RISKS AND RISK MANAGEMENT IN BANK
Md Abdus Salam FCA, FCS
The Banking sector has a pivotal role in the development of an economy. It is the key driver of economic growth of the country and has a dynamic role to play in converting the idle capital resources for their optimum utilization so as to attain maximum productivity. Financial institutions must take risk, but they must do so consciously. However, it should be borne in mind that banks are very fragile institutions which are built on customer`s trust, brand reputation and above dangerous leverage.
Risk in Banking Business: In short, the two most important developments that have made it imperative for Bangladeshi commercial banks to give emphasize on risk management are-
- Deregulation: The era of financial sector reforms which started in early 1990s has culminated in deregulation in a phased manner. Deregulation has given banks more autonomy in areas like lending, Investment, interest rate structure etc. This has made it imperative for banks to pay more attention to risk management.
- Technological innovation: Technological innovation has provided a platform to the banks for creating an environment for efficient customer services as also for designing new products. In fact, it is technological innovation that has helped banks to manage the assets and liabilities in a better way, providing various delivery channels, reducing processing time of transactions.
Banking companies in Bangladesh, while conducting day-to-day operations, usually face following major risks.
Credit risk (including concentration risk, country risk, transfer risk, and settlement risk)
Market risk (including interest rate risk in the banking book, foreign exchange risk, and equity market risk)
Other risks (Compliance, strategic, reputation and money laundering risk)
Risk management framework in banks
An efficient and healthy banking system is a prerequisite for sustainable economic growth of a country. In this context, effective risk management practices enable the banking industry to build public trust and confidence in the institutions which is necessary for mobilizing private saving for investment to facilitate economic growth. The main elements of a risk management framework that apply to banking institutions irrespective of their size and complexity of business are:
First, effective risk management framework demands active involvement of the Board of Directors (BoD) and senior management in the formulation and oversight of risk management processes.
Second, adequate policies, Procedures, and Limits need to be defined by the directors and senior management.
Third, adequate Risk Monitoring and Management Information Systems need to be developed for effective risk monitoring and to identify and measure all material risk exposures.
Fourth, establishing and maintaining an effective system of controls, including the enforcement of official lines of authority and the appropriate separation of duties.
Fifth, the Risk Management Function should be institutionalized to supervise overall risk management at the bank.
Initiatives of Bangladesh Bank for Risk Management
Bangladesh bank vide BRPD Circular No. 17 dated 17.10.2003 indentified 5 (five) nos. core risk for the Banks & Financial Institutions and later on vide FID Circular No. 10 dated 18.09.2005 added another core risk. These six core risks areas are as under:
- Credit (Investment) Risk
- Asset Liability Risk
- Foreign Exchange Risk
- Internal Control & compliance Risk
- Anti Money Laundering Risk
- Information Technology Security Risk (2005)
In 1996, Bangladesh Bank adopted the Basel-I propositions to formulate the capital adequacy regulations against risk weighted assets vide BRPD Circular No.01/1996. The key points of that circular were to define capital following Basel-I.
- Minimum Capital Standards
- Determination of Risk-Weighted Assets
- Implementation Deadline
- Reporting timeframe
As per Quantitative Impact Study (QIS) conducted in April-May 2007 by Bangladesh Bank on commercial banks, Bangladesh Bank issues BRPD Circular No. 14 dated December 30, 2007 on Action plan/Road Map for implementing Basel-II. The key points of that guidelines/circular were to define capital following-
- Introductions and Constituents of Capital
- Credit Risk
- Market Risk
- Operational Risk
- Supervisory Review Process
- Market Discipline
The Basel-III propositions have been formulated by incorporating the following themes:
- To strengthen the capital framework of banks:
- Uplifting the quality, constancy & transparency of the capital base,
- Widening risk coverage,
- Supplementing the RBC requirement with a leverage ratio,
- Shrinking pro-cyclicality and supporting countercyclical buffers,
- Cyclicality of the minimum requirement,
- Forward looking provisioning,
- Capital conservation,
- Excess credit growth,
- Addressing systemic risk and interconnectedness,
- To commence a global liquidity standard
- Liquidity Coverage Ratio (LCR),
- Net Stable Funding Ratio (NSFR),
The major concerns of the risk management committees are as under
- Investment Risk Management Committee
- Asset Liability Committee (ALCO)
- Foreign Exchange Risk Management Committee
- Internal Control and Compliance Risk Management Committee
- Money Laundering Risk Management Committee
- Information & Communication Technology Risk Management Committee
Bangladesh Bank vide Bangladesh Bank vide their BRPD circular No.20, dated 31 December, 2009 issued a detail guideline on Risk Based Capital Adequacy (RBCA) for banks. A separate Supervisory Review Process Guideline has also been circulated to the scheduled banks and also issued Guidelines on Stress Testing.
Regulatory Reporting of Risk Management:
- Risk Management paper: This RMP contains 55 particulars, parameters/subjects/topics under the following risk categories:
- Investment ( Credit) Risk ( 26 particulars )
- Market Risk ( 5 particulars)
- Liquidity Risk ( 16 particulars)
- Operational Risk ( 1 particulars &7 sub category)
- Reputation Risk ( 1 particulars &7 sub category)
- Others Risk. ( 6 particulars)
- Capital Adequacy Statement under Basel Regime: Bangladesh Bank vides BRPD Circular No. 10 dated 25.11.2002 and advised the Bank to submit the Statement of Capital Adequacy to the Bangladesh Bank on half yearly basis. Later on Bangladesh Bank vide BRPD Circular No. 35 dated 29.12.2010 and advised the Bank to submit the Statement of Capital Adequacy to the Bangladesh Bank on quarterly basis.
- Stress Testing Report: Bangladesh Bank vides DOS Circular No. 1 dated 23.02.2011 and advised the Bank to submit the Stress Testing Report to the Bangladesh Bank on quarterly basis.
- Internal Capital Adequacy Assessment Process (ICAAP): Bangladesh Bank vide letter no. BRPD/(BIC)661/14B(P) 2014-2917 dated 21.05.2014 and advised the Bank to submit the ICAAP report along with Supervisory Review Process (SRP) Document to the Bangladesh Bank on yearly basis.