Index A absence of control criteria, as cause of operational risk, 395 accountability, 493 495 additional exposure, incremental loss from, 115 advances and loans, ratio of core deposits to, 308 309 advances, credit risk reform, 100 101 ALCO. See Asset Liability Management Committee ALM. See asset liability management analysis duration gap, 336 341 maturity gap, 334 336 simulation, 341 342 appetite credit risk, 234 risk, 56 57 approaches, liquidity management, 306 307 approval process, rating, 145 architecture, risk management, 47 48 Asian financial crisis causes and impact, 514 515 lessons from, 518 risk proliferation sequence, 516 risks emerging from, 515 518 assessment, capital adequacy, 74 75 asset categorization, 159 asset liability management (ALM), 379 380 Asset Liability Management Committee (ALCO), 321, 379 asset liability review, 379 381 asset values finding volatility of, 344 loss in, 522 523 assets, classification of, 299 301 assumptions, validity of, 324 325 audit system, independence of, 496 497 autonomy, preventing misuse of, 508 509 B back-testing, 64 65 credit risk models, 219 220 bank supervisor, role of, 232 banking book, 327 328, 332 335 banks board of directors, 501 505 corporate governance in, 500 509 internal rating systems, 153 154 rating practices in, 129 senior management, 502 505 Basel Committee on Banking Supervision, 534 535 basis risk, 330 Basel III. See Basel Committee on Banking Supervision BCBS. See Basel Committee on Banking Supervision bias risk, 330 board of directors, selecting, 506 borrower characteristics in credit risk rating, 123 124 Managing Risks in Commercial and Retail Banking By Amalendu Ghosh Copyright 2012 John Wiley & Sons Singapore Pte. Ltd. 541
542 INDEX borrower rating, interpretation of, 141 142 branch office assessment of function, 475 compliance by, 482 credit management by, 475 477 internal control application, 480 482 liquidity management, 477 478 operational risk management, 479 480 rating, 464 467 revenue management, 478 479 risk profiles of, 454 455 systems improvement, 483 business continuity planning, 430 433 methodology, 434 436 support requirements, 433 434 business environment, appropriate, 498 500 business line identification, operational risk and, 411 414 business performance, measuring, 120 121 business risk, 3 4 relationship, 34 35 C capital accord options, 158 159 capital adequacy assessment, 74 75 cash flow approach, 307 collateral management practices, enhancing, 267 268 collateral, too much confidence in lending against, 84 commodity price risk, 283 284 communication efficiency, increasing, 33 compliance, branch office, 482 component rating, derivation of, 189 195 component risk, assessment of, 161 172 computation, loan pricing, 275 279 confidence levels, choosing, 344 conflicts of interest, rating, 145 146 contagion risk, 515 517 contingency planning, liquidity, 313 314 control, 66 detective and corrective, 26, 29 identifying elements of, 32 33 operational risk, 430 431 posttransaction, 25 26 pretransaction, 24 preventive, 26 28 types of, 23 control application field, determining, 31 32 control culture, enhancing, 33 34 control culture, absence of, 395 control foundation, strengthening, 33 34 control framework customization, 21 23 establishing, 28 30 control risk, 3 4, 19 20, 361 how it occurs, 19 control risk relationship, 34 35 control system failure, as cause of operational risk, 395 396 core deposits, ratio of loans and advances to, 308 309 corporate governance, 489 490 banks, 505 509 elements, 493 500 foundation, 492 493 in banks, 500 505 objectives, 490 492 risk, 530 531 values, 494 corporate vision, risk management policy and, 55 56 corrective controls, 26, 29 correlation effect, evaluating, 264 265 counterparty rating derivation of, 195 196 interpretation of, 141 142 country risk, defined, 7 credit, selecting, 113
