CONTENTS Page
Risk Management:
- 4t’s 2
- Risk appetite 2
- Risks facing banks 2
- ERM framework 2
- Block-chain 2
- CGC 2016 3
- Managing Credit Risk 4
Including OTC counterparty risk 4
- Managing Market Risk 5
- Liquidity and funding risk 5
ARs+APs: Liquidity
- Managing Operational Risk
Loan portfolio analysis (+quality assessment + risks arising on acquisition + due diligence) 7-8
Financial statements analysis (ratios + further info) 9
IFRS9:
- Criteria 10
- Classification 10
- Equity investments (+exceptions) 10
- Reclassification of FIs 10
- Derecognition: 10
Repos 11
Factoring 11
Securitization 11
IFRS9-Impairments of FIs:
- SICR 12
- Loan modifications (forbearances) 13
Leases 13
Net interest income: ARs + APs 14
Fees and commissions income + ARs and APs 14
Loan commitment fees 14
Net trading income 15
IFRS 13: FV 16
Derivative FIs 17
Embedded Derivatives 17-18
Hedge accounting + ARs + APs 19-20
ICs to monitor hedge effectiveness
Credit appraisal 21-24
ARs APs: Provisions 25
ARs APs: FV of FIs 26-28
ICs
- Def 29
- Proprietary trading 29
ARs APs: L&A at amortised costs
- Impairments 30
- Forbearance 30
- CRE 31
- Liabilities at amortised cost 32
First time audit 33
ARs APs: Consumer lending 35
Ethics: 36-38
- Financial interests
- Long association
- Fees dependence
- Provision of non-audit services
- Ethical safeguards
- Report to regulator
- ICAEW framework & 5 fundamentals
Specific topics: 39
- CVA
- FX Financial reporting treatment
- Derivatives (explanations) 40
- Ring fencing 40
1
,Risk Management
Response to risk -> 4Ts:
(1) Tolerate (2) Transfer (i.e. Cr Default swap) (3) Treat (mitigate it through an action) (4) Terminate (ending
the situation)
Type of risks facing banks:
(1) Credit risk (counterparty risk is a subset of credit risk, referring to derivatives)
(2) Market risk (price level, volatility, liquidity and basis risk)
(3) Operational risk
(4) Liquidity and funding risk (in the context of not having sufficient liquid
funds to repay obligations)
(5) Capital risk (not meeting regulatory capital, subset of regulatory risk)
(6) Systemic risk (failure of entire system, cannot be hedged)
(7) Concentration risk
Non- financial risks:
(8) Strategic: the risk to the success of a bank’s strategy, from changes in the business
environment.
(9) Reputational: the risk of reputational damage, due to unfavourable news reports or
customer dissatisfaction.
(10) Technology: risk of technology failures and vulnerability to cybercrimes.
(11) Legal: risk of adverse change in law or court decisions against the bank.
(12) Control: risk of failure in a bank’s system of ICs.
(13) Regulatory: risk of not meeting regulatory requirements, leading to fines and penalties.
Concept of Risk appetite
Level of risk it is willing to undertake in order to generate its return.
Risk appetite is a management decision, approved by the Board and monitored and reviewed by BRC.
ERM Framework – manage enterprise risk
The methodology by which a bank seeks to manage its ER is referred to the ERM. Each Bank applies its own
ERM Framework which usually comprises (1) risk governance (2) the three lines of defence (3) active
risk management and risk appetite and (4) ICs
Def: It is the aggregate sum of all categories of risks that a bank is exposed to.
ERM Framework stages involved: (1) Identification and classification of risk (2) Assessment of risk (3)
Response to risk (4T’s) (4) Monitoring and review (monthly reporting)
Block chain 3 P’s (Propagation, permanence, programmability)
Propagation: all participants have access to a full copy of the ledger and all copies are identical and equivalent
Permanence: past transactions cannot be edited without the consent of the majority, meaning BCH records are permanent
Programmability: program codes are allowed to be stored on them
Relatively new technology
Offers an alternative to more traditional ledger accounting
Used a shared database distributed on multiple hosts where transactions are written as blocks which
can be viewed by multiple hosts, but not altered.
Advantages
This improves transparency and validity because all users can verify the accuracy of a transaction.
Eliminates settlement and reconciliation risks
Minimizes fraud because all new records are traceable + contains mechanisms that make it harder to
tamper with historical records.
Banks can use it for identity confirmation, time stamping, transacting and record keeping and
Reduced transaction costs/improves security (tackles AML issue by removing duplication of efforts on KYC
procedures between different banks and also can act as a proof of regulatory compliance for Banks.
Disadvantages
New tech, not well established yet
Reduced oversight and regulation
Limited at pick usage times
As block chains increase in scale, inefficiencies and costs can increase as well as processing time
2
,CG and risk
3
, Managing Credit risk (in relation to Bank’s lending activities and counterparty credit risk)
Def: Is the risk of financial loss if a customer or counterparty fails to meet an obligation under a
contract.
