Page 1 Risk Management in Banking

Page 2 An Introduction to Risk Risk Management Risk Management is the process of measuring or assessing the actual or potential dangers of a particular situation. Risk Management

Page 3 Risk Has Two Components Uncertainty. Uncertainty. Exposure. Exposure.

Page 4 Types of Risk Operational. Operational. Credit. Credit. Reputational. Reputational.

Page 5 Operational Risk The risk of loss resulting from inadequate or failed internal processes, people and systems, or from external events.

Page 6 Operational Risks Include Internal Fraud. Internal Fraud. External Fraud. External Fraud. Employment Practices and Workplace Safety. Employment Practices and Workplace Safety. Clients, Products and Business Practices. Clients, Products and Business Practices. Damage to Physical Assets. Damage to Physical Assets. Business Disruption and System Failures. Business Disruption and System Failures. Execution, Delivery and Process Management. Execution, Delivery and Process Management.

Page 7 Internal Fraud Unauthorized Activity. Unauthorized Activity. Transactions not reported. Transactions not reported. Transaction type unauthorized. Transaction type unauthorized. Mismarking of position. Mismarking of position. Theft and Fraud. Theft and Fraud. Fraud/credit fraud/worthless deposits. Fraud/credit fraud/worthless deposits. Theft/extortion/embezzlement/robbery. Theft/extortion/embezzlement/robbery. Misappropriation of assets. Misappropriation of assets. Forgery. Forgery. Account take-over/impersonation. Account take-over/impersonation. Bribes/kickbacks. Bribes/kickbacks. Insider trading. Insider trading. Money laundering. Money laundering. Willful blindness. Willful blindness.

Page 8 External Fraud Theft and Fraud. Theft and Fraud. Theft/robbery. Theft/robbery. Forgery. Forgery. Check kiting. Check kiting. Identity theft. Identity theft. Elder financial abuse. Elder financial abuse. Systems Security. Systems Security. Hacking damage. Hacking damage. Theft of information (with monetary loss). Theft of information (with monetary loss).

Page 9 Employment Practices and Workplace Safety Employee Relations. Employee Relations. Compensation, benefit, termination issues. Compensation, benefit, termination issues. Organized labor issues. Organized labor issues. Safe Environment. Safe Environment. General liability (slips and falls). General liability (slips and falls). Employee health and safety rules. Employee health and safety rules. Workers compensation. Workers compensation. Diversity and Discrimination. Diversity and Discrimination. All discrimination types. All discrimination types. Harassment. Harassment. Equal Employment Opportunity (EEO). Equal Employment Opportunity (EEO).

Page 10 Clients, Products and Business Practices Suitability, Disclosure and Fiduciary. Suitability, Disclosure and Fiduciary. Fiduciary breaches/guideline violations. Fiduciary breaches/guideline violations. Suitability/disclosure issues. Suitability/disclosure issues. Retail consumer disclosure violations. Retail consumer disclosure violations. Breach of privacy. Breach of privacy. Aggressive sales. Aggressive sales. Inadequate product offerings. Inadequate product offerings. Account churning. Account churning. Misuse of confidential information. Misuse of confidential information. Lender liability. Lender liability.

Page 11 Clients, Products and Business Practices ( CONTINUED ) Improper Business or Market Practices. Improper Business or Market Practices. Antitrust. Antitrust. Improper trade/market practice. Improper trade/market practice. Market manipulation. Market manipulation. Insider trading (on firms account). Insider trading (on firms account). Unlicensed activity. Unlicensed activity. Money laundering. Money laundering.

Page 12 Clients, Products and Business Practices ( CONTINUED ) Selection, Sponsorship and Exposure. Selection, Sponsorship and Exposure. Failure to investigate client per guidelines. Failure to investigate client per guidelines. Exceeding client exposure limits. Exceeding client exposure limits. Advisory Activities. Advisory Activities. Disputes over performance or advisory activities. Disputes over performance or advisory activities.

