Unit 6: Bank Risk Management Financial English Unit 6: Revision of Unit 5Revision of Unit 5Revision of Unit 5Revision of Unit 5 Background information.

Unit 6:Bank Risk Management Financial English

Unit 6:Revision of Unit 5 Background information of Unit 6 Text ExercisesAssignment

Review of Unit 5Dictation Exercises Check-upBlanks fillingRevision of Text A

DictationDictation!You are going to hear 5 sentences. Each willbe read three times. Write down the sentences according to what you hear.1.2.3.4.5.Check-up

Key to Dictation:1.Typically a borrower issues a receipt to the lender promising to pay back the capital .2.Trading of currencies and bonds is largely on a bilateral basis.3.Banks take deposits from those who have money to save. 4.Todays financial crisis is described the current financial crisis as an even that occurs once in 100 years. 5.The Bank of Japan assigned $25 billion to maintain the liquidity of the Japanese market. The government of the country also held a special meeting with the participation of the chairman of the nations central bank and ministers for economy and finance. Dictation

II. Fill in the blanks.Check-up 1.Home loans are available for____________ like buying a luxurious new house or a new car, etc. Student loan as it itself shows is that it is provided basically to students for _______. Students who want to study more but can not _______can get apply for such loans and continue their studies. 2.When a banker evaluates a borrowers character, he likes to see the latters ties to the community such as long residence, _____________and ________________.

3. While applying for a loan, current assets such as________ or goods can increase your loan chances. 4. If you want to get a loan, there is a tip you should follow: first ________ by phone. Ask the receptionist in the bank or the loan department for _________who would handle your loan request. Of course it would be better, but not necessary to get a ___________from a friend or advisor such as your lawyer or accountant. Check-up

1.Home loans are available for general home purposes like buying a luxurious new house or a new car, etc. Student loan as it itself shows is that it is provided basically to students for higher education. Students who want to study more but can not afford can get apply for such loans and continue their studies. 2.When a banker evaluates a borrowers character, he likes to see the latters ties to the community such as long residence, family ties and home ownership. Check-up

Check-up 3. While applying for a loan, current assets such as inventory or goods can increase your loan chances. 4. If you want to get a loan, there is a tip you should follow: first make an appointment by phone. Ask the receptionist in the bank or the loan department for the name of the appropriate person who would handle your loan request. Of course it would be better, but not necessary, to get a referral from a friend or advisor such as your lawyer or accountant.

Unit 6:Revision of Unit 5 Background information of Unit 6 TextAssignment

Unit 6:Part I: 6.1 Brief Introduction Part II: 6.2 Key Risk Management

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Listening Language Points

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ListeningTextBank Risk Management Listen carefully to the first part of the text and then try to translate it.

Bank Risk Management 6.1 Brief Introduction We are indeed witnessing dramatic shifts in the structure of financial markets all over the world in recent years. Since the summer of 2007, there had been a continuous deterioration of conditions in financial markets. For instance, we have seen significant disruption in several key sectors of our financial system, such as normally creditworthy companies having difficulty issuing commercial paper, dramatic increases in interbank lending rates, and significant concerns about money market funds "breaking the buck." Text :

As a result of these ongoing upheavals, we are experiencing substantial institutional changes, in which some long-standing financial institutions have either failed, sought government assistance, or were forced to merge with other institutions. Text :

A number of studies analyzing the causes of the current turmoil impute shortcomings in the risk management practices of financial institutions. It is absolutely clear that many financial institutions need to undertake a fundamental review of risk management. They now realize that ignoring risk management in any aspect of the banking business usually creates problems later on. Risk management shortcomings need to be addressed not only to improve the health and viability of individual institutions, but also to maintain stability for the financial system as a whole. Text B:

Banking, by its nature, entails taking a wide array of risks. Banks need to understand these risks as well as adequately measure and manage them. The key risks faced by banks as well as how to manage the risks will be discussed below. Text B:

Text : Language Points disruption n. , , , 1. a disruption of telephone service during the hurricane .2. The state was in disruption. .3. These were the products of the disruption of the united front of the two parties. .

upheaval n. ; 1. It was faced with the greatest social upheaval since World War ll. 2. The development of science, especially that of electric industry brings about the upheaval of the industrial look. ,, Text : Language Points

turmoil n. currency turmoil 1. The London Stock Exchange is in turmoil today. 2. This turmoil has been a lesson to us.