Index 543 credit administration process, maintaining, 231 credit audit mechanism, 244 248 absence of, 88 89 credit boom, 520 521 credit concentration assessing, 116 117 prevalence of, 86 87 risk, 517, 521 522 credit deployment, 521 522 credit derivatives method, credit risk mitigation, 251 253 credit enhancement method, credit risk mitigation, 249 251 credit granting process, sound, 229 230 credit loss estimation, 200 203 credit management branch office, 475 477 credit risk management and, 225 226 credit monitoring, laxity in, 88 credit portfolios, stress testing of, 220 222 credit problems, beginning of, 81 91 credit risk, 5 7 appetite, 234 assessment, 173 175 causes of, 92 93 control, setting up, 231 232 environment, establishing, 228 229 from lax lending standards, 523 524 hidden, 525 526 identification process, 100 109 indicates, 6 intermediate, 6 7 limits, 238 241 market risk and, 95 96 policy, 236 238 problem loans and, 99 100 credit supervision, laxity in, 88 credit risk identification complications in, 96 99 credit management and, 225 226 organizational structure for, 232 234 principles, 227 232 credit risk measurement models, 215 219 credit risk mitigation, techniques, 248 253 credit risk models, back-testing of, 219 220 credit risk policies and strategies, 234 242 credit risk policy, 236 238 credit risk rating (CRR), 110 113 borrower characteristics in, 123 124 criteria, 124 125 development of methodology, 173 189 new borrower model, 194 old borrower model, 192 193 principles, 122 127 risk measurement models and, 199 200 transaction characteristics in, 123 124 uses of, 113 122 credit risk vision, 234 236 CRR. See credit risk rating D data, storage and retrieval, 146 147 deal size limit, 368 default definition of, 134 136 probability of, 204 207 default frequency, mapping, 263 264 default mode (DM), 200 102 mark-to-market and, 202, 203 default probability, risk rating and, 112 default risk, 360 from unfair lending practices, 524 525 derivative characteristics, 104 105 derivatives credit risk from, 104 106 risks, 106 underestimation of risks, 526 530 detective controls, 26, 29 direction of credit deployment, 521 522
544 INDEX disclosure requirement, 74 75 disclosure standard, 497 498 DM. See default mode due diligence, 81 83 duration gap analysis, 336 341 duration gap implication of, 339 340 management of, 340 341 dynamic liquidity, 301 302 E EAD. See exposure at default early warning signals, 242 246 earnings at risk, 347 351 computation of, 350 estimation of, 350 351 earnings, loss in, 522 523 EL. See estimation of expected loss electronic banking, risk in, 37 38 embedded option risk, 331, 352 entry point ratings, inaccuracy in, 83 84 equity exposure management, framework of, 374 375 equity exposure identification, 373 374 risk measurement, 375 376 equity price risk, 283 284 review, 385 equity value, change in, 338 339 estimation of expected loss (EL), 216 218 estimation of unexpected loss (UL), 218 219 events, significant, 323 324 exchange risk impact, estimating, 265 exit point, selecting, 119 expected loss, estimation of, 216 218 exposure at default (EAD), estimation of, 212 215 exposure limit fixing, 115 116 large, 241 242 external control risks, 19 20 external events, as source of operational risk, 392 393 external loss data measurement, 423 F facility structure risk, 166 168 financial risk, 4 impact of, 16 financial viability risk, 164 166 assessment of, 179 foreign currency exposure measurement, 361 364 liquidity, 325 liquidity risk and, 309 310 foreign exchange risk, 283 284 hedging, 370 371 implication, 357 358 management, 366 370 quantification, 364 366 review, 384 385 types, 358 361 funding risk, 352 G gap limit, 368 369 gap risk, 359 grievance redress, existence of, 507 H hardware systems location, technology risk and, 39 hedging, foreign exchange risk, 370 371 hidden credit risk, 525 526 human resource development, risk management and, 72 73 I identification process, credit risk, 100 109 identification equity exposure, 373 374 liquidity risk, 297 299 risk factors and elements, 455 456
