Bank risk management policy

 

BANK RISK
MANAGEMENT POLICY

 

Economic significance of the risk consists in ability to manage it. Significance of the risk management as a kind of activity consist in possibility first of all to forecast within (certain) limits approach of the risk event, and, secondly, to take beforehand measures to reduce size of possible ill effects. The risk essence expressed in ability quantitatively evaluate possibility of undesired event approach determine necessity to develop means and mechanisms of ill effect mitigation. Knowledge of potential threats and their consequences allows managing risk.

 

GENERAL DEFINITIONS

 

 

Credit risk arises from potential that a borrower will fail to perform on an obligation, which, as a rule, is expressed in non-return (fully or partially) of the debt principal and interests within the terms stipulated by the agreement.
Interest rate risk means risk of reduction of net interest income; it is connected with possible losses from discrepancy between assets and liabilities amounts, sensitive to the change of interest rates.
Capital risk is connected with the Bank’s ability to cover potential losses at non-return of risky assets at the expense of its own capital without recourse to the clients’ attracted means.
Currency risk is connected with the Bank’s possible losses in case of significant changes in national currency exchange rate. Indicators of the currency risk characterize the Bank’s possibility to react upon changes in Moldova’s currency market situation.
Liquidity risk characterizes the Bank’s stability. Assets and liabilities conformity by terms make it possible for the Bank to meet its obligations in time.
Operational risk is connected with possible losses of assets or image of the Bank caused by intentional or accidental actions of its employees or third persons.

 

Risk Management Bodies
Risk management is executed by policies development, strategic and tactical decision-making by the Bank’s Council, its Credit Commission, Assets and Liabilities Committee (ALCO), Investment Committee (INCO) and Credit Committee of the Bank.
Credit Section of the Sales Department and Client Relations Sections/Services of the Bank’s branches are liable for realization of credit risk management.
Finance and Liquidity Section and Securities Section of the Support Department are liable for realization of the capital, currency and interest rate risk management policy.
Department of Accounting Organization and Control, Computer Technologies Section, Security Section and HR Section are responsible for realization of the operational risk management policy.
Support Department (Computer Technologies Section) provides support of information system for collection and analysis of information regarding risk management. Department of Accounting Organization and Control and Clients Relations Coordination Service of the Sales Department coordinate collection of information by all the Bank’s units and provision by them of accurate and timely data, necessary for the efficient risk management.

Risk Management.

 

1.Credit Risk Management

Commercial banks participating in lending process are subject to internal and external trials. Therefore even the best credit policy can not ensure lack of credit losses. The Bank must not issue wittingly bad credits, however it is known that part of them might became the same in future. The Bank’s reputation may be seriously undermined by the increasing of bad loans share, which in its turn may seriously affect the Bank’s position at the market of credit resources.

For mitigation of risks peculiar to credit activity, the Bank developed and introduced the Credit Risk Management System (Fig.1). Principles of system construction and methods of its functioning are listed in Credit Policy, approved by the Bank’s Council, and in the Guide Rules of Credit Relations Establishing.

The Bank aims at constant observance of the norms of the National Bank of Moldova, which limit credit risk (maximal debt to group of persons, who act in common, affiliated persons and the Bank’s staff, ratio between the sum of 10 largest debts and credit portfolio, etc.)

Besides the present Policy determine maximum allowable ratios of following indicators:

• Ratio of the Risk fund to the credit portfolio – 5%.
• Ratio of the past-due credits to the credit portfolio - 5%.
• Ratio of the doubtful and bad loans to the credit portfolio - 2%; to the Risk fund - 15%.

Main credit risk indicators characterize adequacy of the formed Risk fund for coverage of possible losses from the non-returned loans.

Planning of the Bank’s credit risk indicators and establishing of the risk norms is made by absolute values without taking into consideration existing collaterals and guarantees.

2. Capital Risk Management

Annual plans of the bank’s activity determine absolute and relative indicators of capital risk norms:
1. Risk assets, total, including:

• Securities
• Credit indebtedness
• Interest receivable.

2. Aggregated Normative Capital (exclusive of net fixed assets).
3. Ratio of the aggregated normative capital, exclusive of risk weighted assets, to risk assets.
4. Indicator of capital adequacy with risk weighted assets.
5. Investment limits:

• Ratio of the investment volume to the aggregated normative capital.
• Ratio of the investments to the long-term tangible assets to the aggregated normative capital.

3. Interest Rate Risk Management.

Interest Rate Risk Management consists in stabilization and following systematic increase of the bank’s net interest margin.

Management of such kind of risk is controlled by a certain number of methods, among which the gap management is the main one. The Bank’s net interest income and its net interest margin serve the key indicators for evaluation of such type of risk impact.

The Bank may manage interest rate risk by changing terms of placement and attraction of its assets and liabilities, profitability level on assets sensible to the interest rate changes, and diapason of interest rates changeability.

The Bank must minimize the gap not only in terms, but also in amounts of the attracted liabilities and financed asset.

In case when floating interest rates are established both on assets and liabilities the Bank shall stick to the following tactics:
- asset amount may be larger that the amount of the attracted liability when interest rate growth is expected;
- attracted liability amount may be larger than the amount of the financing asset when landslide of interest rates is expected.

