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Risk management in banks summary
1. Risk Management in
Banks
Term IV (Batch 2016-18)
Submitted to
Prof (Dr) Tamal Dutta Chaudhuri
By Shalini Singh 9/20/17 Roll no: 16022
2. By Shalini Singh
Page no. 1
CONTENTS
1. SUMMARY OF J.P. MORGAN PVT BANK: RISK MANAGEMENT DURING THE FINANCIAL
CRISIS 2008-09 ...............................................................................................................2
2. SUMMARY OF ALIGNING ENTERPRISE RISK MANAGEMENT WITH STRATEGY
THROUGH THE BALANCED SCORECARD: THE BANK OF TOKYO-MITSUBISHI
APPROACH .....................................................................................................................3
3. SUMMARY OF RISK MANAGEMENT AT WELLFLEET BANK: DECIDING ABOUT
“MEGADEALS”................................................................................................................4
4. SUMMARY ON THE CASE OF SUBPRIME TSUNAMI ON INDIAN SHORES: CRISIS HITS
ICICI ................................................................................................................................5
5. SUMMARY ON THE CASE ‘FRAUD AT BANK OF BARODA: MANAGE RISK OR MANAGE
CRISIS’.............................................................................................................................6
6. BSI BANK OF SWITZERLAND: VICTIM OF GROWTH OR PERPETRATOR OF CRIME ........7
7. RISK MANAGEMENT IN ICICI BANK ..............................................................................8
I. CREDIT RISK....................................................................................................................................8
i. WORKING CAPITAL FINANCE PROCEDURES...........................................................9
ii. CREDIT APPROVAL AUTHORITY FOR CORPORATE LOANS......................................9
iii. CREDIT MONITORING PROCEDURES FOR CORPORATE LOANS..............................9
II. MARKET RISK ..............................................................................................................................10
III. INTEREST RATE RISK..................................................................................................................10
IV. EQUITY RISK...............................................................................................................................11
V. EXCHANGE RATE RISK ...............................................................................................................12
VI. LIQUIDITY RISK ..........................................................................................................................12
VII. OPERATIONAL RISK..................................................................................................................12
VIII. LEGAL RISK...............................................................................................................................13
IX. DERIVATIVE INSTRUMENTS RISK ............................................................................................13
X. CONCENTRATION RISK ..............................................................................................................13
XI. PROVISIONS AND CAPITAL ADEQUACY RATIO......................................................................13
3. By Shalini Singh
Page no. 2
SUMMARY OF J.P. MORGAN PVT BANK: RISK MANAGEMENT DURING THE FINANCIAL
CRISIS 2008-09
This case highlighted the fact that risk management system of a bank should be such so that
it can deal not only with the known risks but also with unknown risks. It should be designed
as an active attempt to mitigate the effects of the unexpected risk. The case stressed on the
requirement of being prepared and continuing to plan what could go wrong even when the
things are going well and this distinguishes the more successful firms over time.
Thus the case provides perspective about the philosophy with which JP Morgan approach
risk management, which are the issues of greatest concern, with the details of tools and
processes used in practice.
Risk management system in JP Morgan was taking care of operational risk to keep day-to-
day operations in check as well as; to comply with regulatory requirements to mitigate
regulatory / legal risks and monitor trade approvals, product sustainability and investment
performance to mitigate market risks.
Case further focussed on new risk management tool adopted by the bank, which bank
adopted to bring in alignment in the language of the portfolio managers to understand the
required and expected work from them with lesser discrepancies on the issue of risk
exposures. For this purpose to measure market risk eleven market factors were considered
namely:
1) S&P500 Index; 2) Russell 2000 Index; 3) MSCI EAFE Index; 4) MSCI Emerging Markets
Index; 5) CBOE Volatility Index – VIX; 6) 10-year U.S. Treasury rates; 7) High Yield
Corporate Credit Spreads; 8) Trade-weighted USD Index; 9) S&P GSCI Total Return
Index; 10) 1-month LIBOR; and 11) U.S. CPI Urban Consumers MoM% Change Index.
In the time of crisis the case further focussed on the use of models and exercising judgment,
and lessons learned from the crisis about risk management.
