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Post  Admin on Fri 23 Mar 2012 - 0:56

Dear all,

Analyse the various risks in banking [15 marks]

Explain how banks manage these risks [15 marks]

Regards,
Ramchurn Manoushka (Neha)
Student id (111431)

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Second forum

Post  Admin on Fri 23 Mar 2012 - 0:58

Dear all,

Analyse the various risks in banking [15 marks]
Where money is involved, there are always huge risks involved as well; and, the most important place for money is the bank. There are numerous types of financial and non financial risks faced by banks. The most common ones can be defined as the risks associated with maintaining accounts, issuing loans and collecting debts. Even the slightest mistake in these processes can attach the term ‘rupt’ with the bank – ‘bankrupt! Therefore, it is quite important for a bank to make sure it faces all financial risks appropriately.
Here are some of the most common financial risks which a bank faces:
• Paying Creditors:
Banks usually have a large network of clients. These clients deposit their money into the bank. The bank utilizes these funds to provide loans to other clients. The bank pays its clients a small percentage of the interest the bank itself is receiving from the borrower. The risk every bank faces here is of all of its clients withdrawing their money at the same time. If such a situation happens, the bank will not be in the position to accommodate the demands. Henceforth, the bank will become bankrupt. This is probably the biggest risk a bank faces while operating.
• Recovery from Debtors:
Another risky situation for a bank is to recover the loan amount along with the interest from the debtors. If the bank does not do this, it won’t be able to pay the creditors. The major income for a bank is through the interest rates charged from the debtors. If the loan is not paid back by the debtors, the bank will bear losses. Therefore, this aspect is the second major risk factor for a bank to deal with.
• Errors made by Machines and Humans:
The organizational structure of a bank is always dependent upon human and electronic resources. There are errors made by both resource types. However, it is the responsibility of the bank to make sure that these errors are minimal or they might affect the profit and loss ratios.
Some of the most common non financial risks which a bank faces:
• Operational Risk:
A form of risk that summarizes the risks a company or firm undertakes when it attempts to operate within a given field or industry. Operational risk is the risk that is not inherent in financial, systematic or market-wide risk. It is the risk remaining after determining financing and systematic risk, and includes risks resulting from breakdowns in internal procedures, people and systems.
• Model risk – incorrect or misspecified valuation models
• Regulatory risks – uncertainty regarding how transactions will be regulated or how regulations may change
• Legal/contract risk – the potential loss when a contract is not upheld
• Tax risk – uncertainty surrounding tax laws
• Accounting risk – uncertainty regarding proper way to record transactions or regarding potential rule changes
• Sovereign and political risks – regime changes that could affect business relationships, or the potential default of a sovereign borrower

Explain how banks manage these risks [15 marks]
Risk treatment is the process of selecting and implementing measures to modify the risk. Risk treatment includes as its major element, risk control/mitigation, but extends further to, for example, risk avoidance, risk transfer, risk financing, etc.
Any system of risk treatment should provide as a minimum:
• Effective and efficient operation of the organisation
• Effective internal controls
• Compliance with laws and regulations.
The risk analysis process assists the effective and efficient operation of the organisation by identifying those risks which require attention by management. They will need to prioritise risk control actions in terms of their potential to benefit the organisation. Effectiveness of internal control is the degree to which the risk will either be eliminated or reduced by the proposed control measures. Cost effectiveness of internal control relates to the cost of implementing the control compared to the risk reduction benefits expected. The proposed controls need to be measured in terms of potential economic effect if no action is taken versus the cost of the proposed action(s) and invariably require more detailed information and assumptions than are immediately available. Firstly, the cost of implementation has to be established. This has to be calculated with some accuracy since it quickly becomes the baseline against which cost effectiveness is measured. The loss to be expected if no action is taken must also be estimated and by comparing the results, management can decide whether or not to implement the risk control measures. Compliance with laws and regulations is not an option. An organisation must understand the applicable laws and must implement a system of controls to achieve compliance. There is only occasionally some flexibility where the cost of reducing a risk may be totally disproportionate to that risk. One method of obtaining financial protection against the impact of risks is through risk financing which includes insurance. However, it should be recognised that some losses or elements of a loss will be uninsurable e.g. the uninsured costs associated with work-related health, safety or environmental incidents, which may include damage to employee morale and the organisation’s reputation.

Regards,
Ramchurn Manoushka (Neha)
Student id:111431

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Risks faced by banks

Post  Admin on Fri 23 Mar 2012 - 1:01

Question 1).Analyse the various risks in banking

The business of banking entails risk taking to achieve return on investment since profits are considered to be the reward for taking such risks. Hence these major risks are categorised as follows:
-Financial Risks which include
i)Credit risk: is the most salient risk to be taken into account.In fact, this arise when loans turn into bad debts, that is, when debtors fail to repay their debts to the banks.

ii)Market risk: can be in the form of -Liquidity risk which occurs when banks face funding problems and -Interest Rate risk arises when there is fluctuation in interest rate and could have an impact on the profitability of the bank.

iii)Solvency risk: is the risk of being unable to absorb losses,generated by all types of risks, with the available capital.
Reference- Basel Capital Accord 1988 basel 1
- Basel Capital Accord 2

iv)Foriegn Exchange Risk: is directly related to the international finance. This type of risk may cause losses due to changes in exchange rates of all countries.

-Non-Financial Risks may include
i)Operational risk: occur as a result of fraud on a massive scale, incompetencies, errors etc...In the past in Mauritius, Barclays and Brammer banks faced such drawbacks.

ii)Technological Risk:occurs when the technology become outdated and inefficient. Progress is made very slow.
Recently in Mauritius, Mauritius Commercial banks faced the problem of Internet Banking where people had been found hacked- which create a huge costs to the bank itself.

iii) Staff Risk: arise when employees dont feel motivated to work and do a lot of mistakes which in the long run create high labour turnover. In this respect, this affect the continuity of the banks as without good workers, banks will not perform well.

Kind Regards,
Mary Joanna Cherly Gabriella Trime

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HOW banks manage these risks?

Post  Admin on Fri 23 Mar 2012 - 1:55

Question 2)Explain how banks manage these risks?

This fact can't be done alone, banks therefore need a regulator
-A bank can minimize credit risk with regard to its loan by
i)By selection of appropriate borrowers
ii)Reducing the overall risk of its loan portfolio by diversifying

-Banks can provide liquidity
i)By holding an appropriate portfolio of cash flows from maturing assets
ii)By holding sufficient cash which can easily be liquidified

-To prevent systematic risk,external regulations are to be applied.

(This question is very hard to answer- Mr Lecturer)

Kind regards,
Mary Joanna Cherly Gabriella Trime



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Re: Second forum

Post  Admin on Fri 23 Mar 2012 - 4:27

This is not hard Ms Trime. As a tertiary level student you should engage in some research as well and not rely on 100% spoon feeding.


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Re: Second forum

Post  Admin on Fri 23 Mar 2012 - 6:54

Question 1
1) Analyse the various risks in banking [15 marks]
Risks are involved in any place where money is concerned. Banking sector faces lot of such risk in their day to day running. Those risks can be separated into two categories; namely financial risk and non-financial risk.

FINANCIAL RISK
Some of the financial risks are:

1- Credit Risk- Credit Risk is the potential that a bank borrower/counter party fails to meet the obligations on agreed terms. There is always scope for the borrower to default from his commitments for one or the other reason resulting in crystalisation of credit risk to the bank.

2- Market risk- Market Risk may be defined as the possibility of loss to bank caused by the changes in the market variables. It is the risk that the value of on-/off-balance sheet positions will be adversely affected by movements in equity and interest rate markets, currency exchange rates and commodity prices.

3- Liquidity Risk- Bank Deposits generally have a much shorter contractual maturity than loans and liquidity management needs to provide a cushion to cover anticipated deposit withdrawals. Liquidity risk consists of Funding Risk, Time Risk and Call Risk.

4- Interest Rate Risk- Interest Rate Risk is the potential negative impact on the Net Interest Income and it refers to the vulnerability of an institution’s financial condition to the movement in interest rates.

5- Forex Risk- Foreign exchange risk is the risk that a bank may suffer loss as a result of adverse exchange rate movement during a period in which it has an open position, either spot or forward or both in same foreign currency.

6- Country Risk- This is the risk that arises due to cross border transactions that are growing dramatically in the recent years owing to economic liberalization and globalization. It is the possibility that a country will be unable to service or repay debts to foreign lenders in time.


NON-FINANCIAL RISK
Some of the non-financial risks are:

1- Environmental Risk
As the years roll by and technological advancement takes place, expectation of the customers change and enlarge. With the economic liberalization and globalization, more national and international players are operating the financial markets, particularly in the banking field. This provides the platform for environmental change and exposes the bank to the environmental risk. Thus, unless the banks improve their delivery channels, reach customers, innovate their products that are service oriented, they are exposed to the environmental risk resulting in loss in business share with consequential profit.

2- Operational Risk
Always banks live with the risks arising out of human error, financial fraud and natural disasters. Operational risk involves breakdown in internal controls and corporate governance leading to error, fraud, performance failure, compromise on the interest of the bank resulting in financial loss.

3- Systemic risk.
The financial system may undergo contagious failure following other forms of shock/risk.



Question 2
2) Explain how banks manage these risks [15 marks]

Banks manage those risks in order not to face a situation where they will not be able to cope with the different problems that such types of risk bring along. To do so, they can apply the different methods listed below.

For credit risk, banks can use these different methods to manage the risk:
1- Exposure Ceilings
2- Portfolio Management
3- Risk Rating Model
4- Risk based scientific pricing
5- Loan Review Mechanism

To cope with liquidity risk, the Asset Liability Management (ALM) can be used. It implies examination of all the assets and liabilities simultaneously on a continuous basis with a view to ensuring a proper balance between funds mobilization and their deployment with respect to their
a) Maturity profiles,
b) Cost,
c) Yield,
d) Risk exposure, etc.
It includes product pricing for deposits as well as advances, and the desired maturity profile of assets and liabilities.

In order to manage interest rate risk, banks should begin evaluating the vulnerability of their portfolios to the risk of fluctuations in market interest rates. One such measure is Duration of market value of a bank asset or liabilities to a percentage change in the market interest rate.

Putting in place proper corporate governance practices by itself would serve as an effective risk management tool managing operational risk.

The banks must improve their delivery channels, reach customers, and innovate their products that are service oriented, in order to cope with Environmental Risk.