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Text : Language Points impute vt....[]; ...; ...1. I impute his failure to laziness. 2. They imputed the accident to the driver's carelessness.

Text : Language Points absolutely adv.;; 1. He is absolutely wrong. 2. It's absolutely impossible.

Text : Language Points fundamental adj., , ; ,;1. a fundamental change 2. the fundamental rules of grammar 3. The research is at its fundamental stage.

ListeningText6.2 Key Risk Management Listen carefully to the second part of the text and then try to translate it.

9.2 Key Risk Management CREDIT RISK MANAGEMENT The extension of loans is the primary activity of most banks. Lending activities require banks to make judgments related to the creditworthiness of borrowers. These judgments do not always prove to be accurate and the creditworthiness of a borrower may decline over time due to various factors. Consequently, a major risk that banks face is credit risk or the failure of a counterparty to perform according to a contractual arrangement. Text : Language Points

This risk applies not only to loans but to other on- and off-balance sheet exposures such as guarantees, acceptances and securities investments. Serious banking problems have arisen from the failure of banks to recognize impaired assets, to create reserves for writing off these assets, and to suspend recognition of interest income when appropriateText : Language Points

Large exposures to a single borrower, or to a group of related borrowers are a common cause of banking problems in that they represent a credit risk concentration. Large concentrations can also arise with respect to particular industries, economic sectors, or geographical regions or by having sets of loans with other characteristics that make them vulnerable to the same economic factors (e.g., highly-leveraged transactions).Text : Language Points

To evaluate the credit risk, banks must first obtain certain basic information that usually is available in a meeting with the potential borrower, such as the integrity of the borrower, his ability to repay and his financial position, how much money is being sought, the purpose of the loan, how long it is needed, and how it will be repaid, etc. Each part of this information should have a reasonable relationship to the other parts. For example, a company seeking loan to conduct coffee importation business will only need three-month financing.Text : Language Points

Since the normal period of time for the company to ship and process the materials as well as to sell the finished products to a coffee company will be within 90 days. So if the company seek a three-year loan to conduct the business, it will be highly unreasonable. For this, banks are required to establish objective credit and investment function which are grounded in sound principles, meanwhile the maintenance of prudent written lending policies, loan approval and administration procedures, and appropriate loan documentation are essential to a bank's management of the lending function. Text : Language Points

Banks should also have a well-developed process for ongoing monitoring of credit relationships, including the financial condition of borrowers. A key element of any management information system should be a data base that provides essential details on the condition of the loan portfolio, including internal loan grading and classifications. When guarantees or collateral are provided, the bank should have a mechanism in place for continually assessing the strength of these guarantees and appraising the worth of the collateral. Text : Language Points

Lastly, banks can deal with the credit risk by credit rationing. That is, banks refuse to make loans even though borrowers are willing to pay the stated interest rate or even a higher rate. Credit rationing takes two forms. The first occurs when a lender refuses to make a loan of any amount to a borrower even if the borrower is willing to pay a higher interest rate. The second occurs when a lender is willing to make a loan but restricts the size of the loan to less than the borrower would like. Text : Language Points

You may be puzzled by the first type of credit rationing. Even if the potential borrower is a credit risk, the bank may extend the loan but at a higher interest. Is that what you think? In fact, borrowers with the riskiest investment projects are exactly those that are willing to pay the highest interest rates. If the borrower took on a high-risk investment and succeeded, the borrower would become extremely rich. But a lender wouldnt want to make such a loan precisely because the investment risk is high. The likely outcome is that the borrower will not succeed and the lender will not be paid back. So the bank would therefore rather not make any loans at a higher interest rate. Text : Language Points

Generally speaking, the larger the loans, the greater possibilities to the occurrence of credit risk. If a bank gives you a 20,000 yuan loan, you are likely to take actions that enable you to pay it back because you dont want to hurt your credit rating for the future. However, if the bank lends you 10 billion yuan, you are more like to go to Macao for gambling. The larger your loan, the greater your incentives to engage in activities that make it less likely that you will repay the loan. Since more borrower repay their loans if the loan amounts are small, financial institution ration credit by providing borrowers with smaller loans than they seek, thus to some extent to avoid credit risks . Text : Language Points

