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Financial Risk Management

Assignment # 2
Presented By: Mr. Waqas Khan Miss Saima Wazir Presented to: Dr. AttaUllah Shah

20 November, 2012

Financial Risk Management

Assignment # 2

Table of Contents
Table of Contents...................................................................................................... 2 Introduction............................................................................................................... 3 Risk profile of FWBL................................................................................................... 3 Regulatory compliance.............................................................................................. 4 Risk management responsibility................................................................................ 5 Credit Risk (CR)......................................................................................................... 5 Diversification:........................................................................................................... 6 Foreign Exchange (FOREX) risk management:..........................................................7 Equity Price Risk (EPR):............................................................................................. 7 Interest Rate Risk:..................................................................................................... 7 Operational risk:........................................................................................................ 8 Analysis of operations of FWBL.................................................................................. 8

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Introduction
First Women Bank Limited (FWBL) is a scheduled commercial bank that was established in 1989 by the then Prime Minister, Benazir Bhutto. It was launched with the aim of assisting women entrepreneurs in their endeavors, and it is pursuing the aim to date. Most of its products and services are designed in a manner so as to attract women entrepreneurs. This may limit its operations in manner. However, limiting the focus of the bank can also help it to lead the market it is targeting. Knowing the market segment can help FWBL to capture the area that other banks may not be able to concentrate on because of the large number of operations they have to undertake to survive in the competition. Operations of FWBL can be understood with the help of the annual reports that it publishes every year for the benefit of its stakeholders. In this assignment we have studied the annual reports published by FWBL for five years i.e. 2007-2011. We have observed that the bank’s operations are not as sophisticated as others operating in the banking sector. We have also looked at the annual reports of other banks like Habib Bank limited and Soneri Bank limited. After comparing the reports we realized that FWBL still has a lot to work on its internal and external locus of operations. The services provided by the bank are very limited as compared to its competitors. Customizing some of the products for the female population of the country can help them gain more. Though it does not aim to target all the banking area, but it can design different products according to the need of the women of the country.

Risk profile of FWBL
In this assignment we are required to shed light on Risk management system of FWBL. i.e. their risk exposure and management techniques they use to counter the risk outcomes. FWBL has been ranked as BBB+ for its long term entity and A2 for its short term entity from 2004-2011, but recently improvement in the long term entity ratings of the banks have been sighted after PACRA assigned the ranking of A- to its long term entity. This is an improvement

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and a glad tiding for the stakeholders of the bank. The improvement in the rating suggest that the bank is not subject to abundant credit risk and it can be expected to pay for the commitments it makes, well in time. We believe that the improvement in credit ratings is a result of the decision of government to inject more capital in the bank. 800 million rupees have been budgeted by the government to invest in FWBL and allow it to continue its status of a public bank. 600 million rupees have already been injected into FWBL. Before this the performance of the bank could not be called as an exemplary one. It is since 2007 that FWBL is requesting an extension from SBP to meet the capital requirements as per the regulation of the central bank. The pattern has been repeatedly witnessed every year from 2007 till 2011. As per the regulations of State Bank of Pakistan (SBP) - the central regulatory authority which formulates rules and policies to regulate all the banks operating in Pakistan- every bank has its own framework, according to which it manages the risk that the bank operates in. FWBL also has such a system which they count as their strength in relation to their operational performance review. SBP requires all the banks to formulate “basic framework and policy guidelines”. This is not only to regulate the operations of the bank but also to secure its stakeholders. FWBL in compliance to this regulation prepared different manuals to comply with the code of corporate governance like Consumer credit policy, country risk management policy and investment policy manuals which then contribute to risk management of the bank. Operations of the bank are classified into two major categories i.e. risk weighted assets and trading (or banking) book. Detailed discussion on risk profile of the bank is given below.

Regulatory compliance
The bank follows Basel II accord during its operations. Capital adequacy (10% of the risk weighted assets) is thus maintained accordingly. However, it does not follow all the regulations by the book, e.g. although Tier 1 and Tier 2 capital requirements are maintained but Tier 3 capital requirement even though specified by SBP is not maintained by FWBL. This deficiency is noticed in all the documents that the bank has been publishing since half a decade. Change in

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the management of the bank was witnessed in 2009, after Mrs. Shafqat Sultana became the President of FWBL. Performance of the bank has seen improvement. But still more than half of the deficiencies have yet to be taken seriously and require some action to be taken about them.

