Risk Management of Banks

In risk management of banks, we manage mainly three type of risk. One is credit risk, second is market risk and third is operational risk. Solution of following problem may be helpful for you to learn practical field of risk management of Banks


This assignment asks you to be in the role of a Risk Consultant. You have been hired by the board of the White Banking Group to address the risks that the bank currently faces in the form of a report.
You are required to explain in your report what Risk Management is and some of the generic types of risks organisations face, not just the banking and finance sector. In addition you are required to be conduct research and suggest/identify what risks White Banking Group face and what strategies you feel White Banking Group should undertake to minimize or resolve these risks.
Banking Sector Background
The banking and financial services sector has changed dramatically in recent years -- the spread of information and communication technologies has led to new and innovative practices throughout the sector and has also been responsible for significant restructuring of business. Two further trends are the single currency and the movement towards creating a single integrated European financial market. The future is likely to see the strengthening of a few major global players and mergers occurring on an escalating scale, with banks broadening their scope. Cross-border mergers at the European level may develop when the remaining obstacles to their development have been removed as part of a further integration process. Major investment banks are also now beginning to offer more traditional commercial banking products and move into retail brokerage or insurance.
Within the European Union (EU) national financial systems can vary considerably. Since the introduction of the single market in 1992, globalization has added impetus to the growth of 'bulge bracket' investment banks such as UBS, Goldman Sachs, Deutsche and Morgan Stanley. Financial markets operate 24 hours a day with major centre's in Hong Kong, New York, Geneva, Zurich, London, Tokyo, Milan and Frankfurt. Consequently, as cross-border mergers proliferate, wholesale banking is increasingly dominated by a handful of huge institutions without defined boundaries. The single currency has strengthened opportunities by reducing the cost of cross-border investment and transactions within the EU. Different languages and cultures, and taxation and legal disparities have, however, proved to be limiting factors in the development of a truly single market, although hiring across borders has ameliorated some of these difficulties by creating truly multicultural workplaces.
Banking and financial services can be loosely divided into three sectors:
• The banking and investment sector (includes markets, investment banking, corporate banking, investment management, technology and operations).

• The accounting and financial management sector (includes corporate finance and treasury, forensic and management accounting, corporate recovery, tax, audit and insurance).

• The insurance and financial services sector (includes regulation, risk, life assurance, insurance, retail banking and actuarial work).

Banks face major reorganisation (cause study)
A long-awaited report on the banking industry has recommended that banks' high-street and investment arms are separated

UK banks should ring-fence their retail banking divisions to protect them from riskier investment banking arms, a government-backed commission has said.
The Independent Commission on Banking, led by Sir John Vickers, said it would "make it easier and less costly to resolve banks that get into trouble".
The ICB called for the changes to be implemented by the start of 2019.
Chancellor George Osborne welcomed the "good" report and said he planned to stick to the timetable it recommended.
"This commission has tackled that big question that we face in Britain, which is how can we be a home to successful banks that compete around the world, but lend to British families and British businesses, but at the same time protecting us as taxpayers from the cost of them going wrong, and not ending up with a multi-billion pound bill when the bank collapses," he said.
"I think the commission has done a very good job."
Sir John Vickers said the report was "fundamental and far reaching".
Separate entities

The report recommends that ring-fenced banks should be the only operations granted permission by the UK regulator to provide "mandated services", which include taking deposits from and making loans to individuals and small businesses.
It says that the different arms of banks should be separate legal entities with independent boards.
Bank shares initially all fell sharply, with Barclays, Lloyds and RBS all down around 4% and HSBC down 1.6%, although bank shares globally were all lower on Monday on further fears about the eurozone and its debt crisis.

