Page 1 Risk Management in Banking. Page 2 An Introduction to Risk Risk Management Risk Management is the process of measuring or assessing the actual.

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Risk Management in Risk Management in BankingBanking

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An Introduction to RiskAn Introduction to Risk

Risk Management Risk Management is the process of is the process of measuring or assessing the actual measuring or assessing the actual or potential dangers of a particular or potential dangers of a particular situation.situation.

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Risk Has Two ComponentsRisk Has Two Components

Uncertainty.Uncertainty.

Exposure.Exposure.

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Types of RiskTypes of Risk

Operational.Operational.

Credit.Credit.

Reputational.Reputational.

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Operational RiskOperational Risk

The risk of loss resulting from The risk of loss resulting from inadequate or failed internal inadequate or failed internal processes, people and systems, or processes, people and systems, or from external events.from external events.

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Operational Risks IncludeOperational Risks Include Internal Fraud.Internal Fraud.

External Fraud.External Fraud.

Employment Practices and Workplace Safety.Employment Practices and Workplace Safety.

Clients, Products and Business Practices.Clients, Products and Business Practices.

Damage to Physical Assets.Damage to Physical Assets.

Business Disruption and System Failures.Business Disruption and System Failures.

Execution, Delivery and Process Management.Execution, Delivery and Process Management.

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Internal FraudInternal Fraud Unauthorized Activity.Unauthorized Activity.

Transactions not reported.Transactions not reported. Transaction type unauthorized.Transaction type unauthorized. Mismarking of position.Mismarking of position.

Theft and Fraud.Theft and Fraud. Fraud/credit fraud/worthless deposits.Fraud/credit fraud/worthless deposits. Theft/extortion/embezzlement/robbery.Theft/extortion/embezzlement/robbery. Misappropriation of assets.Misappropriation of assets. Forgery.Forgery. Account take-over/impersonation.Account take-over/impersonation. Bribes/kickbacks.Bribes/kickbacks. Insider trading.Insider trading. Money laundering.Money laundering. Willful blindness.Willful blindness.

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External FraudExternal Fraud

Theft and Fraud.Theft and Fraud. Theft/robbery.Theft/robbery. Forgery.Forgery. Check kiting.Check kiting. Identity theft.Identity theft. Elder financial abuse.Elder financial abuse.

Systems Security.Systems Security. Hacking damage.Hacking damage. Theft of information (with monetary loss).Theft of information (with monetary loss).

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Employment Practices and Workplace Employment Practices and Workplace SafetySafety

Employee Relations.Employee Relations. Compensation, benefit, termination issues.Compensation, benefit, termination issues. Organized labor issues.Organized labor issues.

Safe Environment.Safe Environment. General liability (slips and falls).General liability (slips and falls). Employee health and safety rules. Employee health and safety rules. Workers’ compensation.Workers’ compensation.

Diversity and Discrimination.Diversity and Discrimination. All discrimination types.All discrimination types. Harassment.Harassment. Equal Employment Opportunity (EEO).Equal Employment Opportunity (EEO).

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Clients, Products and Business Clients, Products and Business PracticesPractices

Suitability, Disclosure and Fiduciary.Suitability, Disclosure and Fiduciary. Fiduciary breaches/guideline violations.Fiduciary breaches/guideline violations. Suitability/disclosure issues.Suitability/disclosure issues. Retail consumer disclosure violations.Retail consumer disclosure violations. Breach of privacy.Breach of privacy. Aggressive sales.Aggressive sales. Inadequate product offerings.Inadequate product offerings. Account churning.Account churning. Misuse of confidential information.Misuse of confidential information. Lender liability.Lender liability.

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Clients, Products and Business Practices Clients, Products and Business Practices ((CONTINUEDCONTINUED))

Improper Business or Market Practices .Improper Business or Market Practices . Antitrust.Antitrust. Improper trade/market practice.Improper trade/market practice. Market manipulation.Market manipulation. Insider trading (on firm’s account).Insider trading (on firm’s account). Unlicensed activity.Unlicensed activity. Money laundering.Money laundering.

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Clients, Products and Business Practices Clients, Products and Business Practices ((CONTINUEDCONTINUED))

Selection, Sponsorship and Exposure.Selection, Sponsorship and Exposure. Failure to investigate client per guidelines.Failure to investigate client per guidelines. Exceeding client exposure limits.Exceeding client exposure limits.

