Analyzing and Managing Banking Risk: A Framework for Assessing Corporate Governance and Financial Risk

442 Pages·2009·5.38 MB·English

by  Hennie Van Greuning

Analyzing Banking Risk
A Framework for Assessing Corporate
Governance and Risk Management
THIRD EDITION
Hennie van Greuning
Sonja Brajovic Bratanovic

Analyzing Banking Risk
A Framework for Assessing
Corporate Governance and
Risk Management

Analyzing Banking Risk
A Framework for Assessing
Corporate Governance and
Risk Management
3rd Edition
Hennie van Greuning
Sonja Brajovic Bratanovic
WASHINGTON, D.C.
9 Th
© 200 e International Bank for Reconstruction
and Development/THE WORLD BANK
1818 H Street, N.W.
Washington, D.C. 20433
All rights reserved
Manufactured in the United States of America
First printing November 1999
Second edition April 2003
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ird edition April 2009
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e fi ndings, interpretations, and conclusions expressed in this book are entirely those of the authors and
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Design services by EEI Communications
ISBN 978-0-8213-7728-4
eISBN 978-0-8213-7898-4
DOI: 10.1596/978-0-8213-7728-4
Library of Congress Cataloging-in-Publication Data has been requested.
Contents
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Foreword to t i rd Edition xiii
Ack nowledgments xv
1 Overview of Banking Risks 1
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1.1 I ntroduction: e Changing Bank Environment 1
1.2 Bank Exposure to Risk 3
1.3 Corporate Governance 4
1.4 Risk-Based Analysis of Banks 7
1.5 Analytical Tools Provided 10
2 A Framework for Risk Analysis 13
2.1 F inancial Management 13
2.2 Why Banks Are Analyzed 16
2.3 Understanding the Environment in Which Banks Operate 17
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2. e Importance of Quality Data 24
2.5 Risk-Based Analysis of Banks 27
2.6 A nalytical Tools 29
2.7 An alytical Techniques 34
3 C orporate Governance 41
3.1 Corporate Governance Principles 41
3.2 Major Developments in Corporate Governance Principles 44
3.3 Regulatory Authorities: Establishing a Risk-Based Framework 46
3.4 Supervisory Authorities: Monitoring Risk Management 48
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3. e Shareholders: Appointing the Right Policy Makers 51
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3. e Board of Directors: Ultimate Responsibility for a Bank’s Aff airs 53
3.7 Management: Responsibility for Bank Operations and the
Implementation of Risk Management Policies 59
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3. e Audit Committee and Internal Auditors:
An Extension of the Board’s Risk Management Function 64
vi Analyzing Banking Risk
3.9 External Auditors: A Reassessment of the Traditional Approach of
Auditing Banks 66
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3.10 e Role of the General Public 67
Annex 3A: National Initiatives to Improve Corporate Governance 71
4 Balance Sheet Structure 81
4.1 Introduction: Composition of the Balance Sheet 81
4.2 Ba nk Assets 84
4.3 Ba nk Liabilities 88
4.4 Equity and Other Items 92
4.5 Growth and Changes in the Balance Sheet 94
4.6 Risk Analysis of the Balance Sheet Structure and Growth 96
5 Income Statement Structure 101
5.1 P rofi tability 101
5.2 Income Statement Composition 103
5.3 Analyzing the Sources of Banking Income 107
5.4 Analyzing Quality of Earnings 109
5.5 Analysis of Profi tability Indicators and Ratios 113
5.6 Assessing Internal Performance 118
6 C apital Adequacy 121
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6.1 I ntroduction: e Characteristics and Functions of Capital 122
6.2 Capital Adequacy Standards and the Basel Accords 123
6.3 Constituents of Capital and Minimum Capital Requirements 127
6.4 Risk-Based Regulatory Capital Allocation: Pillar 1 131
6.5 Supervisory Review: Pillar 2 143
6.6 Market Discipline: Pillar 3 145
