be considered when the safety and soundness of a bank is assessed. An adequate
capital base serves as a safety net for a variety of risks to which an
institution is exposed in the course of its business. Capital absorbs possible
losses, and thus provides a basis for maintaining confidence in a bank. Capital
is also the ultimate determinant of a bank?s lending capacity. A bank?s balance
sheet cannot be expanded beyond the level determined by its capital adequacy
ratio. Consequently, the availability of capital determines the maximum level
of assets.The key purposes
of capital are to provide stability and to absorb any losses, thereby providing
a measure of protection to depositors and other creditors in the event of
liquidation. As such, the capital of a bank should have three important
characteristics: It must be permanent It must not impose mandatory fixed
charges against earnings and It must allow for legal
subordination to the rights of depositors and other creditors. Capital
Adequacy requirements:The minimum
risk-based standard for capital adequacy was set by the Basel Accord at 8
percent of risk-weighted assets, of which the core capital element should be at
least 4 percent. If a bank is also exposed to market risk, the adjustment for
the market risk is added by multiplying the measure of market risk by 12.5 and
adding the resulting figure to the sum of risk-weighted assets compiled for the
credit risk purposes. The capital ratio is then calculated in relation to the
sum of the two, using as numerator only eligible capital. Tier 3 capital is
eligible only if it is used to support the market risk.The quality of a
bank’s assets must also be mentioned in the capital adequacy context. A bank’s
capital ratios can be rendered meaningless or highly misleading if asset
quality is not taken into account. BALANCE SHEET
STRUCTUREThe composition
of a bank’s balance sheet assets and liabilities is one of the key factors that
determine the risk level faced. Growth in the balance sheet and resulting
changes in the relative proportion of assets or liabilities impact the risk
management process. Monitoring key balance sheet components may alert the
analyst to negative trends in relationship between asset growth and capital
retention capability. Balance sheet structure lies at the heart of the asset /
liability management process. Asset / liability management, comprises strategic
planning and implementation and control process that affect the volume, mix,
maturity, interest rate sensivity, quality and liquidity of a bank’s assets and
liabilities. CURRENCY RISK?????? Currency risk
results from changes in exchanges rates between a bank?s domestic currency and
other currencies. It is a risk of volatility due to a mismatch, and may cause a
bank to experience losses as a result of adverse exchange rate movements during
a period in which it has an open on-or off-balance-sheet position, either spot
or forward, in an individual foreign currency. In recent years, a market
environment with freely floating exchange rates has practically become the
global norm. This has opened the doors for speculative trading opportunities
and increased currency risk. The relaxation of exchange controls and the
liberalization of cross-border capital movements have fueled a tremendous in
international financial markets. The volume and growth of global foreign
exchange trading has far exceeded the growth of international trade and capital
flows, and has contributed to greater exchange rate volatility and therefore
currency risk.?Currency risk arises from a mismatch between
the value of assets and that of capital and liabilities denominated in foreign
currency (or vice versa) or because of a mismatch between foreign receivables
and foreign payables that are expressed in domestic currency. Such mismatches
may exist between both principal and interest due. Currency risk is of a
speculative nature and can thereby result in a gain or a loss, depending on the
direction of exchange rate shift and whether a bank is net long or net short in
the foreign currency. For instance, in the case of a net long position in
foreign currency, domestic currency depreciation will result in a net gain for
a bank, while appreciation will produce a loss. Under a net short position,
exchange rates movements will have the opposite effect.In principle,
the fluctuations in the value of domestic currency that create currency risk
result from changes in foreign and domestic interest rates that are, in turn,
brought about by differences in inflation. Fluctuations such as these are
normally motivated by macroeconomic factors and are manifested over relatively
long periods of time, although currency market sentiment can often accelerate
recognition of the trend. Other macroeconomic aspects that affect the domestic
currency value are the volume and direction of a country?s trade and capital
flows. Short-term factors, such as expected or unexpected political events,
changed expectations on the part of market participants, or speculation-based
currency trading, may also give rise to currency changes. All these factors can
affect supply and demand for a currency and therefore the day-to-day movements of
the exchange rate in currency markets. In practical terms, currency risk
comprises the following:Transaction
risk, or the price based impact of exchange rate
changes on foreign receivables and payables.Economic or
