b_06.pdf
(
137 KB
)
Pobierz
<!DOCTYPE html PUBLIC "-//W3C//DTD HTML 4.01//EN" "http://www.w3.org/TR/html4/strict.dtd">
Bachelor Studies in Finance
Year 2, Spring 2012
Overview
1. Why be concerned about risks?
2. Credit risk
3. Liquidity risk
4. Interest rate risk
5. Other risks
BANKING
Lecture 6
Banking risks
Ewa Kania, Department of Banking
2
1.Why be concerned about risks?
•
Risks increase the
uncertainty of a bank’s net worth
or
capital (assets minus debt liabilities). This is particularly
important because banks tend to be highly levered.
•
Risk is the possibility that expectations may not be realized.
•
If a bank is faced with risks that make its capital volatile, it
has a high probability of financial distress and/or bankruptcy.
•
Must first answer question: What outcome is expected?
•
Measures of risk:
– Variance or standard deviation of return
– Loss realizable at a given probability
•
A bank’s
direct costs of financial distress
are high because
many bank liabilities and assets represent “customers,” not
“investors.”
•
Risk measure is a probability-weighted deviation from what
is expected.
•
Customers
: Parties desiring a bank service and are not willing
to evaluate or to be exposed to the bank’s default risk.
•
Two approaches used:
– Subjective approach – analyst assigns probabilities to each
possible outcome.
– Objective approach – analyst uses past frequencies to
determine probabilities.
•
Investors
: Institutions or wealthy individuals that are willing
to evaluate and to be exposed to bank’s default risk.
3
4
2. Credit risk
•
Even if a bank with high risk-exposure experiences a loss that
does not immediately result in bankruptcy, such a loss could
lead to a
liquidity crisis
. Examples:
•
Credit risk
is the possibility that promised cash flows may not
occur or may only partially occur. Loan charge-offs: deduction
for lack of repayment of either principal or interest.
•
Depositor run
: When a bank’s credit-worthiness deteriorates,
investors may become unwilling to roll-over wholesale CDs or
other wholesale funding (e.g., CB funds). The bank may have
to liquidate assets at “fire sale” prices, exacerbating its decline
in capital.
•
Risk
is about the impact of unanticipated changes in cash
flows on the banks’ market value.
•
It is estimated that 60% of banks’ risk emanates from credit
risk exposure. Credit risk is synonymous with
default risk
.
•
Commercial paper walk
: When a bank’s credit-worthiness
deteriorates, it may be unable to roll over its commercial
paper. It is forced to tap higher-cost sources of funding.
•
Default
occurs when a loan or a fixed-income security fails to
make a promised payment due to the debtor’s inability or
unwillingness to pay.
5
6
•
Firm-specific credit risk
refers to the likelihood that
specific individual assets may deteriorate in quality, while
systematic credit risk
involves macroeconomic factors that
may increase the default risk of all firms in the economy.
•
Similarly, if a bank holds well-diversified assets, the bank
will face only systematic credit risk that will be affected by
the general condition of the economy.
•
Systematic credit risk
– the risk of widespread defaults
associated with general economy-wide or macroeconomic
conditions affecting all borrowers (e.g., an economic
recession).
•
Thus, if S&P lowers its rating on IBM stock and if an
investor is holding only this particular stock, she may face
significant losses as a result of this downgrading.
•
Firm-specific credit risk
– the risk of default by the
borrowing firm associated with the specific types of project
risk taken by that firm. However, portfolio theory in finance
has shown that firm-specific credit risk can be diversified
away if a portfolio of well-diversified stocks is held.
•
Credit risk screening and monitoring can reduce, but not
completely avoid, default risk.
•
While most central governments can prevent default on their
domestic currency-denominated debt due to their ability to
print currency, other entities cannot.
7
8
Consumer credit risk
•
Business credit risk
•
Greater access to easy credit (such as credit cards and
mortgages), even for individuals with a poor credit history
(sub-prime lending), has magnified this risk.
Default by small businesses as well as large corporations
has led to the failure of depository institutions, finance
companies, and insurance companies.
•
Qualitative models: borrower specific factors are considered
as well as market or systematic factors.
•
The largest U.S. bank failure in the 20
th
century, Continental
Illinois in 1984, resulted from overly-aggressive business
lending. Continental Illinois suffered large losses on loans
to energy firms.
