Реферат: Risk Management Case Study Essay Research Paper
Risk Management Case Study Essay, Research Paper
THE PROBLEM AND THE PLANIncidentals of Authorization and
SubmittalThis study of
risk management recommendations of Turk Eximbank is submitted to Mr. H. Ahmet KILIÇOGLU, General
Manager of Turk Eximbank, on Aprıl 30, 2001.As authorized on February 20, 2001,
the investigation was conducted under the direction of Barış Samana and GÜrkan Kocgar. Objective of Risk Management
RecommendationsThe objective of the study was to define
why risk management was needed in Turk Eximbank and how to adjust the risk
management system at the bank. The plan for achieving this objective involved
first determining the techniques used for risk measurements. This information
will then be used for Turk Eximbank?s risk evaluation process.Use of?
Techniques for Risk MeasurementThe methodology used in this investigation was an obsevational study of
defining the risk measurement techniques and then applying them to Turk
Eximbak?s risk evaluation process, if necessary.Investigations have been made at the Bilkent University Library and
Internet, also we have interwieved with the risk analysts of Turk Eximbank. INTRODUCTIONIn recent years, a number of programs
aimed at enhancing the effectiveness of supervisory process for banks. Although
effective risk management has always been central to safe and sound banking
activities, it has become even more important as new technologies, product
innovation, and the size and speed of financial transactions have changed the
nature of banking markets. In response to these changing market realities,
certain supervisory risk management processes have been refined, while others —
in particular, those that have proven most successful in supervising banks
under a variety of economic circumstances and industry conditions – have been retained.
The objective of a risk-focused examination is to effectively evaluate the
safety and soundness of the bank, including the assessment of its risk
management systems, financial condition, and compliance with applicable laws
and regulations, while focusing resources on the bank?s highest risks. The
exercise of examiner judgment to determine the scope of the examination during
the planning process is crucial to the implementation of the risk-focused
supervision framework, which provides obvious benefits such as higher quality
examinations, increased efficiency, and reduced on-site examiner time.UNDERSTANDING THE BANKThe risk-focused supervision process for
banks involves a continuous assessment of the bank. The understanding of the
bank developed through this assessment enables examiners to tailor the
examination of the bank to its risk profile. Understanding the bank begins with
a review of available information on the bank. In addition to examination
reports and correspondence files, each bank maintains various surveillance
reports that identify outliers when a bank is compared to its peer group. The
review of this information assists examiners in identifying both the strengths
and vulnerabilities of the bank and provides a foundation from which to
determine the examination activities to be conducted. Contact with the organization is
encouraged to improve the understanding of the institution and the market in
which it operates. A pre-examination interview or visit should be conducted as
a part of each examination. Such a meeting gives examiners the opportunity to
learn about any changes to bank management, bank policies, strategic direction,
management information systems, and other activities. Particular emphasis
should be placed on learning about new products or markets into which the bank
has entered. The interview or visit also provides examiner’s with management?s
view of local economic conditions, an understanding of the bank?s regulatory
compliance practices, its management information systems, and its
internal/external audit function. In addition, banks should contact the
state-banking regulator to determine whether they have any special areas of
concern that should be focused on during the examination. RELIANCE ON INTERNAL RISK
ASSESSMENTSInternal audit, loan review, and
compliance functions are integral to a bank’s own assessment of its risk
profile. If applicable, it may be beneficial to discuss with the bank’s
external auditor the results of the most recent audit it has completed for the
bank. Such a discussion gives the examiner the opportunity to review the
external auditor?s frequency, scope and reliance on internal audit findings.
Examiners should consider the adequacy of these functions in determining the
risk profile of the bank and the opportunities to reduce regulatory burden by
testing rather than duplicating the work of these audit functions. Transaction
testing remains a reliable and essential examination technique for use in the
assessment of an institution?s condition. The amount of transaction testing
necessary to evaluate particular activities generally depends on the quality of
the bank’s process to identify, measure, monitor, and control the activity’s
risk. Once the integrity of the management system is verified through testing,
conclusions on the extent of risks within the activity can be based on internal
management assessments of the risks rather than on the results of more
extensive transaction testing by examiners. If, however, initial inquiries into
the risk management system, or efforts to verify the integrity of the system,
raise material doubts as to the system’s effectiveness, then no significant
reliance should be placed on the system and a more extensive series of tests
should be undertaken to ensure that the bank’s exposure to risk from a
particular activity can be accurately evaluated. SCOPE
MEMORANDUMThe scope memorandum is an integral
product in the risk-focused methodology as the memorandum identifies the
central objectives of the on-site examination. The scope memorandum also
ensures that the examination strategy is communicated to appropriate
examination staff. A sample scope memorandum is presented in Appendix – A. This
document is of key importance, as the scope will likely vary from examination to
examination. Examination procedures should be tailored to the characteristics
of each bank, keeping in mind its size, complexity, and risk profile.