MARKET RISK MANAGEMENT Banks face a risk of losses in on- and off-balance sheet positions arising from movements in market prices. Established accounting principles cause these risks to be typically most visible in a bank's trading activities, whether they involve debt or equity instruments, or foreign exchange or commodity positions. One specific element of market risk is foreign exchange risk. Banks act as "market-makers" in foreign exchange by quoting rates to their customers and by taking open positions in currencies. The risks inherent in foreign exchange business, particularly in running open foreign exchange positions, are increased during periods of instability in exchange rates. Text : Language Points

To finance trade without any financial risk requires obtaining a rate in advance at which the cash flows in each currency, for every date, can be matched. More specifically, covering the rate risk requires obtaining financing for the complete duration of the financing need. Covering the exchange risk involves obtaining a rate at which the conversion of currencies will eventually be made. The financing and the exchange risk problems can be solved simultaneously by denominating the financing in the currency of the expected inflows and borrowing an amount equal to the total inflows. Alternatively, the financing may be done for the required amount and time in any currency, while the exchange risk is covered in the forward market by selling the inflow currency against the outflow currency for the specific dates when the inflows are expected. Text : Language Points

In addition, banks should posses the ability to accurately measure and adequately control market risks. Where there is a potential risk, banks should provide an explicit capital cushion for the price risks to which banks are exposed, particularly those arising from their trading activities. Introducing the discipline that capital requirements impose can be an important further step in strengthening the soundness and stability of financial markets. There should also be well-structured quantitative and qualitative standards for the risk management process related to market risk. Bank management should have set appropriate limits and implemented adequate internal controls for their foreign exchange business. Text : Language Points

LIQUIDITY RISK MANAGEMENT Liquidity risk arises from the inability of a bank to accommodate decreases in liabilities or to fund increases in assets. When a bank has inadequate liquidity, it cannot obtain sufficient funds, either by increasing liabilities or by converting assets promptly, at a reasonable cost, thereby affecting profitability. In extreme cases, insufficient liquidity can lead to the insolvency of a bank. Text : Language Points

Therefore, liquidity risk management is of paramount importance. A liquidity shortfall at a single institution can have system-wide repercussions. Financial market developments in the past decade have increased the complexity of liquidity risk and its management. The market turmoil that began in mid-2007 re-emphasized the importance of liquidity to the functioning of financial markets and the banking sector. In advance of the turmoil, asset markets were buoyant and funding was readily available at low cost. The reversal in market conditions illustrated how quickly liquidity can evaporate and that illiquidity can last for an extended period of time. Text : Language Points

The purpose of liquidity management is to ensure that the bank is able to meet fully its contractual commitments. Crucial elements of strong liquidity management include good management information systems, central liquidity control, analysis of net funding requirements under alternative scenarios, diversification of funding sources, and contingency planning. On the other hand, banks should manage their assets, liabilities and off-balance sheet contracts with a view to maintaining adequate liquidity. Banks should have a diversified funding base, both in terms of sources of funds and the maturity breakdown of the liabilities. They should also maintain an adequate level of liquid assets. Text : Language Points

INTEREST RATE RISK MANAGEMENT Interest rate risk refers to the exposure of a bank's financial condition to adverse movements in interest rates. This risk impacts both the earnings of a bank and the economic value of its assets, liabilities and off-balance sheet instruments. The primary forms of interest rate risk to which banks are typically exposed are: (1) repricing risk, which arises from timing differences in the maturity (for fixed rate) and repricing (for floating rate) of bank assets, liabilities and off-balance sheet positions; (2) yield curve risk, which arises from changes in the slope and shape of the yield curve; Text : Language Points

(3) basis risk, which arises from imperfect correlation in the adjustment of the rates earned and paid on different instruments with otherwise similar repricing characteristics; and (4) optionality, which arises from the express or implied options imbedded in many bank assets, liabilities and off-balance sheet portfolios. Although such risk is a normal part of banking, excessive interest rate risk can pose a significant threat to a bank's earnings and capital base. Managing this risk is of growing importance in sophisticated financial markets where customers actively manage their interest rate exposure.Text : Language Points

Banks should have systematic and effective control over interest rate risk, including effective board and senior management oversight, adequate risk management policies and procedures, risk measurement and monitoring systems, and comprehensive controls. In addition, Banks should submit sufficient and timely information to supervisors who can in return help them to evaluate the level of interest rate risk. Text : Language Points