How:
(1) CDS – transferring the risk, so reduction in regulatory capital requirements through lower RWAs
They provide protection (minimizing losses) in the event of default, in exchange for a regular premium
payment.
(2) Asset securitisation – reduction in regulatory capital requirements
(1) Assets in Bank sold to a SPV
(2) SPV sells these as Asset-Backed securities to investors – proceeds are returned to Bank
(3) Investors receive the repayments of principal and coupons made by original assets as a
return
(4) Bank ultimately passes on Cr Risk to investors
(3) Efficient and appropriate customer screening and due diligence
Mitigation of Counterparty risk in OTC derivative contracts:
Collateral: Require counterparties to place collateral (cash or government securities)
Exposure limits: Set trading limits on OTC exposures that Bank is willing to accept within its risk
appetite
If major counterparty, consider trading with others to minimize concentration risk
Hedging: Use of credit derivatives
Managing Market risk - (in relation to trading book and FIs measured at FV)
Risk that movements in market factors will reduce other income or the value of assets measured at FV
Price level risk: risk that adverse movements in FX or interest rates will affect FV
Liquidity risk: Absence or reduction in buyers and sellers of particular FIs
Volatility risk: changes in volatility causing market prices to vary affecting the valuation of certain FIs such
as options.
Basis risk: the risk of future prices not moving exactly in line with spot prices
How:
(1) Market risk limits (from individual traders to the bank as a whole)
a. Limits based on the size of position taken
b. Limits based on the type of instrument and type of market
c. Limits based on maximum possible loss
d. Limits based on the value of a specified risk metric (i.e. the greeks)
e. Limits based on the size of a probable level of losses (using VaR technique)
(2) Engagement in hedging
(3) Having a diversified portfolio
(4) Performing stress testing, helps management understand the nature and extend of
vulnerabilities to which Banks are exposed.
(5) Monitoring and managing duration GAP and setting targets
FX Risk: Can be found in the Trading book and in the Banking book
Interest rate Risk: Can be found in the Trading book and in the Banking book
Interest rate risk in both Trading book and Banking book can be measured by the concept of duration; a
measure of the interest rate sensitivity of a portfolio of risk sensitive assets or liabilities.
In Trading Book – Direct impact
4
Risk Management:
- 4t’s 2
- Risk appetite 2
- Risks facing banks 2
- ERM framework 2
- Block-chain 2
- CGC 2016 3
- Managing Credit Risk 4
Including OTC counterparty risk 4
- Managing Market Risk 5
- Liquidity and funding risk 5
ARs+APs: Liquidity
- Managing Operational Risk
Loan portfolio analysis (+quality assessment + risks arising on acquisition + due diligence) 7-8
Financial statements analysis (ratios + further info) 9
IFRS9:
- Criteria 10
- Classification 10
- Equity investments (+exceptions) 10
- Reclassification of FIs 10
- Derecognition: 10
Repos 11
Factoring 11
Securitization 11
IFRS9-Impairments of FIs:
- SICR 12
- Loan modifications (forbearances) 13
Leases 13
Net interest income: ARs + APs 14
Fees and commissions income + ARs and APs 14
Loan commitment fees 14
Net trading income 15
IFRS 13: FV 16
Derivative FIs 17
Embedded Derivatives 17-18
Hedge accounting + ARs + APs 19-20
ICs to monitor hedge effectiveness
Credit appraisal 21-24
ARs APs: Provisions 25
ARs APs: FV of FIs 26-28
ICs
- Def 29
- Proprietary trading 29
ARs APs: L&A at amortised costs
- Impairments 30
- Forbearance 30
- CRE 31
- Liabilities at amortised cost 32
First time audit 33
ARs APs: Consumer lending 35
Ethics: 36-38
- Financial interests
- Long association
- Fees dependence
- Provision of non-audit services
- Ethical safeguards
- Report to regulator
- ICAEW framework & 5 fundamentals
Specific topics: 39
- CVA
- FX Financial reporting treatment
- Derivatives (explanations) 40
- Ring fencing 40
1
,Risk Management
Response to risk -> 4Ts:
(1) Tolerate (2) Transfer (i.e. Cr Default swap) (3) Treat (mitigate it through an action) (4) Terminate (ending
the situation)
Type of risks facing banks:
(1) Credit risk (counterparty risk is a subset of credit risk, referring to derivatives)
(2) Market risk (price level, volatility, liquidity and basis risk)
(3) Operational risk
(4) Liquidity and funding risk (in the context of not having sufficient liquid
funds to repay obligations)
(5) Capital risk (not meeting regulatory capital, subset of regulatory risk)
(6) Systemic risk (failure of entire system, cannot be hedged)
(7) Concentration risk
Non- financial risks:
(8) Strategic: the risk to the success of a bank’s strategy, from changes in the business
environment.