Advisory Activities.Advisory Activities. Disputes over performance or advisory Disputes over performance or advisory

activities.activities.

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Damage to Physical AssetsDamage to Physical Assets

Disasters and Other Events.Disasters and Other Events. Natural disaster losses.Natural disaster losses. Human losses from external sources (terrorism, Human losses from external sources (terrorism,

vandalism).vandalism).

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Business Disruption and System Business Disruption and System FailuresFailures

Systems.Systems. Hardware.Hardware. Software.Software. Telecommunications.Telecommunications. Utility outage/disruptions.Utility outage/disruptions.

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Execution, Delivery and Process Execution, Delivery and Process ManagementManagement

Transaction Capture, Execution and Maintenance.Transaction Capture, Execution and Maintenance. Miscommunication.Miscommunication. Data entry, maintenance or loading errors.Data entry, maintenance or loading errors. Missed deadline or responsibility.Missed deadline or responsibility. Model/system misoperation.Model/system misoperation. Accounting error/entity attribution error.Accounting error/entity attribution error. Other task misperformance.Other task misperformance. Record retention.Record retention. Documentation maintenance.Documentation maintenance. Delivery failure.Delivery failure. Collateral management failure.Collateral management failure. Reference data maintenance.Reference data maintenance.

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Execution, Delivery and Process Execution, Delivery and Process ManagementManagement (CONTINUED)(CONTINUED)

Monitoring and Reporting. Monitoring and Reporting. Failed mandatory reporting obligations.Failed mandatory reporting obligations. Inaccurate external loss (loss incurred).Inaccurate external loss (loss incurred).

Customer Intake and Documentation.Customer Intake and Documentation. Unapproved access given to accounts.Unapproved access given to accounts. Incorrect client records (loss incurred).Incorrect client records (loss incurred). Negligent loss or damage of client assets.Negligent loss or damage of client assets.

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Execution, Delivery and Process Execution, Delivery and Process Management Management (CONTINUED)(CONTINUED)

Customer/Client Account Management.Customer/Client Account Management. Unapproved access given to accounts.Unapproved access given to accounts. Incorrect client records (loss incurred).Incorrect client records (loss incurred). Negligent loss or damage of client assets.Negligent loss or damage of client assets.

Trade Counterparties.Trade Counterparties. Non-client counterparty misperformance.Non-client counterparty misperformance.

Vendors and Suppliers.Vendors and Suppliers. Outsourcing.Outsourcing. Vendor disputes.Vendor disputes.

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Operational Risk ChecklistOperational Risk Checklist Employee training.Employee training.

Close management oversight.Close management oversight.

Segregation of duties.Segregation of duties.

Employee background checks.Employee background checks.

Procedures and process.Procedures and process.

Purchase of insurance.Purchase of insurance.

Exiting certain businesses.Exiting certain businesses.

Capitalization of risks.Capitalization of risks.

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Credit RiskCredit Risk

Risk due to an uncertainty in a Risk due to an uncertainty in a counterparty’s ability to meet its counterparty’s ability to meet its obligations in accordance with obligations in accordance with agreed upon terms.agreed upon terms.

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Credit Risks Include:Credit Risks Include: Loans.Loans.

Acceptances.Acceptances.

Interbank transactions.Interbank transactions.

Trade financing.Trade financing.

FX transactions.FX transactions.

Futures.Futures.

Swaps.Swaps.

Equities.Equities.

Letters of credit.Letters of credit.

Options.Options.

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Sound Practices for Managing Sound Practices for Managing Credit RiskCredit Risk

Establish an appropriate credit risk Establish an appropriate credit risk environment.environment.

Operate under a sound credit-granting Operate under a sound credit-granting process.process.

Maintain an appropriate credit administration, Maintain an appropriate credit administration, measurement and monitoring process.measurement and monitoring process.

Ensure adequate controls over credit risk.Ensure adequate controls over credit risk.

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Establish an Appropriate Credit Risk Establish an Appropriate Credit Risk EnvironmentEnvironment

Board of Directors should review credit risk Board of Directors should review credit risk strategy periodically.strategy periodically.

Senior management should implement credit Senior management should implement credit risk strategy approved by the Board.risk strategy approved by the Board.

