RSK4802 EXAM PACK 2022

RSK4802 EXAM PACK 2022. Financial institutions, particularly banks are a critical component of any economy√. They provide financing for commercial enterprises, basic financial services to the population at large and provide access to payment systems. The importance of banks to national economies is demonstrated by the fact that banking is virtually universally a regulated industry and that banks have some recourse to government particularly √ through the Central banks. It is therefore of crucial importance that banks maintain strong corporate governance. Corporate governance provides the structure through which the objectives of the company are set, and the means of attaining those objectives and monitoring performance are determined. Corporate governance should also provide proper incentives for the board and management to pursue objectives that are in the interests of the company and shareholders and should facilitate effective monitoring, thereby encouraging firms to use resources more efficiently. From a financial industry perspective, corporate governance involves the manner in which the business and affairs of the individual institutions are governed by their boards of directors and senior management affecting how banks:  Set corporate objectives (including generating economic returns for owners)√  Run the day-to-day operations of the bank;√  Consider the interest of recognized stakeholders(*), private and public;√ 8  Align corporate activities and behaviors with the expectation that banks will operate in a safe and sound manner, and in compliance with the applicable laws and regulations;√  Protect the interests of depositors. √ (*) In the financial sector, corporate governance should take in account the interest of other stakeholders (not only the shareholders of the company or owners). These include depositors, savers, life insurance, policy holders, regulators etc. as well as the general stability of the financial system due to the systemic nature of many players. At the same time it is important to avoid any moral hazard by not diminishing the responsibility of private stakeholders. It is therefore the responsibility of the board of directors under supervision of the shareholders, to set the tone and in particular to define the strategy, risk profile and risk appetite of the institutions it is governing. OR A lack of good and strong corporate governance can lead to a banking crisis that in turn can be the catalyst for what can ultimately be an economic recession. Sound corporate governance considers the interests of all stakeholders including depositors and others whose interest may not always be factored. Therefore, banking regulators must determine that individual banks are conducting their business in a way that benefits all stakeholders not just shareholders. Should there not be effective and strong governance lead by the Board down, the business units will tend to regulate risk to achieve their own required levels as a profit centre whilst not appreciating the downside to the organisation as the look towards short term results, inadequate corporate governance stops the board from supervising down to those units. This leads to inadequate internal control by the internal audit department of the group with little or no external supervision of the group. The structure becomes non transparent which in turn leads to no responsibility been taken or oblique responsibility at best. Good strong corporate governance brings about stability and the successful functioning of the financial system. It promotes the taking of appropriate risk and the pricing of that risk. This greases the financial engine and fuels the economy. Leverage is a required catalyst for business and thus the livelihood of the general man in the street. Bad governance and the failure of those “too big to fail” impacts on the lives of everyone. But more importantly the contrary is also true, good governance of the banking sector instills confidence to lend and to borrow, prices these functions appropriately and thus fuels growth which is so important for employment and hence the social benefits that this brings to the wellbeing of mankind. c) Read the following article and identify the corporate governance failures that took place at UBS. (6) How a “safe” strategy incurred write downs USD 18.7bn: the case of UBS RSK4802/201 UBS‟s growth strategy was based in large measure on a substantial expansion of the fixed income business (including asset backed securities) and by the establishment of an alternative investment business. The executive board approved the strategy in March 2006 but stressed that “the increase in highly structured illiquid commitments that could result from this growth plan would need to be carefully analysed and tightly controlled and an appropriate balance between incremental revenue and VAR/Stress Loss increase would need to be achieved to avoid undue dilution of return on risk performance”. The plan was approved by the Group board. The strategic focus for was for “significant revenue increases but the Group‟s risk profile was not predicted to change substantially with a moderate growth in overall risk weighted assets”. There was no specific decision by the board either to develop business in or to increase exposure to subprime markets. "However, as UBS (2008) notes, “there was amongst other things, a focus on the growth of certain businesses that did, as part of their activities, invest in or increase UBS‟s exposure to the US subprime sector by virtue of investments in securities referencing the sector”. Having approved the strategy, the bank did not establish balance sheet size as a limiting metric. Top down setting of hard limits and risk weighted asset targets on each business line did not take place until Q3 and Q4 2007. The strategy of the investment bank was to develop the fixed income business. One strategy was to acquire mortgage based assets (mainly US subprime) and then to package them for resale (holding them in the meantime i.e. warehousing). Each transaction was frequently in excess of USD 1 billion, normally requiring specific approval. In fact approval was only ex-post. As much as 60 per cent of the collateralised debt obligations (CDO) were in fact retained on UBS‟s own books. In undertaking the transactions, the traders benefited from the banks‟ allocation of funds that did not take risk into account. There was thus an internal carry trade but only involving returns of 20 basis points. In combination with the bonus system, traders were thus encouraged to take large positions. Yet until Q3 2007 there were no aggregate notional limits on the sum of the CDO warehouse pipeline and retained CDO positions, even though warehouse collateral had been identified as a problem in Q4 2005 and again in Q3 2006. The strategy evolved so that the CDOs were structured into tranches with UBS retaining the Senior Super tranches. These were regarded as safe and therefore marked at nominal price. A small default of 4 per cent was assumed and this was hedged, often with monoline insurers. There was neither monitoring of counter party risk nor analysis of risks in the subprime market, the credit rating being accepted at face value. Worse, as the retained tranches were regarded as safe and fully hedged, they were netted to zero in the value at risk (VAR) calculations used by UBS for risk management. Worries about the subprime market did not penetrate higher levels of management. Moreover, with other business lines also involved in exposure to subprime it was important