Table Of ContentFormat 260 x 190 mm / ext 328 / spine 13.3mm / 80 gsm matt art
R
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Risk Management M
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Banking
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Principles and Framework m
e Risk Management
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This book offers a broad-based understanding of the types of risk faced by banks and how these risks may be
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identified, assessed and managed. It aims to provide general banking practitioners with insights into key risk
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management concepts and practices, as well as intelligently discuss developments in bank risk management. a Banking
The contents are organized and presented in an easily readable format to enable learners to understand n in
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key qualitative risk factors and how they impact risk management. Each chapter contains numerous
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illustrative examples and case studies of real life situations to enable students to relate theories to real world
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events.
Principles and Framework
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Key features of the book: in
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• Chapter overview complete with clear learning objectives ip
• Real world illustrations that relate theories to real world events le
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• Illustrative examples that contextualize and elaborate on new and complex concepts a
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Philip Te
The other title in this series: F
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Risk Management in Banking: Risk Models, Capital and Asset Liability Management m
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About the Author k
Philip Te is the Programme Director for the Quantitative Finance and Risk Management Series at the Ateneo
Centre for Continuing Education—the largest continuing education institution in the Philippines. He has lectured
extensively on financial risk management, Basel II/III, derivatives, IAS 39/IFRS 9, option pricing, corporate treasury
management and hedging strategies. He is the author of Bank Risk Management Primer, published by the Bankers’
Association of the Philippines. Ph
A Chartered Financial Analyst (CFA), Philip is also a certified Financial Risk Manager (FRM) and ilip
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Energy Risk Professional (ERP), both awarded by the Global Association of Risk Professionals (GARP). e
He is also a Certified Public Accountant (CPA).
Philip is currently a vice president at the Client Solutions Group of a global commercial bank. Prior to this, he
was the head of the Structured Products and Financial Engineering Department of a local commercial bank and
a senior associate at the Ernst & Young Financial Services Risk Management (FSRM) and Quantitative Advisory
Services (QAS) group.
Risk Management
Banking
in
Principles and Framework
Philip Te
Published by Oxford Fajar Sdn. Bhd. (008974-T)
under licence from Oxford University Press,
4 Jalan Pemaju U1/15, Seksyen U1
Hicom-Glenmarie Industrial Park
40150 Shah Alam
Selangor Darul Ehsan
© Asian Institute of Chartered Bankers 2016
First published 2016
ISBN 978 983 47 1691 2
All rights reserved.
No part of this publication may be reproduced,
stored in a retrieval system, or transmitted in any form or
by any means, electronic, mechanical, photocopying, recording
or otherwise, without the prior permission of
Asian Institute of Chartered Bankers.
Impression: 9 8 7 6 5 4 3 2 1
Text set in 10.5 point ITC Legacy Serif Std Regular by
Chitra Computers, India
Printed by Percetakan Printpack Sdn. Bhd., Selangor Darul Ehsan
INTRODUCTION
This book is part of the Asian Institute of Chartered Bankers’ (AICB) Bank Risk Management
Qualification. This qualification is designed as a qualitative introduction to bank risks and
bank risk management. While primarily targeted at banking practitioners, this book also offers
the general audience a highly readable guide to the practices and procedures for managing
risks in banking.
The learning support for the BRMP Qualification is provided by AICB’s premier learning
partner, the Asian Banking School.
This intermediate level qualification on bank risk management comprises two modules:
Module 1: Risk Management in Banking: Principles and Framework
Module 2: Risk Management in Banking: Risk Models, Capital and Asset Liability
Management
The two modules were developed in collaboration with the Ateneo-Bankers Association of
the Philippines (BAP) Institute of Banking.
Asian Institute of Chartered Bankers
The Asian Institute of Chartered Bankers (AICB) is the professional body for the banking
and financial services industry. We are committed to raising the competency standards
of the banking profession by staying industry relevant and embracing innovations in the
development and delivery of our qualifications and learning.