business risk related to the impact of exchange
rate changes on a country?s long term or company?s competitive position. Such
as, a depreciation of the local currency may cause a decline in imports and
growth of exports.Revaluation
risk or translation risk arises when a bank?s
foreign currency positions are revalued in domestic currency, or when a parent
institution conduct financial reporting or periodic consolidation of financial
statements. ?RISK
MEASUREMENT METHOD VaR (Value at
Risk) The general
approaches to VaR computation have fallen into three classes called parametric,
historical simulation, and Monte Carlo. Parametric VaR is most closely tied to
MPT, as the VaR is expressed as a multiple of the standard deviation of the
portfolio’s return. Historical simulation expresses the distribution of
portfolio returns as a bar chart or histogram of hypothetical returns. Each
hypothetical return is calculated as that which would be earned on today’s
portfolio if a day in the history of market rates and prices were to repeat
itself. The VaR then is read from this histogram. Monte Carlo also expresses
returns as a histogram of hypothetical returns. In this case the hypothetical
returns are obtained by choosing at random from a given distribution of price
and rate changes estimated with historical data. Each of these approaches have
strengths and weaknesses. The parametric
approach has as its principal virtue speed in computation. The quality of the
VaR estimate degrades with portfolios of nonlinear instruments. Departures from
normality in the portfolio return distribution also represent a problem for the
parametric approach. Historical simulation (my personal favorite) is free from
distributional assumptions, but requires the portfolio be revalued once for
every day in the historical sample period. Because the histogram from which the
VaR is estimated is calculated using actual historical market price changes,
the range of portfolio value changes possible is limited. Monte Carlo VaR is
not limited by price changes observed in the sample period, because
revaluations are based on sampling from an estimated distribution of price
changes. Monte Carlo usually involves many more repricings of the portfolio
than historical simulation and is therefore the most expensive and time
consuming approach TURK EXIMBANK?S GUIDE TO RISK EVALUATION STUDY OF
BANKSShort Term
Export Credits, one of the most important facilities of Turk Eximbank, are
extended both directly by The Bank and indirectly using selected Turkish banks
as intermediaries. For indirect lending, Turk Eximbank determines short term
TL, FX and letter of guarantee limits for intermediary banks through a risk
evaluation process of each bank. These banks are responsible for the default
risk of the borrowers. Therefore, selected commercial banks must be financially
sound and deemed to be active in the foreign trade business according to Turk
Eximbank standards. The evaluation
process named as risk evaluation study is explained in the following part of
this guide.This study
covers analyzing the financial structures of banks divided into 6 categories; Large-scale private banks Middle / Small- scale private
banks Foreign banks Investment banks Development banks State-owned banks This
categorization is done regarding ownership structure, scale, activities, and
its growth in the sector.This risk
evaluation study is reviewed quarterly in a year. Besides this, extra reports
are prepared according to the requests from the banks, executive committee and
the important changes about the banks. The quarter analysis includes; Basic Information Guideline (It
should be updated when necessary) Financial Sheet Sum Table (covering the sector
data) Tiering (Risk Group Determination) Executive Summary 1.BASIC
INFORMATION GUIDELINETurk Eximbank
requests the banks ready to work with itself to submit ?the basic information
guideline? which covers following information; General information about the bank Ownership structure Board of directors Directors / top executives The list of group companies, if
the bank belongs to a group The list of subsidiaries, joint
ventures and/or equity participation of the bank This information
guideline is updated with every changes. (Enclosure 1.) 2. FINANCIAL
SHEETBanks are
sending their balance sheets and income statements in every 3 months, in the
same format as they prepare for Turkish Central Bank and Undersecretariat of
Treasury. These data submitted with diskettes and written form are transferred
to the standard format of Turk Eximbank in use of risk evaluation study. The
financial sheet covers percentage changes in financial data of the bank and the
financial ratios, which are calculated automatically according to a computer
program developed by Turk Eximbank, about capital adequacy, asset quality, liquidity
and profitability in addition to summarized balance sheet and income statement.3. SUM TABLE This is the
table that gathers the processed financial data of all banks, which are subject
of the risk evaluation study. These data are automatically taken from financial
sheets of each bank. The table covers financial ratio values of each bank based
on divided group and average, minimum and maximum values of each group, also
the sector, in addition some basic financial highlights as total loans, total export
credits, total deposits, paid-up capital etc. and their percentage changes for
