MUHAMMAD ASIF ID NO (11150)

FINAL PAPER FINANCIAL RISK MANAGEMENT

DATE 12/09/2020

ANSWER NO (1)

The key risks that have let to Moody’s downgrading the 4 major

Banks in South Africa:

1: The risk of asset quality deterioration and higher credit costs.

2: The banks' recurring earnings-generating capacity in light of challenging

operating conditions.

3: Any potential negative pressure on their capital levels, funding Sources and the
relevant cost of funding in light of higher interest rates.

Moody reflected its concerns about weaker economic growth in

Africa’s most developed economy. South Africa has been hit by long strikes
this year causing already anemic growth to be pushed towards a
recession, while the country grapples with high levels of poverty and
unemployment. In addition, the rating reviews also take into account the
challenges that the banks' financial performance will face because of South
Africa's weakening economic growth. These challenging economic
conditions, combined with declining commodity prices, increasing interest
rates and high household indebtedness, will lead to elevated credit risks
and potentially higher impairments for banks, exerting pressure on their
earnings and challenging the resilient performance they have featured so
far that are likely to lead to higher credit costs and elevated loan
impairments for the bank. All this challenges require the banks were to face
in the view of weaker economic growth in South Africa. Overall, when
considering developments that South Africa acquired high achievements
but these leaded to be credit negative for South African banks, which will
pressure their operating income and resilient performance so far. To this
end, the rating review will also assess on a forward-looking basis banks'
earnings and capital buffers against risks stemming from the increasingly
challenging operating conditions. The rating agency is also concerned
about potential asset quality pressure building up in the retail, small and
medium enterprise and corporate loan segments of the banks. Beside, the
rating action is primarily driven by the potential deterioration of the South
African government's credit profile therefore investors would suffer losses
as the days of government bailouts for banks are over in response to the
abrupt loss of creditor confidence in African Bank Limited (ABL). On the
other hand, such many of companies were growing too aggressively by
loosening their credit criteria, as captured by Moody's recent rating action
to place the sovereign rating on review for downgrade. The banks' high
sovereign exposure, mainly in the form of government debt securities held
as part of their liquid assets requirement, links their credit profile to that of
the government.

Moody's view:

Moody's view of the lower likelihood of systemic support from South

African authorities to fully protect creditors in the event of a crisis, by the
actions taken by the South African Reserve Bank (SARB). The policy
response addressed related liquidity and capital issues, thereby mitigating
contagion risks with the further objective of reducing potential losses.
However, the inclusion of a bail-in of senior unsecured bondholders and
Wholesale depositors indicate the regulator's willingness to impose losses
on creditors. This needs to be reflected in Moody's ratings. Firstly, factor of
debt ratings are indispensable to speak to both the likelihood of a default
on contractually promised payments and the expected financial loss
suffered in the event of default and similarly. Secondly, factor of deposit
ratings are also as crucial as speaking to banks' ability to repay punctually
uninsured deposit obligations, including wholesale deposits. Moreover,
ensuring a healthy balance between governments and markets, and to
define exit strategies for governments to withdraw their intervention in the
private sector, once we reach the post-crisis phase.

Moody's notes the broad resilience demonstrated:

Moody's notes the broad resilience demonstrated by South African

banks in the past, including the management of adverse economic
environments and recognizes the solidity of key system financial metrics;
however, the rating agency is also concerned about potential asset quality
pressure building up in the retail, small and medium enterprise (SME) and
corporate loans segment of the banks' portfolios. To this end, the review will
focus on a forward-looking assessment of banks' capital, funding and
liquidity buffers against risks stemming from the increasingly challenging
operating conditions.

ANSWER NO (2)

Role of a consultant to the CEO of a hypothetical multinational bank, EM Bank:

