Uncertainty – when you can’t measure
Risk – measureable
Basel committee on banking supervision – plays the most important role in world financial system and creates and develops number of recommendations describing different approaches for the risk management in financial institutions.
Basel II objectives – set of regulations (recommendations given by Basel committee) describing the rules in risk management/measurement in banking. Some countries have started implementations of Basel III. Allows banks in Europe to measure different types of risks.
To promote safety and soundness in the financial system
To continue to enhance completive equality
To constitute a more comprehensive approach to addressing risks
To render capital adequacy more risk-sensitive: will be discussed at the end of may
To provide incentives for banks to enhance their risk measurement capabilities
Three Pillars od Basel II
Pillar I – minimum capital requirements. Gives 3 types of risks: credit risk, operational risk and market risk given by basel committee. Rest of them might be in those 3. Every financial institution must be able to measure level of those three types of risks. They give some solution in how to measure it but at the end it is up to the bank, they must do it anyway.
Pillar II – supervisory review process.
Pillar III – market discipline. Deals with detailed information about risks and threats connected to internet banking services and operations and as a bank customer you should be interested in it the most.
Other description:
Pillar I – calculation of regulatory minimum capital requirements. Regulatory capital is a minimum of core capital that bank should have in order to meet the financial supervision requirement, to cover possible risks. It’s extremely important. Pillar I requirements measures the risk that might occur. If we don’t have enough core capital then we are not able to take certain amount of risk. Divided to 3 parts: the most important: CREDIT RISK in Poland. MARKET RISK more important in UK. Operational risk is going to be important at the same comparable level, but every commercial bank in Poland in UE is obliged to measure this types of risks and compare them to the level of capital.
Pillar II – supervision to pillar I.
Pillar III – rules of disclosure of capital structure blablabla we have on these slides. Should be published in annual reports for commercial banks in Poland.
LAST DECRTIPTION – PICTURE
Different types of solutions for different solutions in pillar I. It is up to bank what kind of solution is going to be taken.
READ SHORT TEXT OF THE HISTORY OF BASEL, READ ABOUT BASEL I, BASEL II and BASEL III and know how to describe the picture.
In basel I was no operational risk, in basel II there was!
Colors emphasize the difference between types of risks. We should make into account interest rate, currency and liquidity problems. We still don’t know how to face reputational risks.
Credit risk
1)Credit risk id defined as a risk of occurrence of losses due to a client’s default of payments to the bank or as a risk of decrease in economic value of amounts due to the Bank as a result of deterioration of a client’s ability to repay due amounts.
2)The objective of credit risk management is to reduce losses of loan portfolio and to minimize the risk of impaired loans while maintaining an expected level of yield and loan portfolio value.
It is important nowadays to have a good record as a bank client so we all should take loans an repay them on time ;p
Credit risk in PKO BP – they apply the following principles: SLIDES
For example: loan transaction requires comprehensive credit risk assessment which is reflected in an internal rating or credit scoring: we can introduce our own regulations that might be even more strict than the ones that are required. Credit scoring is the evaluating the ability of repaying the loan done by banks.
Credit risk is diversified in particulate by geographical location by industry by product and by clients: from the point of view of portfolio management we should diversified our portfolio.
Market risk:
Market risk can be defined as the risk related to the uncertainty of an FI’s earning on its trading portfolio caused by changes, and particularly extreme changes in market conditions such as the price of an asset interest rated, market volatility and market liquidity.
Market risk emphasizes the risk of FIs that actively trade assets and liabilities (and derivatives) rather than hold them
What is the difference between banking and trading book in commercial bank.
Interest rate risk:
Deals with interest rates. WE face a problem of the interest rate for our products like loans and deposits. In fact this is the most important part of the story because the source of interest rate risk deals with mismatching the maturities of banking assets (loans for examples) and liabilities (deposits). This is a problem because we as customers we look for extremely long term loans with low interest rate and at the same time for short term deposits with very high interest rated. But bank risk managers what’s to have long term deposits with low deposits and short term loans with high interest rates. Difference between them can be described by mentioned mismatch and that’s why commercial banks face the problem of interest rate risk.
Liquidity:
Extremely important for banks and something that we call run for the bank – all people want to withdraw money at once and every bank is scared of it. That’s why liquidity is very important (being able to operate even when something unexpected occurs).
Currency risks:
We will always have swiss franks and GBP and CAD and USD and everything so we will always have some kind of risk because even if we join European currency it won’t solve anything. But they are really low.
Operational risk:
The risk of loss resulting from inadequate of failed internal process, people and systems or from external events. It is not financial, every kind of risk that is not credit or ?. In modern banking the information security problems play very significant role. Operational risk means mainly technology and security in commercial banks (we will discuss it in May during some lecture).
Reputation risk
Not measurable. This is something that we should take into account while evaluating bank position. Hard to say anything about reputation.
Median of Value at risk for FX risk and interest rate risk
One of the commonly used risk measurement – value at risk.
LINKS: 1. Just the difference between risk and uncertainty
2. Just the history
3. Report!