Risk management instruments by banks

NPI CRAR HHI CRR IDR SLR NSFR LCR   ROA

Investment Growth ROE NIM MTFR Gap and Duration MCO Recovery Rate Internal & External Fraud VAR

STR CTR  RWA OBSE Net Open Position Liquid Asset (LA)  to TD LA to STL Borrowed Fund to TA

Leverage Ratio Overdue Accepted Bill Un-reconciled Suspense Negative Media Report Equity Price Risk Wholesale Borrowing

Regulatory Reports/statements/Policy prepared/contributed by banks

Sl. No.	Name of the report	Frequency
01	Risk Management Report (RMP)/ Comprehensive Risk Management Report (CRMR)	Monthly, Quarterly and Semi-annually.
02	Stress Testing	Quarterly
03	Risk analysis memos	As and when required
04	ICAAP Report	Annually
05	Queries to Risk Management by DOS of BB	As and when required by BB
06	Compliance Report on Risk Management Rating	As and when required by BB
07	Compliance Report on Risk Management Activities	As and when required by BB
08	Compliance Report on Stress Testing	As and when required by BB
09	Review of Risk Core Risk Manuals	Annually
10	Market Disclosure of Basel-III	Annually

1.      Risk areas, sources and consequences of banks

The Managers should give utmost importance of the following risk areas, sources and consequences in discharging their day to day activities.

Risk Areas	Sources of Risks	Consequences
Investment	§ Faulty Induction/ Appraisal § Biased Recommendation § Non segregation of duties § Wrong/biased decision § Incomplete documentation § Non compliance of policies § Faulty valuation/ disbursement § Inadequate security coverage § Lack of monitoring/ supervision § Lack of follow up and recovery § Improper IRG § Failure in Risk Rating § Inadequate margin & security against LC, BG § Inadequate professionalism in handling export, import business	§  Increase of NPI §  Decay of profit §  Enhanced provision requirement §  Enhanced capital requirement §  Less return on assets, equity §  Decrease of RR for depositors §  Decay of capital §  Liquidity crunch §  Increased expenditure like legal, admin etc. §  Limiting scope for new investment §  Losing confidence of stakeholders. §  Additional capital charge against documentation and valuation error. §  Additional capital charge against investment concentration §  Increased provision
Operational	§ Non compliance § Lack of knowledge  & capacity § Improper distribution of works § Technical and Human error § Lack of internal check and control § External & Internal Fraud	§  Regulatory constraints & punishments §  Profit loss §  Loss of reputation §  Decay of capital §  Threat to the stakeholders §  Losing confidence of the stakeholders. §  Additional capital charge
Market	§ Equity Investment § Foreign Exchange § Rate sensitive instrument	§  Incurring loss §  Enhanced VAR §  Decay of capital
Asset Liability	§ Mismatches in assets & liabilities § Pricing of investment & deposits § GAP in duration of Assets & liabilities § Maintenance of Regulatory Rations like IDR, CRR, SLR, MTFR	§  Liquidity crisis §  Losing confidence of the customers §  Profit loss §  Decay of capital §  Regulatory constraints & punishments §  Additional capital charge
ICT Security	§  Lack of knowledge §  Non compliance of ICT policy §  Business continuity plan §  Unauthorized access §  Setting roles and privileges §  Maker/checker system §  Back up & Virus protection §  Maintenance of ICT inventory	§  Possibility of data loss §  Hacking §  Internal & External Fraud §  Loss of the trust and confidence §  Profit loss §  Damage of ICT assets §  Hindrances business §  Failure in competitive business §  Additional capital charge
Money Laundering	§  Account opening §  Proper documentation §  Reporting STR, CTR §  KYC, TP §  CSR §  Terrorist Finance §  PEPs & IPs §  FATF & FATCA compliance §  UN Sanction List	§  Loss of reputation §  Regulatory punishment §  Business loss §  Loss of confidence of the stakeholders §  Profit loss §  Decay of capital §  Constraints from Int’l partners
Foreign Exchange	§  Fluctuation of exchange rate §  Violation of set limits §  VaR §  Management Action Trigger §  Concentration in single currency §  Utilization of currency	§  Profit loss §  Regulatory punishment §  Decrease in asset value §  Additional capital charge §  Decay of capital §  Liquidity crunch §  Dependency on other banks
Internal Control & Compliance	§  Inefficiency of set policies §  Non compliance of set policies §  Internal & External Frauds §  Inadequate internal check system §  Failure in Internal Control	§  Business loss §  Reputation loss §  Decay of Capital §  Additional capital requirement §  Regulatory punishment §  Damage of compliance culture
Residual	§  Error in documentation §  Error in valuation	§  Business at risk §  Additional capital charge
Concentration	§  Sector concentration §  Area concentration §  Single borrower concentration §  Term wise concentration	§  Business at risk §  Profit loss §  Decay of capital §  Additional capital requirement
Liquidity	§  NSFR §  MTFR §  Surplus Liquidity §  Liquidity crunch §  Asset liability mismatch §  IDR §  SLR/CRR	§  Loss of confidence of the depositors §  Loss of reputation §  Business loss §  Decay of capital §  Additional capital charge §  Regulatory punishment
Reputation	§  Rating of the Bank §  Internal & External Fraud §  Customer service §  Compliance culture	§  Loss of goodwill & business §  Penalty §  Additional capital charge
Strategic	§  Policy making §  Decision making §  Managing NPI §  CAMELS rating	§  Business Loss §  Capital decay §  Additional capital charge §  Reputation loss
Settlement	§  Non settlement of executed transaction	§  Reputation loss §  Additional capital charge
Environmental & Climate Change	§  Environment Risk Rating §  Ignorance	§  Social & ecological damage §  Additional capital charge §  Regulatory penalty §  Threat to sustainability
Sharia’h Compliance	§  Ethics and values §  Execution of buy & sell §  Faulty documents/statements §  Maqasid al Sharia’h	§  Profit loss §  Reputation loss §  Loss of confidence of the stakeholders
Displaced Commercial Risk	§  Banker customer relationship §  Pricing §  Disloyal customers	§  Profit loss §  Reputation losses §  Threat to superiority of Islamic Banking §  Failed Islamic Banking objective