Risk management responsibility
Risk management according to FWBL is the process which assists them in making decisions, while encompassing major risks and their impact on the bank. The bank has established a separate department for the purpose of management of risk in the bank i.e. Risk Management Department (RMD). The management believes in the importance of risk management system and thus aims to work further on it and improve it in the future. There are also a number of committees that contribute to managing risk in the bank e.g. “Credit & risk management Committee”, “Executive Credit Committee” and “fraud and forgery committee” which can contribute to managing operational risk in the bank and “Asset and Liability Management Committee” (ALCO) which deals with assessing credit risk of the bank. After the board approves policies to manage risk, it is then up to the committees to review the policies, monitor and implement them while setting the limits as per the policies approved. Reviewing the policies is given special importance in the bank to ensure that the regulations of SBP are complied with on regular basis. Moreover, the decision of the amount of the risk that the bank may absorb is decided by Board of Directors (BoD) of the bank i.e. the final decision to approve any manual or policy for risk management rests with BoD. The management then operates within the scope defined by BoD. The management of FWBL can take risk up to 20% of the paid up capital of the bank, as decided by BoD.

Credit Risk (CR)
CR for FWBL means the possibility of failure of the counterparty to oblige according to the terms agreed to by both the parties. According to them the failure of one party result in the loss of the other, thus the bank aims to minimize this risk as much as possible. Their main focus thus

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remains on curtailing CR for which they identify, gauge and observe such a risk in advance. Detailed process of dealing with credit risk factors are explained in the Credit Manual of the bank, which is not available to public. (During the assignment, the document was searched for) To manage Country risk, management guidelines and policies have been defined which are approved by BoD and are thus in practise. (These manuals mentioned are not available for general public to view, thus their analysis is not included in this document) Generally, it is noticed that FWBL limits their customers in credit and ask for collaterals to minimize CR the bank is exposed to. It can be due to this step that the bank may not have shown a very profitable record in the past. Asking for collaterals should not be the primary choice of any bank. Its CR management should provide it with other alternatives that it can use in such circumstances.

Diversification:
FWBL invests in different sectors i.e. both private and public. Diversification is also shown in the business segments that the bank invests in. Although not mentioned explicitly in the report, diversification of the bank’s business is one way of decreasing its risk exposure, which it can capitalize on in improving its overall rating. While studying the segments which the bank targets, we observed that non performing classified advances show an increasing trend, as noticed in all the reports studied for this assignment. Whereas, specific provision held have been facing fluctuations over the period of time.

Market risk (MR):
FWBL defines market risk as the uncertainty of loosing from the movements of variables affected by market dynamics. These include change in interest rate, fluctuation in equity indices or movement of foreign exchange rate. This can affect its investment in different financial instruments and institutions. Hence, management of this risk is very important for any bank, provided that its liquid assets, especially, are all affected by any fluctuation in the aforementioned factors.

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It is the responsibility of ALCO to ensure that the policies related to MR are implemented and reviewed time to time as per the requirement. Monitoring these policies is important because market dynamics may change very frequently to very seldom at times. Thus reviewing the policies related to market risk is assigned to ALCO for effective results.

Foreign Exchange (FOREX) risk management:
Although FWBL does invest in foreign currency and maintain FOREX risk, it does not define its view of the specific risk. However, it can be defined as the risk faced by the bank due to any fluctuation observed in the FOREX rate, which can affect the investments that the bank has in foreign currency, in case o FWBL. All the operations of FWBL are within the country. The bank has shown a steady and regular increase in the foreign currency investment. Although the change is very minimal, still an increasing trend can be observed in foreign currency investment by the bank. But with relative comparison, as the paid up capital of the bank has been increased in the recent past, the exposure in foreign currency has not increased in accordance to that. This may indicate that the bank does not want more exposure to FOREX risk.

Equity Price Risk (EPR):
FWBL recognizes the changes in prices of stocks that they have invested in as EPR. Although as mentioned before, the bank takes care of diversification of the risk, they also use individual scrips’ nominal limits.

Interest Rate Risk:
FWBL has referred to this as Yield risk as well, and defines it with the movement of yield curve, i.e. any interest rate change in the market can affect the financial instruments’ value that the bank posses.

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If any mismatch is found in the assets and obligations that the bank has, the settlement is done as per the contract agreement of settlement date, or by maturity of the instrument.

Operational risk:
For the purpose of management of this category of risk, risk weight amount is calculated with the help of the basic indicator approach. FWBL is focusing on improvement of its IT infrastructure to ensure transparency during the operations and reduce the related risk and increase the monitory capacity of the bank.

Analysis of operations of FWBL
The limited portfolio of the products and negligence towards the affairs of the bank can be result of the BoD structure of the bank. Among the owners of the bank are HBL, ABL, MCB, National Bank of Pakistan and Government of Pakistan. They hold the major share and contribute to the decisions related to the bank. It is a possibility that they might want to target a specific segment of the market with the help of the bank but did not want to develop it so much so to make it a competitor and create a situation of being cannibalized by its own prodigy, because the operative structures of its parent banks are a lot more sophisticated and developed as compared to that of FWBL. But it is a theory only supported by the idea that most of the types of the risks mentioned in the requirement of the assignment are not covered in this assignment because they were not addressed in the annual reports of FWBL, which gives rise to the possibility they may not be taken into account by the management or the BoD members, who all have ample experience of banking.

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