Procedures should be completed to the degree necessary to determine whether the
bank?s management understands and adequately controls the levels and types of
risk that are assumed. In addition, the memorandum should address the banking
environment, economic conditions, and any changes that bank management fore
sees that could affect the bank?s condition. A preliminary estimate of staffing
required to perform the examination should also be prepared as part of the
scope memorandum.The key factors that should be addressed
in the scope memorandum include:Preliminary Risk AssessmentThe risks associated with the bank’s
activities should be summarized and based on a review of all available sources
of information on the bank, including but not limited to, prior examination
reports, surveillance reports, correspondence files, and audit reports. The
scope memorandum should include a preliminary assessment of the bank’s
condition and major risk areas that will be evaluated through the examination
process. Summary of the Pre-Examination MeetingThe results of the pre-examination
meeting should be summarized with particular emphasis on the meeting results
that affect examination coverage. Summary of Audit and Internal Control EnvironmentA summary of the scope and adequacy of
the audit environment should be prepared which may result in a modification of
examination procedures initially expected to be performed. Activities that
receive sufficient coverage by the bank’s audit system can be tested through
the examination process. Sufficient audit coverage could result in the
elimination of certain procedures if the audit and internal control areas are
deemed satisfactory.Summary of Examination ProceduresExamination modules have been developed
related to the significant areas reviewed during an examination. The modules
are categorized as being primary or supplemental. The primary modules must be
included in each examination. However, procedures within the primary modules
can be eliminated or enhanced based on the risk assessment or the adequacy of
the audit and internal control environment. The scope memorandum should specifically
detail the areas within each module to be emphasized during the examination
process. In addition, the use of any supplemental modules should be discussed.Summary of Loan ReviewBased on the preliminary risk assessment,
the anticipated loan coverage should be detailed in the scope memorandum. In
addition to stating the percent of commercial and commercial real estate loans
to be reviewed, the scope memorandum should also identify which speciality loan
references to the general loan module are to be completed. The memorandum
should specify activities within the general loan module to be reviewed, as
well as the depth of any speciality reviews.Job StaffingThe staffing for the examination should
be detailed. Particular emphasis should be placed on ensuring appropriate
personnel are assigned to the high risk areas identified in the bank?s risk
assessment.USE OF THE
EXAMINATION MODULESThe state-banking regulator has jointly
developed bank examination modules. This automated format was designed to
define common objectives for the review of important activities within the bank
and to assist in the documentation of examination work. It is expected that
full-scope examinations will include examiners? evaluation of six critical
areas that are necessary to determine the bank?s CAMELS rating. To evaluate
these areas, examiners must perform procedures tailored to fit the risk profile
of the bank. The seven primary examination modules are: Capital Adequacy Earnings Analysis Loan Portfolio Management Liquidity Analysis Management and Internal Control Evaluation Securities Analysis Other Assets and Liabilities There are six supplemental modules that
are available for use if any of these activities present significant risk to
the bank. The supplemental modules are: Electronic Funds Transfer Risk Assessment International Banking Credit Card Merchant Processing Mortgage Banking Electronic Banking Related Organizations In addition, there are ten Loan
References (for specialized lending areas) included in the general Loan
Portfolio Management module. The loan reference modules are: Construction and Land Development Commercial and Industrial Real Estate Residential Real Estate Lending Commercial and Industrial Loans Agricultural Lending Direct Lease Financing Floor Plan Loans Troubled Debt Restructuring Consumer and Check Credit Credit Card Activities The modules establish a three-tiered
approach for the review of a bank?s activities.The first tier is the core
analysis, the second tier is the expanded review, and the final tier is the
impact analysis. The core analysis includes a number of decision factors, which
should be considered collectively, as well as individually when evaluating the
potential risk to the bank. To assist the examiner in determining whether risks
are adequately managed, the core analysis section contains a list of procedures
that may be considered for implementation. Once the relevant procedures are
performed, the examiner should document conclusions in the core analysis
decision factors. Where significant deficiencies or weaknesses are noted in the
core analysis review, the examiner is required to complete the expanded
analysis for those decision factors that present the greatest degree of risk to
the bank. On the other hand, if the risks are properly managed, the examiner
can conclude the review and carry any comments to the report of examination.The expanded analysis provides guidance
to the examiner in determining if weaknesses are material to the bank?s
condition and if they are adequately managed. If the risks are material or
inadequately managed, the examiner is directed to perform an impact analysis to
assess the financial impact to the bank and assess whether any enforcement
action is necessary. The use of modules should be tailored to
the characteristics of each bank based on its size, complexity, and risk
profile. As a result, the extent to which each module should be completed will
vary from bank to bank. One of the features included in the automated format
for the modules allows examiners to select the appropriate procedures in the
modules that address t he area(s) of concern while eliminating unnecessary
procedures. The degree of expected completion of the modules should be
documented in the scope memorandum. The individual procedures presented for
each level are meant only to serve as a guide for answering the decision
factors. Each procedure does not require an individual response and each
procedure may not be applicable at every community bank. Examiners should continue
to exercise discretion in deciding to exclude any items as unnecessary in the
evaluation of the decision factors. Moreover, the listed procedures do not
represent every possible factor to be considered during an examination.