Strategy of this risk management should be carried out under the direction of the Credit Committee and ALCO, which not only select strategy for struggle with the interest rate risk, bot also make short- and long term plans, develop protection measures against non-liquidity risk and organize control over quality of issued credits.

4. Currency risk management

The Bank distinguish two main components of the currency risk: open currency position risk and conversion risk.
Open currency position risk is determined by a status of the Bank’s open currency position i.е. difference between the cost of assets and liabilities in a certain currency taking into account offbalance positions. Revaluation of positions in foreign currency shall be done using the current MDL exchange rate course to foreign currencies established by the NBM. Open currency positions shall be expressed as interest ration between volume of the current interest rate position (recalculated in MDL) and volume of the aggregated normative capital.
Closed position – total value of balance and off-balance liabilities in certain currency is equal to the total value of balance and off-balance demands.

Aggregated currency position – total value of all long and short positions with signs, expressed in MDL.

The Bank’s open currency position evolves as part of its activity in servicing clients and from making arbitrary deals.

Currency conversion risk is connected with limits in making exchange operations. This risk is determined mainly by country risk as soon as such limits, as a rule, are stipulated by the Central banks’ regulations.

Establishing of currency position limits serves as main open currency position risk management. The Bank observes limits of open currency position, established by the NBM at the end of a working day. Based on the limits established by the NBM, and on forecasts of certain currencies movement, Finance and Liquidity Section calculates limits of open currency position for the Bank’s branches. Every exceeding of the established limits shall be closed by the currency buy/sell deals between the branches and Liquidity and finance Section at the course, established by the Currency dealer.

 

5.Liquidity risk management

 

While analyzing risk of liquidity loss, evaluation of correspondence of actual values of current and long-term liquidity norms to the National Bank of Moldova’s requirements shall be made. Changes in actual values of the liquidity level with reference to norms for the last 3 months shall be made. Bank’s demands and/or obligations, which affected changes of actual values of the liquidity norms, shall be discovered.

Every year the following norms of liquidity shall be established:

• Instantaneous liquidity: ratio between volume of high liquidity assets (demand) and volume of demand liabilities (%)
• Current liquidity: ration between volume of demand assets and assets with 30 days maturity, and volume of demand liabilities and liabilities with 30 days maturity (%)
• Long-term liquidity: ratio between long-term assets (with 2 and more years of maturity) and the Bank’s financial resources (%).

While analyzing liquidity risk specific attention shall be paid to credit risk and deposit concentration or concentration of the loans received by the Bank. The Bank shall also determine the risk caused by such concentration.
When analyzing risk of liquidity loss the level of dependence from different bank creditors (interbank market, National Bank of Moldova, clients – legal agents, clients – natural persons) shall be taken into account as well as their level of sensibility to situation at money-market. Changes in structure of the attracted funds in total volume of the Bank’s liabilities in comparison with preceding reporting periods (last 3 reporting dates) shall be analyzed.
Structure of the Bank’s assets and liabilities, as well as their correspondence by terms ensure meeting by the Bank of its liabilities and guarantee necessary level of income to its investors.

The Bank maintains the following structure of its balance sheet:

Assets	Liabilities
Cash and Treasury Bills 25-30%	Deposits and Loans 75-80%
Loans (net) 65-70%	Bank Capital 18-20%
Fixed Assets and Investments 8-10%

This structure allows to preserve 50.0% of the Bank capital in form of liquid funds and to form a risky part of assets – loan portfolio – on the account of attracted funds with the observance of the requirements to reserve their corresponding part on the NBM’s accounts.
Risks of gaps between attraction and placement terms are solved by standard methods of financial institutions:

• Short-term reduction of liquidity which does not increase level of expenses;
• Interbank loans – the cost is by 1-2% higher than nominal, however it has minimal overhead expenses;
• SWAP and REPO deals at open market – sale of the part of assets with their following redemption – the cost is similar to the interbank loans.

In case of liquidity crisis the Bank shall follow the “Liquidity Crisis Emergency Plan”, developed by Asset and Liability Committee (ALCO).

6. Operational risk management

In order to evaluate probability of operational risk generation the Bank applies the system of qualitative (audit reports, internal audit reports, auditing commission report) and qualitative indicators (information about volumes, turnover and losses, risk level of activity expressed through income stability).

Operational risk management is based upon creation of the correct organization structure and internal procedures based on expert’s knowledge.

Another method of operational risk management consists in conclusion of agreements and, in particular, agreements of complex insurance with the insurance companies and insurance brokers.

In practice it is advisable to combine indicated methods of operational risk management.

Table: Methods of operational risk control

Control Instruments	Advantage of usage
Internal control and internal audit	Independent evaluation
System of limits for operational risk	Limitation of possible losses
Reporting system for revelation of potential problems	Creation of incentives to operational risk management
Insurance and reinsurance	Shifting risks to insurers
Creation of reserves (similar to traditional reserve funds)	Possibility of potential losses compensation

As soon as there are extremely many variations of possible manifestations of operational risks, the real possibility to control them consists in splitting of each banking process into elementary operations, composition of documents circulation work card, identification and assessment of possible risk categories in each operation.

Internal control should be the major instrument of operational risk management. Its assignment consists in being a preventive tool and not to state facts of past events.