RISK MANAGEMENT IN INTERNATIONAL BANKING :
While risks are integral part of our lives, and are applicable to domestic trade and investment arena also, as far as international banking activities are concerned, these banks are exposed to additional risks on account of various factors. The important factors are:
– Cross Border Risk: The cross border risks arise on account of trade and investment activities between two or more countries. This is one of the major risks the international banks face. This type of risk is also called as country risk
– Currency Risk: When an international trade and/or financial transaction take place, it would result in a currency deal. In view of the additional deal (involvement of foreign currency) a new risk arises called currency risk. Two or more than two currencies (in case of cross rates) are involved, and due to the market fluctuations the exchange rate (price) of the currencies results in a risk called “foreign exchange rate risk” as well
In addition to the above, the other risks associated with international banking are given below:
Credit Risk: In today’s complicated international financial markets, the credit risk arises on account of nonperformance of obligations by counterparty in respect of On balance sheet items as well as off-balance sheet contracts such as forward contracts, interest rate swaps and currency swaps and counterparty risk in the interbank market. These have necessitated prescribing maximum exposure limits for individual counterparties for fund and non-fund exposures.
Mitigation of Credit Risk: To manage various risks, banks have formulated Risk Management policies duly approved by their board. Some of the risk mitigation practices are mentioned below:
– Banks have setup experienced credit management team to ensure better credit appraisal
– To restrict exposures, credit limits are setup both for at individual and group wise levels
– Investments are subject to bank’s Investment Policy guidelines. Bank’s investment policy is formulated as per the Regulator’s directives
– In view of the uncertainties associated with the non performance in case of off balance sheet items like letters of credit, guarantees, derivative products like forward exchange contracts, futures, interest rate swaps, options, etc., a full credit appraisal needs to be carried out before limits for non funded credit lines are granted to the clients
– Adequate financial and/or physical assets should be obtained as collateral security. On an ongoing basis valuation of such collateral security should be carried out based on the market prices (this procedure is called as market to market practice) to assess the present value
– Exposure limits should be put in place covering counter party, industry, country, and business group, currency for on and off balance sheet items.
Operational Risks:
Operational risks can arise due to
– Non-compliance with laid-down procedures and authorizations for dealing, settlement and custody;
– Fraudulent practices involving deals and settlements;
– Legal risks due to inadequate definitions and coverage of covenants and responsibilities of the bank and counter party in contracts and agreements.
– Information Technology, which drives the markets, should be given importance in managing the risks, especially the operational risks. The quality of software, hardware and the up gradation of IT support system are very crucial for ensuring quick and correct transfer of financial transactions and funds across the international markets. Hence importance needs to be given to handle this particular segment to ensure better control is exercised in disaster control management with an effective and tested backup system.
– Human Resource Management needs to be given proper attention to reduce the impact of operational risks through human errors and systems failure. Good and effective training would help the banks to have better results and lesser operational risks.
– Non compliance of legal and/or regulatory frame work, due to inadequate definitions and coverage of covenants and responsibilities of the bank and counterparty in contracts (especially in case of international loan agreements, derivative agreements, etc.).
– Frauds, insufficient internal control systems: Operational risks can be reduced if banks have a clear cut and effective internal control and audit systems. Banks Treasury functions should be demarcated clearly into (i) Front Office (ii) Mid Office (iii) Back Office, to have better control system. The internal control system should be effective in the sense quite a few activities should be subject to online (concurrent) audit, and risk evaluation should be an integral part of an effective internal control system.
– Money laundering: International banks main concern is to manage the money laundering activities. In view of the fast changing and increasing usage of technology, funds can be transferred from one end to the other part of the world quickly. Unless banks are geared up with a better control system to manage the money laundering it would create lot of operational risks for banks. To ensure better control system, banks should ensure that clear KYC policies are strictly followed at all levels, especially at the entry level of a financial transaction.
Adherence to systems and procedures:
Traders, dealers and other bank employees should strictly follow the guidelines, and ensure
(i) The limits (single borrower limit, group wise limit, counter party limit, country limits, overnight and day light limit, stop loss limit, gap limit etc.) are respected and they operate within the limits.
(ii) All activities, operations are as per approved policies, systems and procedures and with proper approvals, authorizations.
(iii) A proper reporting system should be in place for better management review and control and risk identification. To this end the Management Information System should not only be accurate, but also user friendly.
(iv) There should be proper co-ordination between different divisions of the banks for a better result.
(v) A fair Performance Appraisal System is one of the key factors and this aspect needs to be given proper weights.
(vi) Big ticket deals, transactions and legal documentation should be properly designed and vetted to protect the banks, especially in one-off transactions and structured deals.
(vii) International banking is part of the international markets, which operate on 24 x 7 Basis, in different time zones covering various international centers. Hence banks should give importance to market volatility due to different reasons like PESTEL factors, technical and fundamental factors, and an ongoing review is very important in managing various risks by taking proper and pro active actions.
(viii) With Basel III norms around the corner, banks in international markets need to put in place an effective and efficient risk management system, to identify various types of risks and manage them.