During financial crisis, JP Morgan firstly focussed on enhancing ongoing assessment of credit
quality of counter-parties involved in the transactions. Secondly, it emphasised on
improving ability to gain access to any collateral that was posted by counterparties as
requirement of trading with the bank. Thirdly, they tried to address and understand extent
to which fund managers had drifted away from their respective investment mandates in
search of gains in such tremulous market with subprime holdings. This led them evaluate
the importance of exercising judgement by fund managers in taking investment decisions.
To keep the investors calm they focussed on maintaining transparency and thus they
mitigated the reputation risk in such crisis period. They answered to the questions of their
clients and asked required information from client and tried to maintain this on the ‘real-
time basis.’
The case finally concluded stating the importance of having adequate capital base and
provisioning which helped the bank to absorb the losses in the depressing financial crisis
period.
4. By Shalini Singh
Page no. 3
SUMMARY OF ALIGNING ENTERPRISE RISK MANAGEMENT WITH STRATEGY
THROUGH THE BALANCED SCORECARD: THE BANK OF TOKYO-MITSUBISHI
APPROACH
The case talked about the importance of aligning risk management with the strategies of the
organisation which was implemented in America, Bank of Tokyo-Mitsubishi successfully.
The case stressed on the fact that risk management is concerned with the present activity’s
efficiency and effectiveness adding pressure from system to guide organisation. Whereas
strategy is forward looking if all the time there is restrictions set by pressures created by risk
management which are guiding the organisation formulation of strategy will not be
effective. With such diversities between the two approaches, COSO ERM (Enterprise Risk
Management) system has been discussed to make the alignment doable. It is the new model
that links risk management with strategy. The concept of COSO (Committee of Sponsoring
Organizations) is depicted by the COSO cube.
The model consists of four categories of objectives: strategic, operations, reporting and
compliance. Eight components of risk management and internal controls are indicated in
horizontal rows: internal environment, objective setting, event identification, risk
assessment, risk response, control activities, information and communication, and
monitoring. In the third dimension are the organization’s units.
Balanced scorecard generally focuses on value creation strategies like efficiency but does
not include risk management. Strategic objectives like vision and mission can be cascaded
down to operational levels and hence are translated to operations objectives. Reporting and
compliance objectives are in line with internal business perspective and customer’s
perspective of BSC.
Event identification, Risk assessment, Risk response and control activities are the heart of
risk management. These processes are proactive risk management measures to make
everyone accountable for risk management performance. The organisation would simply
add objectives requiring these steps in every BSC units and everyone is required to go
through these steps in the potential risk areas.
The COSO ERM model also requires relevant information and communication flow related
to strategy and risk management to be across the organisation (both vertically and
horizontally). This accelerates organisation’s learning alignment of risk management with
strategies. By using BSC and COSO ERM model as a package rather than separately, the
organization can achieve simplicity in governance while minimizing confusion. Monitoring
by management and internal auditors will ensure that entire architecture of the strategy-
risk linkage is working efficiently and effectively.
COSO ERM model was given importance as focusing only on risk management pulls the
organisation down from doing things which are not related to day-to-day operations or are
unlike common activities and stresses on doing things on time. Whereas strategies takes the
organisation at a different level to think and do things beyond the common and expected
activities.
5. By Shalini Singh
Page no. 4
SUMMARY OF RISK MANAGEMENT AT WELLFLEET BANK: DECIDING ABOUT
“MEGADEALS”
This case talked about evaluation of project proposal before sanctioning of the proposal by
the Wellfleet Bank and need for a management representative from the board of directors
to be in the committee of the three-member Group Credit Committee who decides upon
the acceptance of the project and is the highest decision making forum in this bank.
Group Credit Committee does not involve any member of board of directors directly, but
includes two credit risk managers and one group head of client relationships to represent
the business side, to decide upon megadeals nearing $1 billion. The Risk Management
Function at the bank consisted of the Relationship Managers who were responsible for
generating leads and they viewed the proposal from the point of view of margins/fees that
the bank could earn from the deal whereas the Senior Credit Risk Officers viewed the
proposal both from its risk and reward perspective. There lies a challenge to manage the
conflict between the relationship managers and credit risk officers in cases where the
proposal is not lucrative for the bank.
