ANALYSIS OF RISK MANAGEMENT STRATEGIES IN COMMERCIAL BANKS BY - ADV. LIDIA MERIN P JOSE, NAFIA FARZANA T A & RESHMA RAMESH
ANALYSIS
OF RISK MANAGEMENT STRATEGIES IN COMMERCIAL BANKS
AUTHORED
BY - ADV. LIDIA MERIN P
JOSE
Practicing Advocate at Cherthala
Munsiff & Magistrate Court, Kerala, India
CO-AUTHOR
- NAFIA FARZANA T A
CO-AUTHOR 2 - RESHMA RAMESH
Institution: 4th Semester LL.M
(Criminal Law) Student at Bharata Mata School of Legal Studies, Choondi, Aluva,
Kerala, India
ABSTRACT
Understanding risk management,
risk assessment & analysis, risk identification, risk monitoring, and
credit risk analysis in commercial banks are some of the elements that this
study looks at that may have an impact on risk management procedures. The dependability
criteria were met by the acquired data, leading to the adoption of regression
and correlation analysis. According to the findings, risk management practices
(RMP) are positively and significantly impacted by an understanding of risk and
risk management (URM), risk assessment and analysis (RAA), risk identification
(RI), risk monitoring (RM), and credit risk analysis (CRA). This implies that
URM, RAA, RI, RM, and RA are important considerations for commercial banks.
Commercial banks should concentrate on RM and RAA since they are significant
factors that affect RMP.
INTRODUCTION
Risk
can create issues that prevent some goals from being successfully accomplished.
Any internal or external component, depending on the type of risk involved in a
given situation, might have an impact on risk. Risk exposure can have
detrimental effects. In situations like this, the best method to manage risk is
to take proactive steps to identify any potential risks that could have
unintended consequences. Managing risks is undoubtedly simpler than dealing
with unintended outcomes. The banking industry is frequently associated with
risk because of its significant reliance on chance. Because of their commercial
orientation and significant exposure to substantial quantities of capital,
banks have a strong correlation with risk. One of the most important practices
that is adopted, especially in banks, is risk management (RM). Banks have used
risk management as a way to control risks. All banks are subject to many types
of risk in the current dynamic environment, including market, interest rate,
liquidity, credit, and foreign exchange risks.
BANK EXPOSURE TO RISK
Three
broad areas can be used to classify banking risks: financial, operational, and
environmental. Two categories of risk are included in financial risks. If
traditional banking risks are not adequately handled, they can cause a bank to
lose money. These risks include credit, solvency, and the structure of the
balance sheet and income statement. Financial arbitrage-based treasury risks
can yield profits in the event that the arbitrage is accurate or losses in the
event that it is not. Treasury risk can be divided into four basic categories:
currency, interest rate, market (including counterparty) risk, and liquidity. Complex
interdependencies pertaining to financial hazards can also greatly raise a
bank's total risk profile. A bank that
deals in foreign exchange, for instance, is typically exposed to currency risk.
However, if the bank has open positions or imbalances in its forward book, it
will also be exposed to additional liquidity and interest rate risk.
Operational risks are associated with the general business processes of a bank
and the possible effects of information security, internal systems and
technology, measures against fraud and mismanagement, and business continuity
issues on compliance with bank policies and procedures. Operational risk also
includes the bank's internal resources and personnel career management,
governance and organisational structure, product and knowledge development, and
customer acquisition strategy. Credit
risk management significantly affected the profitable of the commercial banks
in Nigeria[1].
The business environment of a bank includes legal and regulatory issues,
macroeconomic and policy worries, the infrastructure of the financial industry
as a whole, and the payment systems of the countries in which it conducts
business. All of these elements are linked to environmental risks. All
exogenous hazards that could endanger a bank's operations or make it more
difficult for it to remain in business are considered environmental risks.