Index 545 inadequate communication, as cause of operational risk, 395 incremental loss from additional exposure, 115 incremental risk, measuring, 113 115 independent verification of ratings, 146 ineffective auditing, as cause of operational risk, 397 information technology risk, 42 interbank exposure, credit risk from, 106 108 intercountry exposure, credit risk from, 108 109 interest income stress testing, 353 354 interest rate risk, 283 284, 327 328, 522 523 causes, 328 332 control, 354 management, 351 353 measurement, 332 334 measurement perspective, 333 334 review, 383 384 intermediate credit risk, 6 7 internal audit department, structure, 450 452 internal audit function, review of, 483 internal audit, changing role, 444 445 internal audit, relationship with internal control, 444 internal audit, scope and rationale, 443 449 internal control application, branch office, 480 482 efficacy, 496 framework, 21 28 objectives, 21 relationship with internal audit, 444 internal control, risks, 19 20 internal loss data measurement, 422 423 internal rating based approach, 158, 159 international financial system, 15 investment opportunities, 14 investments credit risk from, 101 102 ratio of purchased funds to, 309 J judicial process, improving, 506 507 K key risk indicator, 418 420 L large exposure, 241 242 legal risk, 12, 361 lending against collateral, too much confidence in, 84 lending practices, unfair, 524 525 lending standards, lax, 523 524 leverage, preferred borrowers too high, 91 LGD. See loss rate given default liabilities, classification of, 299 301 limits credit risk, 238 241 large exposure, 241 242 risk, 57 59 liquid assets, ratio of short-term liabilities to, 308 liquidity contingency planning, 313 314 liquidity crisis, 312 liquidity funding risk, stress testing of, 314 321 liquidity gap analysis, 301 liquidity management alternate scenarios and, 310 313 approaches, 306 307 branch office, 477 478 structure, 306 liquidity risk, 283 284 causes, 293 294 foreign currency and, 309 310 identification, 297 299 measurement, 299 305 review, 380 383 liquidity risk indicators, emergence of, 322
546 INDEX liquidity risk management, 294 295 policies and strategies, 296 297 liquidity risk monitoring and control, 321 325 loan exit point, selecting, 119 loan loss reserves, validating, 121 122 loan prices, fixing, 119 120 loan pricing, 271 computation, 275 279 issues, 272 275 principles, 271 272 loan processing, lack of due diligence in, 81 83 loans and advances, ratio of core deposits to, 308 309 loans credit risk from, 100 101 ratio of total assets to, 307 long-term corporate goals, formulation of, 505 506 loss rate given default (LGD), estimation of, 207 212 loss reserves, validating, 121 122 loss severity, mapping, 264 loss asset value and earnings, 522 523 estimation of, 216 219 M Macaulay s duration, 336 336 macroeconomic risk, 10 11 management commitment, risk management and, 73 74 management information system (MIS), 67 72 strengthening, 34, 266 managerial risk, 163 164 assessment of, 180 mapping default frequency, 263 264 loss severity, 264 rating migration, 261 263 mark-to-market (MTM), 201 202 default mode and, 202 203 market risk, 7 8, 283 credit risk and, 95 96, 517 518 defined, 7 8 management framework, 285 286 policy, 288 types, 283 285 vision, 289 290 market risk management, organizational setup, 286 288 maturity gap analysis, 334 336 limitations of, 335 336 maturity mismatch risk, 352, 518 measurement, liquidity risk, 299 305 microeconomic risk, 10 11 MIS. See management information system mismatch risk, 328 330 misuse of autonomy, preventing, 508 509 mitigation, operational risk, 430 431 model inputs, identification of, 160 161 models, credit risk measurement, 215 219 modified duration, 338 money launderers, 13, 15 money laundering estimates of, 13 laws, 13 14 risk, 12 14 stance, 508 monitoring, 66 MTM. See mark-to-market N net interest position risk, 331 332 new activities, as cause of operational risk, 396 397 new borrower rating models, need for, 155 157 new products as cause of operational risk, 396 397 introduction of without preparation, 90 91 nonfinancial risk, 4 5 impact of, 17
