Here is an essay on ‘Integrated Risk Management in Banks’ for class 11 and 12. Find paragraphs, long and short essays on ‘Integrated Risk Management in Banks’ especially written for school and banking students.
Integrated Risk Management in Banks
- Essay on the Meaning of Integrated Risk Management in Banks
- Essay on the Necessity of Integrated Risk Management in Banks
- Essay on the Challenges of Integrated Risk Management in Banks
- Essay on the Framework of Integrated Risk Management in Banks
Essay # 1. Meaning of Integrated Risk Management in Banks:
Integrated risk management is managing all risks that are associated with all the activities undertaken across the entire organisation. In the context of banking industry or a banking organisation, risks that are associated with it are liquidity risk, interest rate risk, market risk, credit risk and operational risks in their various forms. The common factor in all these risks lies in their possible downside impact on the revenues of an organisation. The sum total of all risk-impacts is a critical factor for all organisations.
We know that profit/loss of an organisation is the sum total of all profits and losses that are generated through various activities. Similarly, total risks of an organisation are also the net effect of all risks that are associated with the activities undertaken throughout the organisation. But, net effect of all risks may not be the same as sum total of all risks as it is in case of profit/loss.
This is because of diversification effect of risks – diversification effect for similar risks and interplay and correlation between various types of risk. Therefore, when we talk of integration of risk, it does not simply imply an accounting approach to it, rather it implies a coordinated approach across various risks and various diversification opportunities that exists and that may be created in an organisation.
Inter-firm comparison between firms on the basis of profits or profitability ratios per se does not provide clear picture unless the risk levels are also taken into account. Risk related capital i.e., capital that is commensurate with the risks that the organisation carries is also a factor that needs to be taken into account. This is because risks add to the instability.
Higher the risks, more is the instability and more is the capital required to meet the losses in expected worst-case scenarios. Risk adjusted return on capital is critical and integrated risk management assumes an important role here. It is not only strategising for surplus, it is also strategising for aggregate risk levels so that desired surplus can be achieved on an optimum capital for better efficiency in capital utilisation.
Essay # 2. Necessity of Integrated Risk Management in Banks:
Risk Management is a basic necessity for financial institutions of all sizes, and ultimately central to their success and survival. It integrates an organisation’s internal and external business processes by applying standard risk terminology, metrics and reporting to facilitate optimal risk/return decisions.
An integrated approach to risk management centralizes the process of supervising risk exposure so that the organization can determine how best to absorb, limit or transfer risk it is an ongoing business process that calls for standard definitions and methods to identify measure and manage risk across all business units. This information can then be analyzed to determine the overall nature of organizational risk exposures, including their correlation, dependencies and offsets.
Integrated Risk Management can go beyond reducing risks and actually help find ways to capitalize on the upside potential of risk. To do that, however, organisations must thoroughly understand the processes of risk in order to make informed decisions about retaining, financing or transferring risks. These decisions require a standardized, integrated approach and integrated reporting so that the organization always has a consistent and timely view of its exposures.
When properly implemented, Integrated Risk Management:
i. Aligns the strategic aspects of risk with day-to-day operational activities.
ii. Facilitates greater transparency for investors and regulators.
iii. Enhances revenue and earnings growth.
iv. Controls downside risk potential.
Essay # 3. Challenges of Integrated Risk Management in Banks:
a. Real-Time Concern:
In order to control risk, one must first measure it. Measurement is critical to validating management process and improving internal discipline. As more and more business processes come under mechanization, identification and response to risks become faster.
In view of the potential impact and service requirements, risk management has become a real-time concern. Without an enterprise- wide approach that includes standard data definitions and integrated reporting, institutions cannot develop consistent and timely view of risk exposures necessary for management decision-making.
To comply with wide ranging regulatory demands, financial institutions must understand, control and report risk across the enterprise. Management is responsible for identifying and managing risks. At some point, rating agencies will likely establish a risk management rating for companies in addition to existing financial ratings.
b. Business Challenge:
Regulatory requirements will be an influence, but business challenges will provide the primary impetus for risk management, because effective risk management is good business management.