Examiners should reference supervisory and administrative letters for
additional guidance. CREDIT RISKBanks should have methodologies that
enable them to assess the credit risk involved in exposures to individual
borrowers or counter parties as well as at the portfolio level. For more
sophisticated banks, the credit review assessment of capital adequacy, at a minimum, should cover four areas:
risk rating systems, portfolio analysis/aggregation, securitisation / complex
credit derivatives, and large exposures and risk concentrations.Internal
risk ratings are an important tool in monitoring credit risk. Internal risk
ratings should be adequate to support the identification and measurement of
risk from all credit exposures, and should be integrated into an institution?s
overall analysis of credit risk and capital adequacy. The ratings system should
provide detailed ratings for all assets, not only for criticized or problem
assets. Loan loss reserves should be included in the credit risk assessment for
capital adequacy.The analysis
of credit risk should adequately identify any weaknesses at the portfolio
level, including any concentrations of risk. It should also adequately take
into consideration the risks involved in managing credit concentrations and
other portfolio issues through such mechanisms as securitisation programs and
complex credit derivatives. Further, the analysis of counter party credit risk
should include consideration of public evaluation of the supervisor?s
compliance with the Core Principles of Effective Banking Supervision. (Refer to
?Principles for the Management of Credit Risk?, September 2000). (Basel Committee on Banking
Supervision)Credit risk
defined as the chance that a debtor will not be able to pay interest or repay
the principal according to the terms specified in a credit agreement is an
inherent part of banking. Credit risk means that payments may be delayed or
ultimately not paid at all, which can in turn cause cash flow problems and
affect a bank?s liquidity. Despite innovation in the financial services sector,
credit risk is the still the major single cause of bank failures. The reason is
that more than 80 percent of a bank?s balance sheet generally relates to this
aspect of risk management. The three main types of credit risk are as fallows: Personal or consumer risk Corporate or company risk Sovereign or country risk Because of the
potentially terrible effects of credit risk, it is important to perform a
comprehensive evaluation of a bank?s capacity to assess, administer, supervise,
control, enforce and recover loans, advances, guarantees, and other credit
instruments. An overall credit risk management will include an evaluation of
the credit risk management policies and practices of a bank. This evaluation
should also determine the adequacy of financial information received from a
borrower, which has been used by banks as the basis for the extension of credit
and the periodic assessment of inherently changing risk.The review of a
credit risk management function is discussed under the following themes: Credit portfolio management Lending function and operations Credit portfolio management Nonperforming loan portfolio Credit risk management policies Policies to limit or reduce credit
risk Asset classification Loan loss provisioning policy ???? LIQUIDITY
RISKLiquidity is
crucial to the ongoing viability of any banking organization. Banks? capital
positions can have an effect on their ability to obtain liquidity, especially
in a crisis. Each bank must have adequate systems for measuring, monitoring and
controlling liquidity risk. Banks should evaluate the adequacy of capital given
their own liquidity profile and the liquidity of the markets in which they operate. (Refer to ?Sound
Practices for Managing Liquidity in Banking Organizations?, February 2000).
(Basel Committee on
Banking Supervision)Liquidity risk
defined as bank transforms the term of their liabilities to have different
maturities on the asset side of the balance sheet At the same time, banks must
be able to meet their commitments (such as deposits) at the point at which they
come due. The contractual inflow and outflow of funds will not necessarily be
reflected in actual plans and may vary at different times. A bank may therefore
experience liquidity mismatches, making its liquidity policies and liquidity
risk management key factors in its business strategy.Liquidity risk
means that a bank has insufficient funds on hand to meet its obligations. Net
funding includes maturing assets, existing liabilities, and standby facilities
with other institutions. Liquidity risks are normally managed by a bank?s asset
and liability committee, and approach that requires understanding of the
interrelationship between liquidity risk management and interest rate
management, as well as of the impact that repricing and credit risk have on
liquidity or cash flow risk, and vice versa.Liquidity is
necessary for banks to compensate for expected and unexpected balance sheet
fluctuations and to provide funds for growth. It represents a bank?s ability to
efficiently accommodate decreases in deposits and/or to runoff of abilities, as
well as fund increases in a loan portfolio. A bank has adequate liquidity
potential when it can obtain sufficient funds (either by increasing liabilities
or converting assets) promptly and at a reasonable cost. The price of liquidity
is a function of market conditions and the degree to which risk, including
interest rate and credit risk, is reflected in the bank?s balance sheet.??? MARKET RISKThis
assessment is based largely on the bank?s own measure of value-at-risk.
Emphasis should also be on the institution performing stress testing in
evaluating the adequacy of capital to support the trading function. (Refer to
Part B of the ?Amendment to the Capital Accord to Incorporate Market Risks?,
January 1996). (Basel
Committee on Banking Supervision)In contrast to
traditional credit risk, the market risk that banks face does not necessarily
result from the nonperformance of the issuer or seller of instruments or asset.
Market or position risk is a risk that a bank may experience a loss in on ?and
off-balance-sheet positions arising from unfavorable movements in market
prices. It belongs to the category of speculative risk, wherein price movements
can result in a profit or loss. The risk arises not only because market change,
but because of the actions taken by traders, who can take on get rid of those
risks. The increasing exposure of banks to market risk is due to the trend of
business diversification from the traditional intermediary function toward
trading and investment in financial products that provide better potential for
capital gain, but which expose banks to significantly higher risks.? Market risk
results from changes in price of equity instruments, commodities, money, and
currencies. Its major components are therefore equity position risk, interest
rate risk, and currency risk. Each component of risk includes a general market
risk aspect and specific risk aspect, which originates in the specific
portfolio structure of bank. In addition to standard instruments, such as
options, equity derivatives, or currency and interest rate derivatives.? The price
volatility of most assets held in investment and trading portfolios is often
significant. Volatility prevails even in mature markets, though it is much
higher in new or illiquid markets. The presence of large institutional
investors, such as pension funds, insurance companies, or investment funds has
also had an impact on the structure of markets and on market risk.