The case softly speaks about risks faced by the bank of no Risk Appetite Statement which
defines the tolerance level – the Group Credit Committee has the powers to approve deals
of any size (upper limit for Group Credit Committee authority not defined). Further, the
CEO/Board of Directors only reviews the corporate loan portfolio.
Other risk that the bank is facing is there is the regulatory risk which is compliance with the
Basel II standards, credit risk, increasing competition as well as the risk from acquisitions
and concentration risk. The bank has a very high concentration on its Corporate Banking
Group. As per the case, Wellfleet corporate banking group constituted 58% of profit before
taxes and 72% of banks assets in 2007 while the remaining portion is attributed to its
consumer banking group. The consumer banking group accounted for bad debt provisions of
$611 million in 2006 as compared to $214 million in 2004.
The bank had its own internal credit risk assessment model to compute Risk Adjusted
performance metrics; Expected Loss (EL); Economic Revenue and Economic Profit. EL (in$)
computed as a product of Probability of Default, Loss Given at Default and Exposure at
Default.
EL ($) is the expected loss on the loan amount lent out by the bank. Risk Adjusted Return
(RAR) calculated as the difference between total revenue (interest income and fee income)
and total expected loss.
Economic Revenue= RAR – Net capital charge by treasury
Economic Profit= Economic Revenue- Overhead Cost allocated- Tax
A risk here is that bank officials over-rely on these models to make a decision. However the
bank also took into account the rating from external credit agencies such as Moody’s. Risk
Models must be used with other available data/experience to arrive at a judgement.
6. By Shalini Singh
Page no. 5
SUMMARY ON THE CASE OF SUBPRIME TSUNAMI ON INDIAN SHORES: CRISIS HITS
ICICI
This case described about the impact of financial crisis of 2008 on ICICI Bank, the second
largest bank of India, when Lehman Brothers went bankrupt and world became sceptical on
the performance of private banks world-wide. Also, the case stressed on the management
and importance of public relation team and government’s role in rescuing the bank from the
mishap.
Industrial Credit and Investment Corporation of India (ICICI) Bank felt the heat of the
financial crisis when rumours of its exposure to Lehman Brothers were spread through the
media and the bank had to experience the sudden abrupt fell in share price reporting a loss
of US$264 million in 2008.
The case provides insights about the impact of communication of media during crisis and
how it was handled through the use of media. It showed the impact of the emerging trend
of communication through media and stressed on how the ignorance or incapability or
delay to keep transparency in communication with the stakeholders during the time of crisis
can cause sudden organizational collapse.
The scenario depicted the shift to moral legitimacy rather than output based legitimacy. The
case focussed on the exposure to reputation risk leading to loss in the value of the business
which is beyond event-related accounting metrics. It laid down importance of public relation
team to form ways to communicate with stakeholders in the time crisis to prevent
stakeholders from panic resulting to exposure to reputation risk. They need to think
systematically, proactively and strategically about their unexpected reputation risk for
example by addressing the issues creating havoc among stakeholders and strategically
responding to them. Because media has become very power and prudent use of the same
will only help from the trap created via this channel of communication.
The ICICI’s management issued press release and started an extreme public relations effort.
Even RBI intervened to assure the stakeholders about its adequate cash reserves and
stability of balance sheet, stating about the ICICI Bank abroad being well capitalized.
Government’s intervention in a matter of private bank was a prudent and strategic decision
to avoid or shield against impact of the sceptical view by public at large on the performance
of private banks shifting to sceptical view on public bank ‘s performance as well. Because
this kind of chaos might have led to Domino effect and could have collapsed the belief from
the entire financial system. This could have led to other banks facing the same fate so
government had to step in to rescue ICICI Bank from this mishap.
7. By Shalini Singh
Page no. 6
SUMMARY ON THE CASE ‘FRAUD AT BANK OF BARODA: MANAGE RISK OR MANAGE
CRISIS’
The case discusses about the operational risk faced by second largest commercial bank in
India, Bank of Baroda. After the arrival of new chief executive officer to the bank within a
week, Bank of Baroda was in the news due to reports of fraud occurring at the bank's
Ahmedabad and New Delhi operations. Further, it stressed on the ultimate reputation risk
faced because of two scams of bank exposed to public.
