article on risk management
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7/29/2019 Article on Risk Management
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Madam Rubina Shahid
Submitted by:
M Nadeem M10MBA059
Asad Abbas Raza M10MBA028
M.Shoaib Hanif M10MBA055
Arshad Hussain M10MBA032
Aamir Farzand M10MBA024
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Services of Financial Sector:
Financial sector provides following services to business
households and government
Mobilizes funds
Provides saving instruments
Allocate resources
Exerts corporate governance
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RISK MANAGEMENT IN FINANCIAL SECTOR :
Risk is the fundamental element that influences
financial behavior. Risk management within the framework of a
financial institution covers the design and operation of the
system managing risk, the technical modeling within the
system, and the interplay between the internal oversight and
the external regulatory components of the system.
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Banks are engaged in risk shifting activities which require
better expertise and know how so managerial emphasis of
banking has shifted from profit oriented to riskintermediation
RISK INTERMEDIATIONRisk intermediation implies consideration of both the
profits and risk associated with banking activities.
Need for risk management
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Typology of Risk Exposures:
Financial Risks can be divided into :
Market Risk
Credit Risk
Operational Risk
Liquidity Risk
Legal and Regulatory Risk
Human Factor Risk
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Market risk
Market risk is the risk that changes in
financial market prices this is the chance
of breakdown between price of oneproduct and price of instrument used to
hedge that price exposure on other.
Market Risk also includes “Basis Risk”.
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CREDIT RISK
Credit Risk is a risk which affects the value of bank’s
position when counterparty changes its credit
quality. i.e. our asset exhibits positive replacementvalue. When counterparty defaults bank can loose
all the value of an asset or some value can be
recovered which is recovery value.
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It includes:
1) Funding liquidity risk and
2) Trade related risk
Funding liquidity risk mean required amount of cash to roll
over debts and cash requirements.
Trade related risk mean that institution would not be able to
execute transaction at market price because there is an appetitefor deal on other.
LIQUIDITY RISK
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Operational risk :
It refers to losses resulting from inadequate system management failure
and human errors .
Legal risk :
It arises when counterparty loses money on transaction and tries to sue
the bank another aspect in the change in tax laws.Another aspect of regulatory risk is the potential impact of a change in tax law on the market
value of a position.
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Human Factor Risk :
It is a special form of operational risk that
relates to losses resulting from human errors
such as pushing the wrong button or destroyinga file or entering the wrong value for the
parameter input of a model.
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M NADEEM M10MBA059
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LimitManagement
Risk Analysis
RAROC
Activate
Profile
Management
Structuring and Managing the Risk
Management Function in a Bank
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Best PracticeInfrastructure
Organization the Risk Management Function : Three-Pillar
Framework
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Best Practice policies
Should express the objectives of the financial
institution in terms of risk./return targets.
Set risk limits or tolerances for major activities.
Market Risk Policy
Establishes a policy in terms of statistically defined‘worst case’ loss. Most major financial institutionsare moving toward a value-at-risk (VaR) frameworkwhich calculates risk in terms of a probabilistic worstcase loss.
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Operational Risk Policy
Fully understand the business
Responsibility for each business activity has to be clearly
established and communicated
Internal control must be established
Credit Risk Policy
Profitability is only one consideration, the
second being the risk of loan. Policy should specify the extent of
diversification, limits on size etc.
A reporting system to track exposure to
credit risk is required
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Best Practice Methodologies
Risk Measurement Methodology
A full VaR measurement methodology consists intricate types of risk
e.g. credit spreads
Such credit risk policy which calls for measuring credit risk for the
loan book and off-balance sheet derivative approach implemented
for market risk.
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Pricing and valuation Methodology
It is the particularly vital that banks develop appropriate
techniques to differentiate between transactions where prices are
transparent, and those where price is more limited
Accounting for Portfolio Effects
A well designed portfolio risk management approach
enables one “to slice and dice “ risk vertically and horizontally
across an organization to facilitate price of risk.
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Best Practice Infrastructure
The first and most important component of
infrastructure in practical sector is people and they
required right environment and support.
Integrity of data and easily communication should
be ensured which enables the firm to maintain acompetitive advantage
One goal is to have an apple to-apple risk
measurement scheme so that the bank can
compare risk across all the products and aggregaterisk at any level.