Some of these business challenges include:
i. Evolution of the real-time business environment.
ii. The developing global marketplace.
iii. Concern about business continuity and operational reliability.
iv. Continuous and accelerating technological change.
v. The need to limit earnings’ volatility and enhances shareholder value.
c. Cultural Issues:
Most financial institutions are saddled with cultural limitations and business unit’s boundaries that make it difficult to identify and collect risk data so they are a long way away from having an integrated approach to risk management. Stand-alone legacy systems with application centre data make workflow connectivity and information sharing nearly impossible. Consequently, it is not possible to collect complete accurate and timely overall picture.
For example, most banks monitor loss events but many do not actually convert the information into a loss database. Data is not captured on a continuous or consistent basis or with sufficient granularity and as such events are not linked across the organisation.
Many of the components of integrated risk management programme already exist within most organisations. In fact components are frequently replicated within many different business units. Multiple silos track the same type of exposures but do not share information. An enterprise view looks at the components holistically. In addition, information leading to operational risks is not fully understood and consequently never recorded or reported after management lines.
d. Practical Benefits:
Financial institution needs an integrated risk framework to relate capital reserves more effectively to their actual level of risk exposure. By aggregating and analyzing by type and across lines of business, they will be able to quantify the amount of capital required to absorb unexpected losses.
Integrated Risk Management also contributes to better business performance for companies in all industries. Net income and return on investment or equity are commonly used to compare business performances, but they do not consider the level of risk taken to achieve those results. However, a risk-adjusted rate of capital (RAROC) can be determined by dividing a unit’s net income by its economic capital, producing a profitability measure that is common across business units.
A risk-adjusted return that is more than the cost of the related economic capital employed adds value to the organisation and its shareholders. The RAROC approach can also be extended to evaluate pricing decisions and product profitability, and to differentiate between relationships that make money for an institutions and those which do not.
Against a policy that establishes the level and types of risks an organisation is willing to absorb and the content of risk portfolios, RAROC is also an important factor in making risk transfer decisions. The benefit of potential risk transfer strategies can be determined by comparing the potential decrease in economic capital and risk of loss against the cost of insuring and hedging the position.
Essay # 4. Framework of Integrated Risk Management in Banks:
Process of Integrated Risk Management:
The process of Integrated Risk Management consists of:
Integration of risk management as a key corporate strategy.
Establishment of the Chief Risk Officer position with his/her accountability to the board of directors.
The process of identifying, assessing, controlling and financing risk must be common across the whole enterprise.
Risk management systems must be developed to provide information and analytical tools to support the Enterprise Risk Management functions.
System of Integrated Risk Management:
a. Organisation Structure:
The board of directors through the Risk Management Committee is the apex body responsible for the entire risks of the Bank. Risks are not seen in silos and are managed at the apex level in an integrated manner.
b. Policies and Procedures:
Risk management and related policies and procedures must be developed using a top down approach to ensure that they are consistent with one another and appropriately reflect the strategic objectives and the overall risk appetite of the bank.
c. Integrated Risk Limits:
A ‘Best Practices’ limit structure would communicate risk appetite throughout the organisation, assist in maintenance of overall exposures at acceptable levels and enable delegation of authority. It would also involve adoption of a common language of risk across all risk categories through risk quantification methodologies across all risk categories.
d. Integrated Risk Reporting:
In an integrated risk management framework, the top management should have a holistic view of all risks. For example, credit risk reports like outstanding counterparty limits should include all outstanding limits across treasury and credit departments. Bank wide risk reports are used to quantify sources of risk across the bank and to estimate total exposure to financial markets.
e. Integrated Systems:
An integrated risk management framework needs to be supported by an information technology architecture that is consistent with such integration.
The impetus of integrated risk management is Basel II. Capital requirement could reduce significantly if a bank takes advantage of the more sophisticated internal measurement options offered under the New Accord. To qualify for lower capital charges, banks must show they have appropriate processes and methods in place, supported by sufficient historical data. This will require them to demonstrate compliance with a number of expected standards relating to identifying, measuring and controlling risk. This requires that risk practices be integrated across the organization.