Kessaven Murthen
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1) Analyse the various risks in banking [15 marks]

Post  Admin on Fri 23 Mar 2012 - 7:37

The past decade has seen dramatic losses in the banking industry. Firms that had been
performing well suddenly announced large losses due to credit exposures that turned sour, interest
rate positions taken, or derivative exposures that may or may not have been assumed to hedge
balance sheet risk. In response to this, commercial banks have almost universally embarked upon an
upgrading of their risk management and control systems.
Commercial banks are in the risk business. In the process of providing financial services, they
assume various kinds of financial risks. In performing these roles
they generally act as a principal in the transaction.risks bank take can be a=classified as follows :
1. Credit risk Defaults may be predicted based on historical data – no strong
correlation of defaults. Inadequate data for robust quantification or risk – strong correlation of default.
2. Market risk Loss of value linked to performance of asset. Loss of value linked to type of asset (contagion)
3. Operation risk More likely to be institution specific. More likely to be environmental

Therefore it must be conceded that there is some set of events which are likely not captured in risk assessment
we operate within our cognitive limits. Recognizing this, however, there do remain alternatives to ignoring these outcomes. Implicitly, regulatory capital may not in fact be adequate to protect banks and the banking system from certain
unanticipated outcomes. The default regulatory results are either (1) institutional failure and resultant systemic risk or
(2) inevitable state intervention to recapitalize a failed bank or failed banking system.
Atchia Azhar

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Explain how banks manage these risks ?

Post  Admin on Fri 23 Mar 2012 - 7:49

Consequently, the capital position of a central bank, its profitability and the degree of financial risk protection provided by its risk control framework seem to be crucial elements that contribute to its credibility, hence facilitating monetary policy. This consideration, along with the principles of prudence and transparency that are required for all public institutions entrusted with the management of public funds, calls for the establishment of state-of-the-art risk management frameworks and the highest governance standards.

Risks taken in central banking activities need to be analysed in a holistic manner, considering the interaction of different portfolios and operations. For that purpose, a state-of-the-art comprehensive risk monitoring and reporting framework is required, capable of providing decision-making bodies with appropriate risk management input. As a key element of the risk management function at a central bank, the highest governance standards need to be observed, both in terms of the reporting lines and organisation of the risk management function.
Atchia Azhar

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Re: Second forum

Post  Admin on Fri 23 Mar 2012 - 12:07

Question (i) Analyse the various types of risks faced by the banking sectors?

Risks are uncertainties resulting in advance variations of profitability or in losses. In the banking universe, there are a large number of risks. The two types of risks are financial and non-financial risk.

Financial risk can be:

(1)Credit risk
Credit risk is the first of all risks in terms of importance. Default risk, a major source of loss is the risk that customers fails to comply with their obligation to service debt. For example; the risk that a bank takes to grant loans to its financial seekers and the latter fails to pay his debts to the bank and this loan turn into bad debt.

Moreover, the banking and trading portfolio may be negatively affected due to the credit risk. That is for banking portfolio there will be various default issues arises such as delay in payment obligation, restructuring of debt obligation due to major deteriorate of the credit standing of the borrower. In addition the quality of trading portfolio may deteriorate over time due to credit risk that will have an impact on both issuers and borrowers.

(2)Market risk
Market risk is the risk of adverse deviations of the mark-to-market value of the trading portfolio, due to market movements, during the period required to liquidate the transactions. The period of liquidation is critical to assess such adverse deviations. If it gets longer, so do the deviations from the current market value. The market risks also include:


•Interest rate risk
The interest rate risk is the risk of a decline in earnings due to the movements of interest rates. Most of the items of banks’ balance sheets generate revenues and costs that are interest rate-driven. Since interest rates are unstable, so are earnings. Anyone who lends or borrows is subject to interest rate risk.


•Liquidity risk
Liquidity risk refers to multiple dimensions: inability to raise funds at normal cost; market liquidity risk; asset liquidity risk. The liquidity of the market relates to liquidity crunches because of lack of volume. Prices become highly volatile, sometimes embedding high discounts from par, when counterparties are unwilling to trade.

(3)Solvency risk
Solvency risk is the risk of being unable to absorb losses, generated by all types of risks, with the available capital. This is all about the solvency of the bank or a company itself that means a negative shareholder wealth will state that the company or bank is insolvent. Moreover in Basel committee it was prescribe that all banks should hold 8% solvency ratio.

(4)Foreign exchange risk
The currency risk is that of incurring losses due to changes in the exchange rates. Variations in earnings result from the indexation of revenues and charges to exchange rates or of changes of the values of assets and liabilities denominated in foreign currencies.



Non-financial risks are:

(1)Operational risk
Operational risks are those of malfunctions of the information system, reporting systems, internal risk-monitoring rules and internal procedures designed to take timely corrective actions, or the compliance with internal risk policy rules. In other word are the errors and frauds that are done by7 human beings. Ex: in Mauritius Bramer bank and Barclays bank have pass through this problem.


(2)Technological risk
Technology risks relate to deficiencies of the information system and system failure. That is when the system become out-dated, thus that increases time taken to perform certain task. Ex; this has happen to the Mauritius Commercial Bank (MCB), due to technological changes MCB have face several problems.

(3)Staff risk
Staff risk in commonly base on the internal workers working in the bank, and if they are unmotivated staff that will lead to a lot of mistakes. On top of that there will be high labour turnover and that will discourage clients to approach such bank.

(4)Systemic risk
Systemic risk is the risk of collapse of an entire financial system or entire market, as opposed to risk associated with any one individual entity, group or component of a system.



Question (ii) Explain how banks manage these risk?

How do banks manage financial risks…:

Management of credit risk
Credit risk is most simply defined as the potential that a bank borrower or counterparty will fail to meet its obligations in accordance with agreed terms. The goal of credit risk management is to maximize a bank's risk-adjusted rate of return by maintaining credit risk exposure within acceptable parameters. Banks need to manage the credit risk inherent in the entire portfolio as well as the risk in individual credits or transactions. Banks should also consider the relationships between credit risk and other risks. The effective management of credit risk is a critical component of a comprehensive approach to risk management and essential to the long-term success of any banking organisation.

Management of interest rate risk
Within an economic market, interest rates play a significant role in determining product costs and earning capacities for banks, businesses and government organizations. Banks, in particular, rely on interest rate calculations as a way to determine profit and losses over the course of time. Interest rate risk management approaches allow banks to contain potential risks and predict the types of effects interest rate changes will have over different periods of time.


Liquidity risk management:
•Efficient liquidity management by forecasting liquidity gaps using accurate, in-depth analyses.
•Assumptions can be used to develop diverse accounting scenarios, assess their effects on the liquidity situation and present liquidity costs.
•Counterbalancing capacity (CBC) can be determined and included in analyses.
•Flexible definition of portfolios and scenarios within the liquidity software.
•Individual treatment of various cash flow types.

Foreign Exchange risk Management:
•To determine the various exchange risks which the treasurer of the selected bank is exposed to in its foreign exchange transaction
•To investigate how these risks can be effectively managed and to identify risk and exposure management
•Techniques required for treasury management


How do banks manage non-financial risk…:

Management of operational risk
Operational risk losses have often led to the downfall of financial institutions, with more than 100 reported losses exceeding US$100 million in the recent years. The regulators of financial companies and banks are demanding a far greater level of insight and awareness by directors about the risks they manage, and the effectiveness of the controls they have in place to reduce or mitigate these risks.

Further, compliance regulations, like Basel II and SOX, mandate a focus on operational risks, forcing financial organizations to identify measure, evaluate, control and manage this ubiquitous risk.

Management of technological risk
Since technology so totally suffuses the entire corpus of the bank — similar, perhaps, to the way they circulatory system touches every cell in the human body to allow the cell to function — managing technology risk should start by identifying all potential risks within the framework of the institution’s business strategy. Given the overall strategy of the bank, it is essential to understand how technology enables the institution’s core business operations in order to appreciate where relevant risks are located.

Management of systemic risk
Private-market incentives play a major role in limiting systemic risk and that the government should always be highly sensitive to whether its actions are undermining or reinforcing the private mechanisms (Kaufman 1996). The latter is especially important in relation to the design and use of various safety-net measures.

Regards; Seeruttun Oujwalsingh (ID 111349)

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Re: Second forum

Post  Admin on Fri 23 Mar 2012 - 13:18

I). Analyze the various risks in banking?
There are six main types of risks: _
Credit risks
Credit Risk is a core risk that the bank enters into every day. It arises mainly when the bank lends money to a company or when we enter into trading risk contracts with counterparty. Credit risk is the risk that the borrower or trade counterparty fails to pay back what it has borrowed, or otherwise fails to meet its obligations towards the bank and which could then lead to a default and, potentially, the bank incurring a loss .

Liquidity risks
Liquidity risks covers all risks that are associated with a bank finding itself unable to meet its commitments on time , or only being able to do by recourse of emergency borrowing.

Market risks
Market risk is the risk of loss resulting from changes in the value of assets and liabilities (including off-balance sheet assets and liabilities) due to fluctuations in risk factors such as interest rates, foreign exchange rates and stock prices and the risk of loss resulting from changes in earnings generated from assets and liabilities.

Exposure Risks
Exposure risks include risks of bank’s exposure to a single entity or a group of related entities, and risks of banks’ exposure to a single entity related with the bank.

Interest rate risks
Interest rate risk: The risk of loss resulting from changes in interest rates. As a result of a mismatch of interest rates on its assets and liabilities and/or timing differences in the maturity thereof, a financial institution may suffer a loss or a decline in profit due to changes in interest rates.

Solvency Risks
This relates to the risk of having insufficient capital to cover losses generated by all types of risks, and is thus effectively the risk of default of the bank.
Operational risks

Operational risk is the risk of negative effects on the financial result and capital of the bank caused by missions in the work of employees, inadequate internal procedures and processes, inadequate management of information and other systems, and unforeseeable external events.

(2/).Explain how banks manage these risks?
The nature of banking is strongly related to the management and control of risks. All these risks management play a significant role behind the growth of an organization in the long run.

For credit risks bank can manage:
1. selection- banks have to choose carefully to whom they are lending money.
2. Limitation – it refers to the ways that bank set credit limits at various levels.
3. diversification- this means that bank need to spread their business over different types of borrower, economic sectors and geographical regions in order to avoid excessive concentration of credit risks problems.

To address the solvency risks it is important to define the level of capital which is appropriate at all levels of overall risk.

For operational risk, it is necessary to ensure separation of the risk takers from the risk controllers.

