Risk Management Case Study Essay, Research Paper
THE PROBLEM AND THE PLANIncidentals of Authorization and
SubmittalThis study of
risk management recommendations of Turk Eximbank is submitted to Mr. H. Ahmet KILIÇOGLU, General
Manager of Turk Eximbank, on Aprıl 30, 2001.As authorized on February 20, 2001,
the investigation was conducted under the direction of Barış Samana and GÜrkan Kocgar. Objective of Risk Management
RecommendationsThe objective of the study was to define
why risk management was needed in Turk Eximbank and how to adjust the risk
management system at the bank. The plan for achieving this objective involved
first determining the techniques used for risk measurements. This information
will then be used for Turk Eximbank?s risk evaluation process.Use of?
Techniques for Risk MeasurementThe methodology used in this investigation was an obsevational study of
defining the risk measurement techniques and then applying them to Turk
Eximbak?s risk evaluation process, if necessary.Investigations have been made at the Bilkent University Library and
Internet, also we have interwieved with the risk analysts of Turk Eximbank. INTRODUCTIONIn recent years, a number of programs
aimed at enhancing the effectiveness of supervisory process for banks. Although
effective risk management has always been central to safe and sound banking
activities, it has become even more important as new technologies, product
innovation, and the size and speed of financial transactions have changed the
nature of banking markets. In response to these changing market realities,
certain supervisory risk management processes have been refined, while others -
in particular, those that have proven most successful in supervising banks
under a variety of economic circumstances and industry conditions – have been retained.
The objective of a risk-focused examination is to effectively evaluate the
safety and soundness of the bank, including the assessment of its risk
management systems, financial condition, and compliance with applicable laws
and regulations, while focusing resources on the bank?s highest risks. The
exercise of examiner judgment to determine the scope of the examination during
the planning process is crucial to the implementation of the risk-focused
supervision framework, which provides obvious benefits such as higher quality
examinations, increased efficiency, and reduced on-site examiner time.UNDERSTANDING THE BANKThe risk-focused supervision process for
banks involves a continuous assessment of the bank. The understanding of the
bank developed through this assessment enables examiners to tailor the
examination of the bank to its risk profile. Understanding the bank begins with
a review of available information on the bank. In addition to examination
reports and correspondence files, each bank maintains various surveillance
reports that identify outliers when a bank is compared to its peer group. The
review of this information assists examiners in identifying both the strengths
and vulnerabilities of the bank and provides a foundation from which to
determine the examination activities to be conducted. Contact with the organization is
encouraged to improve the understanding of the institution and the market in
which it operates. A pre-examination interview or visit should be conducted as
a part of each examination. Such a meeting gives examiners the opportunity to
learn about any changes to bank management, bank policies, strategic direction,
management information systems, and other activities. Particular emphasis
should be placed on learning about new products or markets into which the bank
has entered. The interview or visit also provides examiner’s with management?s
view of local economic conditions, an understanding of the bank?s regulatory
compliance practices, its management information systems, and its
internal/external audit function. In addition, banks should contact the
state-banking regulator to determine whether they have any special areas of
concern that should be focused on during the examination. RELIANCE ON INTERNAL RISK
ASSESSMENTSInternal audit, loan review, and
compliance functions are integral to a bank’s own assessment of its risk
profile. If applicable, it may be beneficial to discuss with the bank’s
external auditor the results of the most recent audit it has completed for the
bank. Such a discussion gives the examiner the opportunity to review the
external auditor?s frequency, scope and reliance on internal audit findings.
Examiners should consider the adequacy of these functions in determining the
risk profile of the bank and the opportunities to reduce regulatory burden by
testing rather than duplicating the work of these audit functions. Transaction
testing remains a reliable and essential examination technique for use in the
assessment of an institution?s condition. The amount of transaction testing
necessary to evaluate particular activities generally depends on the quality of
the bank’s process to identify, measure, monitor, and control the activity’s
risk. Once the integrity of the management system is verified through testing,
conclusions on the extent of risks within the activity can be based on internal
management assessments of the risks rather than on the results of more
extensive transaction testing by examiners. If, however, initial inquiries into
the risk management system, or efforts to verify the integrity of the system,
raise material doubts as to the system’s effectiveness, then no significant
reliance should be placed on the system and a more extensive series of tests
should be undertaken to ensure that the bank’s exposure to risk from a
particular activity can be accurately evaluated. SCOPE
MEMORANDUMThe scope memorandum is an integral
product in the risk-focused methodology as the memorandum identifies the
central objectives of the on-site examination. The scope memorandum also
ensures that the examination strategy is communicated to appropriate
examination staff. A sample scope memorandum is presented in Appendix – A. This
document is of key importance, as the scope will likely vary from examination to
examination. Examination procedures should be tailored to the characteristics
of each bank, keeping in mind its size, complexity, and risk profile.