In recent years, the conflict between Ukraine and Russia because

disputing Crimea was created a crisis in both social and economic aspect.
The internal violence, trade embargo between two countries, the afraid of
the unstable situation make many investors decide to stop invest into this
region, source of budget decrease when defense expenditure rise, was
destroyed the economy both of them. An economic crisis happen, GDP of
both country was substantial decline, increasingly inflation (GDP of Ukraine
expected to be -6.5% , inflation of 19% and budget deficit 1% - source:
IMF) this make many economic subjects have operational in this region
Facing with many difficult as the consultant of EM Bank, I will identify some types
of risk that EM Bank has to face. EM Bank, the hypothetical multinational bank
that has operational in Ukraine and also in Crimea – the region that have faced
several conflict and instability have to faced with many risk because the strain and
the crisis in socioeconomic. First, EM Bank has to face with credit risk. With the
economic crisis, GDP fell by nearly 18% year-on-year in the first quarter of 2015,
worse than even the pessimistic projections, the potential loss from loans in this
region was significantly increase. The other risk that EM also faced is foreign
exchange risk-the risk that exchange rate can affect the value of an FI’s asset and
liabilities held off the balance sheet and market risk. In April 2015, inflation
topped 60% due mostly to utility price hikes in Ukraine. The crisis not only
decrease the value of Ukraine’s currency - hryvnia, but also impact on Russia’s
currency, ruble which is the currency using in Crimea. The interest rate was also
impacted because the demand of deposit will decrease but demand for
withdraw increase because the unstable of economy, leads to the changes
in interest rate. Of course, sovereign risk also occurs in this case, this is the risk
that repayments to foreign lenders or investors may be interrupted because of
restrictions, intervention from foreign governments. Increasingly in inflation rate,
default debt to Russia ($3 billion), internal violence, decrease in source of budget,
etc is some types of many red flags for the default loans by the bank for this
government. And there are more risk could happen but with the types of risk I
was mentioned above is the main impact into EM Bank. The following part will be
some propose strategies to manage these risks. With credit risk, I suggest using
RAROC models, option models of default risk and KMV portfolio manager model
to measure and hedging this type of risk with foreign exchange risk, at first,
manager should focus on both unbalance-sheet and off-balance-sheet hedging.
This including making changes in on-balance sheet assets and liabilities, taking a
position in forward or other derivative securities to hedge risk. Manager also
should hold multicurrency foreign asset-liability positions. We can measure
market risk by using historic (back simulation) model. For sovereign risk, EM Bank
can use CRA model to analyze which key economic and political variables or
factors have driven changes in secondary market prices on least develop country
loans. Some important variable such as country’s debt service ratio (TDGNP and
TDEX), imports ratio (NIRES), accumulated debt in arrears (ARR) and USP should
be calculated.

ANSWER NO (3)

Banking system in epidemic disease, risks and challenges:

The most widespread epidemic of Ebola virus disease happened in

West Africa in 2013 and continued spread in two year had impact not only
Socioeconomic in West Africa, the significantly increase of spreading to other
country such as US, UK which have larger and more integrated economies but
also created a little impact on global economy. First, look into domestic operating
activity. There first industry will have adverse impact that we have to say is
tourism – one of the important sources of income in much country and then
created much negative effect to other relative industry. Starting with the
aeronautical industry, this industry will be facing with the impact of this disease
initially. When the Ebola happen and started to spread into some other country,
people will be restrict to come to West Africa region for prevent the spread and
actually, the panic-driven will decline in demand so the operation of many airline
company will facing with a difficult situation, just few passenger or maybe no one
use airline service would lead to disruption in working of
aeronautical industry. Starting from one object and affect another, it looks
like domino effect for domestic economic, from many large business such
as aeronautical company, tourist company, hotel and restaurant system,
etc, and many small business and following by many company relative
such as fuel company leads to an national economic crisis.
Look into foreign aspect, especially import and export activity. In fact,
West Africa was been restricted these activity because of the fearing of
Ebola. Firstly, from domestic situation, many people died from the disease
were effect the productivity so many company cannot satisfy the contract.
Second, from partner aspect, they will limit or don’t perform the contract
with the firm in Ebola region because afraid of their productivity and from
psychology perspective, customer will fear to use product that was export
from country who was attacked by dangerous disease. When the import,
export activity was restricted, business have to facing with many difficult,
product cannot sell so the company doesn’t have income to pay for their
operational cost. Moreover, with some country such as Liberia, the main
product to export is agriculture product that will be damaged in short time,
so they will totally loss in this case. From the investment side, there were some
negative effect that can be seen in the past through SARS disease and now you
also see that in Ebola, many investors, especially foreign investor were delayed
investment decision into these regions because of the uncertainty. Drawing
decision in this time were like add fuel to the fire, make the economy of these
place harder. The attacked in every aspect of the economy push people in this
place into “chasm”. With the country have a weak economy, the
circumstances of people in these places were already difficulty and when
disease comes it was like a flood sweep away everything they have.
Business activity in and outside the country sluggish make them lose their
job, salary and some people unluckily even can’t keep their life because the
disease. Many people just can expect from the aid from government and
some international organization. From the socioeconomic impact of Ebola as we
already analyzed above, banking system has to facing with many types of risk. It
will be not difficult to see when a serious disease happened; the banking system
will be faced with credit risk. First of all, credit risk could be occur when the
borrower could be died because the disease. Moreover, the economic
crisis created by the negative effect of this disease will push many people
into difficult situation, how can they pay the loan when they just earned a
little or nothing? With the impact of credit risk combined with bad situation
of the economy will decrease significantly the demand of deposit combined
with the asset’s value of the bank will sudden decline could make the bank
facing with insolvency risk. The following risk would be occurred is liquidity risk,
on the economic crisis, many business or people have to facing with the difficult,
problem in their financial situation associated with the panic when day by day
opposite with the death around, many people will sudden have demand to
withdrawals their deposit, and this situation could be like domino effect, the
affection in psychology aspect, much more people come to the bank to Withdraw
money leads the bank in very difficult situation to liquidate assets
in a very short period of time and of course, less than fair market prices.
From the restriction in import, export activity, banking system could
be faced with off-balance-sheet risk. This could be come from the letter of
guarantee or standby letter of credit that the bank have been issued for
their customer who have responsibility as producer. The bad situation of
socioeconomic, the business inside and outside, decreasing of GDP will impact on
value of their currency, this will occur foreign exchange risk and market risk for
the bank. Starting by an external event and leads the bank facing with many
types of risk and some potential loss from their activity, Ebola make this
system opposite with operational risk and moreover for some hypothetical
banks, they should be prepared for sovereign risk. Through some reality events in
the past, the manager of the bank should be prepare for hedging plan and
prevent as much as risks can occur when a disease come to their country.