To deal with market risk, risk limits can be applied to traders or portfolio. Value of risk is being used to define and monitor these limits.
Chummun khusboo (111415)

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Re: Second forum

Post  Admin on Fri 23 Mar 2012 - 13:45

1. Analyse the various risks in banking [15 marks]


A bank is a financial institution and a financial intermediary that accepts deposits and channels those deposits into lending activities, either directly or through capital markets. There exist also risks. Banking risks can have a negative collision on the profitability on different sources of uncertainty. There are two main types of banking risks known as the financial risk and the non-financial risk.
Financial risks
1. Credit risk
2. Market risk
3. Foreign exchange risk
4. Solvency risk
5. Liquidity risk
6. Interest rate risk
Non financial risks
1. Operational risk
2. Technological risk
3. staff risk
4. systematic risk

1. CREDIT RISK
Credit risk is the first risk. It is a very major risk as it is business driven. This is the risk where customer fails to pay their debt which causes to massive loss. Credit risk is also the risk where the bond or stock taker fails to cover their amount towards the bond or stock giver. There are various default events: delay in payment obligations; re structuring of debt obligations due to a major deterioration of the credit standing of the borrower; bankruptcies. Simple delinquencies or payment delays, are not to be turn out as plain defaults, they are to be solved in a very short period of time. For example: if banks provide loan to borrowers which they have to return in certain period of time. If they fail to do so, the banks turn it to bad debts which then caused credit risk.

2. LIQUIDITY RISK
Liquidity risk is where the bank do not have sufficient fund to give to customer. This happen because when depositors deposit money, they receive a maturity of 7 years from the bank. The bank take the same money and give loan to loan seekers and they receive a maturity 30 years. Then after 7 years when the depositors claim their money back, the bank do not have the money to return as it has been given to a 30 years maturity which has not paid the money back. This cause liquidity risk.

3. INTEREST RATE RISK
Interest rate risks are risks that fluctuate in the exchange rates. Interest rate risk may have an impact on the profitability of banks. When interest rates rises, bank deposits (floating rates) also rises as it is directly related causing a fall in loan takers(fixed rate). Depositors know they will be getting high interest rates but this will increase the costs of the banks by giving more inerest rates and following a fall in loan takers, revenue will decrease as less interest will be charged. The same thing apply for the vice versa. This caused the interest rates risk.

4. TECHNOLOGICAL RISK
Technological risk refers to banks using outdated technology that is banks using slow and poor technology. The work is very slowly done and customers have to wait longer period of time before doing any transaction. This will lead the bank to non financial risks.

5. STAFF RISK
Staff risk is another non financial risk of bank risk. Nowadays staffs are not motivated to work hard. This can be because of low wages, poor working conditions and so on. This will have a direct effect on the profitability of the banks.





6. OPERATIONAL RISK
Operational risk is where the information system, internal and external problem in functioning of the banks. In regards to information, there are wrong information taken and the most important information is being ignored. Operational risks appear at different levels:
• People
• Processes
• Technical
• Information technology


2. Explain how banks manage these risks [15 marks]

Banks have different ways to manage their risks as they are very large institution.
1. CREDIT RISK- banks should give loan to only those people who put a guarantee or have a solid bank account and not to any person wanting loan without having any house or land. Banks should know the amount of loan to be given to customers whether they are over demanding according to their guarantee or under demanding. The most important is that banks should set a time limit for the loan to be repaid back whether it is 3 months or 1 year or 3 years etc. this will reduce risks.

2. LIQUIDITY RISK- when money is deposited in the banks, it should not give loans all of it. It should keep some if ever the depositors claim their money back then it will be a problem. Banks should hold 8% solvency cash if ever there is a sudden called of money by depositors. Banks should review their maturity of deposits and giving loans. This will help the banks manage their risks.

3. INTEREST RATE RISK- banks should fluctuate their interest rates according to the exchange rates. This will lead to a balance in both deposits and loans seekers that is at some point in time there will be deposits and loans granting. For example: 6 months the banks increase the interest rates, this will cause rise in deposits and the other 6 months decrease the interest rates as this will cause a rise loans taking. This can manage the banks risks in some way.

4. TECHNOLOGICAL RISK- banks should have an update on the new technology available on the market so as to be in competition with other banks or else they will be lacking behind. New technology provide faster service to customers and thus this will attract more and more clients. This will boost the banks profitability and can manage risks.

5. STAFF RISK- staff should be granted with lots of facilities like higher wages, fringe benefit like car, holidays, good working condition and so on. As they will be motivated, they will be eager to work hard and thus this will be profitable for the banks and manage risks.

Shah-E-Alam Noormamode (111426)

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Re: Second forum

Post  Admin on Fri 23 Mar 2012 - 13:54

(1)Analyse the various types of risks faced by the banking sector.
Risk is inherent in any walk of life in general and in financial sectors in particular. Till recently, due to regulated environment, banks could not afford to take risks. But of late, banks are exposed to same competition and hence are compeled to encounter various types of financial and non-financial risks.

(a)Credit Risk: Credit Risk is the potential that a bank borrower/counter party fails to meet the obligations on agreed terms. There is always scope for the borrower to default from his commitments for one or the other reason resulting in crystalisation of credit risk to the bank.

(b)Market Risk may be defined as the possibility of loss to bank caused by the changes in the market variables. It is the risk that the value of on-/off-balance sheet positions will be adversely affected by movements in equity and interest rate markets, currency exchange rates and commodity prices. Market risk is the risk to the bank’s earnings and capital due to changes in the market level of interest rates or prices of securities, foreign exchange and equities, as well as the volatilities, of those prices. Market risk can be of 2 type; liquidity risk and interest rate risk.

Liquidity Risk: Bank Deposits generally have a much shorter contractual maturity than loans and liquidity management needs to provide a cushion to cover anticipated deposit withdrawals. Liquidity is the ability to efficiently accommodate deposit as also reduction in liabilities and to fund the loan growth and possible funding of the off-balance sheet claims.

Interest Rate Risk: Interest Rate Risk is the potential negative impact on the Net Interest Income and it refers to the vulnerability of an institution’s financial condition to the movement in interest rates. Changes in interest rate affect earnings, value of assets, liability off-balance sheet items and cash flow.

(c)FOREX Risk: Foreign exchange risk is the risk that a bank may suffer loss as a result of adverse exchange rate movement during a period in which it has an open position, either spot or forward or both in same foreign currency. Currency Risk is the possibility that exchange rate changes will alter the expected amount of principal and return of the lending or investment.

(d)Operational Risk though defined as any risk that is not categorized as market or credit risk, is the risk of loss arising from inadequate or failed internal processes, people and systems or from external events. In order to mitigate this, internal control and internal audit systems are used as the primary means.

Other types of banking risks are:
(e)Systemic Risk- the financial system may undergo contagious failure following other forms of shock/risk.

(f)Technological Risk- Technology has become outdated and it takes more time.

(g)Staff Risk- Staffs are not motivated at all. There is high labour turnover and frequently staffs leave the bank.


(1) Explain how banks manage with risks.

(a)Credit Risk- The objective of credit risk management is to minimize the risk and maximize bank’s risk adjusted rate of return by assuming and maintaining credit exposure within the acceptable parameters.

The instruments and tools, through which credit risk management is carried out are:

Exposure ceiling- Prudential Limit is linked to Capital Funds.

Review / Renewal- Multi-tier Credit Approving Authority constitution wise delegation of powers, Higher delegated powers for better-rated customers; discriminatory time schedule for review/renewal are formulated.

Risk Rating Model- Set up comprehensive risk scoring system on a six to nine point scale. Clearly define rating thresholds and review the ratings periodically preferably at half yearly intervals.

Portfolio Management-The need for credit portfolio management emanates from the necessity to optimize the benefits associated with diversification and to reduce the potential adverse impact of concentration of exposures to a particular borrower, sector or industry.


(b)Liquidity Risk
The Asset Liability Management (ALM) is a part of the overall risk management system in the banks. It implies examination of all the assets and liabilities simultaneously on a continuous basis with a view to ensuring a proper balance between funds mobilization and their deployment with respect to their a) maturity profiles, b) cost, c) yield, d) risk exposure.

(c)Interest Rate Risk
In order to manage interest rate risk, banks should begin evaluating the vulnerability of their portfolios to the risk of fluctuations in market interest rates. One such measure is Duration of market value of a bank asset or liabilities to a percentage change in the market interest rate. There are different techniques such as the traditional Maturity Gap Analysis to measure the interest rate sensitivity, Duration Gap Analysis to measure interest rate sensitivity of capital, simulation and Value at Risk for measurement of interest rate risk.

(d)FOREX Risk
By setting appropriates limits-open position and gaps, stop-loss limits, Day Light as well as overnight limits for each currency, Individual Gap Limits and Aggregate Gap Limits, clear cut and well defined division of responsibilities between front, middle and back office the risk element in foreign exchange risk can be managed.

(e)Operational Risk
The key to management of operational risk lies in the bank’s ability to assess its process for vulnerability and establish controls as well as safeguards while providing for unanticipated worst-case scenarios.
Risk education for familiarizing the complex operations at all levels of staff can also reduce operational risk. Bank should strive to promote a shared understanding of operational risk within the organization, especially since operational risk is often interwined with market or credit risk and it is difficult to isolate.


Regards,
DOOKHEE ASIF (111416)




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Re: Second forum

Post  Admin on Fri 23 Mar 2012 - 14:12

Analyse the various risks in banking??

There are 2 types of risks in banking which are classified as financial and non financial risk.
Financial risk:
Credit risk is the most obvious risk in banking, and possibly the most important in terms of potential losses. The default of a small number of key customers could generate very large losses and in an extreme case could lead to a bank becoming insolvent. This risk relates to the possibility that loans will not be paid or that investments will deteriorate in quality or go into default with consequent loss to the bank.

A market risk, which is the risk that an investment or trading portfolio will decrease in value due to change in the market. This risk can also be related to a volatility risk which is the risk of a portfolio price change due to changes in the volatility of any risk factor. The four standard market risk factors are stock prices, interest rates, foreign exchange rates, and commodity prices.

A liquidity risk is the risk that an asset or security cannot be traded quickly enough after receiving it so that the value drops. The two types of liquidity risk include asset liquidity and funding liquidity.
Interest rate risk relates to risk of loss incurred due to changes in market rates, for example, through reduced interest margins on outstanding loans or reduction in the capital values of marketable assets.

Solvency risk relates to the risk of having insufficient capital to cover losses generated by all types of risks. Solvency risk is the risk of being unable to absorb losses, generated by all types of risks, with the available capital. It differs from bankruptcy risk resulting from defaulting on debt obligations and inability to raise funds for meeting such obligations. Solvency risk is equivalent to the default risk of the bank.

The currency risk is that of incurring losses due to changes in the exchange rates. Variations in earnings result from the indexation of revenues and charges to exchange rates or of changes of the values of assets and liabilities denominated in foreign currencies. Foreign exchange risk is a classical field of international finance, so that we can rely on traditional techniques in this book, without expanding them.