Priority task of to manage risk

v  Preparation of Risk Appetite Statement

v  Updating of Core Risk Guidelines

v  Setting up of Sector wise Lending Cap

v  Preparation of Risk Management Manual of IBBL

v  Key Risk Indicators of all core risk areas

v  Risk Assessment Methodology and  Evaluation of the core risk areas

v  Widen the training opportunities for RMD officials

v  Improvement of CAMELS Rating

v  Formation of strong Management Information System

v  Focus on  balancing risk and return

v  Improving Risk Rating of the Bank

v  Analysis on the risk associated with the business portfolio of the Bank

v  “Know Your Customer”, money laundering and ultra vires issues.

v  Training of Trainers

v  Information System Audit and Risk Management in E-Banking

v  Improving the Health of the Bank

v  Enhancement of Environmental  Risk Rating and reducing it's adverse impact on Capital Adequacy of  IBBL

Capital to risk-weighted assets ratio (CRAR)

Herfindahl-Hirschman Index – HHI

 In addition to changes in capital requirements, Basel III also contains two entirely new liquidity requirements: the net stable funding ratio (NSFR) and the liquidity coverage ratio (LCR)

NIM (Net interest margin)  is the ratio of net interest income to invested assets. 

Medium Term Funding Ratio (MTFR). ≥ 30%

Office of Bank Supervision and Examination (OBSE) 

Liquid asset to total deposit TD

LA to STL short term liabilities

Maximum Cumulative Outflow (MCO)

Maximum Cumulative Outflow(MCO) guidelines control the net outflow ( Inflow from asset maturity minus outflow from liability maturity) over the following periods:

i) Overnight
ii) One week
iii) One month

MCO up to 1 month bucket should not exceed 10% of balance sheet amount to avoid funding mismatch (it may vary according to the volume of Assets and Liabilities of a Bank.

Net interest margin is also known as "net yield on interest-earning assets." 

Maximum Cumulative Outflow (MCO)

Maximum Cumulative Outflow(MCO) guidelines control the net outflow ( Inflow from asset maturity minus outflow from liability maturity) over the following periods:
i) Overnight
ii) One week
iii) One month
MCO up to 1 month bucket should not exceed 10% of balance sheet amount to avoid funding mismatch (it may vary according to the volume of Assets and Liabilities of a Bank.

NSFR The net stable funding ratio has been proposed within Basel III, the new set of capital requirements for banks, which will over time replace Basel II

·         Stable funding includes: customer deposits, long-term wholesale funding (from the interbank lending market), and equity.

·         "Stable funding" excludes short-term wholesale funding (also from the interbank lending market).

WHAT IT IS:

The Herfindahl Index, also known as the Herfindahl-Hirschman Index (HHI), measures the market concentration of an industry's 50 largest firms in order to determine if the industry is competitive or nearing monopoly.

The Herfindahl Index formula is calculated by squaring the market share for each firm (up to 50 firms) and then summing the squares.

Here's an example:

Let's say there are four grocery stores in your town: Albert's, Bob's, Carl's and Donald's. Market share is broken down as follows:

Albert's:   50%
Bob's:      25%
Carl's:      15%
Donald's: 10%

HHI = 50² + 25² + 15² + 10² = 3,450

In a perfectly competitive market, HHI approaches zero. Let's say there are thousands of restaurants in your city, but the top 50 each have 0.1% of the market share. The HHI is 0.1² x 50 = 0.5.

In a monopoly, HHI approaches 10,000. If the one largest firm has 100% of the market share, HHI = 100² = 10,000.

Most analysts do some sort of industry analysis to understand where a particular company's source of growth and competitive advantage comes from, and competition structure is one of the main components of industry analysis. For example, if a company exists in a highly competitive industry, it will be more difficult for it to maintain above-average profit margins in the future, even if it has above-average profit margins today.

Furthermore, the Justice Department uses the Herfindahl Index to decide whether a merger is good for competition in the marketplace. A market with an HHI under 1,000 is considered competitive. The Justice Department is likely to scrutinize a merger in an industry with a post-merger HHI of between 1,000 and 1,800, and it is almost certain to outright reject approval for mergers that result in a post-merger HHI exceeding 1,800.