ANSWER NO (4)

The outstanding issues and challenges to bank risk management and the broader
financial system arising from shadow banking:

The shadow banking system makes up 25 to 30 percent of the total financial

system, according to the Financial Stability Board (FSB), a regulatory task force for
the world’s group of top 20 economies. This largely unregulated sector was worth
about $60 trillion (37.97 trillion pound) in 2010, having grown from an estimated
$27 trillion in 2002, according to the FSB. While the sector’s assets declined
during the global financial crisis, they have since returned to their pre-crisis peak.
There are concerns that more business may move into the shadow banking
system as regulators seek to bolster the financial system by making bank rules
stricter.

Shadow banking and engaged entities in shadow banking:

The shadow banking system is made up of financial entities which have the same
functions as traditional banks but which are subject to little, if any, regulation.
Like traditional banks, shadow banks provide credit and liquidity but, unlike their
traditional counterparts, they do not have access to central bank funding or safety
nets like deposit insurance. Shadow banking includes money market funds,
private equity funds, hedge funds, securitization, securities lenders, and
structured investment vehicles. Broad definitions also include investment banks
and mortgage brokers.
Functions of the shadow banking system:

Unlike traditional banks, shadow banks do not take deposits. Instead, they rely on
short-term funding provided either by asset-backed commercial paper or by the
repo market, in which borrowers offer collateral as security against a cash loan
and then sell the security to a lender and agree to repurchase it at an agreed time
in the future for an agreed price. Shadow banks, which are often based in tax
havens, invest in long-term loans like mortgages, providing credit across the
financial system by matching investors and borrowers individually or by becoming
part of a chain involving numerous entities, some of which may be mainstream
banks.

Benefits of shadow banking and broader financial sector:

The shadow banking system offers credit and also provides liquidity and funding
in addition to that provided by the mainstream banking system. Given the
specialized nature of some shadow banks, they can often provide credit more
cost-efficiently than traditional banks.. Shadow banking institutions like hedge
funds often take on risks that mainstream banks are either unwilling or not
allowed to take. This means shadow banks can provide credit to people or entities
that might not otherwise have such access.

Activities and impacts of bank operations and the risks faced by banks:

As shadow banks do not take deposits, they are subject to less regulation than
traditional banks. They can therefore increase the rewards they get from
investments by leveraging up much more than their mainstream counterparts and
this can lead to risks mounting in the financial system. As shadow banks use a lot
of short-term deposit-like funding but do not have deposit insurance like
mainstream banks, a loss of confidence can lead to “runs” on these unregulated
institutions.

Is there any way shadow banks could also make the financial system more stable:
In the United States the Dodd-Frank Act, passed in 2010, made provisions which
go some way towards regulating the shadow banking system by stipulating that
the Federal Reserve would have the power to regulate all institutions of systemic
importance, for example. Other provisions include registration requirements for
hedge funds which have assets totaling more than $150 million and a
requirement for the bulk of over-the-counter derivatives trades to go through
exchanges and clearing houses.