Asian Banking School
The Asian Banking School (ABS) is AICB’s premier learning partner. ABS aims to raise the
calibre and dynamism of talent in the industry through the delivery of world-class professional
qualifications and learning programmes.
Ateneo-Bankers Association of the Philippines (BAP) Institute of
Banking
The Ateneo-Bankers Association of the Philippines (BAP) Institute of Banking is a non-stock,
non-profit organization, which comprises the country’s commercial banks as its institutional
members.
Unique to the BAP, its mandate acts as the unifying voice of the banking industry in an
environment where business interest and background both among domestic and foreign
banks, in particular, are profoundly diverse.
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ACKNOWLEDGEMENTS
The Asian Institute of Chartered Bankers wishes to thank members of the Bank Risk
Management Professional Curriculum Working Committee, who have generously contributed
their time and expertise in guiding the design and development of the curriculum for the
qualification.
Dr John Lee Hin Hock
(Chairman)
Malayan Banking Berhad
Mr Nigel Denby
Ambank Berhad
Mr Suresh V. Raman
Citibank Berhad
Eddie Cheong Wai Seong
Bank of China (Malaysia) Berhad
Dr Vijayan Paramsothy
Asian Banking School
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CONTENTS
Introduction iii
Acknowledgements iv
CHAPTER 1
CONCEPTS OF BANK RISKS
1.1 BANKING BUSINESS ACTIVITIES, PRODUCTS AND BUSINESS LINES 3
1.1.1 Corporate Finance 4
1.1.2 Trading and Sales 6
1.1.3 Retail Banking 9
1.1.4 Commercial Banking 10
1.1.5 Payments and Settlements 13
1.1.6 Agency Services 13
1.1.7 Asset Management 14
1.1.8 Retail Brokerage 15
1.2 ROLES OF BANKS IN THE ECONOMY 15
1.2.1 Primary Role of Banks: Financial Intermediation 15
1.2.2 Functions of Financial Intermediation 17
1.2.3 Other Roles of Banks 19
1.3 TYPOLOGY OF BANK RISKS 20
1.3.1 Financial Risks 22
1.3.2 Non-financial Risks 28
CONCLUSION 30
CHAPTER 2
RISK MANAGEMENT PRINCIPLES
AND FRAMEWORK
2.1 RISK MANAGEMENT IN THE
BANKING CONTEXT 33
2.1.1 Definition of Risk Management 33
2.1.2 Objectives of Risk Management 34
2.2 RISK MANAGEMENT PRINCIPLES 39
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vi Contents
2.3 RISK MANAGEMENT FRAMEWORK 42
2.3.1 Definition of Risk Management Framework 42
2.3.2 Uses of the Risk Management Framework 42
2.3.3 Elements of a Sound Risk Management Framework 43
CONCLUSION 63
CHAPTER 3
RISK MANAGEMENT PROCESS
3.1 OVERVIEW OF RISK MANAGEMENT PROCESS 67
3.1.1 Qualities of a Sound Risk Management Process 67
3.1.2 Risk Management Activities 68
3.2 COMMUNICATION AND CONSULTATION 68
3.3 ESTABLISHING THE CONTEXT 70
3.3.1 Establishing the External Context 71
3.3.2 Establishing the Internal Context 71
3.3.3 Establishing the Risk Management Process Context 72
3.3.4 Risk Criteria 72
3.4 RISK ASSESSMENT 73
3.4.1 Risk Identification 73
3.4.2 Risk Analysis 74
3.4.3 Risk Evaluation 74
3.5 RISK TREATMENT 75
3.5.1 Avoid Risk 76