Institutional investors adjust their large-scale investment and trading
portfolios through large-scale trades, and in markets with rising prices,
large-scale purchases tend to push prices up. Conversely, markets with
downwards trends become more skittish when large, institutional-size blocks are
sold. Ultimately, this leads to a widening of the amplitude of price variances
and therefore to increases market risk. By its very
nature, market risk requires constant management attention adequate analysis. Prudent
managers should aware of exactly how a bank?s market risk exposure relates to
its capital. In recognition of the increasing exposure of banks to market risk,
and to benefit from the discipline that capital requirements normally impose,
the Basel Committee amended the 1988 Capital Accord in January 1996 by adding
specific capital charges for market risk. The capital standards for market risk
were to have been implemented in G-10 countries by end-1997 at the latest. Part
of the 1996 amendment is a set of strict qualitative standards to risk
management process that apply to bank basing their capital requirements on the
results of internal models.Bank
organization of investment, trading, and risk management function follows a
fairly standard format. The necessary projections and quantitative and
qualitative analysis of the economy, including all economic sectors of interest
to a bank, and of securities and money markets are performed internally by
economists and financial analysts and externally by market and industry
experts. This information is communicated through briefing and reports to
traders/security analysts, who are responsible for government securities or a
group of securities in one or more economic sectors. If a bank has large
trading and/or investment portfolios, traders/analysts of groups of securities
may report to a portfolio manager who is responsible for certain types of
securities. The operational responsibility for a bank?s trading or investment
portfolio management is typically assigned to the investment committee or the
treasury team.???????????? INTEREST RATE
RISKThe measurement process should include
all material interest rate positions of the bank and consider all relevant
repricing and maturity data. Such information will generally include: current
balance and contractual rate of interest associated with the instruments and
portfolios, principal payments, interest reset dates, maturities, and the rate
index used forepricing and contractual interest rate ceilings or floors for adjustable-rate
items. The system should
also have well-documented assumptions and techniques.Regardless
of the type and level of complexity of the measurement system used, bank
management should ensure the adequacy and completeness of the system. Because
the quality and reliability of the measurement system is largely dependent on
the quality of the data and various assumptions used in the model, management
should give particular attention to these items. (Refer to ?Principles for
the Management and Supervision of Interest Rate Risk?, January 2001 for
consultation). (Basel
Committee on Banking Supervision)Central Bank and
the state-banking regulator have issued a policy on Interest Rate Risk (Policy
Statement). The Policy Statement provides guidance to bankers on sound interest
rate risk management practices. The procedure follows a multi-level framework
that incorporates the Policy Statement’s guidelines and efficiently allocates
examination resources. Examination scope will vary depending upon each bank’s
interest rate risk management and exposure. The procedures guide examiners
towards a qualitative interest rate risk assessment, rather than a uniform
supervisory measurement. Interest Rate
Risk ConceptsInterest rate
risk is the exposure of a bank’s current or future earnings and capital to
interest rate changes. Interest rate fluctuations affect earnings by changing
net interest income and other interest-sensitive income and expense levels.
Interest rate changes affect capital by altering banks’ economic value of
equity. Economic value of equity represents the net present value of all asset,
liability, and off-balance sheet cash flows. Interest rate movements change the
present values of those cash flows. Economic value of equity estimates the long-term,
expected change to earnings and capital that will result from an interest rate
movement. As financial intermediaries, banks cannot completely avoid interest
rate risk. However, excessive interest rate risk can threaten banks’ earnings,
capital, liquidity, and solvency. IRR has many components, including repricing
risk, basis risk, yield curve risk, option risk, and price risk. Repricing
Risk results from timing differences between coupon
changes or cash flows from assets, liabilities, and off-balance sheet
instruments. For example, long-term fixed rate securities funded by short-term
rate deposits may create repricing risk. If interest rates change, then
deposit-funding costs will change more quickly than the securities’ yield. Basis Risk results from weak correlation between coupon rate changes for
assets, liabilities, and off-balance sheet instruments. For example,
LIBOR-based deposit rates may change by 50 basis points, while Prime-based loan
rates may only change by 25 basis points during the same period. Yield Curve
Risk results from changing rate relationships
between different maturities of the same index. For example, a 30-year Treasury
bond’s yield may change by 200 basis points, but a three-year Treasury note’s
yield may change by only 50 basis points during the same time period. Option Risk results when a financial instrument’s cash flow timing or amount
can change as a result of market interest rate changes. This can adversely
affect earnings or economic value of equity by reducing asset yields,
increasing funding costs, or reducing the net present value of expected cash
flows. For example, assume that a bank purchased a callable bond, issued when
market interest rates were 10 percent, which pays a 10 percent coupon and
matures in 30 years. If market rates decline to eight percent, the bond’s
issuer will call the bond (new debt will be less costly). The issuer
effectively repurchases the bond from the bank. As a result, the bank will not
receive the cash flows that it originally expected (10 percent for 30 years).