Index 547 O off-balance sheet exposure, credit risk from, 102 104 offshore banking risk, 14 15 old borrower rating models, need for, 155 157 operating environment risk, 10 11 operational risk, 8 10, 389 390 awareness of, 9 10 causes, 8 9, 393 397 control and mitigation, 430 431 defined, 8 monitoring, 429 430 sources, 390 393 operational risk assessment methods, 414 421 operational risk events, high-intensity, 430 433 operational risk identification, 409 411 operational risk management branch office, 479 480 framework, 399 407 operational structure, 436 437 operational risk measurement methodology, 421 424 process, 425 429 operational risk policy contents, 398 399 objectives, 397 398 organizational structure for credit risk management, 232 234 market risk management, 286 288 risk management, 48 53 output consistency, rating, 145 over-the-counter derivatives, underestimation of risk, 526 530 overseas banking risk, 169 171 P past dealings risk, 168 169 PD. See probability of default people, as source of operational risk, 391 planning horizon, choosing, 202 203 policies credit risk, 234 242 liquidity risk management, 296 297 policy risk management, 55 56 risk-based internal audit, 449 450 portfolio analysis, technique, 261 266 portfolio classification, 255 256 portfolio evaluation system, absence of, 89 90 portfolio management issues, 256 260 objectives, 256 portfolio review analysis, 257 258 portfolio risk mitigation techniques, 266 269 position limits, 367 368 position risk, 358 359 posttransaction controls, 25 26 preferred borrowers, high leverage to, 91 preparation, introduction of new products without, 90 91 pretransaction controls, 24 preventive controls, 26 28 preventive vigilance, 507 508 prime assets, ratio of total assets to, 308 probability of default (PD), estimation of, 204 207 problem loans, credit risk in, 99 100 processes, as source of operational risk, 391 392 project implementation risk, 171 172 prospect risk, 162 163 purchased funds, ratio of investments to, 309 Q qualitative assessment, scoring norms for, 183 186, 189 quantitative assessment, scoring norms for, 187 189 R rating approval process, 144 145 rating coverage, 143 144
548 INDEX rating criteria, transparency in, 124 125 rating framework design of, 130 131 overview, 148 150 rating granularity, 137 rating migration, mapping, 261 263 rating models need for different, 154 155 types of, 157 158 rating practices in banks, 129 rating process, integrity of, 124 126 rating principles, 122 rating review, 145 rating scale, 138 140 rating system dimension, 133 134 rating, independent verification of, 146 interpretation of, 140 142 rationale, internal audit, 443 449 regulatory risk, 530 531 reinvestment risk, 331 related party lending, lack of transparency in, 85 86 repricing risk, 352 reputation risk, 11 12 responses, to U.S. financial crisis, 533 retrieval of data, 146 147 revenue management, branch office, 478 479 risk categories of, 3 4 concept of, 3 facility structure, 166 168 financial viability, 164 166 impact of, 15 16 increased volume of credit, 520 521 managerial, 163 164 managing, 42 43 overseas banking, 169 171 past dealings, 168 169 project implementation, 171 172 prospect, 162 163 quantitative estimation of, 126 127 sources, 5 stability, 162 163 technology, 37 43 risk appetite, 56 57 risk-based audit differences from transaction-based audit, 445 446 functions, 448 449 planning, 468 469 reporting, 474 475 risk assessment, 174 175 score assessment and, 178 180 tools and techniques, 30 31 verification of, 72 risk components identification of, 160 quantification of, 204 215 risk control, 66 risk elements assignment of weights to, 459 462 development of scoring norms, 456 457 identification of, 455 456 risk events, identification of, 413 414 risk factor rating, 462 464 adoption of scale for, 462 risk factors assignment of weights to, 457 459 identification of, 455 456 selection of, 131 133, 136 137 risk grades, 138 139 risk hedging, 370 371 risk identification, 47 process, 60 62 risk limits, 57 59 risk management (RM), 45, 76 approach, 45 47 architecture, 47 48 human resource development, 72 73 management commitment and, 73 74 organizational structure, 48 53 role of senior management and board in, 503 504 risk management policy, 55 56 corporate vision and goals, 55 56 risk management systems, 59 66
