cbn finance markets

8/6/2019 CBN Finance Markets

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Financial markets the world over have undergone far-reaching changes in

the last decade, spurred by deregulation and liberalization, as well as rapid

developments in communication and Internet technologies. Financial

institutions have generally not paid enough attention to the potential risks

and to evolve mechanisms and systems to control and manage them in line

with the global standards and procedures.

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Risk management by financial institutions

Time to hammer out the chinks

As the Financial institutions no longer operate in a protected and regulated

environment, there is an imperative need for them to develop and improve

their capability to understand the changes in their economic environment and

other circumstances having a critical bearing on their business activities.


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Risk management is a comprehensive process adopted by an organization

that seeks to minimize the adverse effects it is exposed to due to various

factors -- economic, political or environmental, some of them inherent to the

business, others unforeseen and unexpected.

Present practices/situation Prevalent at financial institutions requires a hard

look and call for a greater understanding by bank managements and boards of

the risks involved in their operations


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What is RISK ?

It is the potential that events expected or unexpected, may have an adverseeffect on a financial institutions capital or earnings.

Risk is inherent in all business and financial activities.

The greater the RISK associated with an activity the greater potential to

generate a high return.

Financial institutions do take RISKS The biggest RISK is Not Taking A

RISK.

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What is RISK ?


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Definition of Risk Management

Risk Management is the process of identifying, measuring, monitoring andcontrollingrisks

These four points are essential to risk management

This presentation will cover the main identified risks in Financial institutions

and determine how well risks are being managed.

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Identifying Risks

Where Risks should be Identified Institution-wide Business lines

Products

Transactions

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Bank lending/Investment involves three parties :o The suppliers of funds (The depositor)

o The users of funds (The borrowers)

o

A financial intermediary (Bank)s

SupplierSupplier BankBank BorrowerBorrower


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Risk management is a decentralized process guided by centrally established

policies and rules .Senior staff committees define credit culture and established

overall policies and rules. Line management designs lending procedures and

controls risk.

There are usually five major organization groups that participate in risk

management process. These groups are responsible for defining

implementation ,and/or reviewing risk management policies, rules and

procedures within the bank.


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Taking risks can almost be said to be the business of bank management. A bank

that is run on the principle of avoiding all risks or as many of them as possible, will

be a stagnant institution ,and will not adequately serve the legitimate credit needs

of its society. On the other hand a bank that takes excessive risks or credit is

more likely, takes them without recognizing their extent or their existence will

surely run into difficulty.


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All business involves some type of risk and banking is no exception.

Credit risk is major category of risk of the bank. It occurs whenever there is a

possibility that is the customer cannot meet contractual obligations to the bank

in term of :

-The delivery of documents or commodities where the bank bears the

whole risk OR

- The payment of principal, interest, fees or commissions.


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The overall objective of Risk Management is to

increase enterprise value

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INCREASE VALUE BY

Providing

AppropriateLeveland

Allocationof Capital

Providing

AppropriateLeveland

Allocationof Capital

IncreasingReturn on

Capital

IncreasingReturn on

Capital

ImprovingConsistencyof Earnings

ImprovingConsistencyof Earnings


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The best way to reach this objective is to understand

the full risk environment within which you operate...

External

Environment

Economic

Conditions

Competition

Natural Catastrophes

Social/Legal

Trends

Political/

Regulatory

Climate Technology

Expansion/

Diversification

People

Culture

Distribution

Processes

Risk Appetite

Internal

Environment

Financial Risk

Asset Risk

Operational Risk

Liability Risk

Business Risk

Event Risk


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and the complete set of strategies that are available to

you...

FinancialStrategies

Pricing

Securitisation

Capital

Structure

Product Mix

Asset

Allocation

OperationalStrategies

Incentive Programs

Technology

Internal Controls

Distribution

Products

Customer Service

Market Strategy

Hiring/Training

Asset Risk

Liability Risk

Business Risk

Event Risk

Financial Risk

Operational Risk


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and to apply this knowledge

in a holisticrisk management framework, to drive value

Holistically

ManageFinancial andOperational

Risks

Holistically

ManageFinancial andOperational

Risks

Optimise Financialand Operational

Strategies

Understand Internaland

External Environment

Cap

ital

Re

turn

Cons

ist

en

cy

Increase Value


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To accomplish all this in a consistent manner, it is necessary to

implement a continual management process

Develop

BestStrategie

s

Develop

BestStrategie

s

ImplementStrategies

ImplementStrategies

Monitor

Performance andEnvironment

Monitor

Performance andEnvironment


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In summary, Enterprise Risk Management:

Allows you to determine the necessary capital level, deploy unneeded capital

and improve return on capital

Encourages proper allocation of capital to segments and supports

performance tracking

Provides a method for ensuring that enterprise owners receive proper

compensation for risks assumed

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Provides Competitive AdvantageProvides Competitive Advantage


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RISKS

MUST BE:

KNOWN

UNDERSTOOD

QUANTIFIABLE

CONTROLLABLE / ACCEPTABLE / BANKABLE

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RISKS FACED BY Financial institutions

CREDIT RISK

MARKET RISK

INTEREST RISK

LIQUIDITY RISK

OPERATIONAL RISK

COUNTRY RISK

OWNERSIP / MANAGEMENT RISK

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THE RISK THAT THE OBLIGOR (BORROWER) WILL NOT BE ABLE TOREPAY THE DEBT (LOAN) UNDER THE TERMS OF THE ORIGINAL

AGREEMENT (LOAN AGREEMENT).

