Yanuar Dananjaya, Bsc.

, MM

Analyzing Bank Performance

Managing Risk
Same as other business, goal of bank is to maximize share holder
wealth ==> increase company value

Different from maximizing profit

Value depends on 3 factors: magnitude, timing, discount factor
Discount factor depends on risk
Thus important to minimize risk
Risk: probability that actual is different from expected
Risk management: process to identify, asses, monitor, and control

Chapter 2

risk

Yanuar Dananjaya, Bsc., MM

Analyzing Bank Performance

Managing Risk
6 types of risk relevant t banking:

Chapter 2

Credit risk
Liquidity Risk
Financial Risk
Operational Risk
Reputation Risk
Legal Risk

Yanuar Dananjaya, Bsc., MM

Analyzing Bank Performance

Credit Risk
Likelihood an asset will default

Each asset has different credit risk

Difficult to predict depends on factors outside bank:

Chapter 2

economic condition, firm operating environment, individual

financial condition, etc

Bank evaluate general credit risk by checking:

Historical loss rate on loans
Expected loss in future
How to prepare for the loss

Yanuar Dananjaya, Bsc., MM

Analyzing Bank Performance

Credit Risk (cont)
Historical loss rate:

Gross loan losses: Dollar value of default loan during a

period

Recoveries: Part of gross loan losses that can be

collected

Net losses: gross loan losses recoveries

Net losses does not directly affect NI, it is deducted to

Chapter 2

provision of loan loss

Expected future loss:

By examining the following items:
Past-due loans: payment has been late >30 days. If >90
days, considered Non Performing Loan

Nonaccrual loans: considered problematic and no interest

Yanuar Dananjaya, Bsc., MM

Analyzing Bank Performance

Credit Risk (cont)

Expected future loss:

Total non current loans: past-due loans + nonaccrual
loans

Restructured loans: loan that is re-negotiated on maturity

or interest rate

Classified loans: regulators have forced management to

recognize it as loss

Chapter 2

Preparation for loss:

Provision for loan loss if 100% of noncurrent loans,
bank is fully covered. But reduce NI

Earning coverage of net losses operating income

before tax, security gain/loss, extraordinary items, and

provision of loan loss divided by net loan

Yanuar Dananjaya, Bsc., MM

Analyzing Bank Performance

Credit Risk (cont)

Three additional sources of credit risk:

Lack of loan differsivication loan to same type of
industry, same geographical area, same group, etc

High loan growth historical data does not represent

current situation, new debtor

Chapter 2

Foreign loan exposed to country risk risk related to

a particular country: economic crisis, government
regulation, riot, etc

Yanuar Dananjaya, Bsc., MM

Analyzing Bank Performance

Liquidity Risk

Inability to meet payment in a timely and cost effective way

Happen when bank cannot meet deposit withdrawal or loan
demand

Due to Funding Problem or Market Liquidity Problem

Funding Problem inability to liquidate asset or obtain

adequate funding (from deposit or borrowing)

Market Liquidity Problem inability to sell security

Chapter 2

without significant loss

Liquidity risk measure focus on quality of liquid asset and

ability to borrow fund

Yanuar Dananjaya, Bsc., MM

Analyzing Bank Performance

Quality of Liquid Asset

Ability to convert asset to cash with minimum loss.

Cash does not earn return kept at minimum cannot be
used as liquidity source

Securities are the liquid asset has liquidity risk.

Ability to Borrow

Chapter 2

Depends on equity level and core deposit

Core deposit deposit that is not sensitive to change of
interest rate. Customer choose due to service, location,
personal relation, etc

Yanuar Dananjaya, Bsc., MM

Analyzing Bank Performance

Market Risk

Risk due to change in price of an object

Interest rate risk
Security price risk
Foreign exchange risk
Interest rate Risk
With credit risk, is the highest risk of bank
Measured using earning sensitivity analysis and duration

Chapter 2

analysis

Focus on the effect of interest rate change to asset and

liability, measured the difference

Differentiate rate sensitive/insensitive asset and rate

sensitive/insensitive liability

Yanuar Dananjaya, Bsc., MM

Analyzing Bank Performance

Market Risk

Security price risk

Change in the price of security that a bank hold
Measured by volatility of security price
Foreign exchange risk

Only directly affect banks with asset/liability in different

currency

Measured by net exposure of each currency total

Chapter 2

effect of change of forex rate to a currency

Yanuar Dananjaya, Bsc., MM

Analyzing Bank Performance

Operational Risk

Risk that operating expense differ than expected

Ex: salary cost, processing error, employee and customer
theft and fraud, error on IT system, etc

Risk depends on operating policy and control

Can be differentiated into:
Business Interruption damage or loss of asset, facility,
system, or people

Transaction processing failed/late/incorrect transaction

Chapter 2

settlement

Inadequate information system security data/system is

compromised

Breach in internal control fraud/theft

Reduced by strong internal audit process with follow up procedures

Yanuar Dananjaya, Bsc., MM

Analyzing Bank Performance

Legal and Reputation Risk

Legal Risk unenforceable contracts or lawsuits

Compliance risk problem due to failure to comply with
government regulation

Reputation Risk Negative publicity (can be true or untrue)

By decreasing customer trust or litigation
Reduced mainly by maintaining high standard of law and regulation
understanding among employees

Chapter 2

Off Balance Sheet Risk

Risk due to transaction that currently is not in balance sheet

Will enter balance sheet only after contract is enforced
Dangerous due to invisibility
Ex: loan commitment, swap mediator