3.5.2 Take or Increase Risk 77
3.5.3 Remove the Risk Source 77
3.5.4 Change Likelihood 78
3.5.5 Change Consequences 78
3.5.6 Share the Risk 79
3.5.7 Risk Retention 79
3.6 RISK MONITORING AND REVIEW 80
CONCLUSION 80
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Contents vii
2.3 RISK MANAGEMENT FRAMEWORK 42 CHAPTER 4
2.3.1 Definition of Risk Management Framework 42
INTERNATIONAL RISK REGULATION
2.3.2 Uses of the Risk Management Framework 42
2.3.3 Elements of a Sound Risk Management Framework 43
CONCLUSION 63
4.1 IMPORTANCE AND OBJECTIVES OF REGULATIONS FOR BANKS 83
4.1.1 The Banking Industry and its Critical Role in the Economy 83
4.1.2 Financial Safety Nets 84
CHAPTER 3
4.1.3 Special Nature of the Banking Business 86
RISK MANAGEMENT PROCESS
4.2 ROLE OF BANKING SUPERVISION 87
4.3 TYPES AND SOURCES OF BANKING REGULATIONS 91
4.3.1 Sources of Banking Regulations 91
3.1 OVERVIEW OF RISK MANAGEMENT PROCESS 67
4.3.2 Types of Banking Regulations 94
3.1.1 Qualities of a Sound Risk Management Process 67
4.4 INTRODUCTION TO RISK-BASED CAPITAL FRAMEWORK UNDER BASEL I 99
3.1.2 Risk Management Activities 68
4.4.1 History of the Basel Committee on Banking Supervision 99
3.2 COMMUNICATION AND CONSULTATION 68
4.4.2 Basel I: The 1988 Basel Capital Accord 102
3.3 ESTABLISHING THE CONTEXT 70
4.5 THE THREE PILLARS OF BASEL II 106
3.3.1 Establishing the External Context 71
4.5.1 Pillar 1—Minimum Capital Requirements 107
3.3.2 Establishing the Internal Context 71
4.5.2 Pillar 2—Supervisory Review and Evaluation Process 111
3.3.3 Establishing the Risk Management Process Context 72
4.5.3 Pillar 3—Market Discipline 114
3.3.4 Risk Criteria 72
4.6 INTRODUCTION TO BASEL III REQUIREMENTS 116
3.4 RISK ASSESSMENT 73
4.6.1 2008 Global Financial Crisis and Basel II Weaknesses 116
3.4.1 Risk Identification 73
4.6.2 Basel III—Capital Reforms 120
3.4.2 Risk Analysis 74
4.6.3 Basel III—Liquidity Reforms 123
3.4.3 Risk Evaluation 74
CONCLUSION 126
3.5 RISK TREATMENT 75
3.5.1 Avoid Risk 76
3.5.2 Take or Increase Risk 77
CHAPTER 5
3.5.3 Remove the Risk Source 77
3.5.4 Change Likelihood 78 CREDIT RISK
3.5.5 Change Consequences 78
3.5.6 Share the Risk 79
3.5.7 Risk Retention 79
5.1 DEFINITION OF CREDIT RISK 129
3.6 RISK MONITORING AND REVIEW 80
5.1.1 Credit Risk as Potential Losses 129
CONCLUSION 80 5.1.2 Credit Risk as an Exposure 133
5.1.3 Credit Risk as Failure to Meet Obligations 137
5.2 EXPECTED AND UNEXPECTED CREDIT LOSSES 141
5.2.1 Expected Loss 141
5.2.2 Unexpected Loss 146
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viii Contents
5.3 CREDIT RISK MANAGEMENT FRAMEWORK 147
5.3.1 Credit Risk Environment 147
5.3.2 Credit-Granting Process 155
5.3.3 Credit Administration 159
5.3.4 Credit Monitoring 160
5.3.5 Credit Measurement 160
5.3.6 Credit Risk Control 161
CONCLUSION 162
CHAPTER 6
IDENTIFICATION OF CREDIT RISK
6.1 SOURCES OF CREDIT RISKS 165
6.1.1 Credit Risk from Loans and Advances 165
6.1.2 Credit Risk from Investment Securities 167
6.1.3 Credit Risk from Off-balance Sheet Exposures 169