Page 13 Damage to Physical Assets Disasters and Other Events. Disasters and Other Events. Natural disaster losses. Natural disaster losses. Human losses from external sources (terrorism, vandalism). Human losses from external sources (terrorism, vandalism).

Page 14 Business Disruption and System Failures Systems. Systems. Hardware. Hardware. Software. Software. Telecommunications. Telecommunications. Utility outage/disruptions. Utility outage/disruptions.

Page 15 Execution, Delivery and Process Management Transaction Capture, Execution and Maintenance. Transaction Capture, Execution and Maintenance. Miscommunication. Miscommunication. Data entry, maintenance or loading errors. Data entry, maintenance or loading errors. Missed deadline or responsibility. Missed deadline or responsibility. Model/system misoperation. Model/system misoperation. Accounting error/entity attribution error. Accounting error/entity attribution error. Other task misperformance. Other task misperformance. Record retention. Record retention. Documentation maintenance. Documentation maintenance. Delivery failure. Delivery failure. Collateral management failure. Collateral management failure. Reference data maintenance. Reference data maintenance.

Page 16 Execution, Delivery and Process Management (CONTINUED) Monitoring and Reporting. Monitoring and Reporting. Failed mandatory reporting obligations. Failed mandatory reporting obligations. Inaccurate external loss (loss incurred). Inaccurate external loss (loss incurred). Customer Intake and Documentation. Customer Intake and Documentation. Unapproved access given to accounts. Unapproved access given to accounts. Incorrect client records (loss incurred). Incorrect client records (loss incurred). Negligent loss or damage of client assets. Negligent loss or damage of client assets.

Page 17 Execution, Delivery and Process Management (CONTINUED) Customer/Client Account Management. Customer/Client Account Management. Unapproved access given to accounts. Unapproved access given to accounts. Incorrect client records (loss incurred). Incorrect client records (loss incurred). Negligent loss or damage of client assets. Negligent loss or damage of client assets. Trade Counterparties. Trade Counterparties. Non-client counterparty misperformance. Non-client counterparty misperformance. Vendors and Suppliers. Vendors and Suppliers. Outsourcing. Outsourcing. Vendor disputes. Vendor disputes.

Page 18 Operational Risk Checklist Employee training. Employee training. Close management oversight. Close management oversight. Segregation of duties. Segregation of duties. Employee background checks. Employee background checks. Procedures and process. Procedures and process. Purchase of insurance. Purchase of insurance. Exiting certain businesses. Exiting certain businesses. Capitalization of risks. Capitalization of risks.

Page 19 Credit Risk Risk due to an uncertainty in a counterpartys ability to meet its obligations in accordance with agreed upon terms.

Page 20 Credit Risks Include: Loans. Loans. Acceptances. Acceptances. Interbank transactions. Interbank transactions. Trade financing. Trade financing. FX transactions. FX transactions. Futures. Futures. Swaps. Swaps. Equities. Equities. Letters of credit. Letters of credit. Options. Options.

Page 21 Sound Practices for Managing Credit Risk Establish an appropriate credit risk environment. Establish an appropriate credit risk environment. Operate under a sound credit-granting process. Operate under a sound credit-granting process. Maintain an appropriate credit administration, measurement and monitoring process. Maintain an appropriate credit administration, measurement and monitoring process. Ensure adequate controls over credit risk. Ensure adequate controls over credit risk.

Page 22 Establish an Appropriate Credit Risk Environment Board of Directors should review credit risk strategy periodically. Board of Directors should review credit risk strategy periodically. Senior management should implement credit risk strategy approved by the Board. Senior management should implement credit risk strategy approved by the Board.

Page 23 Operate Under a Sound Credit Granting Process Criteria should include thorough understanding of the borrower, purpose/structure of credit and its source of repayment. Criteria should include thorough understanding of the borrower, purpose/structure of credit and its source of repayment. Establish overall credit limits at the level of individual borrowers/connected counterparties. Establish overall credit limits at the level of individual borrowers/connected counterparties. Have a clearly established process for approving new credits/extension of existing credits. Have a clearly established process for approving new credits/extension of existing credits. Extension of credit must be made on an arms length basis. Extension of credit must be made on an arms length basis.