CORPORATE
GOVERNANCE
As
was previously mentioned, banks are exposed to new risks and challenges as a
result of financial market instability, greater competition, and
diversification. As a result, in order for banks to be competitive, they must
constantly innovate new ways to manage business risks. The growing market
orientation of banks has also made adjustments to the ways that regulation and
supervision are implemented necessary. One nation at a time, the role of
maintaining the banking system and markets is being recast as a collaboration
between several important stakeholders who oversee diverse aspects of
operational and financial risk. This strategy reaffirms that the primary issues
in guaranteeing the security and stability of individual banks as well as the
banking system at large are the calibre of bank management, particularly the
risk management procedure. The following is a summary of how the risk
management partnership operates:
Supervisors
and regulators of banks are powerless to stop bank failures. Their main responsibilities
are to improve and keep an eye on the legal framework that governs risk
management and to facilitate the process of risk management. In order to
influence the other important stakeholders, regulators and supervisors must
provide a sound enabling environment.
The
individuals in charge of corporate governance should be chosen by shareholders,
who are able to do so. Regulators should make sure that shareholders have no
intention of using the bank exclusively to finance their own or their
associates' businesses. Ultimately, the board of directors (sometimes known as
the supervisory board) is in charge of how a bank conducts its operations. The
board is in charge of establishing operational rules, selecting management,
setting the strategic direction, and above all assuring a bank's health. A
bank's executive management must be "fit and proper," which means
that in addition to upholding moral principles, managers must possess the
skills and knowledge required to operate the bank. The management must have a
thorough understanding of the financial risks that are being managed since it
is in charge of carrying out the board's policies through the daily operations
of the bank. The board's responsibility for risk management policy should be
seen as extending to the audit committee and internal auditors. Traditionally,
internal auditors conducted an unbiased assessment of a bank's adherence to its
information systems, accounting procedures, and internal control systems. On
the other hand, the majority of contemporary internal auditors would
characterise their work as supplying assurance concerning the bank's risk
management procedures, control framework, and corporate governance. Only by
comprehending and analysing the primary danger indicators that propel each
business line's distinct activities can assurance be attained. Audit committees
can be very helpful to management in identifying and managing risk areas, but
they should not be given sole responsibility for risk management; instead, it
should be integrated into management at all levels. In the process of gathering
risk-based financial information, external auditors now perform a significant
evaluation function. Proper
methods for contact between bank supervisors and external auditors are
essential, especially on a trilateral basis with bank management, as
supervisors cannot and should not duplicate the work done by the latter.
Instead of being based on a conventional audit of the income statement and
balance sheet, the audit strategy should be risk-oriented. The partnership
would suffer from an over-reliance on outside auditors, particularly if it
resulted in a diminution of the management and supervisory responsibilities. As
participants in the market, the general public and consumers must take
ownership of their financial decisions. They
need to achieve this through providing clear financial information disclosure
and well-informed financial evaluations. If the concept of "public"
is expanded to include financial media, financial experts like stockbrokers, and
rating agencies, the public can be helped in its duty as risk manager.
Generally speaking, a tiny or unsophisticated depositor would want more
protection than just clear disclosure.
RISK-BASED ANALYSIS OF BANKS
Stability
and confidence in the financial system are largely dependent on banking
supervision, which is based on a constant analytical evaluation of banks. With
the exception of a somewhat different end goal, the approach employed in an
analytical evaluation of banks throughout the off-site surveillance and on-site
supervision process is comparable to that of analysts in the private sector
(such as external auditors or a bank's risk managers). For this reason, the
analytical methodology for risk-based bank analysis recommended in this article
is globally relevant. In a market that is competitive and unstable, bank
evaluation is a difficult process. Apart from proficient management and
oversight, other essential elements required to guarantee the security of banking
establishments and the steadiness of financial systems and marketplaces
encompass robust and enduring macroeconomic strategies and coherent and
well-crafted legislative structures. Enough safety nets for the banking
industry, efficient market discipline, and adequate infrastructure for the
financial sector are also essential. Capital management risk has significant
association with return on equity of commercial and operating risk has
significant relation with the financial performance of commercial banks in Sri
Lanka[2].
