Rationalizing
MARKET RISK
MANAGEMENT
Auditing the bank
12
working relations
WHAT'S News Issue 4 April 1996
The Central Banking Sector (CBS) is in the process of implementing a
new, state-of-the-art market risk management concept that addresses J|
the escalating complexity of the risks confronting bankers worldwide.
What's NewS asks the people behind this highest priority
development how it works. Ruud Schalij (left) and Bert Bruggink
The new system - which the CBS
Controller Bert Bruggink describes as a
'number one priority' at the highest levels
of the bank's management - will help the
organization meet new Capital Adequacy
Directives (CAD), scheduled for adoption
this summer, as well as the tougher
requirements of the Basle Convention
which come in force at the start of 1998.
'We are witnessing a sea-change in the
situation that previously prevailed,' says
Bruggink. 'Traditionally, in banking, the
control of market risk never ranked as the
managers' highest priority. Now, of
course, in response to the overall market
climate and the changing regulatory
regime, the attitude is different indeed.'
PINPOINT ACCURACY
The new capital adequacy regime kicks
into force at the middle of this year. This
will bring more active intervention on the
part of bank regulators. Capital set-aside
ratios will come under closer scrutiny.
There will be sanctions if these are not
fully maintained. Thus, it will become
imperative that capital and risk levels be
defined with pinpoint accuracy so that the
level of non-working assets can be
minimized.
STANDARDIZED ANALYSIS
Up until now, different units within the
bank tended to address issues of risk
management on a case-by-case basis. Each
division used its own procedures. 'There
were different principles, different
methodologies, and a tendency overall to
apply these various standards
inconsistently. All of this is now being
rationalized,' says Ruut Schalij, senior vice
president in charge of market risks. Over
the next several years, market risk analysis
will be gradually standardized. A
manageable number of clearly defined
models will apply throughout the
organization: different divisions - hut the
same methodologies for all.
FIRM GRASP
This marks an important step towards
gaining a firm grasp of risk levels
throughout the organization. Another step
has been to transform the market risk
control group, which was originally
created as a coordinating entity last year,
into an upgraded independent unit within
CBS. This will insure that there is a clear
separation between the managers who sell
products and the controllers who
ultimately assess the risks.
BEST METHODS
As the bank rationalizes its risk
management systems, it is simultaneously
Risks - which are an integral part of banking just as they are of everyday life -
tend to come in many ever-changing shapes and sizes.There are credit
risks (related to loan and other credit failures), market risks (related to
fluctuations in market prices), and finally operational risks (which lie in how
risk management procedures are devised and executed).Taken together,
they define the bank's overall risk exposure. But how are these risks to be
measured and controlled?
Systems need to be adapted and
recalibrated continuously. After all, it is
one thing to design a system for risk
management - using complex
methodologies for information gathering,
analysis, and organizational control - but
it is quite another to make sure that this
admirable system works as advertised
under dynamic, real-life circumstances.
Hence, the need for an independent
perspective.
CONTROLLING SYSTEMS
One way of thinking of risk management
is to compare it with the system that heats
up your home. At the heart of this system
lies the heating element. This is connected
to a network of pipes that deliver boiling
water to distributed points. Radiators
emanate the heat. Finally, and crucially,
there is a thermostat. This is where the
desired temperature - (or your risk policy)
- is set. If the market grows too hot, this
data should ideally be fed back through
the system and thus cause the boiler to
slow down. If it's too cold, the reverse
should take place. Your house will stay
comfortable only so long as every element
in this feedback loop is working exactly as
designed - which is why you have heating
engineers check it now and again. This
essential task - the reality check if you will
- falls to the Audit Department.
INDEPENDENT APPROACH
'The audit function is independent from
the Central Banking Sector and reports
directly to the executive board,' explains
