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critically analyse key risk management concepts in banking, critically…
critically analyse key risk management concepts in banking
critically analyse key risk management concepts in banking
Financial Risk Modelling
The use of econometric techniques (tools that attempt to model the economy using mathematical and statistical relationships) to determine the aggregate risk of a portfolio
Uses include capital requirement maintenance and guidance on the purchase/sales of particular financial assets.
Required as part of Basel II
Distribution Analysis
Using Historical data to predict the future
Normal Distribution bell curve:
x axis - performance, y axis probability
Fat tailed distribution considers rare unexpected events. This distribution is undesirable as it is riskier than the normal distribution
Confidence Levels
Typically 95%, 97.5% & 99% - Means that for (99%) a VaR number will be produced and out of 100 days losses will be exceeded 1 day.
Holding Period
The amount of time an investment is held and consequently, how long you should track changes in it's price are linked.
Holding periods depend on the assets held and their liquidity
Observation Period
How far back in history should you go when assessing a asset/company? Most recent price changes hold the most relevance.
Regulatory requirements
Basel recommends the following when calculating capital requirements: Confidence level of 99%. Holding Period of 10 business days and Observation period of 12 months
Probability
The likelihood of an event.
Equally likely outcome model = No of outcomes corresponding to a particular event/ Total no of outcomes
Sensitivity analysis
Measures how one variable is affected by another
Earnings risk
Considers the "spread" between assets and liabilities: ie interest earned v interest payable
Drawbacks: do not consider long term effects. Over simplify and do not consider such things as early repayment & assume perfect correlation (Gap models/Repricing schedules)
Market models are assumption based. Cash flows are dynamically simulated over the entire life of the banks holdings.
Economic Capital
Economic capital is the level of capital that is effectively chosen by the bank shareholders without impact of regulation
Regulatory capital is the minimum capital required by the regulator which may be the capital charge required by the Basel Committee.
Application of risk in other companies
Weak economies
Regulatory and legislative changes
inability of an organisation to comply with current, changing or new regulations.
Increasing competition
Damage to reputation
Failure to attract top talent
Failure to innovate
Business interruption
Commodity price risk
Cash flow and liquidity risk
Political risk