Instead, the bank must invest that principal at the new, lower market rate. In addition,
many loan and deposit products contain option risk. For example, many borrowers
can prepay part or their entire loan principal at any time. Also, savings
account depositors may withdraw their funds at any time. Price Risk results from changes in the value of marked-to-market financial
instruments that occur when interest rates change. For example, trading
portfolios, held-for-sale loan portfolios, and mortgage servicing assets
contain price risk. When interest rates decrease, mortgage servicing asset
values generally decrease. Since those assets are marked-to-market, any value
loss must be reflected in current earnings. PROFITABILITYProfitability is
in indicator of a bank?s capacity to carry risk and / or to increase its
capital. Supervisors should welcome profitable banks as contributors to
stability of the banking system. Profitability ratios should be seen in
context, and the cost of free capital should be deducted prior to drawing
assumptions of profitability. Net interest income is not necessarily the
greatest source of banking income and often does not cover the cost of running
a bank. Management should understand on which assets they are spending their
energy, and how this relates to sources of income.A sound banking
system is built on profitable and adequately capitalized banks. Profitability
is a revealing indicator of a bank?s competitive position in banking markets and
of the quality of its management. It allows a bank to maintain a certain risk
profile and provides a cushion against short-term problems. Profitability, in
the form of retained earnings, is typically one of the key sources of capital
generation.The income
statement, a key source of information on a bank?s profitability, reveals the
sources of a bank?s earnings and their quantity and quality, as well as the
quality of the bank?s loan portfolio and the targets of its expenditures.
Income statement structure also indicates a bank?s business orientation.
Traditionally, the major source of bank income has been interest, but the
increasing orientation toward nontraditional business is also reflected in
income statements. For example, income from trading operations, investments,
and fee-based income accounts for an increasingly high percentage of earnings
in banks. This trend implies higher volatility of earnings and profitability.Changes in the structure and stability
of bank?s profits have sometime been motivated by statutory capital
requirements and monetary policy measures, such as obligatory reserves. In
order to maintain confidence in t he banking system, banks are subject to
minimum capital requirements. The restrictive nature of this statutory minimum
capital may cause banks to change their business mix in favor of activities and
assets that entail a lower capital requirement. However, although such assets
carry less risk, they may earn lower returns.Taxation is
another major factor that influences a bank?s profitability, as well as its
business and policy choices, because it affects the competitiveness of various
instruments and different segments of the financial markets.A thorough
understanding of profit sources and changes in the income profit structure of
both an individual bank and the banking system as a whole is important to all
key players in the risk management process. Supervisory authorities should, for
example, view bank profitability as an indicator of stability and as a factor
that contributes to depositor confidence. Maximum sustainable profitability
should therefore be encouraged, since healthy competition for profits is an
indicator of an efficient and dynamic financial system.Ratios must be
used with judgment and caution, since they alone do not provide complete
answers about the bottom line performance of the banks. In the short run, many
tricks can be used to make bank ratios look good in relation to industry
standards. An assessment of the operations and management should therefore be
performed to provide a check on profitability ratios.Asset /
liability management has become an almost universally accepted approach to risk
management. Since capital and profitability are intimately linked, the key
objective of asset / liability management is to ensure sustained profitability
so that a bank can maintain and augment its capital resources. An analysis of
the interest margin of a bank can highlight the effect of current interest rate
patterns, while a trend analysis over a longer period of time can show the
effect of monetary policy on the profitability of the banking system. It can
also illustrate the extent to which banks are exposed to changes in interest
rates.CAPITAL
ADEQUACYCapital is
required as a buffer against unforeseen losses. Capital cannot be a substitute
for good management. A strong core of permanent capital is needed, supplemented
by loans or other temporary forms of capital. The Basel Accord currently allows
for three tiers of capital, the first two measuring credit risk related to on
and off balance sheet activities and derivatives, and the third for overall
assessment of market risk.An 8 percent
capital adequacy requirement must be seen as a minimum. However, a 15 percent
risk weighted capital adequacy requirement is more appropriate in transitional
or volatile environments.The board of
directors of the banks? has a responsibility to project capital requirements to
determine if current growth and capital retention are sustainable.Almost every
aspect of banking is either directly or indirectly influenced by the
availability and/or the cost of capital. Capital is one of the key factors to
be considered when the safety and soundness of a bank is assessed. An adequate
capital base serves as a safety net for a variety of risks to which an
institution is exposed in the course of its business. Capital absorbs possible
losses, and thus provides a basis for maintaining confidence in a bank. Capital
is also the ultimate determinant of a bank?s lending capacity. A bank?s balance
sheet cannot be expanded beyond the level determined by its capital adequacy
ratio. Consequently, the availability of capital determines the maximum level
of assets.The key purposes
of capital are to provide stability and to absorb any losses, thereby providing
a measure of protection to depositors and other creditors in the event of
liquidation. As such, the capital of a bank should have three important
characteristics: It must be permanent It must not impose mandatory fixed
charges against earnings and It must allow for legal
subordination to the rights of depositors and other creditors. Capital
Adequacy requirements:The minimum
risk-based standard for capital adequacy was set by the Basel Accord at 8