Another of the ICB's recommendations is that banks must have a buffer to absorb the impact of potential losses or future financial crises - of at least 10% of domestic retail assets in top-quality form, such as shares or retained earnings. That is a stiffer target than the 7% recommended by the international Basel Committee on Banking Supervision.
It says the biggest banks should go further than this and have a safety cushion of between 17% and 20% of assets, made up of highest-quality assets topped up with bonds that can be easily converted to equity.
ICB main reforms (Important)
• Ring fence retail from investment banking
• Keep 17-20% of certain assets as "loss-absorbers"
• Lloyds branch sale to be opportunity to bring in competitor
• New system to help customers switch current account
• Reforms to be implemented by 2019 at the latest
• Cost to banks of between £4bn-7bn
The ICB report also says the government should ensure that Lloyds Banking Group's planned sale of 632 branches leads to the emergence of a "strong challenger bank".
The commission also recommends that steps should be taken to make it simpler to switch bank accounts.
It wants a free current account redirection service to be formed by September 2013, with an improved system to catch all credits and debits going to a customer's old, closed account, including automated payments on debit cards and direct debits.
'Into the unknown'
The BBC's business editor, Robert Peston, called it the most radical reform of British banks in a generation, and possibly ever.
He said it would be hated by the biggest UK banks, Royal Bank of Scotland (RBS) and Barclays.
The British Bankers' Association (BBA) said banks had already begun the process of making themselves safer.
"UK banks are well on the way to implementing the sweeping reforms already brought in and expected to be brought in by UK, EU and global authorities to make banks and the system safer and to ensure that banks can fail in the future with savers and taxpayers protected and the supply of finance to the economy maintained," the BBA said.
The Chancellor, George Osborne, said the commission had "done a very good job"
Michael Symonds, an analyst at Daiwa Capital Markets, said there was a danger that the changes would damage UK banking's international competitiveness.
"Into the unknown we go, in terms of the recommendations," Mr Symonds said. "The main issue really is the fact that the UK is going it alone on their structural reforms and the potential damage it will do to the competitiveness of the UK banking sector and economy as a whole."
There is a view that regulating UK banks could push some to leave the country in search of a place where regulation is lighter.
Debate in the papers
Commentators are divided over the effect of ring-fencing the investment from retail side of banks.
David Wighton argues in the Times it is a knee-jerk reaction, creating regulation which will "strangle any recovery".

However, the Independent's Mary Ann Sieghart says lending to businesses will be allowed inside the ring-fenced retail arm, meaning the cost of loans will not rise.
In the Financial Times, the former chairman of the Royal Bank of Scotland, George Mathewson, says splitting banks' activities is not the real danger to banks. He says imposing higher capital requirements, which will reduce bank returns and their ability to lend, poses a much greater threat to the UK's economic recovery.
Sir John said he thought this was unlikely, at least as far as High Street banking was concerned.
The ICB was set up last year to look at how taxpayers could be protected from future banking crises.
The credit crisis ultimately led to the government nationalising Northern Rock and part-nationalising Royal Bank of Scotland and Lloyds.
The government now has stakes of 83% and 41% in RBS and Lloyds, respectively.
The ICB said its proposed reforms could result in a pre-tax cost of between £4bn ($6.4bn) and £7bn for Britain's banks, something Sir John said would be unlikely to be felt by individuals.
He said the cost would be about one-10th of 1% to customers, with the banks themselves absorbing some of the costs.
Source of story: BBC News 12/9/11 Accessed 12/9/11
White Banking Group (WBG)
With Head Quarters in London, WBG is one of the largest banking and financial services organisations in the Europe. It provides a comprehensive range of financial services: personal financial services; commercial banking; corporate, investment banking and markets; private banking; and other activities.
WBG international network comprises around 500 offices in 16 countries and territories in Europe. With listings on the London Stock Exchange, shares in WBG Holdings plc are held by around 220,000 shareholders worldwide.
Through prudent risk strategies and an international network linked by advanced technology, including a rapidly growing e-commerce capability, WBG has withstood most of the pressures and crisis created during the current economic slowdown and last credit crunch. As a result of this strategy and with other banks having difficult trading conditions, the board is considering a move outside of Europe into the US, the Pacific Rim and Australasia
The WBG has an international pedigree which is unique. Many of its principal businesses opened for business over a century ago and have a history which is rich in variety and achievement. The WBG is named after its founding member, Neil White, which was established in 1865 to finance the growing trade between Great Britain and Europe.

