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Summary Risk Management in Banking | Minor Risk Management VU (Deloitte)
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WEEK 1: THE WORKING OF BANKS AND THE DIFFERENT BUSINESS MODELSBanks
Loans (people or company with a shortage in money)
Savings and Investments (people or company with too much money)
Transformation of money
- Too much money
o Allocate it
o Bonds
o Real Estate
o Loans
- Short in money
o Collect money (saving accounts)
o Loans
Interest rates
- Profit or losses
Transform a lot of small accounts to one big account, so banks can give loans of a big
amount.
Investment bank (Capital Markets orientated)
- Support other banks or institutions with issues/ investments (raising capital)
- Mergers and acquisitions
- Goldman
Commercial bank (retail funded or wholesale funded)
- Services: savings, loans, mortgages, debit and credit cards
- Directly with customers, rather than corporations
- ABN-AMRO, ING
Simplified balance: Banks finance customer loans fully
from own equity.
There is not risk for clients
- Equity will decline
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Lectures Risk Management in Banking
, - In the future it will increase (interest)
Simplified balance: Banks mainly fund loans and advances
to customers with equity. The bank starts attracting debt,
which starts customer risk.
- More people can lose their money
- Risk is spread
Simplified balance: Equity is only a small portion of the
liabilities. Customer deposits run serious risk
- If customers can’t pay back their loans
- Riskier than the last example
- This is how banks work (risky)
On and off-balance sheet products
- Liquidity portfolio: Liquidity position
- Equity (own funds)
- Deposit (withdraw)
- Credit cards (different arrangements per bank)
- Credit lines 1% is 100 basis points and 0.01% is 1 basis point
- Derivatives
o Interest rate swaps (macroeconomic variable, manage balance sheets)
(mitigate risks)
o Mitigating risk
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Lectures Risk Management in Banking
, WEEK 2: CREDIT RISK, MARKET RISK AND OPERATIONAL RISK
Risk management & organization
- Every bank has a function in the economy and the financial markets
- Protection of all clients against dependency on banks
- Diversification is a key
Objective risk management
- Maintaining solidity (strong capital position)
- Ensure sufficient liquidity
- Duty of care for clients (behavioural and advice)
- Achieving efficiency (sound business)
Three risky ways banks get in a difficult position
- Systemic risk: markets go down (the whole bank sector) (market stress)
- Bank run: people withdraw their money
- Customers are not able to pay back their loans
Risk management & capital – liquidity
Capital: buffer for losses, losses can occur by different types of risks
Liquidity Risk: bank run, market stress (most severe consequences (within a year))
Credit Risk
- If a customer is not able to pay back their loans or interest. Credit risk refers to the
potential that a banks’ borrower or counterparty will fail to meet its obligations in
accordance with agreed terms (BIS).
- Days past due, for instance the 90 days suggested by EBA, can be used as an indicator
for default.
- Important risk mitigating factor: collateral (guarantee in case of default),
improvement credit quality (rating)
- Differences in credit risk (governments, mortgages, businesses, real estate)
o Clients: income, past behavior, age (rating a client type), social media
Is it ethical to rate clients on such a way/ distinguish a client?
- The riskier the loan the higher the risk weighted assets (RWA)
Calculating credit risk
- Exposure at Default (EAD): the expected exposure to a particular obligor at the time
of default.
o Outstanding amount at the time of default
o Note: amount may be more by drawing rights
- Probability of Default (PD): Probability that a borrower will pay back in a certain time.
o Probability of default within 1 year
o Designated as default by special credits department
o 90 days overdue with interest payments
- Loss Given Default (LGD): the percentage of loss over the total exposure when bank's
counterparty falls into default.
o Loss at the time of default, taking into account the enforcement of collateral
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Lectures Risk Management in Banking
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