(9) Reputational: the risk of reputational damage, due to unfavourable news reports or
customer dissatisfaction.
(10) Technology: risk of technology failures and vulnerability to cybercrimes.
(11) Legal: risk of adverse change in law or court decisions against the bank.
(12) Control: risk of failure in a bank’s system of ICs.
(13) Regulatory: risk of not meeting regulatory requirements, leading to fines and penalties.
Concept of Risk appetite
Level of risk it is willing to undertake in order to generate its return.
Risk appetite is a management decision, approved by the Board and monitored and reviewed by BRC.
ERM Framework – manage enterprise risk
The methodology by which a bank seeks to manage its ER is referred to the ERM. Each Bank applies its own
ERM Framework which usually comprises (1) risk governance (2) the three lines of defence (3) active
risk management and risk appetite and (4) ICs
Def: It is the aggregate sum of all categories of risks that a bank is exposed to.
ERM Framework stages involved: (1) Identification and classification of risk (2) Assessment of risk (3)
Response to risk (4T’s) (4) Monitoring and review (monthly reporting)
Block chain 3 P’s (Propagation, permanence, programmability)
Propagation: all participants have access to a full copy of the ledger and all copies are identical and equivalent
Permanence: past transactions cannot be edited without the consent of the majority, meaning BCH records are permanent
Programmability: program codes are allowed to be stored on them
Relatively new technology
Offers an alternative to more traditional ledger accounting
Used a shared database distributed on multiple hosts where transactions are written as blocks which
can be viewed by multiple hosts, but not altered.
Advantages
This improves transparency and validity because all users can verify the accuracy of a transaction.
Eliminates settlement and reconciliation risks
Minimizes fraud because all new records are traceable + contains mechanisms that make it harder to
tamper with historical records.
Banks can use it for identity confirmation, time stamping, transacting and record keeping and
Reduced transaction costs/improves security (tackles AML issue by removing duplication of efforts on KYC
procedures between different banks and also can act as a proof of regulatory compliance for Banks.
Disadvantages
New tech, not well established yet
Reduced oversight and regulation
Limited at pick usage times
As block chains increase in scale, inefficiencies and costs can increase as well as processing time
2
,CG and risk
3
, Managing Credit risk (in relation to Bank’s lending activities and counterparty credit risk)
Def: Is the risk of financial loss if a customer or counterparty fails to meet an obligation under a
contract.
How:
(1) CDS – transferring the risk, so reduction in regulatory capital requirements through lower RWAs
They provide protection (minimizing losses) in the event of default, in exchange for a regular premium
payment.
(2) Asset securitisation – reduction in regulatory capital requirements
(1) Assets in Bank sold to a SPV
(2) SPV sells these as Asset-Backed securities to investors – proceeds are returned to Bank
(3) Investors receive the repayments of principal and coupons made by original assets as a
return
(4) Bank ultimately passes on Cr Risk to investors
(3) Efficient and appropriate customer screening and due diligence
Mitigation of Counterparty risk in OTC derivative contracts:
Collateral: Require counterparties to place collateral (cash or government securities)
Exposure limits: Set trading limits on OTC exposures that Bank is willing to accept within its risk
appetite
If major counterparty, consider trading with others to minimize concentration risk
Hedging: Use of credit derivatives
Managing Market risk - (in relation to trading book and FIs measured at FV)
Risk that movements in market factors will reduce other income or the value of assets measured at FV
Price level risk: risk that adverse movements in FX or interest rates will affect FV
Liquidity risk: Absence or reduction in buyers and sellers of particular FIs
Volatility risk: changes in volatility causing market prices to vary affecting the valuation of certain FIs such
as options.
Basis risk: the risk of future prices not moving exactly in line with spot prices
How:
(1) Market risk limits (from individual traders to the bank as a whole)
a. Limits based on the size of position taken
b. Limits based on the type of instrument and type of market
c. Limits based on maximum possible loss
d. Limits based on the value of a specified risk metric (i.e. the greeks)
e. Limits based on the size of a probable level of losses (using VaR technique)
(2) Engagement in hedging
(3) Having a diversified portfolio
(4) Performing stress testing, helps management understand the nature and extend of
vulnerabilities to which Banks are exposed.
(5) Monitoring and managing duration GAP and setting targets
FX Risk: Can be found in the Trading book and in the Banking book
Interest rate Risk: Can be found in the Trading book and in the Banking book
Interest rate risk in both Trading book and Banking book can be measured by the concept of duration; a
measure of the interest rate sensitivity of a portfolio of risk sensitive assets or liabilities.
In Trading Book – Direct impact
4
