Risk Management After International Crisis

1. Risk Management After International Crisis Prepared by: Dr.AdnanAl’Araj BLOM Bank

2. Notes on crisis • Size, depth and impact completely unexpected • Banks caught undercapitalized and insufficient liquidity at the beginning of the crisis • Banks were generally unable to respond effectively either because of: • inadequate stress test scenarios • poor visibility of portfolios • sudden collapse in liquidity • loss of confidence in the markets • inadequate internal reporting systems, and • problems with revaluation of collaterals

3. Traditional Approach to Risk Management • Operated in “silos” - • Dedicated teams • Separate reporting • Different measures used • Structure varied from bank to bank Good risk governance is a must • Strong risk management • ERM (Enterprise-wide Risk Management)

4. Need for Improved Controls and Systems Quantitative and/or Qualititative Risk Management? • Market Risk • Stressed Value-at-Risk • Incremental Risk • Increase in demand for improved understanding – and proactive management of – credit and liquidity risks and their processes: Credit Risk – • Better quality risk assessment and counterparty credit assessment needed • Aim to improve quality of the portfolio • Increase in NPL’s is a concern for the majority of banks • Loss & Recovery processes and systems inadequate • Collateral management – lacking in a number of institutions • Collateral Management – needs to have the ability to value / revalue • Stress Testing

5. Need for Improved Controls and Systems Liquidity Risk – • Near-term liquidity measurement was lacking in a number of institutions • Liquidity / Credit inter-relationship • Systems were not fully implemented in a number of institutions • Challenges around how to fund the shortfall • Role of Liquidity under Basel II was not as prominent as Credit, Market, Operational Risk

6. New Approach to Risk Management • Integrated risk management: consistent measures combining a number of different parameters and sources • Basel 2 – Basel 2 1/2, Basel 3 ? • More scrutiny from regulators “Overly complex, opaquely priced products that no-one really understood got many banks into trouble; overly complex, opaque regulations surely can't be the answer”

7. Important Aspects • Reputational Risk – for a long time a small part of Operational Risk- has now become a very important element • Model risk • Risk is quantified now but risk management still needs to be standardised (definition of trading book and banking book) • High-level risk principles have to be determined Economic Capital is the solution. • Leverage ratio can only be a supplement to risk-based capital requirements and should be simple and commonly defined • Regulations should consider procyclicality (at good times above the target levels, difficult times below) • The choice is between rescuing a financial institution and risking the financial stability of a system.

8. Main Challenges for Risk Management • Data quality • Better liquidity risk management systems • Updated credit risk ratings systems and improved back-testing • Robust enterprise systems which bring together banking and risk processes • A workable capital adequacy framework • Better guidance and feedback to the banks from regulators • Protect the banking system from too much political interference

9. Four key lessons learned with respect to credit risk management practices at commercial banks: • Governance structure and policies. • Banks must establish an effective governance structure, including credit risk policies with explicit risk-tolerance levels.

10. 2. Credit Analyses. Banks must develop credit analyses from the bottom up--by borrower and transaction, by industry and geographic region, and by country and portfolio segment.

11. 3. Credit Risk Management. Banks must integrate their credit analyses into business decisions. Moreover, they should consider change management requirements when planning for major risk management initiatives.

12. 4. Reporting and Monitoring. Banks must establish effective reporting and monitoring processes to identify key credit risk exposures and trends.

13. In the aftermath of the financial crisis, banks should address three specific issues: 1) improving the risk governance structure and processes at the board level, 2) establishing risk-tolerance levels for key credit risk exposures, and 3) enhancing the independence of the risk management function.