Prepare a report to the board of WBG that:-
a. addresses the concepts and processes of Risk management (Done it)
b. identifies the different types of risks (Done it)
c. identifies the types of risks that WBG face and are faced with. (Have problems with this task, I have to find the risk from the cause study and identify 6 risks from the theory for the Whit Bank Group)
d. What strategies WBG can use to manage these risks (Here I should find a strategies for WBG, I think the 4ts will be a good strategy for the bank, if you heard about 4ts?...or if you think some other strategy I can change it)

Word count

Your report should not exceed 3,500 words

Khaty287 (Youtube Channel) From Norway

Q:- B. Identifies the Different Types of Risks 

 Khaty287! First of all we have to understand the basic of bank’s risk. Bank gets money at low cost from depositors. Then bank invests same money by providing different type of loans. If the persons who get loan but  do no repay the same loan. At that time, bank faces two type of risk. One side, bank will not get interest on such loan and due to loss of given loan and other side, faith of its depositors will decrease. All these risks are related to credit risk. In simple words, risk due to taking or giving of credit. Second risk happens due to operation of bank. Due to any internal or external fraud, bank may face losses of money. For example, in your assignment, your bank started e-banking facility. Due to this, your bank may face the problem of hacking of banking site. So, all these losses will be operational losses of bank. Now, we come to market risk of any bank, you know that bank works on the basis of equity share capital and funds from depositors. Equity share market has its own risk. Value of share may increase in one day. Value of share may decrease in other day. Other risk will increase; share market risk will also increase because shareholder will feel bank’s other risk. They will not be interested to buy bank’s share at that time, one share whose price is 1000 pound will go down to 1 pound. At that time, they will be few second sufficient for collapse of any bank. If your bank will deal in foreign country, at that time, forex risk may be.

Q: (b) Addresses the concepts and processes of Risk management

Risk management is simple way to monitor the risk and to control it on the time. Process of risk management is just equal to the process of management. First of all, we make plan of risk management by knowing all expected and unexpected risks and then manage with different techniques

Following may main techniques for risk management of bank

1.   Check the Non-Performing Assets

Some assets perform well by giving us good profit but some assets of bank are non-performing which does not give us profit. For risk management, we should check all these non-performing assets and then when assets are non-performing, we must dispose off as soon as possible.

2. Competition

 Competition is one other major risk which banks have to manage. As per my personal thinking, good competition is always helpful for bank and never be a risk. Because more bank’s competitor will increase, bank will get more chance to improve his quality. But sometime other competitor uses bad techniques to fail us.

3.   Reserves

To reserve more money out of earning is also good way to manage the risk of bank.  ICB main recommendation’s one part “keep 17% to 20% of certain assets as “loss-absorbers” is focusing on this point.

4. Capital Adequacy Ratio

Capital adequacy ratio is the relationship between capital and risk weighted assets. To study and analyze Capital adequacy ratio is very helpful to manage risk of bank because this ratio gives idea of strength of company’s capital. For more you can get reference from http://www.svtuition.org/2010/05/capital-adequacy-ratio-wiki.html

5. Value at Risk and Risk adjusted Rate of Return

To calculate value at risk and risk adjusted rate of return can also use as technique for risk management. Value at risk is sum of all risk of any bank. Total risk will be

= Credit Risk + Market Risk + Operation Risk + Insurance Risk + Liquidity Risk  

Level of this risk will give us idea how much have our capacity to survive.

To calculate Risk adjusted rate of return is also necessary because this return comes after adjusting all expected losses. Following are its formula.

revenue - expenses + return on capital - expected losses 

Q: (C)  Identifies the types of risks that WBG face and are faced with. (Have problems with this task, I have to find the risk from the cause study and identify 6 risks from the theory for the Whit Bank Group)

Dear, there is no end of list of risks. For example, I can tell one more risk of your life that tomorrow, your house will fall down due to earthquake. Next day, road accident may be happen and next day, next bad happen may be happen. So, we have to use positive approach. For example, you want to know the risk for shifting, its business from UK to USA or any other country. At this point, I will say, you that there is no risk only, if your bank's thinking is good. If your bank will do the rule of honestly and truth. If your bank will see first the benefits of USA or other country's customers. At that time, there will be zero risk of loss of the business of your bank. You can take its written guarantee from me. According to my experience, Truth and honesty is powerful tool to manage all the risk. So, as risk consultant, you should go and say that do your duty honestly and follow the rules of truth. In above debate between Govt. and ICB, I read about the financial crisis. So, we have to find the roots of financial crisis and try to handle it instead run back from war fight like a  timid fighter. You can read all the roots of financial crisis.

Q (d.) What strategies WBG can use to manage these risks (Here I should find a strategies for WBG, I think the 4ts will be a good strategy for the bank, if you heard about 4ts?...or if you think some other strategy I can change it)

Try to do Yourself from taking Idea from above part of report. 


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Accounting Education: Risk Management of Banks
Risk Management of Banks
Accounting Education
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