Risk Management Guidelines

04/13/23 SBP Risk Guidelines 1

Risk Management Guidelines

For Commercial Banks


Risk Management Clear understanding Within established limits In line with business strategy and

objectives Expected pay-offs compensates for risks

taken Not minimizing rather optimizing risk reward

trade-off Decisions are explicit and clear Sufficient capital as buffer


Hierarchy levels Strategic Level

Senior Management (SM) & Board of Directors (BOD) Ascertaining risk appetite Formulating strategy Policies, systems and controls

Macro level Risk manager within business area

Risk review Micro Level

Front office, loan originations function Risk created here


BOD & SM Oversight Concern and tone must start at the

top Responsibility rest with BOD SM transforms the strategic

direction through policies and procedures

BOD approves the policies Policies and procedure must

communicate down the line Embedded in the organization

culture Material exceptions to be reported

to SM Triggers appropriate corrective

measures BOD to review policies when

deemed necessary

BOD

Division Head1 Division Head2 Division Head3

Unit Head1 Unit Head2 Unit Head3


Risk Management Framework Scope of risk to be managed

Identification, measurement, monitoring and control

Process/ systems and procedures Management information systems (MIS) Procedure to address deviations

Roles and responsibilities Separate setup like RMC Risk review independent of risk originating role

Ongoing review of policies and procedures


Risk Evaluation Aggregate exposure of institute

Risk Type Business line Short and Long run impact

Quantitative or qualitative measures quantitative techniques/model, as good as

underlying assumptions the rigor and robustness of analytical methodologies the controls surrounding data inputs and

applications


Contingency Planning Disaster Recovery Public Relations damage control Litigation strategy Regulatory criticism Plans should be tested for

Appropriateness of response Escalation channels Impact on other parts of institution


CREDIT RISK MANAGEMENT

Potential that an obligor is either unwilling to

perform on an obligation or its ability to perform such obligation is

impairedresulting in economic loss to the

bank.

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Specific Areas of Oversight Define risk Tolerance

Client segments, products, economic sectors, currency and maturity

Preferred level of diversification Pricing strategy

Risk exposure at prudent levels and consistent with capital

Policy should include Detailed and formalized evaluation process Approval authority at various hierarchy Risk acceptance criteria Credit origination, administration and documentation Guidelines on management of NPL


Organization Structure Credit Risk Management Committee (CRMC)

Head of credit risk Credit Department Treasury

Responsible for: Implementation of policy Monitor risk and ensure limits compliance Recommend policies to board Decide delegation of powers, standards of loan

collaterals, loan review mechanism, risk concentrations, provisioning and regulatory compliance

Credit Risk Management Department (CRMD) Assists the committee in running day to day oversight.


Systems and Procedures Banks must make an assessment based on

Borrower industry and economic conditions Purpose for credit and source of re-payment Track record and re-payment history and current capacity Adequacy and enforceability of collaterals Required approvals

Name lending should be discouraged Price to cover economic costs, terms to cover bank

interest Credit use as per intended purpose, conduct

assessment on group basis (where necessary) Syndicate participants must do independent analysis

and review Must not over rely on collaterals

Buffers are considered protection provision


Systems and Procedures Size of limits should be based on

Strengths of obligor Genuine requirements Economic conditions and Risk tolerance

Impose restrictions if frequent sharing of limits among associated group of companies

Limits should be reviewed at least annually Credit administration unit performs following

Documentation including correspondences Disbursement Monitoring Repayment reminders Collaterals under dual control and fire proof safes with

regular physical checks and insurance coverage


Systems and Procedures Banks are advised to device internal risk ratings to help

them in Selection, exposure, tenure and price Analysis of migration of deteriorating credits Accurate computation of loan provisions

Corporate and commercial exposures are subject to internal rating Consume/retail loans are subject to scoring models

Risk rating framework may, incorporate Business risk

Industry characteristics Competitive position (marketing/ technological) Management structure and capability

Financial risk Financial condition and Profitability Present and future cash flows


Systems and Procedures Dedicated remedial process for NPL Specialized work out section improves collection

results Proactive efforts prevent litigation and loan losses Remedial strategies improve repayment capacities

Restructuring Enhancements in limits Reduction in interest rates

These measures need to be applied with caution, so that it does not encourage others to default intentionally


MANAGING MARKET RISK

Risk that the value of on and off-balance sheet positions of a financial institution will be adversely affected by movements in market rates or prices such as interest rates, foreign exchange rates, equity prices, credit spreads and/or commodity prices resulting in a loss to earnings and capital

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Specific Areas of Oversight Define risk Tolerance

Market risk appetite Ensure prudent risk exposure levels and

are consistent with capital Needs to consider

Economic conditions and its effects Ability to identify and profit in specific

markets Review based on financial results


Organization Structure The risk management committee (RMC)

Ensure adequate risk management resources Review and approve limits Ensuring the robustness and effectiveness of systems

calculating risk Asset Liability management committee (ALCO)

Observe composition of banks assets and liabilities Required maturity profile Articulate interest rate view and funding policy Evaluate risk in new product launch

The Middle Office – reports to ALCO Treasury operations and resp. risk review on day to day

basis Reporting may vary from simple gap analysis to VaR

modeling Prepare forecast analysis


Risk Measurement Assess all material risk factors

GAPtimeband = IS (Asset–Liabilities+OBS exposure) If ISA > ISL --> Positive GAP IS Ratio = ISA/ISL

Utilize generally accepted financial concepts Have well documented assumptions and

parameters, clearly under stood at all levels For traded portfolios banks should use

valuation approach. Encouraged to use VaR Models Expected to adopt maturity mismatches,

sensitivity analysis as a minimum


Risk Measurement Review and validate each step of the process

for Appropriateness of system Accuracy or integrity of data used in risk model Reasonableness of scenarios and assumptions

Set limits based on Trading desk Products Instruments Markets Industries Regions


MANAGING LIQUIDITY RISK

Potential for loss to an institution arising from either its

inability to meet its obligations or to fund increases in assets as they fall duewithout incurring unacceptable cost or

losses.

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Specific Areas of Oversight Concentrations Deterioration in portfolio credit quality Decline in earnings/ performance Rapid asset growth funded by large volatile

deposit Large OBS exposure Deteriorating 3rd party evaluation about bank Identifying funding markets bank has access to

Nature of those markets Current and future use of those markets Monitor signs of confidence erosion

04/13/23 Managing Liquidity Risk 22

Organization Structure

Responsibility should lie with a particular group e.g., ALCO

ALCO should interact frequently with risk managers and strategic planners


Risk Measurement Timeliness should be preferred over

accuracy Liquidity is affected by large aggregate cash

flows Fund flow analysis and Continuous funding

plan reports Set of policies and procedures to meet funding

in a timely manner and reasonable cost Useful for both short and long term

Should include asset and liability side Asset: liquidate surplus money market assets Liability: Use of SBP discount window


Risk Monitoring Net deficit or surplus over a time horizon Maturity ladder Liquidity Ratios, in conjunction with more

qualitative information Likelihood of increased withdrawals Decease in credit lines Shortening of term funds

Liability concentration ratio: prevents relying on too few providers/ funding sources

Limit exceptions early indicators of excessive risk


MANAGING OPERATIONAL RISK

Risk of loss resulting from inadequate or failed

internal processes, people and system or from external

events.

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Risk Assessment Systematically record on individual loss

event Frequency Severity Other related information

Adequacy of counter measures for effectiveness in Reducing the probability of risk Reducing the impact should it occur

Documents

Risk Management Guidelines