive to move to IRB status and reduce capital charges by improving risk management systems
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The minimum capital requirement calculation first Basel Accord, however Credit Risk determined by reference to the public borrower: Min. Capital Requirement = 10% (CAR % Loan amount x credit risk weighting
AA rated corporate risk weighting = 20% CCC rated corporate risk weighting = 150% Unrated corporate risk weighting = 100%
Defining the required Regulatory Capital is objective based solely on the criteria within the Accord
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ECA Scores
0,1
JCR-VIS
AAA AA+ AA AAA+ A ABBB+ BBB BBBBB+ BB BBB+ B BCCC+ and below
Unrated
50%
100%
100%
5,6
150%
6
Unrated
7
Unrated
150%
100%
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PACRA
JCRVIS
Risk Weight
1 2 3 4
S1 S2 S3 S4
Short-Term Rating
Short term rating may only be used for short term claim. Short term issue specific rating cannot be used to riskweight any other claim.
e.g. If there are two short term claims on the same counterparty. 1. Claim-1 is rated as S2 2. Claim-2 is unrated
Claim-1 rated as S2 Claim-2 unrated
Risk -weight
50%
100%
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150%
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8%
Basel II: Risk Sensitive Framework RWA (PSO) = Risk Weight * Total Exposure Amount = 20 % * 10 M =2M 100 % * 10 M = 10 M =12 M
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2 M + 10 M
Customer Title
PAKISTAN STATE OIL DEWAN SALMAN FIBRE LIMITED
Rating
AAA A
Outstanding Balance
100 100 100 100
Risk Weight
20% 50% 100% 150%
Total:
400
320
32.0
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guarantees and credit derivatives must represent a direct claim on the provider
Legal certainty requires: enforceable in all the relevant jurisdictions binding on all the parties
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Banks are allowed to reduce their exposure under that particular transaction by taking into account the risk mitigating effect of the collateral.
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e.g.
Suppose that a Rs 80 M exposure to a particular counterparty is secured by collateral worth Rs 70 M. The collateral consists of bonds issued by an Arated company. The counterparty has a rating of B+. The risk weight for the
counterparty is 150% and the risk weight for the collateral is 50%.
The risk-weighted assets applicable to the exposure using the simple approach is therefore: Risk Adjusted Exposure: (10M*150) +(70M*50%) = 50M
Comprehensive Approach: Assume that the adjustment to exposure to allow for possible future increases in the exposure is +10% and the adjustment to the collateral to allow for possible future decreases in its value is -15%. The new exposure is: 1.1 X 80 (50%*85%* 70) = 58.25 million A risk weight of 150% is applied to this exposure: Risk-adjusted assets = 58.25 X 1.5 =87.375M
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