A bank analyst needs to be well-versed in the specific regulatory, market, and
economic environment that a bank operates in in order to formulate effective
and practical courses of action, diagnose major issues, estimate future potential,
and make meaningful assessments and interpretations of specific findings. In
other words, even while focussing on a particular bank, an analyst needs to
have a comprehensive understanding of the financial system in order to perform
their work effectively. Both bank supervisory procedures and financial
analysts' methods of appraisal are always changing. The evolution of
international supervisory standards and practices is seen necessary in part to
address the problems posed by innovation and new developments, and in part to
facilitate the broader process of convergence. The Basel Committee on Banking
Supervision is continuously deliberating on these matters. In order to evaluate
a bank's state, traditional banking analysis has relied on a variety of quantitative
supervisory methods, such as ratios. Ratios are typically associated with big
exposures, open foreign exchange holdings, insider and related lending, loan
portfolio quality, liquidity, and capital adequacy. Even if these metrics are
very helpful, they do not provide a sufficient indicator of a bank's risk
profile, stability in its financial situation, or future prospects.
Additionally, the timeliness, precision, and completeness of the data utilised
to compute financial ratios have a significant impact on the picture they
depict. The comprehensive examination of a bank is the primary method for
analysing financial risk. Financial ratios are positioned within a
comprehensive framework of risk assessment, risk management, and changes or
trends in such risks in risk-based bank analysis, which also include
significant qualitative aspects. Bank analysis that is focused on risk also
highlights the pertinent institutional factors. A bank's policies and
procedures, their adequacy, completeness, and consistency, the efficacy and
completeness of internal controls, the timeliness and accuracy of management
information systems, and information support are a few examples of these
aspects. It's been claimed that risk increases exponentially with the rate of
change, but bankers take a long time to modify their risk appetite. Practically
speaking, this means that the market's capacity for innovation is typically
higher than its capacity to recognise and appropriately manage the risk that
goes along with it. Banks have always viewed managing credit risk as their
primary responsibility, but as the industry has evolved and the market has
grown more unpredictable and complex, it has become clear that managing
exposure to other operational and financial risks is just as vital.
ANALYTICAL TOOLS PROVIDED
Even
though every study is different, there are a lot of commonalities in the
overall analytical process when it comes to technical professionals'
evaluation, on-site inspection, off-site surveillance, and bank risk management.
In addition to financial and management data, the background and financial
information required in the questionnaire should give a general picture of the
bank to enable evaluation of the standard and thoroughness of bank policies,
management, and control procedures. There are various categories for questions:
·
Needs for institutional development
·
Corporate governance, covering
specific key players and accountabilities;
·
Overview of the financial sector and
regulations;
·
Accounting systems, management information,
internal controls, and information technology;
·
Risk management, including balance
sheet structure management, earnings and income statement structure, credit
risk, and the other major types of financial and operational risk
UNDERSTANDING THE ENVIRONMENT IN WHICH
BANKS OPERATE
One
of the most important responsibilities of financial analysts and bank
supervisors is gathering and evaluating risk management data from banks. A
risk-based analytical evaluation of each bank's financial data highlights
market patterns and relationships while providing information on the banking
industry as a whole for bank management, financial analysts, bank supervisors,
and monetary authorities. Sectoral analysis is crucial because it makes it
possible to set standards for both a peer group within the sector and the
sector as a whole. These standards can then be used to assess the performance
of specific banking organisations. Disturbances from anticipated patterns and
correlations should need additional examination, as they could reveal not only
the risk encountered by specific institutions, but also shifts in the financial
landscape of the banking industry overall. A sector analyst can learn about
changes in the industry and how they affect different economic agents and
sectors by looking at sector statistics. Banking statistics can provide light
on the state of the economy since banks are an integral part of national
economies and engage in both the domestic and global financial systems.
Macroeconomists may find that their monetary models no longer accurately
reflect reality as a result of the financial system's dynamism, which typically
causes changes to measurable economic variables. Policy makers are also
concerned about how banking operations affect monetary statistics, including
money supply data and credit extension to the domestic private sector.