Non financial risk:
An operational risk is the risk that comes from the execution of a company's business functions. This category can also include fraud risks, physical risks, legal risks and environmental risks. Operational risk is the risk of loss resulting from inadequate or failed internal processes, people and systems, or from external events.

Systemic risk is the risk of collapse of an entire financial system or entire market. It can be defined as "financial system instability, potentially catastrophic, caused by idiosyncratic events or conditions in financial intermediaries". It refers to the risks imposed by interlink ages and interdependencies in a system, where the failure of a single entity or cluster of entities can cause a cascading failure, which could potentially bankrupt or bring down the entire system or market.

Technology risks relate to deficiencies of the information system and system failure. That is when the system become out-dated, thus that increases time taken to perform certain task; this has happen to the Mauritius Commercial Bank (MCB), due to technological changes MCB have face several problems.

Explain how banks manage these risks??

Credit risk:

In general, protection against credit risks involves maintaining high credit standards, appropriate diversification, good knowledge of the borrower’s affairs and accurate monitoring and collection procedures. In general, credit risk management for loans involves three main principles:
• Selection
• Limitation
• Diversification.

First of all, selection means banks have to choose carefully those to whom they will lend money.
Limitation refers to the way that banks set credit limits at various levels. Limit systems clearly establish maximum amounts that can be lent to specific individuals or groups. Banks also have to observe maximum risk assets to total assets, and should hold a minimum proportion of assets, such as cash and government securities, whose credit risk is negligible.
Credit management has to be diversified. Banks must spread their business over different types of borrower, different economic sectors and geographical regions, in order to avoid excessive concentration of credit risk problems. Large banks therefore have an advantage in this respect.

Liquidity risk:

Liquidity risk relates to the eventuality that banks cannot fulfill one or more of these needs. Banks must ensure that they have a satisfactory mix of various assets or liabilities to fulfill their liquidity needs. The choice among the variety of sources of liquidity should depend on several factors, including:
• Purpose of liquidity needed
• Access to liquidity markets
• Management strategy
• Costs and characteristics of the various liquidity sources
• Interest rate forecasts

Interest rate risk:

Interest rate risk relates to the exposure of banks’ profits to interest rate changes which affect assets and liabilities in different ways. Banks are exposed to interest rate risk because they operate with unmatched balance sheets. If bankers believe strongly that interest rates are going to move in a certain direction in the future, they have a strong incentive to position the bank accordingly.
Banks use the concept of matching to minimize their interest rate exposure. This requires the classification of assets and liabilities according to their interest rates. The aim of such matching is to show how each side of the bank’s balance sheet is related to particular rates of interest, and how it is exposed to changes in market rates.


Market risk:

Regulators are increasingly focusing on requiring banks to measure their market risk using an internally generated risk measurement model. The industry standard for dealing with market risk on the trading book is the Value-at-Risk .This model is used to calculate a VaR-based capital charge. The aim of VaR is to calculate the likely loss a bank might experience on its whole trading book.

The validity of a bank’s estimated VaR is assessed by back testing, whereby actual daily trading gains or losses are compared to the estimated VaR over a particular period. Concerns would arise if actual results were frequently worse than the estimated VaR. A bank may measure its specific risk through a valid internal model or by the ‘standardized approach’.. Some banks supplement the VaR estimate with stress tests, which estimate losses under extreme adverse market events.

Technology risk:

Identifying vulnerabilities and threats provides bank management with a view of the risks faced by the bank given the enabling role of information technology. Once these risks have been identified, an appropriate risk management strategy can be developed and implemented. Bank management has a choice in its approach to managing these risks. Generally, there are three alternatives that can be used individually and in combination: risk management via internal processes and controls, risk management via outsourcing or contracting out the activity; and risk transfer via the purchase of insurance coverage

Foreign exchange risk:

At times, banks may try to cope with this specific risk on the lending side by shifting the risk associated with exchange rate fluctuations to the borrowers.By setting appropriates limits-open position and gaps, stop-loss limits, Day Light as well as overnight limits for each currency, Individual Gap Limits and Aggregate Gap Limits, clear cut and well defined division of responsibilities between front, middle and back office the risk element in foreign exchange risk can be managed/monitored.

Risk management is both a set of tools and techniques, and a process that is required to optimize risk–return trade-offs. The aim of the process is to measure risks in order to monitor and control them. There are four stages that are usually followed in risk management.
• Identify the areas where risk can arise.

• Measure the degree of risk: this could range from evaluating an individual customer risk to reviewing the risks inherent in a particular sector or industry.

• Balance risk and return trade-offs, and determine prudent levels of total risk exposure by individual, firm, country or business activity, within the agreed level of overall risk.

• Establish appropriate monitoring and control procedures within the bank.

Conclusion:
Banking is financial inter-mediation between the financial savers and the funds seeking business entrepreneurs.As such, in the process of providing financial services,banks assume various kinds of risks both financial and non-financial. Therefore, banking practices, which continue to be deep routed in the philosophy of securities, based lending and investment policies, need to change the approach,rather radically, to manage and mitigate the perceived risks, so as to ultimately improve the quality of the asset portfolio.

Regards,
Vanita Bahadoor.



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Re: Second forum

Post  Admin on Fri 23 Mar 2012 - 14:31

1.Analyse the various risks in banking [15 marks]

Bank risk may be defined as the risk that a bank takes in a transaction where it fails to honour its commitment, and just has a negative effect on its profitability. Banking risk is also defined as adverse impacts on profitability of several distinct sources of uncertainty. To curtail the risk we have to find the source of the uncertainty and the volume of adverse effect it can have on its profitability. There are two types of risks, financial risk and non financial risk.


Financial risk
1.Credit risk
Credit risk is the risk that customers failed to comply with their obligations to service debt. Thus the customer default becomes a major source of loss which may be total or partial. Credit risk is also the risk of a decline in the credit standing of an obligator of the issuer of a bond or stock. In the money market a deterioration of the credit standing of a borrower does materialize into a loss because it triggers an upward move of the required market yield to compensate the higher risk and triggers a value decline.

2.Market risk
Market risk can be defined as possible loss to banks due to adverse deviation of the mark to market value, due to market movements. In equity and interest rate markets, currency exchange rates and commodity prices. Market risk is the risk to the bank’s earnings and capital due to changes in the market level of interest rates or prices of securities, foreign exchange and equities, as well as the volatilities, of those prices

Liquidity risk
bank deposits are for a shorter maturity than loans therefore liquidity management are required to cover anticipated deposits withdrawals. Liquidity can accommodate deposit efficiently, reduction in liabilities and to fund the loan growth. Thus the cash flows are placed differently for future likely behavior of assets and liabilities. Some assets are highly liquid and have low liquidity risk while other assets are highly illiquid and have high liquidity risk.

interest rate risk
interest rate risk is the negative impact on the net interest income and it is vulnerable to the financial condition of an institution. Changes in interest rate affect earnings, value of assets, liabilities off balance sheet, items and cash flow. A rise in interest rates reduce the value of a security especially a bond.

3.forex risk
Foreign exchange risk is the risk that a bank may suffer loss as a result of adverse exchange rate movement during a period in which it has an open position, either spot or forward or both in same foreign currency. Even in case where spot or forward positions in individual currencies are balanced the maturity pattern of forward transactions may produce mismatches. There is also a settlement risk arising out of default of the counter party and out of time lag in settlement of one currency in one center and the settlement of another currency in another time zone. Banks are also exposed to interest rate risk, which arises from the maturity mismatch of foreign currency position.- the bank is expose to uncovered position of mismatch indicated by the Value at Risk.

4.SOLVENCY RISK
Solvency risk is the risk of being unable to absorb losses, generated by all types of risks, with the available capital. It is different from bankruptcy risk which is a result of defaulting on debt obligations and unable to raise funds to cover such obligations. Solvency risk is same as default risk of the bank. Solvency is an outcome of both available capital and all risks. The regulators, through basic principles of capital adequacy decides the level of capital allowed a bank to sustain the potential losses arising from all current risk and complying with an acceptable solvency level.

Non financing risk
5.Operational risk
Due to human error the banks have to face with risks such as financial frauds and natural disasters. Operational risk is the risk of loss arising from inadequate internal processes, people and systems or from external events. The use of technology and inter-linkage in global financial has contributed to such risks. Operational risk is not categorises as market or credit risk.

Technological risk
Technology risk is related to deficiency of the information system and the system failure. Due to fast development in technology systems, the system the bank users currently is outdated. Thus, to be at the point of new technology the banks should update meanwhile the process runs technology risk.

Staff risk
Staff risk can be defined as risk in which there is human errors, lack of expertise and frauds. Furthermore, there is lack of compliance with existing procedures and policies due to lack of motivations



2.Explain how banks manage these risks [15 marks]
Due to the potential risks banks have to manage and provide quantitative measures and applied regulatory rules to cope with the potential risk.

Credit risk
In a financial institution a credit risk management framework is setup which manages the acceptable level of risks. It is the overall responsibility of bank’s Board to approve bank’s credit risk strategy and significant policies relating to credit risk and its management which should be based on the bank’s overall business strategy. The board has to review its overall strategy annually The senior management of the bank should develop and establish credit policies and credit administration procedures as a part of overall credit risk management framework and get those approved from board. The management should ensure the effective implementation of the policies. Banks must operate within the define criteria for credit we should be extended within the target market and lending strategy. The bank must make an assessment of risk profile of the transactions before allowing a credit facility. Bank should also consider the relationship between credit risk and other risks the effective management of credit risk is essential to the long term success of banking organization.

Liquidity risk
In order to curtail liquidity crisis a bank adopt an asset liability management which view the liquidity situation. This restricts liquidity risk to bank specific factors. The time profile of projected uses and sources of funds capture the liquidity position of a bank. Debt management manage future liquidity gaps within acceptable limits.

Interest risk
Interest rates play significant role and determine product cost and earning capacities for banks, government organizations and businesses. Financial organizations are profit making institution. They mostly rely on interest rate to calculate their profit and loss across the time. Interest rate risk management provides banks to contain potential risk and also predicts the effect interest rate and changes to come near future. To control inflation and profits of financial organizations the bank of Mauritius determines the repo rate to be applicable from time to time.

Forex risk
Forex risk is a classical of field of international finance using traditional techniques. For baking portfolio foreign exchange risk relates to ALM. Multi currency ALM uses several techniques for each local currency. Foreign exchange rates form part in market parameters. Classical hedging instrument accommodate both exchange rate and interest rate risk.

