The need of the hour— managing risks in banks

Risk, a buzzword in banking, is perceived as a potential event that has adverse effects on capital and thus impacts negatively on financial performance of a bank. Since banks are engaged with very risky arbitrage as they sell highly secured instruments (deposits) and buy more risky instruments (loans) practically, taking risks is an integral as well as inseparable part of banking business. Making decision of taking risk and developing strategies for managing risk are imperative for bankers.
Risk management, as the modern concept advocates, is a deliberate acceptance of risk considering absorbing capacity of the institution. With the pace of globalisation and market competition, the risk-taking attitude of banks has been increasing. Gradually, risk management has become an indispensable discipline in the banking industry. In response to the past history of financial crisis, the notion of Basel came in and guidelines were formulated as a safeguard. The Basel norms focused on risks in credit, market and operational areas as well as liquidity, which helped the banks to quantify the risks and standardise their risk management practices.
Although the era of Basel III is underway, sound risk management has not achieved desired level of prerogative in practice in banks in Bangladesh yet, compared to other profit-making units.
Banking sector of Bangladesh has already passed a remarkable time. But risk management infrastructure, risk culture and risk governance have not been structured enough yet in respect of the industry size and age. In most of the banks, the business gets priority over risks, and decisions are made overlooking the controlling measures to mitigate the risks.
In 2000, Laurence H Meyer, former member of the Board of Governors of the US Federal Reserve System, told at the Bank of Thailand symposium on Risk Management of Financial Institutions, Thailand: 'The Asian financial crisis of 1997 illustrates that ignoring basic risk management can also contribute to economy-wide difficulties. The long period of remarkable economic growth and prosperity in Asia masked weaknesses in risk management at many financial institutions. Many Asian banks did not assess risk or conduct a cash-flow analysis before extending a loan and lent on the basis of their relationship with the borrower and the availability of collateral, despite the fact that collateral was often hard to seize in the event of default.' He thus emphasised pragmatic and sophisticated risk management in practice.
According to Financial Stability Report of Bangladesh Bank (BB), second quarter of 2015 reveals that banking sector's capital to risk weighted asset ratio (CRAR) was 10.3 per cent and out of 56 banks, 9 banks could not meet the minimum regulatory requirement of 10.0 percent. It is also observed that if three largest borrowers of each bank in the industry defaulted, 26 banks would have been non-compliant in maintaining minimum required CRAR. Similarly, if the number of the largest borrowers increased to seven, the number of non-compliant banks in maintaining minimum required CRAR would have been 31. Therefore, it is easily understandable how adverse a situation could be if bankers do not consider the importance of managing risks for their own sake. This analysis foresees the significance of risk management and indicates that how costly it can be if banks fail to ensure pragmatic risk management measures.
Globally, the perception of risk management is fundamentally changing within the institutions. It is no longer purely used as a control mechanism or whistle blowing tool. After 2007, the largest crisis of financial sector faced by the world economy, the magnitude of risk management has been emphasised more by the banks both locally and internationally.
The Bangladesh Bank, the central bank, is very much proactive to establish an organised and well regulated banking sector through effective risk management process. To perform the effective regulatory role, the Bangladesh Bank (BB) has issued Risk Management Guidelines for banks (2012), Capital Adequacy Guidelines (Basel II-2010; Basel III-2014), and Internal Capital Adequacy Assessment Process (ICAAP-2013) Guidelines for Banks, etc. from time to time.
Furthermore, in order to achieve effective results, BB instructed the banks in 2009 to form a special organisational unit in charge of risk management to assign a special responsibility to abstain banks from taking excessive risks in lure for hefty bonus. Moreover, the unit is responsible to conduct stress test on regular basis for finding inexplicable risks and to inform the findings to the Board and senior management on a regular basis, in addition to regulatory compliance. BB introduced three layer approaches for risk management: Operational layer, Management layer and Supervisory layer.  
Bangladesh Bank, as a regulator, has been taking timely initiatives for managing risks of the scheduled banks. The central bank sees things from its position (macro view) as a regulatory body whereas scheduled banks practice it in the field (micro view). Both the views need to be amalgamated to make the practice of managing risks more pragmatic and efficient. The nature of risk is such that it cannot be anticipated all the time, but however, a combined view of both regulator and practitioners can make the process complete. This process of sharing views has to be updated after a certain period. In this case, scheduled banks have to practice risk management very effectively all through the structure with an enterprise risk management approach.
To ensure the long-term sustainability and consistent growth, an enterprise risk management (ERM) practice has been introduced. ERM enables the organisations to pragmatically deal with uncertainties and associated risks and opportunities thereby enhancing the brand value and profitability. ERM helps identify and select alternative risk responses. It also helps ensure the effective reporting and compliance with laws and regulations, and avoid damage to the entity's reputation and associated consequences. An organisation has to understand the challenges of various risk domains and areas relevant to the business and to different kinds of ERM activities, which need to be carried out for successful implementation of ERM application.
To ensure an effective enterprise risk management practices, banks can consider the following issues:
* Deconstructing 'the concept of risk management', risk management is not a 'cost centre', it is rather a 'highly strategic unit', as proper structuring of risks and loss prevention is extremely critical in today's financial environment.
* Establishing risk culture and risk governance through trainings, communications and incentives. Arranging training for board of directors, senior management, and desk level officers including the assigned officials.
* Formulating risk policies and guidelines defining roles and responsibilities at different levels and setting risk appetite keeping risk bearing ability as well as goals and objectives of the organization in mind.
* Deploying sufficient skilled officials, ensuring operational autonomy and providing risk allowance.
* Putting more emphasis on proactive risk management rather to make mere regulatory compliance.
* Developing a robust IT system that can assist the bank in risk management by providing control and compliance monitoring technology, databases, market and industry research, and analysis and communication tools.
The practice of risk management in banking is inherent, as risk is an inseparable part of business. It is the DNA of banking industry that determines the risk behaviour of the institutions. In response to the regulatory instructions of BB, the banking sector has embraced the risk management activities with no hesitation. However, some recent jaw dropping scams that popped up in banking industry have questioned the proper implementation of risk management practices, its effectiveness, and corporate and risk governance. Experts opined that these scams are surely the outcome of ignoring the effective risk management system.
Bangladesh is now passing through a very crucial time. It has been showing a six plus GDP (gross domestic product) growth over a decade. Its economy is booming showing significant improvement in economic indicators. It has recently been graduated to lower middle-income country and already has started its journey to attain upper middle-income status. The next ten to fifteen years will be very important for the banking sector as a huge volume of business activities is to be performed. Therefore, at this stage, banks have to evolve a firm risk management system that is capable of shouldering the economy and absorbing economic shocks with its sound risk management shields. For ensuring soundness and sustainability of banking, enterprise risk management and corporate governance with high professional and ethical standards are, therefore, the need of the hour.
Views expressed are those of the writers and do not necessarily reflect the official position of the organisation the writers are associated with.
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