Page 24 Maintain a Credit Administration, Measurement and Monitoring Process Have in place a system for ongoing administration of various risk-bearing portfolios. Have in place a system for ongoing administration of various risk-bearing portfolios. Develop an internal risk rating system for managing credit risk. Develop an internal risk rating system for managing credit risk. Have an information system and analytical techniques that enable management to measure credit risk of on/off balance sheet activities. Have an information system and analytical techniques that enable management to measure credit risk of on/off balance sheet activities.

Page 25 Maintain a Credit Administration, Measurement and Monitoring Process (CONTINUED) System for monitoring overall composition and quality of the credit portfolio. System for monitoring overall composition and quality of the credit portfolio. Consider future changes in economic conditions when assessing individual credits. Consider future changes in economic conditions when assessing individual credits.

Page 26 Ensure Adequate Controls Over Credit Risk System of independent, ongoing credit review. System of independent, ongoing credit review. Credit granting function is properly handled and credit exposures are within limits. Credit granting function is properly handled and credit exposures are within limits. System for managing problem credits. System for managing problem credits.

Page 27 Credit Risk Checklist Credit Risk Checklist Stringent credit standards for borrowers and counterparties. Stringent credit standards for borrowers and counterparties. Strict portfolio risk management. Strict portfolio risk management.risk managementrisk management Constant focus on changes in economic or other circumstances that can lead to a deterioration in the credit standing of a banks counterparties. Constant focus on changes in economic or other circumstances that can lead to a deterioration in the credit standing of a banks counterparties.

Page 28 Reputational Risk Reputational risk is the potential that negative publicity, whether true or not, will result in loss of customers, severing of corporate affiliations, decrease in revenues and increase in costs.

Page 29 Benefits of Effective Reputation Management Improving relations with shareholders. Improving relations with shareholders. Creating a more favorable environment for investment. Creating a more favorable environment for investment. Recruiting/retaining the best employees. Recruiting/retaining the best employees. Reducing barriers to development in new markets. Reducing barriers to development in new markets. Securing premium prices for products. Securing premium prices for products. Minimizing threats of litigation. Minimizing threats of litigation.

Page 30 The key to managing reputational risk is sound risk management, coupled with straightforward communication about the problem the bank is facing. risk managementrisk management

Page 31 Re-establishing a firms reputation takes a long time. reputation takes a long time.

Page 32 Reputational Risk Cases Perrier – Toluene traces. Perrier – Toluene traces. Exxon – Valdez spill. Exxon – Valdez spill. Union Carbide – Bhopal, India. Union Carbide – Bhopal, India. Arthur Andersen – Enron shredding. Arthur Andersen – Enron shredding. Firestone – Tires. Firestone – Tires.

Page 33 Reputational Risk Checklist Processes for crisis management are planned and documented. Processes for crisis management are planned and documented. External perceptions of the bank are regularly measured. External perceptions of the bank are regularly measured. Reputational threats are systematically tracked. Reputational threats are systematically tracked. Employees are trained to identify and manage reputational risks. Employees are trained to identify and manage reputational risks. Standards on environmental, human rights and labor practices are set publically. Standards on environmental, human rights and labor practices are set publically. Relationships and trust with pressure groups and other potential critics are established. Relationships and trust with pressure groups and other potential critics are established.

Page 34 True or False? Corporate reputation is one of the primary assets of my bank. Corporate reputation is one of the primary assets of my bank. The risks involving a banks reputation have increased significantly over the past five years. The risks involving a banks reputation have increased significantly over the past five years. Reputational risk is harder to manage than other forms of risk. Reputational risk is harder to manage than other forms of risk. My bank is proactive in enhancing and protecting its reputation. My bank is proactive in enhancing and protecting its reputation.

