Market Risk Management Unit
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- Elinor Cox
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1 Risk in Bank In the today s world of globalization risk management has become a significant area. Thus, risks occurred as a result of numerous operations in the developed countries has underlined the importance of development of this segment. Though the Risk unit of the Bank was established in 2006, it practically carried out the duties of current Credit Department. However, within the framework of Institutional Building Project implemented with financial support of EBRD, one of the key shareholders of the Bank, and with technical assistance of Lloyds TSB, the following organizational structure was set to carry out the function of risk management in compliance with Corporate Standarts: Supervisory Board Risk Committee Executive Board Audit Committee IT Committee ALCO Credit Committee Internal Audit Department Risk Department Other departments Branch network Accordingly, Risk Department was established upon the Supervisory Board resolution No and received long-term technical support to improve the activities in this area. The Department was set in the fillowing structure as designed by the Regulations: Risk Department Credit Risk Unit Market Risk Unit Operations Risk Unit I.T. security unit 1
2 After the organization of structure, the sub-divisions of the department started their risk management activities following the process below in accordance with the risk management process based on the best practices: Indentification Assessment Measuring Monitoring Controlling As described above, the first steps in risk management involves identification, assessment and measuring of risks. For every risk, the results of these steps are summarized and included in the Bank s risk map. In result, the overall Risk Map reflects the likelihood and significance of existing and potential risks and provides information on Bank s sensitivity to any risk occurred/expected to occur. This is of a special importance in determination of Bank s Strategic Plans. For the purposes of development of Risk Map, the risk areas were reviewed and 38 types of the biggest risks were identified. Likelihood of risk occurance and its significance for the Bank was evaluated upon the consultations with other departments. As a result, the risks were plotted in the Map according to their levels. Besides, factors of each risk and their possible impact on Bank s performance were identified. It should be noted that since the Bank has prioritized Risk Map while developing the audit plan, it prevents the possible risks in many cases. Risk Map of the Bank has been highly assessed by Lloyd TSB personnel and other experts. Moreover, Bank also developed Risk Reporting System in order to ensure risk monitoring and supervision as the continuation of risk management process. Risk Reporting System is one of the tools which enable the Bank to monitor emerged risks in a regular manner. Furthermore, risk reports allow 2
3 collecting static data which makes it possible to apply tools used in a number of best practices, such as VAR, Duration, and Monte-Carlo simulation. Risk Reporting System containing 21 types of reports has been operating since October These reports included a number of issues, such as past due loans, reviews conducted, interest rates, bad loans, compliance with covenants, resources attracted and allocated and etc. The reports are prepared by relevant departments on monthly basis and submitted to Risk Department which conducts regular analysis of Bank performance based on these reports and if necessary, submits reports with relevant information to the management in order to take actions. Thus, based on risk reports, Risk Department has organized stress tests related to a number of issues since 2007 in order to evaluate long-term stability of the Bank. These Stress Tests are of special importance with the view of informing the management on possible impacts of such events on the Bank and its customers, taking preventive measures on test results and indentifing the limits. From the beginning of 2008 the department used more advanced techniques and launched stress tests in 3 components with different scenarios in order to assess Bank s financial sustainability and started to develop relevant regulations. Along with the aforementioned, taking into consideration the importance of stress tests, Central Bank (CBAR) has set a requirement on all bank sectors, as well as our Bank to conduct quarterly stress tests and submit the results to the CBAR. Besides, within the framework of monitoring process, Instruction on Financial and Market Risk Assessment and Analysis was developed in early 2008 in order to apply CAEL assessment method, largely used in international practice, in the constant review of Bank performance. It contains guidance to compare 41 types of economic indicators under 4 components on their current and previous performance and then define the future trends: Equity Assets Profitability Liquidity It should be noted that, in order to ensure more advanced application of this method, the automation and visualization of these indicators are one of prioritized issues and much work has already been done in this field. As a result of all assessment, the Bank established new Risk limitations in order to distribute authorities based on the chart above in accordance with Corporate Standards. 3