OPERATIONAL RISK MANAGEMENT The most important types of operational risk involve breakdowns in internal controls and corporate governance. Such breakdowns can lead to financial losses through error, fraud, or failure to perform in a timely manner or cause the interests of the bank to be compromised in some other way, for example, by its dealers, lending officers or other staff exceeding their authority or conducting business in an unethical or risky manner. Other aspects of operational risk include major failure of information technology systems or events such as major fires or other disasters. Text : Language Points

For this, the senior management of banks should work out and execute effective internal control and auditing procedures as well as have policies for managing or mitigating operational risk (by insurance or contingency planning). For the risks from technological failures or unexpected events, banks should have adequate and well-tested business resumption plans for all major systems, with remote site facilities, to protect against such events. Text : Language Points

extension n. Text : Language Points1.the extension of our foreign trade 2.the extension of a loan 3.the extension of education among the peasants

related to ; --;--Text : Language Points1.My success relates to his help. 2.She found it difficult to relate to her roommate.

accurate adj. , ; Text : Language Points1.She gave an accurate account of the accident. 2.The accounting is accurate 3.an extremely accurate micrometer ()

Text : Language Points apply to --1. Apply high technology to production. 2. I will apply to college.

suspend vt. , , Text : Language Points1.To suspend in a liquid. 2.The management decided to suspend negotiation. 3.Tom is suspended from school for a week for bad conduct. 4.The sentence was two years hard labor suspended for a year. ,

respect to Text : Language Points1.It is not invariant with respect to direction. 2.I promise to respect your wishes. 3.We should give more respect to bad students.

vulnerable adj. , , , Text : Language Points1.He is vulnerable to 2.They young girl looked very vulnerable. 3.The potato is vulnerable to several pests.

potential adj. Text : Language Points1. Every seed is a potential plant. 2. Knowledge is only potential power.

essential adj. , ;, ; Text : Language Points1. essential differences 2. essential English 3. An essential bodily fluid. 4.Impartiality is essential to a judge.

mechanism n. ,Text : Language Points1.steering mechanism of motor vehicles 2.a risk prevention mechanism 3.mechanism of price formation

occurrence n. Text : Language Points1.daily occurrences 2.Make allowance for unfavorable occurrences. 3.Graduation from university is an event in life.

portfolios n. Text : Language Points These unit trusts are investment portfolios managed by a professional fund manager. As the fund manager pools the funds from many investors, he can invest in a diversified portfolio that offers lower risk.

simultaneously adv., , , Text : Language Points 1. They almost touch the wall simultaneously. 2. I posted them simultaneously to different publishers.

stability n.(), ; , Text : Language Points1.social stability 2.Threatening Middle East stability 3.Success requires patience, stability and confidence.

inadequate adj.; ; Text : Language Points1.Dictionaries are useful but quite inadequate. 2.The supply is inadequate to meet the demand.

shortfall n., , Text : Language Points1. There will be a shortfall in wheat supplies this year. 2. We have to borrow money to cover the shortfall between expenditure and revenue.

complexity n.)Text : Language Points1.The complexity of the road map puzzled me. 2.You should recognize the complexity of the problem.

alternative n. ; adj. , Text : Language Points1.I have no alternative. 2.That's the only alternative. 3.An alternative newspaper; alternative greeting cards.

Text : Language Pointsbreakdown n. , []; 1.the breakdown of an empire 2.Their car had a breakdown. 3.Please give me a breakdown of those income tax totals.

Text : Language Points1. adverse wind 2. adverse fortune 3. Is there any adverse reaction? adverse n., ; ,

Text : Language Points1. A new oversight body must be establishedreporting to the SEC. 2. He kindly winked at the oversight. 3. Your essay was not marked through an oversight on my part. oversight n., ; ;, , ,

Text : Language Points1. Is the equipment operational yet? 2. The eight helicopters are fully operational.

operational adj., ;,

Text : Language Points1. unexpected guests; unexpected news. 3. The question was unexpected. unexpected adj.,

I. Study questions. 1. What are the major risks banks may have to face? 2. From where the credit risk usually arise for a bank? 3. Suppose you are a banker, now a borrower comes to apply for a 3-month loan to construct a new manufacturing plant, will you approve his application? Why? 4. What are the primary forms of interest rate risk banks may be exposed to? Excises

