An Overview of Risk Management System in the Banking
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 stakeholders, 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-à-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 comes 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 through-out the organisation, 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 organisation 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 organisational 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.