6.1.4 Credit Risk from Derivatives 171
6.2 TYPOLOGY OF STANDALONE CREDIT RISK 172
6.2.1 Retail Credit Risk 173
6.2.2 Sovereign Credit Risk 183
6.2.3 Corporate Credit Risk 192
6.2.4 Counterparty Credit Risk 201
6.3 OVERVIEW OF PORTFOLIO CREDIT RISK 203
6.3.1 Sources of Portfolio Credit Risks 203
6.3.2 Credit Concentration Risk Management 207
CONCLUSION 208
CHAPTER 7
OPERATIONAL RISK
7.1 DEFINITION OF OPERATIONAL RISK 211
7.1.1 Operational Risk—the Residual Definition 211
7.1.2 Operational Risk—the Causal Definition 211
7.2 OPERATIONAL RISK EVENTS 216
7.2.1 Internal Fraud 216
7.2.2 External Fraud 218
7.2.3 Employment Practices and Workplace Safety 218
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Contents ix
5.3 CREDIT RISK MANAGEMENT FRAMEWORK 147 7.2.4 Clients, Products and Business Practices 219
5.3.1 Credit Risk Environment 147 7.2.5 Damage to Physical Assets 221
5.3.2 Credit-Granting Process 155 7.2.6 Business Disruption and Systems Failures 222
5.3.3 Credit Administration 159 7.2.7 Execution, Delivery and Process Management 222
5.3.4 Credit Monitoring 160
7.3 OPERATIONAL RISK CONSEQUENCES 223
5.3.5 Credit Measurement 160
5.3.6 Credit Risk Control 161 7.4 OPERATIONAL RISK MANAGEMENT GOVERNANCE AND PROCESS 225
7.4.1 Operational Risk Governance 225
CONCLUSION 162
7.4.2 Operational Risk Framework 229
7.4.3 Operational Risk Management Process 231
7.4.4 Business Resiliency and Continuity 233
CHAPTER 6
CONCLUSION 233
IDENTIFICATION OF CREDIT RISK
CHAPTER 8
IDENTIFICATION OF OPERATIONAL
6.1 SOURCES OF CREDIT RISKS 165
RISK
6.1.1 Credit Risk from Loans and Advances 165
6.1.2 Credit Risk from Investment Securities 167
6.1.3 Credit Risk from Off-balance Sheet Exposures 169
6.1.4 Credit Risk from Derivatives 171 8.1 SOURCES OF OPERATIONAL RISKS 236
6.2 TYPOLOGY OF STANDALONE CREDIT RISK 172 8.2 OPERATIONAL RISK BUSINESS LINES 238
6.2.1 Retail Credit Risk 173
8.3 INTERNAL OPERATIONAL RISK LOSS DATA 240
6.2.2 Sovereign Credit Risk 183
8.3.1 Incident Reporting 242
6.2.3 Corporate Credit Risk 192
8.3.2 The 8 × 7 Matrix 244
6.2.4 Counterparty Credit Risk 201
8.3.3 Basic Statistical Analysis 245
6.3 OVERVIEW OF PORTFOLIO CREDIT RISK 203
8.4 EXTERNAL OPERATIONAL RISK LOSS DATA 246
6.3.1 Sources of Portfolio Credit Risks 203
6.3.2 Credit Concentration Risk Management 207 8.5 NEW PRODUCTS AND BUSINESS ACTIVITIES AND OUTSOURCING
ACTIVITIES 248
CONCLUSION 208
8.5.1 New Products and Business Activities 249
8.5.2 Outsourcing in Financial Services 249
CONCLUSION 252
CHAPTER 7
OPERATIONAL RISK
CHAPTER 9
MARKET RISK
7.1 DEFINITION OF OPERATIONAL RISK 211
7.1.1 Operational Risk—the Residual Definition 211
7.1.2 Operational Risk—the Causal Definition 211
9.1 FINANCIAL MARKET ACTIVITIES 255
7.2 OPERATIONAL RISK EVENTS 216
9.1.1 Functions and Roles of Financial Markets 255
7.2.1 Internal Fraud 216
9.1.2 Types of Financial Markets 255
7.2.2 External Fraud 218
7.2.3 Employment Practices and Workplace Safety 218
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