Index 549 risk mapping, 419, 421 risk measurement models, credit risk rating and, 199 200 risk measurement, tools, 62 64 risk migration, tracking, 117 119 risk mitigation options, selecting, 266 267 risk mitigation techniques, 65 66 portfolio, 266 269 risk monitoring, 66 risk perception, differentiation in, 123 risk prioritization, 75 76 risk profiling inputs, 467 468 risk rating scale, determining, 139 140 risk rating system dimension, 133 134 risk rating default probability and, 112 developmental issues, 136 140 granularity in, 137 risk-based audit differences with transaction-based audit, 445 446, 447 planning, 468 469 process, 471 484 reporting, 474 475 scope, 470 471 risk-based internal audit functions, 448 449 methodology, 453 468 policy, 449 450 transition to, 446 448, 484 risk-based loan pricing, 276 RM. See risk management S scenario-based measurement, 423 424 scenario test, 221 scope, internal audit, 443 449 score assessment risk assessment and, 178 180 norms for, 182 183 scale for, 180 182 scoring norms qualitative assessment, 183 189 risk elements, 456 457 small exposures, 189 scrutiny, methods and focus, 471 474 self-assessment, of control and risk, 416 418 sensitivity test, 221 shareholder responsibility, 495 496 short-term liabilities ratio of liquid assets to, 308 ratio of total assets to, 308 significant events, 323 324 simulation analysis, 341 342 software programming, technology risk and, 39 40 stability risk, 162 163 stock approach stop-loss limit, 369 370 storage of data, 146 147 strategies credit risk, 234 242 liquidity risk management, 296 297 stress testing of credit portfolios, 220 222 interest rate income, 353 354 of liquidity funding risk, 314 321 procedures, 316, 319 321 undertaking, 265 266 structural liquidity normal scenario, 318 319 statement of, 303 305 structure internal audit department, 450 452 liquidity management, 306 operational risk management, 436 437 subprime lending, 525 526 systems compatibility, technology risk and, 40 systems handling, technology risk and, 41 42 systems improvement, branch office, 483 systems planning and design, technology risk and, 40 41
550 systems as source of operational risk, 392 risk management, 59 66 T taxation, 14 technology risk defined, 37 management of, 42 43 sources of, 38 42 term structure risk, 352 time horizon, selecting, 344 346 tolerance limit, 370 appropriateness of, 322 323 total assets ratio of loans to, 307 ratio of prime assets to, 308 ratio of short-term liabilities to, 308 ratio of volatile liabilities to trading book, 327 328 traditional method, credit risk mitigation, 249 transaction characteristics in credit risk rating, 123 124 transaction settlement, credit risk from, 109 transaction-based audit, differences with risk-based audit, 445 446, 447 transparency, 493 495 transparency in related party lending, lack of, 85 86 U U.S. financial crisis causes and associated risks, 520 533 impact of, 519 lessons from, 531 533 responses to, 533 UL. See estimation of unexpected loss uncertainty, 3 unexpected loss, estimation of, 218 219 unfair lending practices, 524 525 unrevised profile, as cause of operational risk, 397 V validation, 64 65 validity of assumptions, 324 325 value-at-risk, 342 347 limit, 370 review, 385 386 vendor choice, technology risk and, 39 verification, of ratings, 146 verification, risk assessment, 72 vigilance system, establishment of, 507 508 volatile liabilities, ratio of total assets to, 309 volatility, asset values, 344 volume of credit risk, 520 521 W warning symbol indicators, 242 244 weight assignment, 174 175 risk components, 175 176 risk elements, 178, 459 462 risk factors, 177 178, 457 459 Y yield curve risk, 330