1. Credit Risk, market risk, liquidity risk, interest rate risk , operational risk and so on.

Excises

2. A major risk that banks face is credit risk or the failure of a counterparty to perform according to a contractual arrangement. This risk applies not only to loans but to other on- and off-balance sheet exposures such as guarantees, acceptances and securities investments. Serious banking problems have arisen from the failure of banks to recognize impaired assets, to create reserves for writing off these assets, and to suspend recognition of interest income when appropriate. Excises

3. I dont think I am going to approve his loan. In common sense, one cant expect to finish constructing a new manufacturing plant in only 3-month. It is quite impractical. If I lend him money, I may have to face great credit risk as well as his inability to repay the money. Excises

4. The primary forms of interest rate risk to which banks are typically exposed are: (1) repricing risk, which arises from timing differences in the maturity (for fixed rate) and repricing (for floating rate) of bank assets, liabilities and off-balance sheet positions; Excises

(2) yield curve risk, which arises from changes in the slope and shape of the yield curve; (3) basis risk, which arises from imperfect correlation in the adjustment of the rates earned and paid on different instruments with otherwise similar repricing characteristics; and (4) optionality , which arises from the express or implied options imbedded in many bank assets, liabilities and off-balance sheet portfolios. Excises

II. Matching . 1. risk management a.2. continuous deterioration b.3. credit rationing c. 4. off-balance sheet exposure d.5. resumption plan e. 6. financial institution f. 7. internal control g. 8. interest rate h. 9. liquidity management i. 10.data base j.ExcisesCheck-up

Answers: 1-5) f h i g a 6-10) e j c b d Excises

III. Fill in the blanks according to what you have learned. 1. Risk management shortcomings need to be addressed not only to improve the _________________ of individual institutions, but also to ________________ for the financial system as a whole. 2. To evaluate the credit risk, banks must first obtain certain basic information, such as the integrity of the borrower, ____________ and the his ______________, how much money is being sought, _________________, how long it is needed, and how it will be repaid, etc.ExcisesCheck-up

1. Risk management shortcomings need to be addressed not only to improve the health and viability of individual institutions, but also to maintain stability for the financial system as a whole. 2. To evaluate the credit risk, banks must first obtain certain basic information, such as the integrity of the borrower, his ability to repay and the his financial position, how much money is being sought, the purpose of the loan, how long it is needed, and how it will be repaid, etc.Excises

3. The essentials that a banks management of a lending function needs to adhere to are _________________, loan approval and ____________________, and _____________. 4. Liquidity risk arises from the __________ of a bank to accommodate decreases in____________ or to _____________. ExcisesCheck-up

3. The essentials that a banks management of a lending function needs to adhere to are maintenance of prudent written lending policies, loan approval and administration procedures, and appropriate loan documentation. 4. Liquidity risk arises from the inability of a bank to accommodate decreases in liabilities or to fund increases in assets. Excises

5. Interest rate risk refers to the exposure of a bank's financial condition to _______________ in ________________.6. The most important types of operational risk involve __________________ and ________________. ExcisesCheck-up

5. Interest rate risk refers to the exposure of a bank's financial condition to adverse movements in interest rates.6. The most important types of operational risk involve breakdowns in internal controls and corporate governance. Excises

IV. Translation ( Answers) 1. It is driven home to investors that the higher the risk, the greater the return. 2. The judgments made by the banks related to the creditworthiness of borrowers do not always prove to be accurate. The creditworthiness of a borrower may decline over time due to various factors. 3. The small bank collapsed due to heavy losses on its foreign exchange exposures. 4. Interest rates are one of the most important variables in the economy. Excises

5. The senior management of banks should work out policies for managing or mitigating operational risk. 6. Frequent supervisory examinations of banks are necessary to keep them from taking on too much risk or committing fraud. 7. Excises

8. Excises

V. Choose one best choice that is closest in meaning to the underlined part in each sentence. (Answers)A. affect B. employ C. catch D. invent A. rising B. falling C. raising D balancing A. danger B. question C. cause D. anxiety A. Acceptable B. Reasonable C. Overmuch D. Expressive A. audible B. edible C. seeable D. possible Excises

Excises6. A. holdings B. debts C. reliabilities D. capital

7. A. restoration B. consumption C. assumption D. redeem 8. A. disgusting B. uncontrollable C. competitive D. complicated

9. A. retorted B. given C. transmitted D. permitted

10. A. fragile B. resistible C. consumable D. uncompetitive

Assignments1.Review the Text .Keep in mind the special terms learned in this Unit.Do exercises in the book.