Evaluations of banks can function as a methodical approach to guarantee that
monetary authorities identify and measure nonintermediate lending and
financing, together with other procedures that hold significance for central
bank policymakers. A structured approach to analysing banks has the benefit of
taking a methodical and logical approach to the behaviour of the banking
sector, which makes sector information easily accessible for macroeconomic and
monetary analysis. As a result, bank supervisors are in a position to
significantly support monetary authorities, whose policies are impacted by
changes in the banking industry.
THE IMPORTANCE OF QUALITY DATA
Increasing
openness and providing information that is helpful in making economic decisions
are the goals of financial statements prepared in accordance with Generally
Accepted Accounting Principles (GAAP) and International Financial Reporting
Standards (IFRS). However, because financial statements primarily depict the
effects of past events and may not always provide nonfinancial information,
even those prepared in accordance with strict international standards may not
contain all the information a person may need to perform all types of risk
analysis. However, information regarding an entity's historical performance
(income and cash flows) and present financial situation (assets and
liabilities) may be found in IFRS accounts, and this information can be helpful
in evaluating the entity's prospects and risks for the future. To make sound
investment decisions, the financial analyst needs to be able to use the
financial statements in conjunction with other data. A study of the financial
situation as well as particular concerns about risk exposure and risk
management are typically included in financial statement analysis, or
analytical reviews. These assessments can be conducted off-site, but an on-site
study would cover a far wider range of subjects and focus more on qualitative
elements, such as the physical infrastructure, the standard of corporate
governance, and the management's application of sound management information. Because many bank assets are illiquid and lack an
objectively defined market value, a trustworthy assessment of the financial
health of banks requires skilled analysts and supervisors. Timely evaluation of
the net worth of banks and other financial institutions is made even more
difficult by new financial products. The amount of information needed to attain
financial stability has significantly increased due to the liberalisation of
banking and capital markets, and it is now crucial to provide adequate and
relevant information about market participants and their transactions in order
to keep the systems efficient and in order. In theory, information is needed by
market players, depositors, and the general public just as much as it is by
supervisory bodies. Theoretically,
influential players in the market can exert gradual peer pressure to promote
information sharing. Under normal circumstances, this kind of pressure could
demonstrate to banks that transparency helps them raise capital, e.g., by
encouraging depositors and potential investors to contribute capital. Even in
economies with sophisticated financial systems, there is a regrettable tendency
to transform the need to conceal information especially that which indicates
unfavourable outcomes into a lack of transparency. Furthermore, the material
that has the greatest potential to cause abrupt and severe market reactions is
typically revealed at the last possible minute, usually unwillingly, due to the
sensitivity of bank liquidity to a poor public view.
CONCLUSION
Understanding
risk management, risk assessment & analysis, risk identification, risk
monitoring, and credit risk analysis in commercial banks are some of the
elements that this study looks at that might affect risk management procedures.
Risk Management Practices (RMP) are positively and significantly impacted by an
understanding of risk and risk management (URM), risk assessment and analysis
(RAA), risk identification (RI), risk monitoring (RM), and credit risk analysis
(CRA). This implies that URM, RAA, RI, RM, and RA should receive increased
attention from commercial banks. Furthermore, as RM and RAA are significant
factors that affect RMP, Pakistani commercial banks must to pay attention to
them. The findings will be valuable to individuals who are interested in
learning more about the commercial banking system and may serve as a useful
guide for improving RMP in commercial banks.
[1] Abiola, I., & Olausi, A. S.
(2014). The impact of credit risk management on the commercial banks performance
in Nigeria. International Journal of Management and Sustainability, 3(5),
295-306.
[2] Wijewardana, W. P., &
Wimalasiri, P. D. (2017). Impact of risk management on the performance of commercial banks. in Sri Lanka. International
Journal of Advanced Research., 5(11), 1441-
1449.https://doi.org/10.21474/IJAR01/5919