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RISK MANAGEMENT AND FINANCIAL INSTITUTIONS ! (Types of risk (Liquidity…
RISK MANAGEMENT AND FINANCIAL INSTITUTIONS !
Types of risk
Forex Risk
Country or Sovereign Risk
Off-Balance-Sheet Risk
Technology Risk
Market Risk
Operational Risk
Interest Rate Risk
Steps
Analyze effect of IR - to determine Net Interest Margin
Decide assets & liabilities - rate sensitive
Insolvency Risk
What
Risk - FI may not have enough capital to offset a sudden decline in the value of its assets
Why
Means of protection against insolvency & failure - FI's equity capital
Credit Risk
Loans & Bonds - possible not to be paid in full
Principle of Credit Risk Management
Principle of Proportionate Stake
Principle of Pari Passu
Principle of Ptotection
Principle of Control
Principle of Well-Spread Lending Portfolio
Principle of Good First Way Out
Principle of Tenor In Financing
Principle of Reflective National Policy
How to Manage
Screening & Monitoring
Why
Collect reliable info
Filling out loan application form
Screen out bad credit risks from good ones
Establish pay-ability through credit scoring
Components
Credit Scoring
Why
Managers able to
Improving pricing of default risk
Screen high risk loan applicants
Evaluate degree of importance
Calculate reserves to meet expected loss
Factors of default risk - establish numerically
Statistical technique
Altman Z Score
KMV Model
Credit Analysis
Able to make credit decision
Uncertainty
Incomplete info
Sources of info
Borrowers
Trade Associations
Government agencies
Publications
Purpose
Examine borrower's nature
Identify business risks - lending situation
Analyze cash flow
Make recommendations
When
Real Estate Lending
Mid Size Consumer and SME Lending
Mid Size Commercial and Industrial Lending
Large Commercial and Industrial Lending
Credit evaluation - 5 C's Approach
Capacity
Capital
Characters
Conditions
Collateral
Property promised to lender as compensation (if default)
Compensating Balance-Keep min amount of fund
Other C's
Monitoring
Legal Action
Bankruptcy Notice
Restrictive covenant
Credit Rationing
No loan extended even paying high interest
Rationing the amount of financing to fit borrower's capacity
Long Term Customer Relationship
Existing Savings/Current Account
Other Loan Commitment
Salary Instruction
Long Term Customer Relationship
Loan Commitments
Collateral
Compensating Balance
Credit Rationing
Liquidity Risk
What
Sudden surge in liability withdrawals
Require FI liquidate assets (in a very short period time & low price)
Why
Lack of confidence in liability holders
Unexpected need of cash - withdrawal may be larger
When
Commitments made by FI - recorded off the balance sheet
FI liability holders/depositors/insurance policyholders - seek to cash in / withdraw financial claims
& Depository Institutions
Asset side liquidity risk
How to obtained
Selling liquid asset
Borrowing funds in the money/purchased funds market to maximum amount
Use any excess cash reserves
Liability side liquidity Risk
Demand deposit issue
Monitoring the net deposit drain
Purchased liquidity
Stored liquidity
Measuring Bank's Liquidity
Liquidity Index
Measure potential loss
FInancing Gap & Requirement
Difference - bank's average loans & average core deposits
Financing Gap +, banks must fund it using its cash and liquid assets and/ or borrow funds in the money market
Liquidity Planning
Making important borrowing priority decisions
Peer Group Comparison
Borrowed funds to total assets
Commitment to lend-to-asset ratio
Ratios as loans to deposits
Net Liquidity Statement
List sources & uses of liquidity