Procedures should be completed to the degree necessary to determine whether the
bank?s management understands and adequately controls the levels and types of
risk that are assumed. In addition, the memorandum should address the banking
environment, economic conditions, and any changes that bank management fore
sees that could affect the bank?s condition. A preliminary estimate of staffing
required to perform the examination should also be prepared as part of the
scope memorandum.The key factors that should be addressed
in the scope memorandum include:Preliminary Risk AssessmentThe risks associated with the bank’s
activities should be summarized and based on a review of all available sources
of information on the bank, including but not limited to, prior examination
reports, surveillance reports, correspondence files, and audit reports. The
scope memorandum should include a preliminary assessment of the bank’s
condition and major risk areas that will be evaluated through the examination
process. Summary of the Pre-Examination MeetingThe results of the pre-examination
meeting should be summarized with particular emphasis on the meeting results
that affect examination coverage. Summary of Audit and Internal Control EnvironmentA summary of the scope and adequacy of
the audit environment should be prepared which may result in a modification of
examination procedures initially expected to be performed. Activities that
receive sufficient coverage by the bank’s audit system can be tested through
the examination process. Sufficient audit coverage could result in the
elimination of certain procedures if the audit and internal control areas are
deemed satisfactory.Summary of Examination ProceduresExamination modules have been developed
related to the significant areas reviewed during an examination. The modules
are categorized as being primary or supplemental. The primary modules must be
included in each examination. However, procedures within the primary modules
can be eliminated or enhanced based on the risk assessment or the adequacy of
the audit and internal control environment. The scope memorandum should specifically
detail the areas within each module to be emphasized during the examination
process. In addition, the use of any supplemental modules should be discussed.Summary of Loan ReviewBased on the preliminary risk assessment,
the anticipated loan coverage should be detailed in the scope memorandum. In
addition to stating the percent of commercial and commercial real estate loans
to be reviewed, the scope memorandum should also identify which speciality loan
references to the general loan module are to be completed. The memorandum
should specify activities within the general loan module to be reviewed, as
well as the depth of any speciality reviews.Job StaffingThe staffing for the examination should
be detailed. Particular emphasis should be placed on ensuring appropriate
personnel are assigned to the high risk areas identified in the bank?s risk
assessment.USE OF THE
EXAMINATION MODULESThe state-banking regulator has jointly
developed bank examination modules. This automated format was designed to
define common objectives for the review of important activities within the bank
and to assist in the documentation of examination work. It is expected that
full-scope examinations will include examiners? evaluation of six critical
areas that are necessary to determine the bank?s CAMELS rating. To evaluate
these areas, examiners must perform procedures tailored to fit the risk profile
of the bank. The seven primary examination modules are: Capital Adequacy Earnings Analysis Loan Portfolio Management Liquidity Analysis Management and Internal Control Evaluation Securities Analysis Other Assets and Liabilities There are six supplemental modules that
are available for use if any of these activities present significant risk to
the bank. The supplemental modules are: Electronic Funds Transfer Risk Assessment International Banking Credit Card Merchant Processing Mortgage Banking Electronic Banking Related Organizations In addition, there are ten Loan
References (for specialized lending areas) included in the general Loan
Portfolio Management module. The loan reference modules are: Construction and Land Development Commercial and Industrial Real Estate Residential Real Estate Lending Commercial and Industrial Loans Agricultural Lending Direct Lease Financing Floor Plan Loans Troubled Debt Restructuring Consumer and Check Credit Credit Card Activities The modules establish a three-tiered
approach for the review of a bank?s activities.The first tier is the core
analysis, the second tier is the expanded review, and the final tier is the
impact analysis. The core analysis includes a number of decision factors, which
should be considered collectively, as well as individually when evaluating the
potential risk to the bank. To assist the examiner in determining whether risks
are adequately managed, the core analysis section contains a list of procedures
that may be considered for implementation. Once the relevant procedures are
performed, the examiner should document conclusions in the core analysis
