Risk Management in Financial Institutions Part 2
Yasir is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Recently, there have been several major losses to some of the biggest financial institutions and banks due to several reasons such as interest rates and credit exposure. Risk management is a type of strategy which every financial institution needs to have at its core and there are several parts involved in this including monitoring the risks, measuring these risks and controlling risks.
One of the basic risks, which many financial institutions face, is systematic risk. Interest rate risk is one of the major parts of systematic risk and the institutions needs to measure the variation and the responsiveness of the rate sensitive assets towards the changes in interest rates. Barclays PLC (NYSE: BCS) is one of the banks which have a decent market and systematic risk management system. The Group Governance and Control Committee at Barclays uses the 'Value at Risk" strategy in order to manage its risk. However, the Value at Risk method is not that reliable when measuring the losses in extreme cases. Therefore, Barclays does use other strategies including firm-wide stress tests after analyzing historical movements in market prices.
Credit risk is the risk which all the financial institutions face and they need to manage this in order to be proactive against any future losses. Barclays uses a solid credit risk management strategy and their risk professionals try to analyze the impact of changes in the financial climate on their customers. The bank has several steps. Firstly, it uses risk to return analysis in order to determine the target audience. Then credit scoring strategies are used for account management. Then finally, steps are taken in order to recover the maximum amount from debtors before cutting the relationship with poor client.
HSBC (NYSE: HBC) uses the Retail Banking and Wealth Management operation for credit risk management. Basically, it has several categories within the credit risk management department. The credit risk management team is divided in different parts and focuses on acquisition risk, decision analytics, portfolio management, collections and credit risk intelligence. HSBC uses a special filter for risk identification in order to identify any potential problem accounts. It, then, uses an effective risk strategy in order to manage its risk by developing a risk appetite, scenario stress testing and by governance capabilities.
Operational risk is associated with the problems resulting from selling, processing and recording cash transactions. HSBC has put a lot of emphasis on Operational risk management. It tries to handle operational risk in a very cost effective manner while keeping the risk in the desired levels of the bank. A Global Operational Risk and Control Committee is responsible for operational risk management and the committee reports to all risk management meetings at HSBC. The bank also has an operational risk management framework for helping managers to monitor and keep control of the employees and to minimize operational risk.
Barclays has a strong operational risk management approach as they try to minimize their operational risks. It uses AMA (Advanced Measurement Approach) for controlling operational risk. The bank uses AMA in the majority of the situations, however, it also uses the basic indicator approach for specific parts. The firm uses several strategies in order to benchmark the international risk operations with peer banks and in order to develop advanced operational techniques around the banking industry.
The Credit Suisse Group (NYSE: CS) is one of the biggest financial institutions in the world and is another institution which uses some effective risk management strategies. The risk appetite depends only on the strategic priorities of the institution and it uses the Economic Capital (EC) approach for managing its risks. Around 75% of the risk is associated with investment, market conditions and credit and the firm faces a 4% operational risk. This solid framework, based on Economic Capital, helps the Credit Suisse Group to match its risk with its financial resources.
Apart from the basic framework, Credit Suisse also uses a unique approach of risk limits which not many financial institutions use. The maximum risk limit represents the maximum risk that the institution can take without being fully exposed. Value-at-risk is a decent approach towards market risk and the firm uses VaR in order to manage its market risk, which contributes a major part in the 75% position risk. Apart from these 2 basic tools, Credit Suisse also uses Bank-wide stress testing, country exposures, derivative credit equivalents and Monte-Carlo credit exposure scenarios. These tools, along with VaR and Economic Capital, contributes to an overall solid risk management framework for The Credit Suisse Group.
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