Info: Today's Inv.Bus.Daily article. Any help for ACRT here?
In A Global Market,
Managing The Risks Gets
More Complex
Date: 3/7/97
Author: Gerard A. Achstatter
When you think of a bank, the first thing that
comes to mind is a big pile of cash. But even for
banks, there's no free lunch. To earn those juicy
fees requires keen risk-management skills.
Without them, you're yesterday's news.
Banking is fraught with risk: Credit, interest rate,
liquidity, price, foreign exchange, transaction,
compliance, strategic and reputation. Just try
juggling all those balls in the air at one time.
Problem is, some of these risks can't be
measured. Strategic, operating and reputation
risks are not quantifiable. Neither is systematic
risk - the failure of multiple banks via the
''domino effect.''
And systematic risk is likely to grow in
importance as globalization of capital and money
markets increases. A technological breakdown
or a default by a large counterparty are ways that
systemic failure could occur.
C A P I T A L F L O W S
Even quantifiable risks are hard to measure
accurately. And trying to lessen exposure to any
one type of risk could exacerbate the risk in
another.
All this is not to imply that banks have given up
the fight on managing risks. On the contrary.
They look at risk in every way imaginable: From
the bottom-up, top-down, by geography, by
industry and by credit quality, says Sheri
Ptashek, a bank analyst at New York-based
Salomon Brothers.
Rather than run away from risks, bankers
embrace them. Risks well-taken, that is. Without
risk, there's little or no return.
The key to mitigating risk is an effective risk
management system, says Edward Zaik, senior
vice president of risk and capital analysis at San
Francisco-based BankAmerica Corp. Such a
system includes:
Accurate and timely measurement of risk.
Well- established control systems, including
policies and procedures.
Well-defined and communicated responsibility
and accountability.
A monitoring system that ensures timely review
of current and potential exposures.
Practitioners experienced in managing risk.
These steps apply to both banks and nonbanks.
That's because the risks are the same, says Zaik.
''The differences appear to lie primarily in degree
and size of risk exposures.''
No risk-management system these days would
be complete without derivatives. Banks use them
primarily ''to manage market and interest-rate
risk,'' said Ptashek. For banks, interest-rate
swaps, collars, forward-rate agreements, as well
as FX contracts and options are the most
popular instruments.
Credit derivatives - shedding unwanted credit
risk onto those more willing and able to bear it -
are still not mainstream products. But that's likely
to change as the market expands. Another
reason: Credit risk is a key exposure for banks.
Derivatives, however, are a two-edged sword
for banks. That's because, in addition to reducing
their own risk with these instruments, they also
sell them to clients.
On derivative sales, a problem arises when
banks are left with an open position. This occurs
when the bank can't find a counterparty for the
derivative deal. Until a counterparty is found, the
bank remains exposed.
Banks also use alternative risk- management
strategies, says Zaik. They include: structuring
natural hedges, using balance sheet and
transaction structuring, and buying insurance.
But as with any risk management tool, you have
to be sure you're actually reducing risk. And
lacking a 1-to-1 correlation between the risk-
reduction instrument and the underlying exposure
creates a new problem - basis risk.
There are other considerations, says Zaik: Does
a hedging tool exist for the risk? What level of
protection does the hedge provide? How easy is
it to unwind the position? And what's its price
relative to the risk protection?
No matter how well-prepared banks are for
today's risks, new challenges surface daily. Stiff
bank competition is one. Cut-throat prices,
relaxed terms and lower credit quality are
symptoms of a competitive banking environment.
As long as the economy stays healthy, banks
should be able to weather the competitive storm.
But warning signs have already been posted:
''Consumer losses have begun to move up,'' said
Ptashek.
To cope with tomorrow's risks, banks are
beginning to employ performance evaluation
models. Risk-adjusted return on capital is one
such technique. It helps banks with their capital
allocation decisions.
RAROC allows banks to discount the
profitability of each investment based on the
associated risk. As inputs, RAROC uses
revenue and expense projections, as well as the
credit-, country-, market-, and business-related
risks associated with an investment. These risks
are usually inferred from historical volatilities.
Practitioner-level details of how RAROC works
can be found in the summer '96 issue of the
Journal of Applied Corporate Finance.
No matter where risk originates, bankers will be
on the forefront, ready to do battle. Armchair
warriors in other industries should take notice.
It'll be their turn soon enough. |