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Operate Under a Sound Credit Operate Under a Sound Credit Granting ProcessGranting Process

Criteria should include thorough understanding Criteria should include thorough understanding of the borrower, purpose/structure of credit of the borrower, purpose/structure of credit and its source of repayment.and its source of repayment.

Establish overall credit limits at the level of Establish overall credit limits at the level of individual borrowers/connected counterparties.individual borrowers/connected counterparties.

Have a clearly established process for Have a clearly established process for approving new credits/extension of existing approving new credits/extension of existing credits.credits.

Extension of credit must be made on an arm’s Extension of credit must be made on an arm’s length basis.length basis.

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Maintain a Credit Administration, Maintain a Credit Administration, Measurement and Monitoring ProcessMeasurement and Monitoring Process

Have in place a system for ongoing Have in place a system for ongoing administration of various risk-bearing administration of various risk-bearing portfolios.portfolios.

Develop an internal risk rating system for Develop an internal risk rating system for managing credit risk.managing credit risk.

Have an information system and analytical Have an information system and analytical techniques that enable management to techniques that enable management to measure credit risk of on/off balance sheet measure credit risk of on/off balance sheet activities.activities.

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Maintain a Credit Administration, Maintain a Credit Administration, Measurement and Monitoring Process Measurement and Monitoring Process

(CONTINUED)(CONTINUED) System for monitoring overall composition System for monitoring overall composition

and quality of the credit portfolio.and quality of the credit portfolio.

Consider future changes in economic Consider future changes in economic conditions when assessing individual credits.conditions when assessing individual credits.

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Ensure Adequate Controls Over Credit Ensure Adequate Controls Over Credit RiskRisk

System of independent, ongoing credit System of independent, ongoing credit review.review.

Credit granting function is properly handled Credit granting function is properly handled and credit exposures are within limits.and credit exposures are within limits.

System for managing problem credits. System for managing problem credits.

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Credit Risk ChecklistCredit Risk Checklist

Stringent credit standards for borrowers and Stringent credit standards for borrowers and counterparties.counterparties.

Strict portfolio Strict portfolio risk managementrisk management..

Constant focus on changes in economic or Constant focus on changes in economic or other circumstances that can lead to a other circumstances that can lead to a deterioration in the credit standing of a deterioration in the credit standing of a bank’s counterparties.bank’s counterparties.

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Reputational RiskReputational Risk

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

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Benefits of Effective Reputation Benefits of Effective Reputation ManagementManagement

Improving relations with shareholders.Improving relations with shareholders.

Creating a more favorable environment for Creating a more favorable environment for investment.investment.

Recruiting/retaining the best employees.Recruiting/retaining the best employees.

Reducing barriers to development in new Reducing barriers to development in new markets.markets.

Securing premium prices for products.Securing premium prices for products.

Minimizing threats of litigation.Minimizing threats of litigation.

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The key to managing reputational risk is The key to managing reputational risk is sound sound risk managementrisk management, coupled with , coupled with straightforward communication about straightforward communication about

the problem the bank is facing.the problem the bank is facing.

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Re-establishing a firm’s Re-establishing a firm’s reputation takes a long reputation takes a long time.time.

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Reputational Risk CasesReputational Risk Cases

Perrier – Toluene traces.Perrier – Toluene traces.

Exxon – Valdez spill.Exxon – Valdez spill.

Union Carbide – Bhopal, India.Union Carbide – Bhopal, India.

Arthur Andersen – Enron shredding.Arthur Andersen – Enron shredding.

Firestone – Tires.Firestone – Tires.

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Reputational Risk ChecklistReputational Risk Checklist Processes for crisis management are planned and Processes for crisis management are planned and

documented.documented.

External perceptions of the bank are regularly External perceptions of the bank are regularly measured.measured.

Reputational threats are systematically tracked.Reputational threats are systematically tracked.

Employees are trained to identify and manage Employees are trained to identify and manage reputational risks.reputational risks.

Standards on environmental, human rights and labor Standards on environmental, human rights and labor practices are set publically.practices are set publically.

Relationships and trust with pressure groups and other Relationships and trust with pressure groups and other potential critics are established.potential critics are established.

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True or False?True or False?

Corporate reputation is one of the primary Corporate reputation is one of the primary assets of my bank.assets of my bank.