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M ARSHAD
HUSSAIN
M10MBA032
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Data and Technology Infrastructure
Key features of an effective risk management systems:
Balance between management control and flexibility
Backup/retrieval capabilities
Comprehensive inclusion of risk
Modularity
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Cont…
Multitasking
High speed
Ability to handle extreme
market movements
Easy integration of new
applications/platforms
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The risk management system needs to be supported by an
information technology architecture that is employed in all of the
company’s information process. Banks have many business units,
which are engaged in different architecture and support different
products.
Information Technology Architecture
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Cont…
The decision of the IT infrastructure should optimize the
exchange of information between each entity with in the
firm.
Organization architectures deals with the responsibilities
necessary to ensure comprehensive information
interchange between parties.
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Cont…
A key task is to organize the necessary management data
into a common format.
The information might be static(contractual details of
transaction) or
Dynamic (market information, e.g. daily closing price).
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Trading institutions select three tired risk management system to
integrate there, Front office
Middle office (handles risk management, monitoring key trades,pricings deals etc) .
Back office ( performs recording the interest amount paid,
maintained tax accounting information).
Tiered Risk Management System
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RAO AAMIR
FARZAND
M10MBA024
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• Roles And Responsibilities
• For best practice the board of directors should approve risk managementpolicy at least once a year.
• A senior operating committee should be responsible for documenting and
enforcing all policies.
Risk Authorities and Risk Control
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Cont…
• AlCO
It is responsible for the delegation of market risk limits to the president and
chief risk officer(CRO) of the bank.
• CRO It is responsible for risk management strategy ,policy, methodology and
overall governance.
• Managers are dependant upon each other when they try to manage risk in
bank.
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Standards For Risk Authorities
Write down the policies and procedures that govern their trading activities
is the best practice.
These policies include how a bank approves new products as well as howit establishes market risk limits.
The standard should also establish procedure for approving limit
exceptions.
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Business Unit Mandate
The format for obtaining approval of a business unit mandate should be
standardized.
First, The managers seeking approval should provide an overview and restate
the key decisions that need to be taken.
Second, The managers should bring every one up to date about the business.
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• The format for obtaining approval of a business unit mandate should be
standardized.
• First, The managers seeking approval should provide an overview and
restate the key decisions that need to be taken.
• Second, The managers should bring every one up to date about the
business.
CONT….
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SHOAIB HANIF M10MBA055
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Delegation Process For Risk Authorities
The risk management committee should approve the bank’s risk
every year and delegate authority to the CEO of the bank.
The risk committee provides a detailed review and approval of each
business unit mandate and it’s impact in terms of respective risk
limits and delegate these limits to a chief risk officers
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Also delegate some responsibilities to the head of global trading.
The head of global trading is responsible for risk and performance of
all trading activities
And in turn delegate the management of limits to the business
manager ,who is responsible for the risk and performance of the
business in turn ,delegates limits to the bank's traders.
Cont…
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Standards For Monitoring Risk
Profit and loss statements should be prepared daily.
There should be timely and meaningful reports to measure compliance to
policy.
It should be clear what a manager must do if his subordinate breach trading
limits.
Stress stimulation should be executed to determine the market changes on P&L.
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Integrity of data must be ensured.
If any limit is breached it should be put in exception
report, with an appropriate explanation and plan of
action to cope with this.
Cont…
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Role of Audit
The role audit is to provide independent assessment of the design and
implementation of the risk management process.
Conclusion of audit should include :
The risk control unit is independent of the business unit.
The internal risk models are utilized by business management.
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The bank’s risk measurement models captures all material risk.
An adequate and effective process exist for:
Risk pricing model and valuation system used by front and back office
personnel.
Documenting the risk management process.
Validation of any significant change in risk management process.
Ensuring the integrity of risk management system
The verification of consistency, timeliness, and reliability of data sources.
Ensuring the accuracy of the valuation and risk transformation calculations.
Cont:
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CONCLUSION
Today, the profitability of a financial institution depends on its ability to price risk
and to hedge its global exposure.
Needs to tailor the vision by identifying user and business needs, and by
defending objectives, deliverables, and benefits.
Next, the managers of the bank need to agree on their organizational
infrastructure.
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