Firstly, the frauds involved bill discounting schemes of Rs.3.5 billion in Ahmedabad and
money laundering scam of Rs.62 billion in New Delhi. When some of the bills discounted by
a client in Ahmedabad were dishonoured on maturity, the bank investigated & found 184
bills discounted against which no export had actually taken place. To prevent these
problems, banks generally avoided bills discounting unless it was for a reputed client and
transactions met adequate checks and balances.
After few days, Bank of Baroda was in the news again for money laundering scam of Rs.62
billion of foreign exchange in New Delhi. To prevent this, RBI issued guidelines for banks
which says banks should have a customer acceptance policy, customer identification
procedure and regular transaction monitoring.
The bank’s Board of Directors was responsible for maintaining the bank’s risk management
framework. The objective of risk management was to ensure that the risks remained within
the range defined by the board. The bank's violations of its "Know Your Client" and “Anti-
Money Laundering Standards” raised concerns about its risk management practices-or lack
of such practices.
The two scams shows the failure of bank to comply with its own stated risk management
practices leading to increased provisioning and reducing income. Review of policies and
procedures were looked upon through all the branches of the bank.
The new CEO tried to address public at large through media and talked about the issue and
shared general remedies thought by the bank’s management, to rescue bank from the state
of loss, so as keep the stakeholder’s faith in them.
8. By Shalini Singh
Page no. 7
BSI BANK OF SWITZERLAND: VICTIM OF GROWTH OR PERPETRATOR OF CRIME
The 143 year old BSI Bank ltd weathered the financial crisis of 2008 and backed its clients
with high quality tailored solutions. It restructured and revamped its investment product
offerings in particular investment funds and portfolio management to provide clients with
greater security while minimizing volatility and maximizing credit quality. For investment
and corporate banking services, BSI Singapore built alliances with smaller corporate
investment organizations, for structured products (leverage products, participation
products, yield enhancement products and capital protection products) it subscribed to
open architecture, using a wide range of third party products.
The case stressed on the operational risk, regulatory and credit risk faced by the bank
leading to the reputational risk and withdrawal of banking licence once granted to the bank.
On inspection by Monetary Authority of Singapore (MAS), many lapses were found where
multiple breaches of money laundering regulations were revealed leading to exposure of
regulatory risk due to operational risk at the same time. Hence, MAS decided to revoke the
merchant banking licence of BSI Bank. MAS required banks to abide by three layers of anti-
money laundering defence. However, the bank was hastened by a progressing outrage
around its greatest customer, 1MDB, a Malaysian sovereign riches support led by the Prime
Minister Najib Razak.
Criminal proceedings were declared by Swiss Financial Market Supervisory Authority leading
to regulatory/legal risk exposure against the BSI for inability to direct statutory due
tirelessness on exchanges including a huge number of dollars connected to 1MDB and
slapped on a fine of CHF 95 million. BSI chief executive Stefano Coduri has resigned with
immediate effect. Swiss prosecutors said the probe was "based on information revealed by
the criminal proceedings related to 1MDB". 1MDB is faced with multiple international
investigations around the world into allegations of corruption.
The case gives a chance to break down the elements that prompted to the destruction of
BSI, one of the most established banks in Switzerland and the 6th biggest in the nation. BSI
seems to have sought after top-line development to the detriment of consistence.
Switzerland's Office of the Attorney General (OAG) said it had information suggesting "the
offences of money laundering and bribery of foreign public officials currently under
investigation in the context of the 1MDB case could have been prevented" by BSI. The bank
failed to carry out plausibility checks. BSI’s senior management did not question why
sovereign wealth fund was using a private bank for institutional services. In one case, BSI
management supported the client advisor instead of compliance department.
BSI was accused of "poor management oversight" and "gross misconduct" by some
employees. Singapore prosecutors charged a former BSI employee as part of their
investigations into the Malaysian fund. MAS named five more individuals, including its
former chief executive, to the state prosecutor to evaluate whether they committed
criminal offences.