•
Specific factors
include: reputation, leverage, volatility of
earnings, covenants and collateral.
•
Market specific factors
include: business cycle and interest
rate levels.
•
The FDIC made a $4.5 billion cash infusion into
Continental. It was later reconstituted as Continental Bank
and sold to Bank of America.
9
10
•
Credit risk management
is important for bank managers
because it determines several features of a loan: interest rate,
maturity, collateral and other covenants. Riskier projects
require more analysis before loans are approved.
Municipal bond risk
• Bonds issued by state and local governments bear credit risk.
• The largest municipal bond failure was the 1983 default on
$2.5 billion of bonds issued by Washington Public Power
Supply System. After 5 years of legal proceedings,
bondholders recovered $753 million (30 percent).
Sovereign credit risk
•
•
If credit risk analysis is inadequate, default rates could be
higher and push a bank into insolvency, especially if the
markets are competitive and the margins are low.
•
Credit risks of some off-balance-sheet products
such as
loan commitments, options, and interest rate swaps, are
difficult to assess because the contingent payoffs are not
deterministic, making the pricing of these products
complicated.
Many countries, especially developing ones, experience high
and volatile inflation making their domestic-currency
denominated debt unattractive to foreign investors.
•
Hence, many of these countries borrow from large foreign
banks and investors by issuing foreign currency debt
(usually denominated in dollars, euros, or yen).
11
12
3. Liquidity risk
•
Liquidity risk
tends to compound other risks. If a bank has
a position in an illiquid asset, its limited ability to liquidate
that position at short notice will compound its market risk.
• E.g., a bank has offsetting cash flows with two
counterparties on a given day. If the counterparty that owes
it a payment defaults, the bank will have to raise cash from
other sources to make its payment. Should it be unable to do
so, it too will default. Here, liquidity risk is compounding
credit risk.
• Rarely are the
demands for liquidity
equal to the
supply of
liquidity
at any particular moment. The banks must
continually deal with either a liquidity deficit or surplus.
• It is the risk that a given security or asset cannot be traded
quickly enough in the market to prevent a loss (or make
the required profit).
•
Asset liquidity risk
means that an asset cannot be sold
due to lack of liquidity in the market; essentially it is a
sub-set of market risk.
•
Funding liquidity risk
means that liabilities cannot be
met when they fall due or can only be met at an
uneconomic price. It can be name-specific or systemic.
• Sudden surges in liability withdrawals may require losses
as bank liquidates illiquid assets at fire sale prices.
13
14
Costs of asset liquidity management
• Loss of future earnings on assets that must be sold
• Transaction costs on assets that must be sold
• Potential capital losses if interest rates are rising
• May weaken appearance of balance sheet
• Liquid assets generally have low returns
Loss guidelines for liquidity managers
• They should keep track of all fund-using and fund-raising
departments
• They should know in advance withdrawals by the biggest
credit or deposit customers
• Their priorities and objectives for liquidity management
should be clear
• Liquidity needs must be evaluated on a continuing basis
• There is a
trade-off between bank’s liquidity and
profitability
. The more resources are tied up in readiness to
meet demands for liquidity, the lower is the bank’s expected
profitability.
•
Northern Rock
suffered from funding liquidity risk back in
September 2007 following the subprime crisis.
• The firm suffered from liquidity issues despite being solvent
at the time, because maturing loans and deposits could not
be renewed in the short-term money markets.
• In response, the FSA now places greater supervisory focus
on liquidity risk especially with regard to high-impact retail
firms.
15
16
4. Interest rate risk
•
Refinancing risk
is the uncertainty of the cost of a new
source of funds that are being used to finance a long-term
fixed-rate asset. This risk occurs when a bank is holding assets
with maturities greater than the maturities of its liabilities.
•
The risk incurred by a bank when the maturities of its assets and
liabilities are mismatched.
•
Occurs when the value of a bank’s assets and liabilities have
different sensitivities
to market interest rates. Assets with
longer durations have more sensitivity to market interest rates.
•
If a bank has a 10-year fixed-rate loan funded by a 2-year time
deposit, it faces a risk of borrowing new deposits, or
refinancing, at a higher rate in two years. Thus, interest rate
increases would reduce net interest income.