Page 35 True or False? It is impossible to quantify the impact of reputational risks. It is impossible to quantify the impact of reputational risks. My bank usually thinks about its reputation only when things go wrong. My bank usually thinks about its reputation only when things go wrong. A well run bank doesnt need to invest extra resources into guarding against reputational risk. A well run bank doesnt need to invest extra resources into guarding against reputational risk.

Page 36 Risk Management Risk managementRisk management is the process of monitoring and addressing the potential for loss. Risk management

Page 37 Evolution of Risk Management Emerged as a discipline during the early 1990s. Emerged as a discipline during the early 1990s. Used long before (1960s). Used long before (1960s). Typically used to describe techniques for addressing insurable risks. Typically used to describe techniques for addressing insurable risks.

Page 38 Old Risk Management Risk reduction through safety, quality control and hazard education. Risk reduction through safety, quality control and hazard education. Alternative risk financing, including self-insurance and captive insurance. Alternative risk financing, including self-insurance and captive insurance. The purchase of traditional insurance products. The purchase of traditional insurance products. Use of derivatives to hedge or customize market risk exposures. Use of derivatives to hedge or customize market risk exposures.

Page 39 New Risk Management Treats derivatives as a problem as much as a solution. Treats derivatives as a problem as much as a solution. Focuses on reporting, oversight and segregation of duties within the organization. Focuses on reporting, oversight and segregation of duties within the organization.

Page 40 By the Mid-1990s Regulatory initiatives. Regulatory initiatives. Concerns about derivatives. Concerns about derivatives. Release of RiskMetrics. Release of RiskMetrics. Published losses. Published losses.

Page 41 Enrons Experience with Risk Management Maintained a risk management function. Maintained a risk management function.risk managementrisk management Lines of reporting were reasonably independent. Lines of reporting were reasonably independent. Mark-to-market valuations were subject to adjustments by management. Mark-to-market valuations were subject to adjustments by management. Few career risk managers. Few career risk managers. Fluid workforce. Fluid workforce. Employees constantly looking for next transfer. Employees constantly looking for next transfer.

Page 42 Regulatory Responses from the Financial Services Community Basel II. Basel II. Sarbanes-Oxley Act of Sarbanes-Oxley Act of Graam-Leach-Bliley Act. Graam-Leach-Bliley Act. Bank Secrecy Act/Anti-Money Laundering. Bank Secrecy Act/Anti-Money Laundering. Insider Trading Rules. Insider Trading Rules. Bank Bribery Act. Bank Bribery Act. Fair and Accurate Credit Transactions Act (FACTA) Fair and Accurate Credit Transactions Act (FACTA) Fair Lending Fair Lending Federal Conflicts of Interest Statutes. Federal Conflicts of Interest Statutes. Various record retention and reporting requirements. Various record retention and reporting requirements.

Page 43 Success Depends Upon A positive corporate culture. A positive corporate culture. Actively observed policies and procedures. Actively observed policies and procedures. Effective use of technology. Effective use of technology. Independence of risk management professionals. Independence of risk management professionals.risk managementrisk management

Page 44 When risk management is done correctly you CAN sleep at night! correctly you CAN sleep at night!

Page 45 Thank you for your interest in The Edcomm Group Bankers Academy. We are the #1 financial services training company in the world for three reasons: We are so committed to our clients that we offer a complete money-back quality guarantee. Our Pledge Our Expertise – We have been proudly serving the global financial community for over 20 years. Our Expertise – We have been proudly serving the global financial community for over 20 years. Our Products – The breadth and depth of our products assures you that we will provide you with a solution that meets your business needs. Our Products – The breadth and depth of our products assures you that we will provide you with a solution that meets your business needs. Our Service – The excellent service we provide demonstrates that we are your partner. Our Service – The excellent service we provide demonstrates that we are your partner. Dr. Linda Eagle Founder & President The Edcomm Group Banker's Academy