6.7 Management of Capital Adequacy 146
6.8 Analysis of a Bank’s Capital Adequacy 147
Annex 6A: Credit Risk–Related Weight Assignments Under
the Basel I Accord, Covered by Tier 1 and Tier 2 Capital 153
Annex 6b: Calculation of the Capital Adequacy Ratio to
Include Market Risk (Tier 3 Capital) 156
7 Credit Risk Management 161
7.1 Establishing Policies for Managing Credit Risk 161
7.2 Regulatory Policies to Limit Exposures 162
7.3 Management Policies to Reduce Credit Risk 166
7.4 Analyzing Credit Risk 171
7.5 A sset Classifi cation and Loan Loss Provisioning 177
7.6 Assessing Credit Risk Management Capacity 187
Content vii
8 Liquidity Risk Management 191
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8. e Need for Liquidity 191
8.2 Liquidity Management Policies 195
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8. e Regulatory Environment 198
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8. e Structure of Funding 201
8.5 Cash Flow Analysis 203
8.6 Volatility of Funding and Concentration of Deposits 207
8.7 Liquidity Risk Management Techniques 209
9 Managing Liquidity and Other Investment Portfolios 215
9.1 Nature of the Liquidity Portfolio 215
9.2 I nvestment Policy 216
9.3 Strategic Asset Allocation 217
9.4 B enchmark Portfolio 219
9.5 E ligible Instruments 221
9.6 C redit Risk 222
9.7 M arket Risk 223
9.8 A ctive Management 223
9.9 R isk Budgets 225
9.10 M anagement Reporting 226
10 Market Risk Management 227
10.1 Sources of Market Risk: Selected Concepts 227
10.2 Measuring Interest Rate Sensitivity 231
10.3 Portfolio Risk Management 235
10.4 Market Risk Measurement: Value at Risk (VAR) as a Possible Tool 238
10.5 Risk and Performance Measurement 246
10.6 Stress Testing and Scenario Analysis 251
11 Currency Risk Management 255
11.1 Introduction: Origin and Components of Currency Risk 255
11.2 Policies for Currency Risk Management 257
11.3 Currency Risk Exposure and Business Strategy 264
11.4 Review of Currency Risk Management Procedures 268
12 A sset-Liability Management 277
12.1 Objective of Asset-Liability Management 277
12.2 Interest Rate Risk Management Responsibilities 280
12.3 Models for the Management of Interest Rate Risk in the
Balance Sheet 282
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12.4 e Impact of Changes in Forecast Yield Curves 290
viii Analyzing Banking Risk
13 Operational Risk Management in a Treasury Environment 293
13.1 Operational Risk Management and the Basel Committee Initiatives 294
13.2 A Framework for Managing and Reporting Operational Risk 300
13.3 Identifi cation of Business Line Functions and Activities 306
13.4 Process Flows: Documenting the Manner in Which Functions
Are Performed 308
13.5 Risk Assessment: Contribution of People, Processes, Systems, and
External Events 309
13.6 C ontrol Assessment 312
13.7 Key Indicators of Performance and Risk 315
13.8 Operational Risk Reporting: Analysis, Actions, and Accountability 320
Annex 13A. Overview of Functions and Activities in a
Treasury Environment 325
14 Transparency and Data Quality 339
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14.1 I ntroduction: e Importance of Useful Information 339
14.2 Transparency and Accountability 341
14.3 Transparency in Financial Statements 343
14.4 Disclosure in the Financial Statements of Banks 347
14.5 Application of Accounting Standards 352
15 A Risk-Based Approach to Bank Supervision 357
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15.1 I ntroduction: e Bank Supervisory Process 357
15.2 Banking Risks and the Accountability of Regulatory/Supervisory
Authorities 361
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15.3 e Supervisory Process 364
15.4 C onsolidated Supervision 373
15.5 Supervisory Cooperation with Internal and External Auditors 377
Ap pendixes
A Questionnaire: Analytical Review of Banks 379
B Summary of Core Principles Evaluation 413
C Basel Core Principles for Eff ective Banking Supervision October 2006 417