•
Interest rate risk occurs because the prices and reinvestment
income characteristics of long-term assets react to changes in
market interest rates differently from the prices and interest
expense characteristics of short-term liabilities.
•
The bank would benefit if the rates fall as the cost of renewing
the deposits would decrease, while the earning rate on the
assets would not change. In this case, net interest income
would increase.
•
Interest rate risk
is the effect on prices (value) and interim
cash flows (interest coupon payment) caused by changes in the
level of interest rates during the life of the financial asset.
17
18
•
Reinvestment risk
is the uncertainty of the earning rate on the
redeployment of assets that have matured. This risk occurs when
a bank holds assets with maturities that are less than the
maturities of its liabilities.
•
The
repricing
(or
funding
)
gap
is the difference between the
value of assets that will reprice and the value of liabilities that
will reprice within a specific time period, where
reprice
means the potential to receive a new interest rate.
•
If a bank has a 2-year loan funded by a 10-year fixed-rate time
deposit, the bank faces the risk that it might be forced to lend or
reinvest the money at lower rates after two years, perhaps even
below the deposit rates.
•
In effect, if interest rates change, interest income and interest
expense will change as the various assets and liabilities are
repriced, that is, receive new interest rates.
•
If the bank receives periodic cash flows (coupon payments from
a bond or monthly payments on a loan), these periodic cash
flows will also be reinvested at the new interest rates.
•
The
maturity bucket
is the time window over which the
amounts of assets and liabilities are measured. The length of
the repricing period determines which of the securities in a
portfolio are rate-sensitive. The longer the repricing period,
the more securities either mature or need to be repriced, and,
therefore, the more the interest rate exposure.
•
Besides the effect on the income statement, this reinvestment
risk may cause the realized yields on the assets to differ from the
a priori expected yields.
19
20
5. Other risks
•
Maturity gap
is the difference between the average maturity of
assets and liabilities.
• If the maturity gap is zero, it is possible to immunize the
portfolio, so that changes in interest rates will result in equal but
offsetting changes in the value of assets and liabilities and net
interest income.
• Thus, if interest rates increase (decrease), the fall (rise) in the
value of the assets will be offset by a perfect fall (rise) in the
value of the liabilities.
• The critical assumption is that the timing of the cash flows on the
assets and liabilities must be the same.
• Large banks are able to reprice securities every day using their
own internal models so reinvestment and repricing risks can be
estimated for each day of the year.
•
Market risk
is the risk of price changes that affects any firm
that trades assets and liabilities. The risk can surface because
of changes in interest rates, exchange rates, or any other
prices of financial assets that are traded rather than held on
the balance sheet.
•
Arises in both the trading book and the more stable banking
book.
•
Off-balance sheet risk
is the impact of unanticipated shocks
resulting from contingent assets and liabilities.
•
May be due to credit risk – e.g., default triggers letter of
credit guarantee or performance bond; to market risk – e.g.,
exchange rate or interest rate swap payments; to operational
risk – e.g., catastrophic options.
21
22
•
Foreign exchange risk
involves the adverse affect on the
value of a bank’s assets and liabilities that are denominated
in the foreign currency when the exchange rate changes.
•
Various other risks
: operational risk; country or sovereign
risk; sudden changes in taxation; changes in regulatory
policy; sudden and unexpected changes in financial market
conditions due to war, revolution, or market collapse; theft,
malfeasance, and breach of fiduciary trust; increased
inflation, and unemployment.
•
A bank is
net long (short) in foreign assets
when the
foreign currency-denominated assets (liabilities) exceed the
foreign currency denominated liabilities (assets).
•
In this case, a bank will suffer potential losses if the
domestic currency strengthens (weakens) relative to the
foreign currency when repayment of the assets (liabilities)
will occur in the foreign currency.
•
These risks are all
interdependent
.
•
Risks of financial intermediation have increased as the
economies have become more integrated.
23
24
Plik z chomika:
Lajira
Inne pliki z tego folderu:
b_0.pdf
(11 KB)
b_01.pdf
(175 KB)
b_02.pdf
(148 KB)
b_03.pdf
(209 KB)
b_04.pdf
(150 KB)
Inne foldery tego chomika:
odpowiedzi banking od oli k
test 2011
tutorials
Zgłoś jeśli
naruszono regulamin