percent of risk-weighted assets, of which the core capital element should be at
least 4 percent. If a bank is also exposed to market risk, the adjustment for
the market risk is added by multiplying the measure of market risk by 12.5 and
adding the resulting figure to the sum of risk-weighted assets compiled for the
credit risk purposes. The capital ratio is then calculated in relation to the
sum of the two, using as numerator only eligible capital. Tier 3 capital is
eligible only if it is used to support the market risk.The quality of a
bank’s assets must also be mentioned in the capital adequacy context. A bank’s
capital ratios can be rendered meaningless or highly misleading if asset
quality is not taken into account. BALANCE SHEET
STRUCTUREThe composition
of a bank’s balance sheet assets and liabilities is one of the key factors that
determine the risk level faced. Growth in the balance sheet and resulting
changes in the relative proportion of assets or liabilities impact the risk
management process. Monitoring key balance sheet components may alert the
analyst to negative trends in relationship between asset growth and capital
retention capability. Balance sheet structure lies at the heart of the asset /
liability management process. Asset / liability management, comprises strategic
planning and implementation and control process that affect the volume, mix,
maturity, interest rate sensivity, quality and liquidity of a bank’s assets and
liabilities. CURRENCY RISK?????? Currency risk
results from changes in exchanges rates between a bank?s domestic currency and
other currencies. It is a risk of volatility due to a mismatch, and may cause a
bank to experience losses as a result of adverse exchange rate movements during
a period in which it has an open on-or off-balance-sheet position, either spot
or forward, in an individual foreign currency. In recent years, a market
environment with freely floating exchange rates has practically become the
global norm. This has opened the doors for speculative trading opportunities
and increased currency risk. The relaxation of exchange controls and the
liberalization of cross-border capital movements have fueled a tremendous in
international financial markets. The volume and growth of global foreign
exchange trading has far exceeded the growth of international trade and capital
flows, and has contributed to greater exchange rate volatility and therefore
currency risk.?Currency risk arises from a mismatch between
the value of assets and that of capital and liabilities denominated in foreign
currency (or vice versa) or because of a mismatch between foreign receivables
and foreign payables that are expressed in domestic currency. Such mismatches
may exist between both principal and interest due. Currency risk is of a
speculative nature and can thereby result in a gain or a loss, depending on the
direction of exchange rate shift and whether a bank is net long or net short in
the foreign currency. For instance, in the case of a net long position in
foreign currency, domestic currency depreciation will result in a net gain for
a bank, while appreciation will produce a loss. Under a net short position,
exchange rates movements will have the opposite effect.In principle,
the fluctuations in the value of domestic currency that create currency risk
result from changes in foreign and domestic interest rates that are, in turn,
brought about by differences in inflation. Fluctuations such as these are
normally motivated by macroeconomic factors and are manifested over relatively
long periods of time, although currency market sentiment can often accelerate
recognition of the trend. Other macroeconomic aspects that affect the domestic
currency value are the volume and direction of a country?s trade and capital
flows. Short-term factors, such as expected or unexpected political events,
changed expectations on the part of market participants, or speculation-based
currency trading, may also give rise to currency changes. All these factors can
affect supply and demand for a currency and therefore the day-to-day movements of
the exchange rate in currency markets. In practical terms, currency risk
comprises the following:Transaction
risk, or the price based impact of exchange rate
changes on foreign receivables and payables.Economic or
business risk related to the impact of exchange
rate changes on a country?s long term or company?s competitive position. Such
as, a depreciation of the local currency may cause a decline in imports and
growth of exports.Revaluation
risk or translation risk arises when a bank?s
foreign currency positions are revalued in domestic currency, or when a parent
institution conduct financial reporting or periodic consolidation of financial
statements. ?RISK
MEASUREMENT METHOD VaR (Value at
Risk) The general
approaches to VaR computation have fallen into three classes called parametric,
historical simulation, and Monte Carlo. Parametric VaR is most closely tied to
MPT, as the VaR is expressed as a multiple of the standard deviation of the
portfolio’s return. Historical simulation expresses the distribution of
portfolio returns as a bar chart or histogram of hypothetical returns. Each
hypothetical return is calculated as that which would be earned on today’s
portfolio if a day in the history of market rates and prices were to repeat
itself. The VaR then is read from this histogram. Monte Carlo also expresses
returns as a histogram of hypothetical returns. In this case the hypothetical
returns are obtained by choosing at random from a given distribution of price
and rate changes estimated with historical data. Each of these approaches have
strengths and weaknesses. The parametric
approach has as its principal virtue speed in computation. The quality of the
VaR estimate degrades with portfolios of nonlinear instruments. Departures from
normality in the portfolio return distribution also represent a problem for the
parametric approach. Historical simulation (my personal favorite) is free from
distributional assumptions, but requires the portfolio be revalued once for
every day in the historical sample period. Because the histogram from which the
VaR is estimated is calculated using actual historical market price changes,
the range of portfolio value changes possible is limited. Monte Carlo VaR is
not limited by price changes observed in the sample period, because
revaluations are based on sampling from an estimated distribution of price
changes. Monte Carlo usually involves many more repricings of the portfolio
than historical simulation and is therefore the most expensive and time
consuming approach TURK EXIMBANK?S GUIDE TO RISK EVALUATION STUDY OF
BANKSShort Term
Export Credits, one of the most important facilities of Turk Eximbank, are