MOST CRITICAL RISK IN BANKING

REQUIRES MOST SUBJECTIVE JUDGEMENT

MUST BE MANAGED CAREFULLY


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CHANGES IN MARKET RATES AND PRICES WILL IMPAIR AN

OBLIGORS ABILITY TO PERFORM UNDER THE CONTRACT

NEGOTIATED BETWEEN THE PARTIES.

NEEDS MONITORING OF CHANGES IN PRICES OF COMMODITIES,

REAL ESTATE, ETC.


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INTEREST RATE RISK IS THE EXPOSURE OF AN INSTITUTION'S

FINANCIAL CONDITION TO ADVERSE MOVEMENTS IN INTEREST RATES,

WHETHER DOMESTIC OR WORLD-WIDE.

ANOTHER CRITICAL RISK

RE-PRICING/ MISMATCHES NEED TO BE ADDRESSED.


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THE RISK THAT A BANK WILL BE UNABLE TO ACCOMMODATE

DECREASES IN LIABILITIES OR TO FUND INCREASES IN ASSETS. SUCH

RISKS ARISE WHEN THE REPRICING OR MATURITIES OF ASSETS DO

NOT MATCH THOSE OF LIABILITIES.

CRITICAL RISK

MATURITY MISMATCHES

BASED ON MARKET CONDITIONS & PERCEPTIONS


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OPERATIONAL RISK

THIS RISK ARISES FROM THE LACK OF EFFECTIVE INTERNAL CONTROLS AND AUDITING

PROCEDURES. PARTICULARLY IMPORTANT IS THAT THE BANK SHOULD HAVE GOOD

INTERNAL CONTROLS

Risk of a failure in the banks procedures whether from externalcauses or as a result of error or fraud within the institution.

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RISK ASSOCIATED WITH THE ECONOMIC, SOCIAL AND POLITICAL

ENVIRONMENT OF THE BORROWERS COUNTRY. COUNTRY RISK IS

MOST APPARENT WHEN LENDING TO FOREIGN GOVERNMENTS/ THEIR

AGENCIES AND OTHER CUSTOMERS.

BANKS HAVING GLOBAL PRESENCE


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THE RISK THAT OWNERS / SHAREHOLDERS, DIRECTORS OR SENIOR

MANAGEMENT MIGHT BE UNFIT FOR THEIR RESPECTIVE ROLES OR THEY

ARE ACTUALLY DISHONEST.

ALSO A CRITICAL RISK

THE BEST WAY TO ROB A BANK IS TO OWN IT


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RISK MANAGEMENT

Familiarisation of Management with Risks

Implementation of Internal Controls

Sound Internal Audit System

Efficient MIS in Place

Competent Group of Risk Managers

Prompt Action & Monitoring

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Risk Quantification

Risk quantification techniques becoming important to determine capital

requirementsMore reliance on Financial institutions own systems for identifying and

managing risk

Not only quantitative; also processes and culture:

scrutiny of model design

data integrity risk management resources validation independent audit management understanding

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DEPOSITS IN A BANK REPRESENTS WHAT ?

financial institutions support a mountain of RISK on a slender capital base.

The bulk of their liabilities is redeemable at PAR and on DEMAND, with

depositors regarding their money as perfectly safe.

Yet bank assets are subject to credit risk, market risk, and settlement risk.

With international lending, there is foreign exchange risk and transfer risk.

Also there is management risk and risk of fraud.

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GENERAL

Many of The Risks Overlap. Need To Be Evaluated In The Context Of Individual Institution With On-site

Presence.

Evaluation of Risks Requires An Understanding of The Bank, its Customer

Mix, its Assets & Liabilities And The Economic And Competitive

Environment.

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INTERNAL CONTROLS

RISK RATING SYSTEM FOR CREDITS

CLOSE MONITORING OF OPERATIONS

COMPETENT CREDIT MANAGERS

DUAL CONTROLS

SYSTEM TO STUDY THE INDUSTRIAL AND ECONOMIC DEVELOPMENT FOR ESTABLISHING TARGET AREAS

OF INVESTMENT

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Once the management system is in place, supervisors can determine that the

systems are working properly by testing the systems. If the systems are

inadequate, the scope of the inspection can be expanded so that risks are

properly identified, quantified and corrective action initiated.

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Reliance on Internal Control ?


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Segregation of duties

Dual control

Rotation of assignments or duties

Two weeks continuous vacation

Adequate Compensation

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Principles of Control


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INTERNAL AUDIT SYSTEM

IMPLEMENTATION OF INTERNAL CONTROLS

PROVIDES SECONDARY RISK REVIEW

INDEPENDENC.

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The overall objective of internal auditing is to assist all members of

management in the effective discharge of their responsibilities by furnishing

them with objective analysis, appraisals, recommendations and pertinent

comments concerning the activities reviewed. The internal auditor, therefore,

should be concerned with any phase of banking activity wherein he can be

any service to management

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Objective of Internal Audit


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Procedures for Internal Auditors WorkOrganizational Structure of the Audit Department

Independence of the Audit Function

Auditors Qualifications

Audit Staff Qualifications

Content and Utilization of the Audit Frequency and Scope Schedule

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MIS

AN ADEQUATE MIS HELPS IN TIMELY IDENTIFICATION OF RISKS

REPORTS ON MATURITY OR INTEREST RATE MISMATCHES

REPORTS ON PROBLEM CREDITS

REPORTS ON CREDITS SHOWING DETERIORATING TREND IN RISK

RATING

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