each bank. The table is used as a reference guide while conducting regular risk
evaluation study.4. TIERING
(RISK GROUP DETERMINATION) As noted
earlier, the banks? risk profile is depicted quarterly through a detailed risk
evaluation study of each bank. For each bank category 8 different financial
ratio standards are determined compared with group and sector averages, minimum
and maximum values placed on the sum table.The financial
ratios are divided into 4 categories; Capital Adequacy Asset Quality Liquidity Profitability The standards of
8 ratios could be different for each bank category. For example, the ratio of
share holders? equity / risk bearing asset was applied as minimum 10% for
State-Owned Banks, while it was applied as minimum 15% for Large-Scale Private
Banks in September 2000 period.Banks are rated
and ranged into one of four categories regarding to the criteria they are
violating.There are 4
financial analysis groups indicating the risk levels of the banks. 4th
financial analysis risk group covers banks with maximum risk, whereas 1st
risk group covers banks with minimum risk. The total number of violated
criteria of each bank is important, since; If a bank violates maximum 2
criteria, it is placed in the 1st financial analysis risk
group, If a bank violates maximum 3
criteria, it is placed in the 2nd financial analysis risk
group, If a bank violates maximum 4
criteria, it is placed in the 3rd financial analysis risk
group, If a bank violates more than 4
criteria, it is placed in the 4th financial analysis risk
group. After
determining the financial analysis risk groups of each bank, the violation
criteria?s table is prepared showing violated criteria as minuses.The second step
of the study is that the banks are scrutinized according to the proportion of
export credits financed through the bank?s own sources and average rate of
using Turk Eximbank?s credit line as compared to the sector averages. In other
words, effective use of Turk Eximbank limits by the bank is very important. The
banks? risk groups are altered depending on these two rates and a new risk
group is created called limit allocation group. (For example, the being above
the average rate of export credits is considered a positive factor and upgrades
that specific bank?s ranking)The third step
of the study is that the banks are ranked for final risk group taking into
considerations the following additional criteria; Ownership structure Management quality Whether top management is
frequently changed or not Customer / market segmentation Human resource quality Reputation of the bank in the
market place Interest rate policies FX short position and exchange
rate exposure Importance of export credit
financing among its financing activities, Giving emphasis to technology
investments. Notified credit
line allocations do not create a binding obligation on Turk Eximbank. The bank
can easily slow down or cease credit payments and partially or fully cancel
credit limits, if necessary. When the financial strength of an intermediary
bank becomes questionable, Turk Eximbank may require the bank to establish
collateral with Turk Eximbank in the form of cash deposits and/or Treasury
Bills and Government Bonds.5. EXECUTIVE
SUMMARYExecutive
summary reports is prepared by analysts in every three months for each bank and
covers a summation about changes in the bank?s performance, it?s risk group,
and current position in the sector for the specified quarter.In addition to
that, extra reports are prepared in the case of demands of the banks regarding
increase in their limits, extra-ordinary changes of status or ownership
structure etc. and presented to the top management of Turk Eximbank.Also, analysts of
Risk Assessment Division regularly visit the intermediary commercial banks?
CEO?s to get information on their future strategies and plans, new activities,
loan and interest rate policies, customer portfolio and target customer
segment, etc. After visiting, analysts prepare a meeting report and present to
the top management of the Bank. TURK EXIMBANK?S RISK MANAGEMENT
DEPARTMENT?S DOSSIER HARMONY1) BANK
DOSSIERSAll of the
information about the banks is collected in credit limit dossier separately and
they include the information; Basic information guideline Financial sheet Executive summaries Corresponds with the bank Meeting reports and Press releases about the bank 2) GENERAL
BANKING DOSSIERAll of the
studies done with the banking sector, corresponds and documents are collected
in these documents. They include; Risk group determination studies Limit allocation studies Management decisions Reports and other studies DISCLOSURES
ABOUT THE BANKS? RISK GROUP DETERMINATION RATIOSRisk group
determination studies of the banks? are made with the financial sheets and sum
tables that are prepared quarterly in a year. By using these, banks? capital
adequacy, asset quality, liquidity and profitability ratios are calculated. As
regards with the told banks? groups ratios and banking sector averages are
found in order to determine the risk groups. Bank groups are
state-owned banks, large-scale private banks, middle and small-scale private
banks, foreign banks, investment banks and development banks. Ratios are
determined according to the bank groups? specialties.These ratios are
used for all kinds of bank groups: Net asset / Risky assets Balance sheet excluded risks / Net
assets Follow up debt receivables / Total