Operational risk
There are sources of historical data on various incidents and their cost which served to measure the number of incident and direct losses in operational risk. The general principle for operational risk management is to access the like-lihood and cost of adverse events. Data gathering process, data analysis and statically techniques help in finding core relation and drivers of risk. There should be expert judgments, possible operational events and their implications, pooling data from insurance costs and other institutions related to event frequencies and cost.
Regards,
Vedish ramjeeawon ( student id: 111433)


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Re: Second forum

Post  Admin on Fri 23 Mar 2012 - 14:37

Analyse the various risks in banking.

A risk is a danger that a certain unpredictable contingency can occur, which generates randomness in cash flow. A bank has many risks that must be managed carefully, especially since a bank uses a large amount of leverage. Without effective management of its risks, it could very easily become insolvent. If a bank is perceived to be in a financially weak position, depositors will withdraw their funds, other banks won't lend to it nor will the bank be able to sell debt securities in the financial markets, which will aggravate the bank's financial condition even more. Here are some examples of major risks that affect banks. In the banking universe, risks can be categorised as financial and non-financial risks.
Here are some examples of financial risks.

Liquidity Risk
Liquidity is the ability to pay, whether it is to pay a bill, to give a depositor their money, or to lend money as part of a credit line. The main problem in liquidity management for a bank is that, while bills are mostly predictable, both in timing and amount, customer demands for funds are highly unpredictable, especially demand deposits.
Credit Risks
Credit default risk occurs when a borrower cannot repay the loan. Eventually, usually after a period of 90 days of nonpayment, the loan is written off. Banks are required by law to maintain an account for loan loss reserves to cover these losses.

Interest Rate Risk
A bank's main source of profit is converting the liabilities of deposits and borrowings into assets of loans and securities. It profits by paying a lower interest on its liabilities than it earns on its assets—the difference in these rates is the net interest margin. However, the terms of its liabilities are usually shorter than the terms of its assets. In other words, the interest rate paid on deposits and short-term borrowings are sensitive to short-term rates, while the interest rate earned on long-term liabilities is fixed. This creates interest rate risk, which, in the case of banks, is the risk that interest rates will rise, causing the bank to pay more for its liabilities, and, thus, reducing its profits.

Foreign Exchange Risk
International banks trade large amounts of currencies, which introduces foreign exchange risk, when the value of a currency falls with respect to another. A bank may hold assets denominated in a foreign currency while holding liabilities in their own currency. If the exchange rate of the foreign currency falls, then both the interest payments and the principal repayment will be worth less than when the loan was given, which reduces a bank's profits.


Sovereign Risk
Many foreign loans are paid in U.S. dollars and repaid with dollars. Some of these foreign loans are to countries with unstable governments. If political problems arise in the country that threatens investments, investors will pull their money out to prevent losses arising from sovereign risk. In this scenario, the native currency declines rapidly compared to other currencies, and governments will often impose capital controls to prevent more capital from leaving the country. It also make foreign currency held in the country more valuable; hence, foreign borrowers are often prohibited from using foreign currency, such as U.S. dollars, in repaying loans in an attempt to conserve the more valuable currency when the native currency is declining in value.

Non-financial risks

Operational Risk
Operational risk arises from faulty business practices or when buildings, equipment, and other property required to run the business are damaged or destroyed.

Technological Risk
Technology enables key processes that a company uses to develop, deliver, and manage its products, services, and support operations. If the technology becomes outdated or there is a system failure, then banks will not be able to carry out any task.

Systemic risk
It is the risk of collapse of an entire financial system or entire market, as opposed to risk associated with any one individual entity, group or component of a system. A good example of a systemic risk is a market risk

Explain how banks manage these risks.
Recent financial disasters in financial and government agencies point up the need for various forms of risk management.

Liquidity risk
The Asset Liability Management is a part of the overall risk management system in the banks. It implies examination of all the assets and liabilities simultaneously on a continuous basis with a view to ensuring a proper balance between funds mobilisation and their deployment with respect to their maturity profiles, cost, yield, risk exposure and so on.

Credit risk
The objective of credit risk management is to minimize the risk and maximize bank’s risk adjusted rate of return by assuming and maintaining credit exposure within the acceptable parameters. The management of credit risk includes measurement through credit rating, quantification through estimate of expected loan losses, pricing on a scientific basis and controlling through effective loan review mechanism and portfolio management.

Interest rate risk
In order to manage interest rate risk, banks should begin evaluating the vulnerability of their portfolios to the risk of fluctuations in market interest rates. One such measure is Duration of market value of a bank asset or liabilities to a percentage change in the market interest rate. The difference between the average duration for bank assets and the average duration for bank liabilities is known as the duration gap which assesses the bank’s exposure to interest rate risk. By reducing the size of the duration gap, banks can minimize the interest rate risk.

Operational risk
The key to management of operational risk lies in the bank’s ability to assess its process for vulnerability and establish controls as well as safeguards while providing for unanticipated worst-case scenarios. Risk education for familiarizing the complex operations at all levels of staff can also reduce operational risk. Bank should strive to promote a shared understanding of operational risk within the organization, especially since operational risk is often interlined with market or credit risk and it is difficult to isolate.
Lav Beeharry (111408)


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Risk Management

Post  Admin on Fri 23 Mar 2012 - 14:50

1. Analyze the various risks in banking?
Risk is the uncertainty associated with the return on an investment and is concerned where money is involved. Banks constantly deal with money and face a number of risks. The main types of risks that banks face are classified as financial risks and non-financial risks.

The various types of financial risks that banks face are as follows:

• Credit risk- It is the change in net asset value due to changes the perceived ability of counterparties to meet their contractual obligations.

• Market risk- It relates to risk of loss associated with adverse deviations in the value of the trading portfolio.


• Interest rate risk- It relates to risk of loss incurred due to changes in market rates for example through reduced interest margins on outstanding loans.

• Liquidity risk- It covers all risks that are associated with a bank finding it unable to meet its commitment on time.

• Foreign exchange risk- It is the risk that a bank may suffer loss as a result of adverse exchange rate movement during a period in which it has an open position either spot or forward or both in same foreign currency.

• Solvency risk- It relates to the risk of having insufficient capital to cover losses generated by all types of risks.

• Country risk- It is associated with the risks of incurring financial losses resulting from the inability or unwillingness of borrowers within a country to meet their obligations.


The types of non-financial risks are:

• Operational risk- It results from costs incurred through mistakes made in carrying out transactions such as settlement failures.

• Model risk- It is important in the market universe which traditionally makes relatively intensive usage of models for pricing purposes.

• Technological risk- It refers to the risk that a delivery system may become inefficient because of new delivery systems.

• Regulatory risk- It involves living with some rules that place a bank at competitive disadvantage.

• Competitive risk- It occurs because more and more financial and non-financial firms can offer most bank products and services.

2. Explain how banks manage these risks ?

Risk management is simple way to monitor the risk and to control it on the time. Risk management is both a set of tools and techniques and the aim is to measure risks in order to monitor and control them. There are four stages that are usually followed in risk management and these are as follows:

• Identify the areas where risk can arise.

• Measure the degree of risk.

• Balance risk and return trade-offs and determine prudent levels of total risk exposure by individual firm, country or business activity within the agreed level of overall risk.

• Establish appropriate monitoring and control procedures within the bank.

Bank’s capacity to ensure against excessive risk depends on the following:
• Capital size

• Its bank management quality

• Its technical expertise

Generally bank’s prudential measures against risk may be the following:
• Bank management must be aware of the risks resulting from the bank’s activity and must be able to measure, monitor and control all the types of risks that it faces.

• Banks must have clear policies as well as risk management and control procedures.

• Bank management must establish the internal limits of risk.

• Periodical reports must be concluded and controlled by the bank’s internal control and its censors.


Some examples how bank manage financial risks and non-financial risks are described as follows:
Some financial risks that bank manage are:

• Credit risk: The instruments and tools, through which credit risk management is carried out are detailed below:

a) Exposure ceilings
b) Review or renewal
c) Risk rating model
d) Risk based scientific pricing
e) Portfolio management
f) Loan review mechanism

• Liquidity risk
Banks manage their liquidity risk by carefully monitoring the relationship between their short-term liabilities as opposed to their short-term assets. The management of risk is achieved by applying stress tests to all liquidity components in order to determine what would happen if conditions were to change.


• Interest rate risk: by making the interest rate balance work, for example when banks see slacking loan demand, management will lower their interest rate outlook.

Two examples of non-financial risks that bank manages are:

• Technological risk- There are 3 main approaches and these are:

1) Managing technology risk through internal processes and controls.
2) Managing technology risk by outsourcing.
3) Managing technology risk by transferring risk through insurance.


• Operational risk- Banks are requiring greater level of understanding by directors about the types of risks they handle and the effectiveness of the controls they have to reduce these risks.

Conclusion: Risk management underscores the fact that the survival of an organization depends heavily on its capabilities to anticipate and prepare for the change rather than just waiting for the change and react to it. The objective of risk management is not to prohibit or prevent risk taking activity but to ensure that the risks are consciously taken with full knowledge, clear purpose and understanding so that it can be measured and mitigated.

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Marie Corina Beesoo

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Analyse the various risks in banking [15 marks]

Post  Admin on Fri 23 Mar 2012 - 15:16


Risks are uncertainties resulting in adverse variations of profitability or in losses. In the
banking universe, there are a large number of risks. Most are well known. The different risks need careful definition to provide sound
bases serving for quantitative measures of risk. As a result, risk definitions have gained
precision over the years. Current risks are tomorrow’s potential losses. Still, they are not as visible as tangible revenues and costs are. The regulations, imposing capital charges against all risks, greatly helped the process. The underlying philosophy of capital requirement is to bring capital in line with risks. This philosophy implies modelling the value of risk. The foundation of such risk measures is in terms of potential losses. Banking risks are defined as adverse impacts on profitability of several distinct sources of uncertainty .

CREDIT RISK
 Credit risk is the first of all risks in terms of importance. Credit Default Risk - The risk of loss when the bank considers that the obligor is unlikely to pay its credit obligations in full or the obligor is more than 90 days past due on any material credit obligation; default risk may impact all credit-sensitive transactions, including loans, securities and derivatives.
Default triggers a total or partial loss of any amount lent to the counterparty. Credit risk is also the risk of a decline in the credit standing of an obligor of the issuer of a bond or stock
The view of credit risk differs for the banking portfolio and the trading portfolio.
Credit risk is critical since the default of a small number of important customers can
generate large losses, potentially leading to insolvency. There are various default events:
delay in payment obligations; restructuring of debt obligations due to a major deterioration
of the credit standing of the borrower; bankruptcies. Simple delinquencies, or payment
delays, do not turn out as plain defaults, with a durable inability of lenders to face debt
obligations. Many are resolved within a short period (say less than 3 months).
Credit risk can be classified in the following way:

 Concentration Risk - The risk associated with any single exposure or group of exposures with the potential to produce large enough losses to threaten a bank's core operations. It may arise in the form of single name concentration or industry concentration.

