Background Risk management in banking is a relatively newer practice. Banks and financial institutions assume risks during the course of conducting business for the purpose of realizing returns on investments. […]
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Risk Management in Nepalese Banking
Background
Risk management in banking is a relatively newer practice. Banks and financial institutions assume risks during the course of conducting business for the purpose of realizing returns on investments. Balance sheet of every bank or financial institution exposes it to different types of risk, all of which need to be managed in a coherent and institution-wide way and relative to each other. During the past decade, Nepalese banking industry continued to respond to the emerging challenges of competition, risks and uncertainties.
Risks originate in the forms of customer default, funding a gap or adverse movements of markets. Measuring and quantifying risks is neither easy nor intuitive. In this context, Nepal Rastra Bank (NRB) have made some sincere attempts to bring prudential and supervisory norms conforming with international bank practices with an intention to strengthen the stability of the banking system.
Initiatives of NRB
Central banks around the world had started
working towards strengthening prudential norms and enforcing transparency in
financial reporting by financial institutions to avert any future international
financial crisis.
To strengthen financial sector of Nepal,
NRB started the financial reform process in early 1990s. NRB has taken a series
of measures to realign its supervisory and regulatory standards almost on par
with the international best practices. Accordingly, NRB had issued prudential
regulations in the following area in the initial stage of reform:
Capital Adequacy Norms: Banks need
to maintain minimum capital based on Risk-weighted Asset approach for the
purpose of capital adequacy standards.
Exposure Norms: Banks are subject to
limit on exposure to single borrower or group of borrowers on funded as well as
Non-funded exposure. There will be capital charge for the exposure in excess of
prescribed limit.
Asset Classification and Provisioning:
Banks are required to classify their loan and non-banking assets and make
provisions accordingly.
Income Recognition: Recognition of
income on cash basis was mandatory with certain exceptions. However, now NFRS permits
accrual basis of accounting.
Maintenance of Liquidity: Banks and Financial institutions are required to maintain 4% cash as liquidity.
Corporate Governance Norms: Banks and Financial institutions are required to follow stringent corporate governance norms such as norms for directors, formation of board sub-committees, appointment of CEO, code of conduct for employees, audit Committee, risk management committee, connected lending, etc.
Directives Specific to Risk Management
NRB has issued directives specific to Risk Management which requires banking sector to ensure effective management of various risks.
Liquidity Risk: Conduct Liquidity Gap Analysis and manage the risk.
Market Risk: Formulate robust policy, establish middle office at treasury department to ensure proper firewall, etc.
Interest Rate Risk: Conduct Maturity Gap Analysis and manage the risk.
Foreign Exchange Risk: Conduct Foreign Exchange Gap Analysis and manage the risk.
Credit Risk: Manage the risk through formulation and implementation of robust policies and processes, making appropriate provisions, complying exposure related norms, etc.
Operational Risk: Formulate robust HR Policies and procedures, ensure rotation of duties of employees, ensure robust internal checking system, ensure effective internal audit, formulate IT policy, formulate disaster recovery plan, etc.
Other Risks: Identify and manage reputational risk, strategic risk, AML/CFT risk.
Risk Management Guidelines
Nepal Rastra Bank had issued Risk Management Guidelines 2010 in July 2010 for the Banks and Financial Institutions which is recently replaced by Risk Management Guidelines 2018. This document is key for risk management in banking. It provides guidance to all financial institutions on minimum standards for risk management. Banks and Financial Institutions may, depending on its size and complexity, establish a more sophisticated framework than outlined in this document. The directive encourages banks and Financial Institutions to self-assess their risk profile and operational context. Also, Banks need to customize their risk management architecture and approach to attain organizational goals while meeting the minimum requirements standards set out in these Guidelines.
Model Risk Management in Banks
Banks may choose any risk management model commensurate with its risk appetite. But the model chosen should ensure safety as well as soundness of the bank’s financial position. Model Risk is the risk that theoretical models used in pricing, trading, hedging and estimating risk will turn out to produce misleading results. The model risk can have significant effect on financial performance of the bank. The loss arising out of the model inaccuracy and consequent model risk can be mitigated if the banks observe certain fundamental principles while making use of the model.
Risk Models have assumed importance in the area of Risk Management because they provide the decision-maker with insight or knowledge that would not otherwise be readily available. Such models aid banks in quantifying, aggregating and managing risk across geographical and product lines. The outputs of these models also play an increasingly important role in banks’ risk management and performance measurement process.
LD Mahat is a Chartered Accountant, Financial Adviser and Risk Management Specialist possessing over 29 years of diverse experience across several sectors covering a wide spectrum of assurance, business advisory and taxation disciplines. LD is a committed, highly motivated and result-oriented professional, consistently developing and nurturing client relationship and building long-lasting relationships with diverse clients. He has the ability to define issues, propose customized solutions that significantly add value and contribute to client’s success.
LD has got master’s in risk management form New York University, Stern Business School. He has undergone executive education at Harvard Business School and Insead Business School. He was risk management specialist in several Asian Development Bank Funded projects. He has provided risk management advisory services in various Nepalese corporate sectors.
LD has worked on large projects jointly with big 4 international accounting firms ~ PwC, Deloittee, Ernst & Young and KPMG in the field of Assurance, Diagnostic Review, Capacity Building, e-Government Procurement, e-Governance, Special Review, Investment Climate, and IFRS Implementation.
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