An Over-view of
Risk Management in the Banking Industry- 
The characteristics of present banking system is exposed to diverse
market and non-market risks, which has put risk management in these
sectors to a core functionary within the financial institutions. This
has been essentially done to protect not only the interests of the
stockholders, but more obviously, in protection to the shareholders and
creditors. The growing economy demands a safe and sound banking system,
and as such,
risk management has
become a critical task for the banking
sectors, bringing in stability in the financial markets. A good
supervision of all the factors involved, would lead to
identifying,
assessing, and promoting a secured risk management system.
The banking sector is increasingly faced with tougher challenges in
meeting various risk management requirements, and no matter how tough
it is, the present day operations requires the risk managers to be
vigilant, and unusually diligently perceptive towards the causes of
protecting the interest of the people concerned. In the practical
scenario,
risk management is very
much fragmented, spread across in
pockets, resulting in inconsistency in reporting, inadequate
measurements, and poor quality of management. Poor data
availability is
one of the major causes in inefficient risk management, making it
difficult for the bank to manage and control in an institution-wide
environment.
In order that a consolidated step could be taken towards a better risk
management, there has been much interaction between the public and
private sectors, with an attempt to evolve techniques, mostly pertinent
to the banking sector, which represents the largest and most
internationally active industry in the world. Through these
deliberations,
Basel Committee (BCBS)
in Basel, Switzerland, in 1988,
came out with Basel I framework proposal, which brought together closer
ties between the banks' capital holding, and the risks that are
involved. This brought in higher capital level. The banking sector is
growing rapidly, and with its large and complex operations, Basel I
have become inadequate in continuing with the improvement of the
advanced method of risk management that the banking sectors have today.
A more comprehensive guideline was evolved in Basel II. This regulation
envisaged that, the banking sector should ensure a proper handling of
the capital, separate the operational risk from the credit risk while
quantifying both, and distribute capital vis-a-vis the
economic risk.
We shall discus Basel I and Basel II in a little more detail in the
articles to follow.
The
basic concept of risk management
involves making an assessment of
the risk and then developing a strategy to manage that risk. Risks
ensuing out of physical or legal causes, such as, natural disasters or
fires, accidents, death, and lawsuits, are one of those, which are
traditionally focused. But, in banking sectors, the focus is mainly on
risk factors involved with traded financial instruments. In an ideal
situation, the risks concerned with substantial losses and the high
probability of its occurrence, are handled first, and given the highest
priority in risk management. The lesser probable ones come next. In
doing so, it is quite difficult to maintain the balance between the
combination of different scenarios, viz., risks with a high probability
of occurrence but lower loss vs. a risk with high loss but lower
probability of occurrence.
In meeting the basic characteristics in banking sectors, there is a
need to provide human and financial resources throughout the
organization, enough to meet the purpose of an effective compliance
risk management system. In proving such resources, it is necessary to
delegate proper authority and independence in the working method. There
needs to be a sense of 'ownership' in the compliance function, in order
that the organization can keep itself focused on its compliance risk
management responsibility. A comprehensive database should be in place,
along with monitoring and measuring of the risks involved in any kind
of circumstances, which, in combination, may provide meaningful reports
based on the laws and regulations governing compliance risks,
associated with existing or new products, and new business activities.
The banking sector need to understand operational risk exposure at the
organizational level, where the concerned risk factors are consolidated
into one, making it somewhat easier to have a verification of
operational risk involved. We shall examine in the consequent articles
the problems that banking sector finds most difficult to address, which
are deficient in the current methodology used. There are gaps in
analysis of risk elements
in the current procedures adapted, in
establishing
risk management and risk control.
Contributing
writer