 Country Risk - The risk of loss arising when a sovereign state freezes foreign currency payments (transfer/conversion risk) or when it defaults on its obligations (sovereign risk).

LIQUIDITY RISK
Liquidity risk refers to multiple dimensions: inability to raise funds at normal cost. Systematic risk arises from the fact liquidity risk, that is, from the fact that bank’s asset and liabilities have a particular feature which may render them liable to financial difficulties even when they are basically sound. Their liabilities are very liquid, often withdrawable on demand, whereas a large proportion of their asset are in the form of loans and advances which are illiquid owing to both the difficulty of securing repayment at short notice and the absence of a wide secondary market in bank debt. Consequently exercise of the right to withdraw by a large number of depositors (i.e. a run on the bank) may cause failure of a bank. Until insolvency is declared the bank is obliged to pay the full amount of any deposit withdrawn. The run mentality can spead to other banks even though those banks may not be in difficulties. Hence failure of one bank will adversely affect the financial position of other banks.

INTEREST RATE RISK
A person can easily expand the time periods of the fixed rate ventures that are held at a given time, in order to diminish the risk caused by rise in interest rates. In order to survive in this competitive and complex corporate world, one must know how and when to buy or sell at the right time.
This type of deflation does not affect the investment plans directly; one can easily balance this kind of risk by investing with fixed time periods, or by investing in schemes with the ability of swapping between the interest rates from time to time. Those who invest in fixed price income are the target of such mishaps as the yield produced by the bonds are directly proportionate to the interest rates that are available in the market. No one can predict the market situation; one can gain significantly, or one can lose considerably with just a click of a button.
one cannot predict the future interest rate risk when planning for investment. Due to the volatile mature of the stocks, people usually prefer buying bonds or any other type of investment plan which helps them save to a greater extent. Banks are at the main risk situation as there are certain situations where borrowers are unable to return back the loan and as a result, the bank faces a huge loss.
Rise or fall on interest rates is mainly due to the demand and supply of the credit available in the market. Inflation on the other hand plays an important role as well in the rising risk of interest rates which is mainly to the higher demand of interest rates from the lenders. Government has the ultimate power to change interest rates. Whether rates will go up or down, no one has the ability to predict this. Through the central bank, government facilitates the variations in the interest rates.


MARKET RISK
Market risk refers to the possibility of asset prices changing in a manner which will have adverse effects on the bank’s financial position. A good illustration of this was provided by the position of the savings and loans associations in the US in the 1980’s. If assts are held with a longer maturity duration than liabilities, then anticipated rises in interest rates will cause losses unless the lending is at floating rates of interest. Open currency positions also incur market risk since unanticipated changes in the relevant exchange rate will result in windfall gains or losses to the bank concerned. The final type of risk occurs when an institution is forced to sell an asset to obtain funds quickly. Market risks in general has increased because of the rising volatility of asset prices.

FOREIGN EXCHANGE RISK
The currency risk is that of incurring losses due to changes in the exchange rates. Variations
in earnings result from the indexation of revenues and charges to exchange rates,
or of changes of the values of assets and liabilities denominated in foreign currencies. When a business deals in a foreign currency you are exposed to certain risks. For example, you might find that after agreeing a price for exported or imported goods the exchange rate changesbefore delivery. Clearly, this can work both for and against you.
Some currencies are more volatile than others because of their unstable economies or inflation. However, the current economic climate is also impacting more stable currencies such as the euro and the US dollar. As exchange rates can go both up and down, it can be tempting to gamble that this will work out in your favour. However, this is extremely risky and could land you with a significant financial loss.
It's safer to reduce the risk by using one of the forms of hedging available through a bank. Hedging simply means insuring against the price of currency moving against you in the future.
OPERATIONAL RISK
Operational risk, which refers to the risk arising from inadequate or failed internal processes, people or systems, is a risk that has been given increased attention by regulators in recent years. The New Basel Accord of
January 2001 defines operational risk as ‘the risk of direct or indirect loss resulting from
inadequate or failed internal processes, people and systems or from external events’. The very first step for addressing operational risk is to set up a common
classification of events that should serve as a receptacle for data gathering processes on
event frequencies and costs. Such taxonomy is still flexible and industry standards will
emerge in the future.

Explain how banks manage these risks [15 marks]
Better credit risk management practices are essential.

Credit risk
Lenders mitigate credit risk using several methods:
 Risk-based pricing: Lenders generally charge a higher interest rate to borrowers who are more likely to default, a practice called risk-based pricing. Lenders consider factors relating to the loan such as loan purpose, credit rating, and loan-to-value ratio and estimates the effect on yield (credit spread).
 Tightening: Lenders can reduce credit risk by reducing the amount of credit extended, either in total or to certain borrowers.
 Diversification:[19] Lenders to a small number of borrowers (or kinds of borrower) face a high degree of unsystematic credit risk, called concentration risk. Lenders reduce this risk by diversifyingthe borrower pool.
 Deposit insurance: Many governments establish deposit insurance to guarantee bank deposits of insolvent banks. Such protection discourages consumers from withdrawing money when a bank is becoming insolvent, to avoid a bank run, and encourages consumers to hold their savings in the banking system instead of in cash.

Liquidity Risk
There are six key challenges in effectively managing liquidity risk:
1. Moving from tactical stop-gap solutions to a long-term strategic model for risk management, and cascading the new governance structure through all levels of management.

2. Having clear guidance and requirements when global regulators are lacking alignment.

3. Committing huge resources to implement needed changes in liquidity risk management and regulatory compliance.

4. Re-thinking the viability of a business operating model that has traditionally relied on the wholesale funding markets to fund business growth.

5. Integrating stress-testing (vs. using a siloed stress-test approach) when complications arise between intra-day, short-term scenarios vs. longer term scenarios.

6. Projecting contractual cash flows for underlying transactions when some institutions manage millions of transactions.

Interest rate risk
Interest rate risks can be reduced (hedged) using bonds, fixed income instruments or fixed-for-floating interest rate swaps.
FOREIGN EXCHANGE RISK
It's safer to reduce the risk by using one of the forms of hedging available through a bank. Hedging simply means insuring against the price of currency moving against you in the future.

Regards,
Boodhoo Kheerishma


Last edited by Admin on Fri 23 Mar 2012 - 15:17; edited 1 time in total (Reason for editing : Forgot to put my name :P)

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risk faced by the banking sector

Post  Admin on Fri 23 Mar 2012 - 15:30

(1) Analyse the various risks in banking sector.
A bank has many risks that must be managed carefully, especially since a bank uses a large amount of leverage. There are lots of different types of risks in banking sector. The following risks are as follows:
Firstly, we have credit risk, which is the risk of an investor and it occur when cannot repay the loan as original agreed. As per the law the banks are required to maintain an account for loan loss reserve to cover these losses if the borrower does not pay after a period of 90 days then the loan is written off. Credit risk can arise under many circumstances for example a business that does not pay an invoice when it is due.
Secondly, we have foreign exchange risk, the risk of an investment's value changing due to changes in currency exchange rates. This risk usually affects businesses that export or import, but it can also affect investors making international investments. For example, if money must be converted to another currency to make a certain investment, then any changes in the currency exchange rate will cause that investment's value to either decrease or increase when the investment is sold and converted back into the original currency.
Thirdly we have liquidity risk, it is the risk that an asset or security cannot be traded immediately after receiving it then the assets or security their value drops. The two types of liquidity risk include asset liquidity and funding liquidity.
Then we have market risk, it is more general term for risk of market price shifts. This risk can also be related to a volatility risk which is the risk of a portfolio price change due to changes in the volatility of any risk factor.
Interest rate risk is risk deriving from variation of market prices owing to interest rate changes. T he possibility of a reduction in the value of a security, especially a bond, resulting from a rise in interest rates.

There are also other types of risk, an operational risk is the risk that comes from the execution of a company's business functions.
A reputational risk is, as suggested by the name, a risk which endangers the reputation of a well respected company.
Systemic risk is that the financial system may undergo continuous failure following other forms of risk.
(2) Explain how bank manage these risks?
The bank manages the liquidity risk by using the deposit money to lend loans and makes a profit. If they lend too many loans, they may not have money to meet withdrawal demands. So banks have to maintain their liquidity position in a strong way. To monitor liquidity and funding, financial institutions need to have the capability and knowledge for regular liquidity risk management and reporting that measure the potential impact of moderate risk and crisis situations, and project sources and uses of funds
Interest rate risk can be reduced by diversifying the duration of the fixed income investment that are held at a given time.
The management of the banking firm relies on a sequence of steps toimplement a risk management system. These can be seen as containing the following four parts: 6
(i) Standards and reports,
(ii) Position limits or rules,
(iii) Investment guidelines or strategies,
(iv) Incentive contracts and compensation.
In general, these tools are established to measure exposure, define procedures to manage these exposures, limit individual positions to acceptable levels, and encourage decision makers to manage risk in a manner that is consistent with the firm's goals and objectives.

Regards: Nevin Puttoo (111429)

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Re: Second forum

Post  Admin on Fri 23 Mar 2012 - 15:32

1) Analyse various risks in banking?
Risk is bound to be for a bank,as it deals with money. Where there is money there is risks. risks can be financial and non financial that a bank has to face. A definition of risk would be a probability or threat of a damage,injury,liability,loss or other negative occurrence that is caused by external or internal vulnerabilities: and that may be neutralized through pre emptive measures
Financial risks can be:
a) Credit Risk: it is the risk that bank incur if debtor fails to pay its obligation towards them. In simple words: borrowers will not be able to repay principle and interest as arranged.(also known as default risk)

b)Market Risk: is the risk of losses resulting from changes in the value of assets and liabilities due to fluctuation in risk factors. Market risk can be divided into 2 sections namely liquidity and interest rate risk:

Interest Rate Risk is the risk that fluctuation in the interest rates may impact on profitability of the bank. For example: Decline in net interest income will result from changes in relationship between interest income and interest expense.

Liquidity Risk is the risk faced by the bank when it does not have sufficient funds to lend to customers. For example: There will not be enough cash and/or cash equivalents to meet the needs of depositors and borrowers.

c) Foreign Exchange Risk is the risk that can be incurred due to changes in exchange rate. For example: Appreciation or depreciation of a currency will result in a loss or an naked position.