extended both directly by The Bank and indirectly using selected Turkish banks
as intermediaries. For indirect lending, Turk Eximbank determines short term
TL, FX and letter of guarantee limits for intermediary banks through a risk
evaluation process of each bank. These banks are responsible for the default
risk of the borrowers. Therefore, selected commercial banks must be financially
sound and deemed to be active in the foreign trade business according to Turk
Eximbank standards. The evaluation
process named as risk evaluation study is explained in the following part of
this guide.This study
covers analyzing the financial structures of banks divided into 6 categories; Large-scale private banks Middle / Small- scale private
banks Foreign banks Investment banks Development banks State-owned banks This
categorization is done regarding ownership structure, scale, activities, and
its growth in the sector.This risk
evaluation study is reviewed quarterly in a year. Besides this, extra reports
are prepared according to the requests from the banks, executive committee and
the important changes about the banks. The quarter analysis includes; Basic Information Guideline (It
should be updated when necessary) Financial Sheet Sum Table (covering the sector
data) Tiering (Risk Group Determination) Executive Summary 1.BASIC
INFORMATION GUIDELINETurk Eximbank
requests the banks ready to work with itself to submit ?the basic information
guideline? which covers following information; General information about the bank Ownership structure Board of directors Directors / top executives The list of group companies, if
the bank belongs to a group The list of subsidiaries, joint
ventures and/or equity participation of the bank This information
guideline is updated with every changes. (Enclosure 1.) 2. FINANCIAL
SHEETBanks are
sending their balance sheets and income statements in every 3 months, in the
same format as they prepare for Turkish Central Bank and Undersecretariat of
Treasury. These data submitted with diskettes and written form are transferred
to the standard format of Turk Eximbank in use of risk evaluation study. The
financial sheet covers percentage changes in financial data of the bank and the
financial ratios, which are calculated automatically according to a computer
program developed by Turk Eximbank, about capital adequacy, asset quality, liquidity
and profitability in addition to summarized balance sheet and income statement.3. SUM TABLE This is the
table that gathers the processed financial data of all banks, which are subject
of the risk evaluation study. These data are automatically taken from financial
sheets of each bank. The table covers financial ratio values of each bank based
on divided group and average, minimum and maximum values of each group, also
the sector, in addition some basic financial highlights as total loans, total export
credits, total deposits, paid-up capital etc. and their percentage changes for
each bank. The table is used as a reference guide while conducting regular risk
evaluation study.4. TIERING
(RISK GROUP DETERMINATION) As noted
earlier, the banks? risk profile is depicted quarterly through a detailed risk
evaluation study of each bank. For each bank category 8 different financial
ratio standards are determined compared with group and sector averages, minimum
and maximum values placed on the sum table.The financial
ratios are divided into 4 categories; Capital Adequacy Asset Quality Liquidity Profitability The standards of
8 ratios could be different for each bank category. For example, the ratio of
share holders? equity / risk bearing asset was applied as minimum 10% for
State-Owned Banks, while it was applied as minimum 15% for Large-Scale Private
Banks in September 2000 period.Banks are rated
and ranged into one of four categories regarding to the criteria they are
violating.There are 4
financial analysis groups indicating the risk levels of the banks. 4th
financial analysis risk group covers banks with maximum risk, whereas 1st
risk group covers banks with minimum risk. The total number of violated
criteria of each bank is important, since; If a bank violates maximum 2
criteria, it is placed in the 1st financial analysis risk
group, If a bank violates maximum 3
criteria, it is placed in the 2nd financial analysis risk
group, If a bank violates maximum 4
criteria, it is placed in the 3rd financial analysis risk
group, If a bank violates more than 4
criteria, it is placed in the 4th financial analysis risk
group. After
determining the financial analysis risk groups of each bank, the violation
criteria?s table is prepared showing violated criteria as minuses.The second step
of the study is that the banks are scrutinized according to the proportion of
export credits financed through the bank?s own sources and average rate of
using Turk Eximbank?s credit line as compared to the sector averages. In other
words, effective use of Turk Eximbank limits by the bank is very important. The
banks? risk groups are altered depending on these two rates and a new risk
group is created called limit allocation group. (For example, the being above
the average rate of export credits is considered a positive factor and upgrades
that specific bank?s ranking)The third step
of the study is that the banks are ranked for final risk group taking into
considerations the following additional criteria; Ownership structure Management quality Whether top management is
frequently changed or not Customer / market segmentation Human resource quality Reputation of the bank in the
market place Interest rate policies FX short position and exchange
rate exposure Importance of export credit
financing among its financing activities, Giving emphasis to technology
investments. Notified credit
line allocations do not create a binding obligation on Turk Eximbank. The bank
can easily slow down or cease credit payments and partially or fully cancel
credit limits, if necessary. When the financial strength of an intermediary
bank becomes questionable, Turk Eximbank may require the bank to establish
collateral with Turk Eximbank in the form of cash deposits and/or Treasury
Bills and Government Bonds.5. EXECUTIVE
SUMMARYExecutive
summary reports is prepared by analysts in every three months for each bank and
covers a summation about changes in the bank?s performance, it?s risk group,
and current position in the sector for the specified quarter.In addition to
that, extra reports are prepared in the case of demands of the banks regarding
increase in their limits, extra-ordinary changes of status or ownership
structure etc. and presented to the top management of Turk Eximbank.Also, analysts of
Risk Assessment Division regularly visit the intermediary commercial banks?