4 As described in the chart, the limitations are not set by organizational units separately. Each unit submits the limitations related to relevant activities for the discussion of Risk Department or other relvant committees after which the limitations are initially approved by Risk Committee and returned to the relevant units for final approval. In order to keep regular control over Bank performance and find out the risks in a timely manner, the department works out annual and quarterly reports on following ratios based on Credit, Market, Liquidity and other risks, and submits these reports to the management and various financial institutions. Furthermore, Risk Department conducts regular analysis of these indexes and trends and makes appropriate proposals to the management. Indexes in risk groups are as follows: Credit risk RATIOS Ratio Covenant Table 1 Bank index, Total amount of loans to related parties and persons acting on their behalf / Total equity Max 15% 11.9% a) Legal entities (each) (%) Max 10% 6.5% b) Individuals (each) (%) Max 3% 0.7% 1.2. Top 20 Client exposure / Total Equity Max 400% 67.3% Single Group Exposure Ratio (fully collateralized) Max 20% 18% Single Group Exposure Ratio (unsecured/partially collateralized) Max 7% 5% 1.4. Open credit risk ratio ((NPL loans - provisions ) / Total equity) Max 10% -2.1% 1.5. Total NPL laons / Total loan portfolio Max 5% 4.0% 1.6. PAR > 30 days / Total loan portfolio Max 7% 5.3% 1.7. Writeoffs / Total loan portfolio Max 2% 0.5% 1.8. Total amount of loan portfolio / Total Assets Min 60% 72.3% Sector exposure ratio 1.9. Industry Max 25% 14% Agriculture Max 25% 9% Trade Max 25% 17% Service Max 25% 5% Construction Max 25% 19% 4
5 1.14. Transportation Max 25% 4% Communication Max 25% 2% Table 1 displays Bank s position in respect of Credit Risk Ratios developed on basis of covenants both set by the CBAR and international financial institutions (EBRD, FMO, IFC, DEG, SparBank, ING, Incofin etc.) that DemirBank cooperates with. It is clear from the Table that all covenants on credit risk were followed. Sector exposure ratio section shows concentration risk in loan portfolio, as well as requires the equal diversification of 25 % limit portfolio in each sector. As described in the table, the Bank complied with each of these requirements. Table 2, describing market risk ratios below, shows open currency position ratio, as well as maturity gap ratios. As result of possible FX fluctuations there may be a loss or gain arised from the Bank s open currency position on different foreign currencies. In any case, since such operation is risky, it is important to follow some covenants required by CBAR and proposed by international financial institutions cooperating with the Bank. As described in the table, the open currency position in each foreign currency and total open currency position of the Bank comply with the covenants. Market Risk RATIOS Table 2 Ratio Covenant Bank index, 2010 Currency risk 2.1. Open Currency Position Ratio Min/Max +/- 20% 4.51% USD Min/Max +/- 10 % 4.25% EUR Min/Max +/- 10 % 0.01% RUR Min/Max +/- 10 % 0.27% Interest rate risk 2.2. Interest exposure ratio (Floating Liabilities Floating Assets / Total Assets) Max 10% -5.6% Total interest rate ratio Min/Max +/- 20% -2.6% to 180 days (1%) Min/Max +/- 10 % 0.1% to 365days (3.5%) Min/Max +/ 10 % -0.05% to 3 years (8%) Min/Max +/ 10 % 2.4% 5
6 to 5 years (13%) Min/Max +/ 10 % -4.4% over 5 year (18%) Min/Max +/ 10 % -0.6% Table 2 also illustrates possible risks arising from variations on different maturities and changes in interest rates of the Bank. So, one can see that the Bank complies with the limitations set by International Finance Corporation (IFC). Liquidity risk RATIOS Ratio Covenant Table 3 Bank index, Liquid Assets / Total Assets min 15% 23.49% 3.2. Liquid Assets / Demand Deposits min 30% % 3.3. Liquid Assets / Short-term liabilites (<30 days) min 100% % 3.4. Liquid Assets / Short-term liabilites (<90 days) min 55% 90.34% Maturity gap (Assets (up to 90 days) - Liabilites (up to 90 days) / 3.5. Max 100% Total equity % 3.6. Non-bank deposits / Total Loan Portfolio Max 100% 59.25% Negative liquidity ratio on period (0 30 days) min -30% 10.48% (0 90 days) min -30% 4.41% (0 360 days) min -30% 2.11% (0 360days and more) min -30% 0.00% 3.8. Interbank short-term debt / Total Liabilites Max 20% 0.00% 3.9. Loan obligations / Equity Max 700% 360% Table 3 includes basic ratios of liquidity risks that the Bank may encounter. Liquidity risk is the inability of the Bank to change its assets to the relevant interchangeable facility with as minimum loss as possible. The Bank may face liquidity risk especially while fulfilling its short-term obligations, since the banks usually finance long-term assets with short-term liabilities. Various liquidity ratios are applied in order to ensure timely fulfillment of Bank s obligations. There was no breach of these covenants in Bank performance last year. ========================================================================= 6
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