Non Financial Risk can be
a) Operation Risk: It is risk that occurred due to human incapability. For Example: Failure of data processing equipment will prevent the bank from maintaining its critical operations to the customers satisfaction

b) Technological Risk: that is when technology becomes outdated and obsolete,for the bank to operate it takes more time thus causing dissatisfaction to customers.
veev
c) Staff Risk: staff that are not motivated ,will do lots of mistakes. There will be high labour turnover,causing staff and clients to leave the bank.

d) Systemic Risk: is the risk associated with the entire financial system. Suppose among 4 banks 1 of them close,depositors will remove their money from that bank and other depositors will remove their money in the three respective banks also.It is the domino effect

e) Delivery Risk: Buyer and seller of a financial instrument or foreign currency will not be able to meet associated delivery obligations on their maturity.

Kaveer Rughoonauth (student Id: 111436)

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Re: Second forum

Post  Admin on Fri 23 Mar 2012 - 15:49

ANYALISE THE VARIOUS TYPES OF RISKS FACED BY THE BANKING SECTOR

A brief introduction to the banking world…Banks operates by borrowing funds-usually by accepting deposits or by borrowing in the money markets. Banks borrow from individuals, businesses, financial institutions, and governments with surplus funds (savings). They then use those deposits and borrowed funds (liabilities of the bank) to make loans or to purchase securities (assets of the bank). Banks make these loans to businesses, other financial institutions, individuals, and governments (that need the funds for investments or other purposes). Interest rates provide the price signals for borrowers, lenders, and banks.

As we are all aware, in every business there are ups and downs. Similarly, the banking sector also faces many difficulties on which it has to work on in order to find their solutions. Below are some of the risks which banks have to deal with:

1) “Survival of the fittest” – For example in Mauritius, we have around 20 banks, thereby giving the public a larger choice to decide with which bank they would like to be associated with. In such a scenario, each bank has to come up with new and effective schemes and strategies so as to be able to attract the maximum number of clients and thus be the leader in the banking sector. In simple words, the amount of loans raised by individuals is growing day by day and as a result, people will tend to go with the bank which provides the best scheme.

2) Technological Risk – Nowadays, technology permeates the operations of an entire institution. Recently, the Mauritius Commercial Bank encountered problems with its system (ATMs, Online Banking Service and so on) for some 3 days due to a new technology which was being implemented in the bank. This caused much frustration among its clients. Such risks need to be avoided as this can lead to a negative impact on the reputation of the bank.

3) Operational Risk – It is the risk of loss resulting from inadequate or failed internal processes, people and systems, or from external events. It also includes political and legal risks.

4) Staff Risk – The literacy rate in many countries is now very high. Staffs are more aware of their rights and conscious about their needs. Therefore, they are ready to bargain for higher salaries, better working conditions, environment and also voicing out their opinion in case of unfairness at work. This has entailed a high labour turnover in many banks which do not look well after their employees. Consequently, new staffs are constantly recruited and since it takes some time to train them, clients happen to be dissatisfied with the service.

5) Systemic Risk - Systemic risk can be compared to a bank run which has a cascading effect on other banks which are owed money by the first bank in trouble, causing a cascading failure. As depositors sense the ripple effects of default, and liquidity concerns cascade through money markets, a panic can spread through a market, with a sudden flight to quality, creating many sellers but few buyers for illiquid assets.

6) Credit Risk – One the most important financial risks of the banking sector is credit risk. This risk arises when money lent by banks are not recuperated. In other words, loans taken by people from banks, are not paid back to the bank increasing credit risk.

Credit risk is also called Solvency risk. It is the risk that a creditor will lose his entire Investment if a debtor cannot repay him in full, even if all the debtor's Assets are liquidated.

7) Market Risk - Market risk is the risk that the value of a portfolio, either an investment portfolio or a trading portfolio, will decrease due to the change in value of the market risk factors. The four standard market risk factors are stock prices, interest rates, foreign exchange rates, and commodity prices.

(i) Foreign Exchange Risk is the risk of resulting from transactions in foreign currencies which are always fluctuating;
(ii) Interest Rate Risk is the risk where the fluctuation of interest rate may have an impact on the profitability of a business;
EXPLAIN HOW BANKS MANAGE THESE RISKS

It is vital to indentify vulnerabilities and threats to banks and thus come up with the appropriate solutions as follows:

1) It is right to say that people choose their banks but this also applies the other way. Similarly, banks also may choose their clients and this can be done through carrying out due diligence or even enhanced due diligence where necessary on big clients. Furthermore, the bank can have a more efficient compliance department working on the credibility of customers. This can avoid many of the risks mentioned above for example credit risk.

2) Information technology introduces a new dimension to vulnerability assessment. The dynamics of technology represented by the speed that new hardware, software, and services are introduced, adds complexity. In order to evaluate the controls surrounding systems that host critical data, bank management must have the tools and expertise to assess the technology that enables them. With each new release of an operating system, software application, or device, a variety of security holes may be introduced.

3) Who does not want to have a company car, a salary to be able to afford all the luxury possible and lead a decent life and many other benefits? Therefore, banks need to ensure that all staffs are remunerated fairly on a performance basis. The better the performance, the higher the rewards which may be both monetary and non-monetary. Moreover, team building exercises and regular appraisals can be done to assess the performance of staff can be arranged. Ultimately this will lead to better profitability for banks and also less labour turnover, reducing the cost of training new staff.

4) Banks must also continually seek ways to convert market uncertainties into risks which can be objectively measured and thus handled efficiently either by insurance, transfer to specialist or by consolidation.

5) It has been mentioned above that it is the best which survives. Banks can do so by sending representatives to various companies and presenting their new products to employees, thereby targeting a greater population. Another simple way would be increasing the number of ATMs around a country for a particular bank avoiding people travelling long distances in order to withdraw or deposit money.

6) In order to address systemic risk, financial regulatory policies are an essential part of the solution, but they alone will not suffice to address systemic risk in all its complexity. Other policies - especially monetary and fiscal policy - also have a role to play. Third, policy coordination is essential - not just nationally among monetary policy, fiscal policy and macro- and microprudential policies - but also internationally.

To conclude, all banks have a regulator which ensures that each bank is complying with the laws and having a smooth running. However, it is also very important for each bank to work towards filling its gaps and thus ensuring quality-based services to the public.

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Re: Second forum

Post  Admin on Fri 23 Mar 2012 - 15:54

Question 2.
Explain how bank manage these risks?


Management of credit risk
Credit risk is most simply defined as the potential that a bank borrower or counterparty will fail to meet its obligations in accordance with agreed terms. These methods can be used tp manage credit risk:
1- Exposure Ceilings
2- Portfolio Management
3- Risk Rating Model
4- Risk based scientific pricing
5- Loan Review Mechanism
Management of Liquidity risk
when money is deposited in the banks, it should not give loans all of it. It should keep some if ever the depositors claim their money back then it will be a problem
Management of foreign exchange Risk.

(d)FOREX Risk
By setting appropriates limits-open position and gaps, stop-loss limits, Day Light as well as overnight limits for each currency, Individual Gap Limits and Aggregate Gap Limits, clear cut and well defined division of responsibilities between front, middle and back office the risk element in foreign exchange risk can be managed.
Management of Operation risk
Operational risk
There are sources of historical data on various incidents and their cost which served to measure the number of incident and direct losses in operational risk. The general principle for operational risk management is to access the like-lihood and cost of adverse events. Data gathering process, data analysis and statically techniques help in finding core relation and drivers of risk. There should be expert judgments, possible operational events and their implications, pooling data from insurance costs and other institutions related to event frequencies and cost
Kaveer Rughoonauth (student Id: 111436)

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Re: Second forum

Post  Admin on Fri 23 Mar 2012 - 15:57

(i)Analyse the various risks in banking
Banking risks can be defined as the negative impacts on the gainfulness of various distinct sources of uncertainty. The banking sector encounters with several risks which can be classified into financial risks and non-financial risks.
Financial risks are:
1.Credit risk-it can be defined as “the risk that the interest or principal, or both, on securities and loans will not be paid as promised”. The loss here is comprehended for only being to break contract actual occurrence would produce. Therefore, the credit risk is again called default risk.
2.Market risk- it means to make the banks inside and outside balance-sheet business take risk because of the disadvantageous fluctuation of price (interest rate, exchange rate and stock price and merchandise price) in the market. Market risk can divide into the interest rate risks and liquidity risks.
3.Liquidity risk- is the current and prospective risk to earnings or capital arising from a bank’s inability to meet its obligations when they come due without incurring unacceptable losses. Liquidity risk includes the inability to manage unplanned decreases or changes in funding sources. Liquidity risk also arises from the failure to recognize or address changes in market conditions that affect the ability to liquidate assets quickly and with minimal loss in value.
4.Interest rate risk-risk that an interest-earning asset, such as a bank loan, will decline in value as interest rates change. Longer maturity, fixed rate loans (for example, 30-year conventional mortgages) are more sensitive to price risk from changes in rates than variable rate loans.
5.Solvency risk-it is the risk of not being able to cover losses regardless of the source, type or size of the losses. In broad sense, solvency is often equated with liquidity risk since ready money is needed to cover losses. Therefore it is the risk that the bank will default. Ultimately, it is the risk of bank failure.
6.Foreign exchange risk-it is the currency risk is that of incurring losses due to changes in the exchange rates. Variations in earnings result from the indexation of revenues and charges to exchange rates or of changes of the values of assets and liabilities denominated in foreign currencies.

Non financial risks:
1.Operational risk-it is the risk to the bank that errors made in the course of conducting its business will result in losses. Operational risk arises from the potential that inadequate information systems, operational problems, breaches in internal controls, fraud, or unforeseen catastrophes will result in unexpected losses. Operations risk is covered under Basel II pillar I.
2.Technological risk- it refers to banks using outdated technology that is banks using slow and poor technology. The work is very slowly done and customers have to wait longer period of time before doing any transaction. This will lead the bank to non financial risks.
3.Staff risk- it is when the staffs are not motivated and this lead to lots of errors or the bank has a high labour turnover.
(i) Explain how banks manage with risks.
Credit risks
Credit risk affects individuals, businesses and countries. Elements to credit risk can be understood and managed. By being vigilant from the consumer level all the way to the national level, credit risks can be lessened or avoided altogether. Failure to monitor credit risks can result in widespread financial problems.
The management of credit risks includes:
•Measurement through credit rating
•Quantification estimate of expected loan losses
•Pricing on a scientific basis
•Controlling through effective loan review mechanism and portfolio management
The tools and instruments through which credit risks are carried out are:
oExposure ceilings
oReview and renewal
oRisk rating model
oRisk based scientific pricing
oPortfolio management
Liquidity risks management
Banks manage their liquidity risk by carefully monitoring the relationship between their short-term liabilities as opposed to their short-term assets. The management of risk is achieved by applying stress tests to all liquidity components in order to determine what would happen if conditions were to change. The Asset Liability Management (ALM) is a part of the overall risk management system in the banks. It implies examination of all the assets and liabilities simultaneously on a continuous basis with a view to ensuring a proper balance between funds mobilization and their deployment with respect to their a) maturity profiles, b) cost, c) yield, d) risk exposure.