CEO?s to get information on their future strategies and plans, new activities,
loan and interest rate policies, customer portfolio and target customer
segment, etc. After visiting, analysts prepare a meeting report and present to
the top management of the Bank. TURK EXIMBANK?S RISK MANAGEMENT
DEPARTMENT?S DOSSIER HARMONY1) BANK
DOSSIERSAll of the
information about the banks is collected in credit limit dossier separately and
they include the information; Basic information guideline Financial sheet Executive summaries Corresponds with the bank Meeting reports and Press releases about the bank 2) GENERAL
BANKING DOSSIERAll of the
studies done with the banking sector, corresponds and documents are collected
in these documents. They include; Risk group determination studies Limit allocation studies Management decisions Reports and other studies DISCLOSURES
ABOUT THE BANKS? RISK GROUP DETERMINATION RATIOSRisk group
determination studies of the banks? are made with the financial sheets and sum
tables that are prepared quarterly in a year. By using these, banks? capital
adequacy, asset quality, liquidity and profitability ratios are calculated. As
regards with the told banks? groups ratios and banking sector averages are
found in order to determine the risk groups. Bank groups are
state-owned banks, large-scale private banks, middle and small-scale private
banks, foreign banks, investment banks and development banks. Ratios are
determined according to the bank groups? specialties.These ratios are
used for all kinds of bank groups: Net asset / Risky assets Balance sheet excluded risks / Net
assets Follow up debt receivables / Total
credits Risky assets / Total assets Net profit / Net assets Net asset /
Risky assets ratios: In order to meet the banks?
risky asset, indicates the competence of the net assets.Balance sheet
excluded risks / Net assets ratios: They are
important for the control of non-cash credits and minimum ratios are valid in
order to rival known level of assets.Follow up
debt receivables / Total credits ratios: One of the
important problems of the banks? is the credits that cannot be collected back
and when they rise by the ratios they can be risky for the financial situations
of the banks. Follow up debt receivables / Total credit ratios are important
indicators of the banks? assert qualities and if it is high, it is a negative
development for the bank. Maximum boarders are put, as it is wanted to be low
as it can be.Net profit /
Net assets ratios: Indicates net asset
profitability.Bank groups
main peculiarities and ratios that differ according to the groups are:State-owned
banks: in addition to the ratios that are used for
all kinds of banks; Cash values / Current liabilities and Cash values /
Deposit ratios are being used. These ratios indicate the banks? sufficiency
to reinsure the deposits and short-term liabilities.Large-scale
private banks: Again for this group Current
liabilities / Cash values ratios are important liquidity indicators. An
upper limit is determined for the Current deposits not to exceed the Total
deposit ratio. Another ratio that is used for all kinds of bank groups
except the state-owned banks is Net interest incomes ratio. This ratio
indicates the banks income assets profitability.Middle /
Small- scale private banks: Cash values / Total asset ratio that is used except for the large scale private banks and
state-owned banks is also an indicator of how liquid are the banks? assets.Foreign
banks: As if their credit policies are the same
with the small-scale private banks, the same ratios are also used for them.Development
banks: They are founded in order to finance the
state investments and they don?t have profit goals, Eximbank doesn?t work with
them.Investment
banks: As if they don?t have a main goal of export
financing, Eximbank doesn?t work with them. RECOMMENDATIONS FOR RISK MANAGEMENTBanking
supervision, which is based on an ongoing analytical review of banks, continues
to be one of the key factors in maintaining stability and confidence in the
financial system. The methodology used in an analytical review of banks that
are in the process of off-site surveillance and on-site supervision is similar
to that of private sector analysts (for example, external auditors or a bank?s
risk managers), except that the ultimate objective of the analysis is somewhat
different. To attain a
meaningful assessment and interpretation of particular findings, estimates of
future potential, a diagnosis of key issues, and formulation of effective and
practical courses of action, a bank analyst must have extensive knowledge of
the particular regulatory, market, and economic environment in which a bank
operates. In short, to be able to do this job well, an analyst must have a
holistic perspective on the financial system even when considering a specific
bank.The practices of
bank supervisors and the appraisal methods practiced by financial analysts
continue to evolve. This evolution is necessary in part to meet the challenges
of innovation and new developments, and in part to accommodate the broader
process of convergence of international supervisory standards and practices,
which are themselves continually discussed by the Basel Committee on Banking
Supervision.? Traditional
banking analysis has been based on a range of quantitative supervisory tools to
assess a bank?s condition. Ratios normally relate to liquidity, the adequacy of
capital, loan portfolio quality, insider and connected lending, large exposures
and open foreign exchange positions. While these measurements are extremely
useful, they are not in themselves an adequate indication of the risk profile
of a bank, the stability of its financial condition or its prospects.The central
technique for analyzing financial risk is the detailed review of a bank. Risk
based bank analysis includes important qualitative factors and places financial
ratios within a broad framework of risk assessment and risk management and
changes or trends in such risks, as well as underscoring the relevant
institutional aspects. Such aspects include the quality and style of corporate
governance and management; the adequacy, completeness and consistency of a
bank?s policies and procedures; the effectiveness and completeness of internal
controls; and the timeliness and accuracy of management information systems and
information support.