decision factors. Where significant deficiencies or weaknesses are noted in the
core analysis review, the examiner is required to complete the expanded
analysis for those decision factors that present the greatest degree of risk to
the bank. On the other hand, if the risks are properly managed, the examiner
can conclude the review and carry any comments to the report of examination.The expanded analysis provides guidance
to the examiner in determining if weaknesses are material to the bank?s
condition and if they are adequately managed. If the risks are material or
inadequately managed, the examiner is directed to perform an impact analysis to
assess the financial impact to the bank and assess whether any enforcement
action is necessary. The use of modules should be tailored to
the characteristics of each bank based on its size, complexity, and risk
profile. As a result, the extent to which each module should be completed will
vary from bank to bank. One of the features included in the automated format
for the modules allows examiners to select the appropriate procedures in the
modules that address t he area(s) of concern while eliminating unnecessary
procedures. The degree of expected completion of the modules should be
documented in the scope memorandum. The individual procedures presented for
each level are meant only to serve as a guide for answering the decision
factors. Each procedure does not require an individual response and each
procedure may not be applicable at every community bank. Examiners should continue
to exercise discretion in deciding to exclude any items as unnecessary in the
evaluation of the decision factors. Moreover, the listed procedures do not
represent every possible factor to be considered during an examination.
Examiners should reference supervisory and administrative letters for
additional guidance. CREDIT RISKBanks should have methodologies that
enable them to assess the credit risk involved in exposures to individual
borrowers or counter parties as well as at the portfolio level. For more
sophisticated banks, the credit review assessment of capital adequacy, at a minimum, should cover four areas:
risk rating systems, portfolio analysis/aggregation, securitisation / complex
credit derivatives, and large exposures and risk concentrations.Internal
risk ratings are an important tool in monitoring credit risk. Internal risk
ratings should be adequate to support the identification and measurement of
risk from all credit exposures, and should be integrated into an institution?s
overall analysis of credit risk and capital adequacy. The ratings system should
provide detailed ratings for all assets, not only for criticized or problem
assets. Loan loss reserves should be included in the credit risk assessment for
capital adequacy.The analysis
of credit risk should adequately identify any weaknesses at the portfolio
level, including any concentrations of risk. It should also adequately take
into consideration the risks involved in managing credit concentrations and
other portfolio issues through such mechanisms as securitisation programs and
complex credit derivatives. Further, the analysis of counter party credit risk
should include consideration of public evaluation of the supervisor?s
compliance with the Core Principles of Effective Banking Supervision. (Refer to
?Principles for the Management of Credit Risk?, September 2000). (Basel Committee on Banking
Supervision)Credit risk
defined as the chance that a debtor will not be able to pay interest or repay
the principal according to the terms specified in a credit agreement is an
inherent part of banking. Credit risk means that payments may be delayed or
ultimately not paid at all, which can in turn cause cash flow problems and
affect a bank?s liquidity. Despite innovation in the financial services sector,
credit risk is the still the major single cause of bank failures. The reason is
that more than 80 percent of a bank?s balance sheet generally relates to this
aspect of risk management. The three main types of credit risk are as fallows: Personal or consumer risk Corporate or company risk Sovereign or country risk Because of the
potentially terrible effects of credit risk, it is important to perform a
comprehensive evaluation of a bank?s capacity to assess, administer, supervise,
control, enforce and recover loans, advances, guarantees, and other credit
instruments. An overall credit risk management will include an evaluation of
the credit risk management policies and practices of a bank. This evaluation
should also determine the adequacy of financial information received from a
borrower, which has been used by banks as the basis for the extension of credit
and the periodic assessment of inherently changing risk.The review of a
credit risk management function is discussed under the following themes: Credit portfolio management Lending function and operations Credit portfolio management Nonperforming loan portfolio Credit risk management policies Policies to limit or reduce credit
risk Asset classification Loan loss provisioning policy ???? LIQUIDITY