A bank’s basic duty is to collect money from excess units and maximize usage by lending to individuals and corporate bodies that need it at prevailing interest rates. In doing this, banks and other financial institutions take various forms of risks. This informed the need for risk management, which ensures that depositors’ funds are safe to a very large extent. If this safety valve is not guaranteed, it could lead to failure of banks and possibly affect the national economy.
There are three kinds of risks: credit, operational and market risks. Credit risk: This constitutes the largest quantum of any bank’s risk portfolio. If not properly managed, a bank stands the risk of losing both the principal and interest accruable on the facility. In the circumstance, provisions arise because credit has gone bad. The focus is on the reduction of non-performing loans to boost a bank’s bottom-line and shareholders’ funds.
Operational risk: As the name indicates, this arises when there are system failures, natural disasters or sheer fraud (collusion). When there is infrastructural malfunction, it becomes risky honouring or giving value to financial instruments. If anything goes wrong, the liability will be on the bank except the terms and conditions were otherwise expressly stated. Insider collusion (abuses) and unexpected natural disasters also lead to bad debts. Occasionally, credit and operational risks overlap.
Changes in market rates and exchange rate policies also constitute a form of risk. For instance, unstable international oil prices play a role in the profile of certain credits.
In the past, there was inadequate attention to risk management. Before now, the concentration of most banks was how to make and optimize profit.
Previously, too, the voice of the risk manager was not listened to. All that is beginning to change as the process is being integrated in today’s banking culture. In some banks, risk management has been elevated to the Directorate level.
The issue of corporate governance is a major threat to the enthronement of a risk management regime. Prior to consolidation, risk management was clearly absent. Even now, what we have is pseudo corporate governance, all the current pervasive pretensions notwithstanding.
Let us go back to the basics of risk management, particularly by paying attention to credit and liquidity risks. Managing risks in our polity means that you have to create sufficient buffers by establishing two sources of independent (primary and secondary) repayment.
Another approach is paying close attention to liquidity and treasury portfolios which ensures adequate reserves and cushion for balance. This strengthens risk management. In managing risks locally, there is need to adopt a holistic system that takes on all the risk elements the bank is involved in. Risks cannot be managed in silos; it has to be broad-based.
Why does a bank need capital? A bank needs it to absorb unanticipated losses. Losses can be anticipated and therefore you price your capital. What determines the level of capital a bank has is the amount of risk it is ready to take. Conversely, the less capital you have, the less risk you are likely to take. The general trend is for banks to have minimal capital below which distress could set in. In Nigeria, the standard is 10 per cent of risk-adjusted assets. Overall, it is in the bank’s interest to have less of idle funds.
Issues on Basel 1 and 11
Basel is the name of a town in Switzerland where central bank governors of different countries came together and agreed in 1988 (Basel 1) on the level of capital each country should have. The primary objective of both accords is to ensure that banks have enough reserves to attend to risks when they occur. A bank must maintain at least eight per cent of its risk portfolio.
Due to some deficiencies in Basel 1, Basel 11 was introduced in 2006 which harped on much more sophisticated and detailed analysis of risk assets.
…What are these deficiencies? No differentiation between categories or different borrowers in the same sector. No mention of operational risk
For developing countries, the main challenge is lack of historical data. Unlike Basel 1, Basel
11 requires a lot of documentation, which is still a setback in this part of the world. In the case of developed countries, the challenge may be capital. Because of the level playing field enshrined in Basel 11, all the big banks are encouraged to adopt Basel 11.
If we implement Basel 11, it will make risk management so sweet and simple. It will enhance by a factor of over 100 our ability to manage risks simply because we will have a dossier of our credit portfolio. A good example will be credit risk. It gives a large window for risk management. The advantage is much. Implementation meant that risks will be broken to finite elements and will be easily managed. It will provide detailed information that will help to give birth to proactive risk management.
You will all agree with me that the market size for the affluent class in Nigeria has been growing over the years. The financial needs of this class is multifarious and changes in the context by the day.
Generic banking products designed for the generality of the banking populace no longer meet the yearning of the affluent class, hence the need to design tailor made products and services to specifically address the aspirations of the high net worth individuals
Next week: Chinua Achebe
When an illustrious personage passes on, his death is not mourned but celebrated. This phenomenal human characteristic underlies the celebratory circumstance that had underpinned the epochal translation of Professor Albert Chinualumogu Achebe.
The global outpouring of eulogies was a splendid testament to the superlative reckoning and a profundity of aura this renowned novelist of facile precepts symbolized.
A literary trailblazer and a man of transcendental pedigree, Achebe is an irreplaceable enigma. Nigeria and indeed the world have lost a gem. This is just an appetizer—watch out next week for the main course.