Chapter 4 : Banking risks

• A risk is a threat or a missed opportunity. It is

characterized by an event, one or more causes
and one or more consequences.

• Risk is the possibility of an event occurring

whose consequences could affect people,
assets, the environment, the company's
objectives or its reputation.
• 1. Counterparty risk

• -This is the first risk mentioned when referring to

the banking activities.

• -By counterparty risk we mean the risk relating to

loans granted to customers (referred to as credit
risk), also the risk affecting securities held by the
bank (referred to as market risk).
 1.1. Credit risk
• The borrower may not be able to repay the
loans granted.

• The client's default results in a loss

corresponding to the partial or total non-
recovery of the funds lent or the claim of the
guarantee.

• There are various reasons why a bank's

customers may become insolvent.
credit risk origines

• -There are a number of possible reasons why a

bank customer may default and be unable to
meet their commitments to the lending
institution.
• -These causes may be specific to the borrower,
or they may go beyond the borrower.-

• -Professional risk: Insolvency is related to the

economic situation in a specific sector of
activity, such as tourism or agriculture.
• -Borrower risk: this is the most common risk and
the most difficult to identify. The borrower may
not pay because of a deterioration in his financial
situation (management decisions, financial and
investment decisions), and it is sometimes
necessary to check whether or not the borrower
is willing to pay his commitments.

• -Country risk: Insolvency is linked to factors

arising from the political and economic situation
of the country in which the customer operates.
 1.2. Market risk
• -With the development of the various capital
markets and the diversity of financial assets,
banks often hold a wide range of securities for
large amounts.
• As with credit risk, they are exposed to the
risk of insolvency of the issuer of the
securities, resulting in total or partial loss of
the credit.
• -Market risk generally refers to risks relating
mainly to the volatility of returns on financial
securities.
Internal model approach:

Value-At-Risk represents an investor's maximum

potential loss on the value of one asset or portfolio of
financial assets, which is expected to be achieved only
with a given probability over a given time horizon.

In short, it is the worst expected loss over a given time

horizon for a given level of confidence.
Based on portfolio theory, the standard deviation σ is used
in particular to quantify the volatility of returns on a
portfolio of securities,
σ determines the maximum of fluctuations around the
expected average price of the portfolio.

VaR is calculated as follows:

VaR = α * σ + mean.

With σ :standard deviation

Mean: is the average of the variations in the value of the
portfolio available to the bank.

α is the factor read from the distribution table and depends

on the confidence interval selected.
• 2. Solvency risk :

• -Solvency risk is the risk that the bank's equity

will not be high enough to cover any losses.

• -The central bank applies the recommendations

of the BASEL committees, by defining a solvency
ratio which relates the bank's core fund (capital
requirement) to all bank risks (weighted risks)

•
Basel regulations

-Historically, the work of the Basel Committee has led

to the publication of three major agreements:

-Basel I in 1988,

-Basel II in 2004 and

-Basel III, 2010.

The solvency ratio is as follows:

Net core funds

--------------------------------------------------------------- ≥ 8%.

Credit risk + Market risk + Operational risk

Article 4 of circular no. 91-24, as amended by circular no. 2012-09 of

29/06/2012, stipulates that ‘banks are required to comply at all times with a
solvency ratio (ratio between net capital (NCF) and total net assets according
to weighted risks) that may not be less than 8%. This ratio is increased to 9%
at the end of 2013, and to 10% at the end of 2014’
• 3. Liquidity risk

• -The maturity transformation specific to the

financial intermediary function gives rise to
liquidity risk.

• -The maturity of a bank's resources is often

much shorter than the maturity of its assets.

-Liquidity risk generally takes two forms:

• - Immediate liquidity risk:

this is the risk of a massive withdrawal of

deposits that the bank is not ready to meet.

• -The extreme risk is that customers of other

banks will imitate this behavior, which could
cause a problem for the entire banking
system.
• Transformation risk:
• Banks often have long- and medium-term assets
financed mainly by short-term resources.

• -If a bank finds itself in such a situation, it will

have to turn to the money and interbank markets
to meet its customers' cash needs.

• - This situation means that the bank has to pay

interest charges to meet the deposit withdrawals,
which are supposed to be ‘free resources’ for the
bank.
 R1 liquidity

Control of long-term liquidity (Net Stable Funding Ratio or

NSFR)
-This stock ratio is created to control the bank's
transformation activity so that stable financing needs are
financed by stable resources.
-Where stable resources are made up of liabilities such
as share capital and debts of more than one year but
excluding deposits from financial institutions.

-Where stable requirements are made up of balance

sheet assets weighted according to the speed with which
the bank will be able to make them liquid within one
year.
R2 liquidity

-The new liquidity ratio was introduced in Tunisia in January

2015. In accordance with CBT circular no. 2014-14 of 11
November 2014, a new liquidity ratio is applied, which is the
LCR (Liquidity Coverage Ratio) indicated by the BASEL III
standards.

High quality liquid assets

LCR = ------------------------------------------------------------------------

Expected cash outflows - Expected cash inflows

• 4. Operational risk
• Operational risk is a risk associated with the
Bank's day-to-day business and operations.

• In 1999, the Basel Committee defined

operational risk as ‘the risk of loss resulting from
inadequate or failed internal processes, people, and
systems or from external events. This definition
includes legal risk, but excludes strategic and
reputational risk ’.

• Operational risk therefore requires both staff

training to avoid mistakes made in good faith,
and control through an effective information
system to limit actions taken in bad faith
 Loss Event Types and Examples

Event Type Examples

Internal fraud Employee theft, intentional misreporting of positions,
and insider trading on an employee’s own account
External fraud Robbery, forgery, and check kiting
Employment practices Workers’ compensation and discrimination claims,
and workplace safety violation of employee health and safety rules, and
general liability
Clients, products, Fiduciary breaches, misuse of confidential customer
andbusiness information, money laundering, and sale of unauthorized
practices products
Damage to physical Terrorism, vandalism, earthquakes, fires, and floods
assets
Business disruption Hardware and software failures, telecommunication
and system failures problems, and utility outages
Execution, delivery, Data entry errors, collateral management failures,
andprocess incomplete legal documentation, and vendor disputes
management
The Basel Committee introduced principles for
sound operational risk management in 2003.

One of the main innovations of Basel II compared

with Basel I was not only to require the allocation of
capital to cover operational risk, but also to
advocate an operational risk management system.

Basel II offers banks three methods of calculating

capital. The method chosen must be consistent
within a banking group.
1) The basic indicator method consists of applying a
weighting of 15% using the Net Banking Income of
the last three financial years

Required Capital = Average (last 3 NBI) *0.15.

2) The standardized approach applies a multiplying

factor depending on the business

Required Capital =
Average (last 3 NBI) * Multiplying Factor.

3) Finally, the advanced approach allows the bank to

develop its own method for assessing and calculating
operational risk.