MANAGING RISK IN FINANCIAL SECTOR

(MS WJEEHA TAHIR)

Special Thanks to :

Madam Rubina Shahid

Submitted by: M Nadeem
M10MBA059 Asad Abbas Raza M10MBA028 M.Shoaib Hanif M10MBA055 Arshad Hussain M10MBA032

Aamir Farzand M10MBA024

Services of Financial Sector: Financial sector provides following services to business households and government Mobilizes funds Provides saving instruments Allocate resources Exerts corporate governance

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.

Need for risk management

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 risk intermediation

RISK INTERMEDIATION
Risk intermediation implies consideration of both the profits and risk associated with banking activities.

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

Market risk
Market risk is the risk that changes in financial market prices this is the chance of breakdown between price of one product and price of instrument used to hedge that price exposure on other. Market Risk also includes Basis Risk.

CREDIT RISK

Credit Risk is a risk which affects the value of banks position when counterparty changes its credit quality. i.e. our asset exhibits positive replacement value. When counterparty defaults bank can loose all the value of an asset or some value can be recovered which is recovery value.

LIQUIDITY RISK
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 appetite for deal on other.

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.

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 destroying a file or entering the wrong value for the parameter input of a model.

M NADEEM

M10MBA059

Structuring and Managing the Risk Management Function in a Bank

Activate Profile Management

RAROC

Risk Analysis

Limit Management

Organization the Risk Management Function : Three-Pillar Framework

Best Practice Infrastructure

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 institutions are moving toward a value-at-risk (VaR) framework which calculates risk in terms of a probabilistic worst case loss.

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

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.

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.

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 a competitive 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 aggregate risk at any level.

M ARSHAD HUSSAIN

M10MBA032

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

Cont
Multitasking High speed Ability to handle extreme market movements Easy integration of new applications/platforms

Information Technology Architecture

The risk management system needs to be supported by an information technology architecture that is employed in all of the companys information process. Banks have many business units, which are engaged in different architecture and support different products.

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.

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).

Tiered Risk Management System

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).

RAO AAMIR FARZAND

M10MBA024

Risk Authorities and Risk Control

Roles And Responsibilities

For best practice the board of directors should approve risk management policy at least once a year. A senior operating committee should be responsible for documenting and enforcing all policies.

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.

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 how it establishes market risk limits. The standard should also establish procedure for approving limit exceptions.

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.

CONT.
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.

SHOAIB HANIF

M10MBA055

Delegation Process For Risk Authorities

The risk management committee should approve the banks 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 its impact in terms of respective risk limits and delegate these limits to a chief risk officers

Cont
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.

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.

Cont

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.

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.

Cont:
The banks 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.

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.