Interest rate risk management
To manage risk, banks follow a process that identifies potential risk areas, measures potential risks and attempts to control risk factors. Some banks may use a centralized approach that works on containing risks within certain areas, such as money market accounts or investment portfolios. Other banks may use a more decentralized approach in which each area of the bank manages interest rate risk based on how it affects their product and service offerings

Technological risk
Banks should introduce new technology available on the market so as to be in competition with other banks. New technology provides faster service to customers and thus this will attract more and more clients. This will boost the banks gainfulness and can manage risks.
Staff risk
Staff wages should be increased, get fringe benefit like car, holidays, good working condition and among others. As they will be motivated, they will work hard and thus this will be profitable for the banks and manage risks.

Leksheena Juggessur

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Re: Second forum

Post  Admin on Fri 23 Mar 2012 - 15:57

Analyse the various risks in banking [15 marks]
Risk is the potentiality that the expected and unexpected event may have an adverse impact on the bank’s capital or earnings. Thus, these risks can be classified into two forms; financial and non-financial risks.
Below are the forms of financial and non-financial risks that exist:
FINANCIAL RISK

(i)Credit risk
Credit risk is inherent to the business of lending funds to the operations linked closely to market risk variables. The objective of credit risk management is to minimize the risk and maximize bank’s risk adjusted rate of return by assuming and maintaining credit exposure within the acceptable parameters.

(ii)Market risk
Market risk is the risk to the bank’s earnings and capital due to changes in the market level of interest rates or prices of securities, foreign exchange and equities.

(iii) Foreign exchange risk
Foreign is the possibility that exchange rate changes will alter the expected amount of principal and return of the lending or investment.

(iv) Country risk
This is the risk that occurs because a country is unable to repays the debts due to foreign lender in time.


NON-FINANCIAL RISK
a) Operational risk
Operational risk involves breakdown in internal controls and corporate governance leading to error, fraud, performance failure, compromise on the interest of the bank resulting in financial loss. Example of a fraud which occurs in MCB. Clifford Allet , fraud auditor in MCB had been accused to commit this offence

b) Technological risks
It can be related for the presence of high technology which become quickly obsolete and some people may find it difficult. Nowadays every one can get access by the help of internet, can hack a bank or even send a spam to ask people theirs account number and also theirs secret code.

c) Staff risks
Staffs can easily be demotivated and they can undertake many mistakes in theirs works. Hence, these mistakes can lead to a high turn over
.

Explain how banks manage these risks [15 marks]

Risk management must be a fully integrated part of planning and executing any operation,
routinely applied by management, not a way of reacting when some unforeseen problem occur.

The management of:

Credit risk

Tools to manage credit risks:
  • Review
    Risk rating model
    Risk based scienfic pricing
    Portfolio management


Market risks
Market risks result from the danger of negative market developments (changes in the money and
capital markets), which affect a company’s financial assets. As such, we can distinguish between
the risks associated with changes to stock prices, interest rates, and exchange rates

Country risks
  • *self-insurance (sovereign wealth funds, international borrowing, international borrowers )
    *Facilities from multilateral institution. (ex :UN , United Nation)


Operational risks

  • .Identify the Hazard
    .Assess the Risk
    .Analyze Risk Control Measure
    .Make Control Decision
    .Implement Risk Control
    .Supervise and Review


Kindly regards,
Marie-laure Conchita Melissa Odeur

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Re: Second forum

Post  Admin on Fri 23 Mar 2012 - 15:57

Analyze the various risks in banking. (15 marks)
Nowadays banks are exposed to competition and hence are compelled to encounter various types of financial and non financial risks. Risks and uncertainties form an important part of banking which by nature entails taking risks. These risks are
1. Credit risk-Credit risk is when a borrower or counterparty fails to meet the obligations on agreed terms or that the counterparty deteriorates in its credit standing. Direct loans, commitments to extend credits, settlement exposures are all subject to credit risk.
2. Liquidity risk-It covers all risks that are associated with a bank finding itself, unable to meet its commitment on time, or only being able to do so by recourse to emergency borrowing.
3. Interest rate risk-Interest rate risk results from mismatches between asset and liability positions which are subject to unfavorable movements in interest rates with potentially adverse impact on margins, net interest income and the economic value of a bank’s assets, liabilities and shareholders’ value.
4. Market risk encompasses exposure to interest rates, foreign exchange rates, share prices and commodity prices.
5. Country risk-This is the risk that arises due to cross borders transactions that are growing rapidly in the recent years owing to economic globalization. In other words it is associated with the risk of incurring financial losses resulting from the inability or unwillingness of borrowers with a country to meet their obligation.
6. Solvency risk relates to the risk of having insufficient capital to cover losses generated by all types of risk.
7. Operational risk (non-financial risk)-It arises from shortcoming or deficiencies at either a technical level or at an organizational level. It can cause financial loss, reputational loss, loss of competitive position or regulatory sanctions
Systemic Risk-It refers to the risks imposed by interlinkages and interdependencies in a system or market, where the failure of a single entity or cluster of entities can cause a cascading failure, which could potentially bankrupt or bring down the entire system or market.
Other types of risks are environmental risk, forex risk and so on.


Explain how banks manage these risks? (15 marks)
Risk Management is the process of identifying and assessing potential risks facing an organization and taking measures to avoid (eliminate) or to control (mitigate) the risk. Many risks are avoided and or controlled through a system of internal controls designed in banks. There are various ways of managing such risks;
Bank manage credit risk by
-Limit and safeguards-policy, process and procedures
-Credit approval authorities and transaction approval process
-Aggregating exposure limits by customers, sector and correlated credit
-Portfolio techniques
-Diversification and correlation concepts
Market risks are managed by
-risk appetite and capital requirement
-Capital treatment of market risk under Based I and II
-setting and monitoring transaction and portfolio limits
Liquidity risk is manage by
-asset and liability management and gap limits
-Contingency liquidity
-Use of securitisation;impact on capital, credit quality and liquidity.
To conclude, risk managing system is the pro-active action in the present future. Managing risk is nothing but managing the risk before the risk manages.Business grows mainly by taking risks.
Durvashi Devi Ramasawmy


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Re: Second forum

Post  Admin on Fri 23 Mar 2012 - 15:58

[b]I) Analyze the various risks in banking?[/b]
The nature of banking is strongly related to the management and control of risks. These risk can be financial or non-financial risks.

[b]Credit risk (default risk)[/b]: Risk due to an uncertainty in a counterparty’s ability to repay the loan and meet its obligations in accordance with agreed upon term.
Credit Risk include Loans, Acceptances, Interbank transactions, Trade financing, FX transactions, Swaps, Equities, Letters of credit.

[b]Interest Rate risk[/b] is the uncertainty in bank earnings and returns on bank assets that results from interest-rate changes.
Maturity mismatch between liabilities and assets – Depositors can withdraw funds at any time, but many loans don’t mature for years. Liabilities more rate-sensitive than assets: e.g., an increase in rates increases cost of borrowings more than income from loans

[b]Insolvency Risk[/b] arise basically when the liabilities is greater that the bank’s assets. So the bank will be unable to satisfy its debts.

[b]Reputational risk[/b] is the potential that negative publicity, whether true or not, will result in loss of customers, severing of corporate affiliations, decrease in revenues and increase in costs.

[b]Liquidity Risk[/b] is the potential failure of a bank to meet its payment obligations in a timely and cost effective manner. It arises when the bank is unable to generate cash to cope with a decline in deposits/liabilities or increase in assets. Typically the bid-offer spread (the difference between where you buy and sell a product) is a good indication of liquidity risk.

[b]Market Risk[/b] may be defined as the possibility of loss to a bank caused by the changes in the market variables. It is the risk that the bank’s earnings and capital will be adversely affected by changes in market level; level of interest rates or prices of securities, foreign exchange and equities, as well as the volatilities of those prices.

[b]Systemic Risk[/b] in banking is evidenced by high correlation and clustering of bank failures in a single country, in a number of countries, or throughout the world. Systemic risk also may occur in other parts of the financial sector—for example, in securities markets as evidenced by simultaneous declines in the prices of a large number of securities in one or more markets in a single country or across countries. Systemic risk may be domestic or transnational.

[b]Operational Risk[/b]: The risk of loss resulting from inadequate or failed internal processes, people and systems, or from external events.
Operational Risk include Internal Fraud, External Fraud, Employment Practices and Workplace Safety, Clients, Products and Business Practices, Damage to Physical Assets, Business Disruption and System Failures, Execution, Delivery and Process Management.


[u][b]II)Explain how bank manage these risks?[/b][/u]

Banks reduce [b]credit risk[/b] by requiring collateral, an asset of the borrower that banks can seize if borrower defaults. Requiring collateral reduces…
 adverse selection: risky borrowers less likely to take out loans
 moral hazard: after taking out a loan, borrower has incentive to use the funds responsibly
 Banks can also reduce credit risk by selling some of their loans

To manage [b]interest rate risk[/b], banks can:
 sell loans to reduce their exposure to rate changes
 make loans with floating interest rates (also called adjustable rates), so an increase in interest rates increases income as well as costs
 trade derivatives to hedge against interest rate changes

[b]Insolvency risk[/b]. A wave of defaults can cause insolvency.
 Banks can protect themselves by holding more capital.

To manage [b]liquidity risk[/b], banks should keep the maturity profile of liabilities compatible with those of assets, the behavioral maturity profile of various components of on/off balance sheet items must analysed and variance analysis is been undertaken regularly. Efforts must be made by some banks to track the impact of repayment of loans and premature closure of deposits to estimate realistically the cash flow profile.

For [b] reputational risk[/b], there may be mostly preventive actions.
[list][*]Improving relations with shareholders.
Creating a more favorable environment for investment.
Processes for crisis management are planned and documented.
External perceptions of the bank are regularly measured.
Reputational threats are systematically tracked.
Employees are trained to identify and manage reputational risks.
Standards on environmental, human rights and labor practices are set publically.
Relationships and trust with pressure groups and other potential critics are established.
[/list].


To prevent [b]Operational Risk[/b] these solutions can be used:
[list][*]Employee training.
Close management oversight.
Segregation of duties.
Employee background checks.
Procedures and process.
Purchase of insurance.
Exiting certain businesses.
Capitalization of risks[/list]

Name: mandakini bhurtun id: 111411


Last edited by Admin on Fri 23 Mar 2012 - 15:59; edited 1 time in total

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