The risks involving a bank’s reputation have The risks involving a bank’s reputation have increased significantly over the past five increased significantly over the past five years.years.

Reputational risk is harder to manage than Reputational risk is harder to manage than other forms of risk.other forms of risk.

My bank is proactive in enhancing and My bank is proactive in enhancing and protecting its reputation.protecting its reputation.

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True or False?True or False?

It is impossible to quantify the impact of It is impossible to quantify the impact of reputational risks.reputational risks.

My bank usually thinks about its reputation My bank usually thinks about its reputation only when things go wrong.only when things go wrong.

A well run bank doesn’t need to invest extra A well run bank doesn’t need to invest extra resources into guarding against reputational resources into guarding against reputational risk.risk.

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Risk ManagementRisk Management

Risk managementRisk management is the process is the process of monitoring and addressing the of monitoring and addressing the potential for loss.potential for loss.

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Evolution of Risk ManagementEvolution of Risk Management

Emerged as a discipline during the early Emerged as a discipline during the early 1990s.1990s.

Used long before (1960s).Used long before (1960s).

Typically used to describe techniques for Typically used to describe techniques for addressing insurable risks.addressing insurable risks.

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““Old” Risk ManagementOld” Risk Management

Risk reduction through safety, quality control Risk reduction through safety, quality control and hazard education.and hazard education.

Alternative risk financing, including self-Alternative risk financing, including self-insurance and captive insurance.insurance and captive insurance.

The purchase of traditional insurance The purchase of traditional insurance products.products.

Use of derivatives to hedge or customize Use of derivatives to hedge or customize market risk exposures.market risk exposures.

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““New” Risk ManagementNew” Risk Management

Treats derivatives as a problem as much as a Treats derivatives as a problem as much as a solution.solution.

Focuses on reporting, oversight and Focuses on reporting, oversight and segregation of duties within the organization.segregation of duties within the organization.

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By the Mid-1990sBy the Mid-1990s

Regulatory initiatives.Regulatory initiatives.

Concerns about derivatives.Concerns about derivatives.

Release of RiskMetrics.Release of RiskMetrics.

Published losses. Published losses.

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Enron’s Experience with Risk Enron’s Experience with Risk ManagementManagement

Maintained a Maintained a risk managementrisk management function. function.

Lines of reporting were reasonably Lines of reporting were reasonably independent.independent.

Mark-to-market valuations were subject to Mark-to-market valuations were subject to adjustments by management.adjustments by management.

Few career risk managers.Few career risk managers.

Fluid workforce.Fluid workforce.

Employees constantly looking for next transfer.Employees constantly looking for next transfer.

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Regulatory Responses from the Regulatory Responses from the Financial Services CommunityFinancial Services Community

Basel II.Basel II.

Sarbanes-Oxley Act of 2002.Sarbanes-Oxley Act of 2002.

Graam-Leach-Bliley Act.Graam-Leach-Bliley Act.

Bank Secrecy Act/Anti-Money Laundering.Bank Secrecy Act/Anti-Money Laundering.

Insider Trading Rules.Insider Trading Rules.

Bank Bribery Act.Bank Bribery Act.

Fair and Accurate Credit Transactions Act (FACTA)Fair and Accurate Credit Transactions Act (FACTA)

Fair LendingFair Lending

Federal Conflicts of Interest Statutes.Federal Conflicts of Interest Statutes.

Various record retention and reporting requirements.Various record retention and reporting requirements.

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Success Depends UponSuccess Depends Upon

A positive corporate culture.A positive corporate culture.

Actively observed policies and procedures.Actively observed policies and procedures.

Effective use of technology.Effective use of technology.

Independence of Independence of risk managementrisk management professionals.professionals.

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When risk management is doneWhen risk management is done correctly you CAN sleep at night!correctly you CAN sleep at night!

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Thank you for your interest in The Edcomm Group Banker‘s Academy.Thank you for your interest in The Edcomm Group Banker‘s Academy.

We are the #1 financial services training company in the world for three reasons:We are the #1 financial services training company in the world for three reasons:

We are so committed to our clients that we offer a complete money-back quality guarantee.We are so committed to our clients that we offer a complete money-back quality guarantee.

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Our ServiceOur Service – The excellent service we provide demonstrates that – The excellent service we provide demonstrates that we are your partner.we are your partner.

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