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What is risk?

Risk arises from uncertainty about the future. It is uncertainty that can be identified, measured, and managed.

Does risk management mean eliminating all risk?

No. Risk management means deciding what risks to take and how much risk is appropriate.

What is the relationship between risk and return?

Risk-taking is generally accepted in pursuit of future returns. Higher potential returns generally require accepting more risk.

What is expected loss?

A predictable or anticipated loss that can be incorporated into pricing, planning, or normal business operations.

What is unexpected loss?

A loss that exceeds expectations and can disrupt business objectives.

What is the difference between risk and uncertainty?

Risk can be measured using probabilities. Uncertainty cannot be reliably quantified.

What is market risk?

The risk of losses caused by changes in market factors such as interest rates, foreign exchange rates, equity prices, or commodity prices.

What is credit risk?

The risk that a customer or counterparty fails to pay or defaults.

What is operational risk?

The risk of losses caused by failed internal processes, people, systems, or external events.

Why classify risks?

To identify, communicate, control, assign responsibility for, and measure risks more effectively.

What are risk silos?

A situation in which risks are managed separately by departments, potentially ignoring connections between different risks.

What is Enterprise Risk Management (ERM)?

An enterprise-wide approach that manages risks across the organization instead of treating each risk separately.

What is the main goal of ERM?

To keep exposure within the risk level agreed upon by the board and provide reasonable assurance that organizational objectives can be achieved.

What does a risk manager do?

Identifies sources of risk, makes risks visible, analyzes possible outcomes, supports decisions, implements policies, and balances risk and reward.

Why is independence important for a risk manager?

The risk manager should interact with business leaders without being dominated by them.

What risks can corporations face?

Demand changes, price changes, new competitors, new technologies, and supply-chain disruptions, among others.

What is hedging?

A strategy used to protect against unexpected changes in prices, interest rates, or exchange rates.

What is the main objective of hedging?

To reduce potential losses and unwanted financial exposure.

What is risk appetite?

The level and type of risk a company is willing to take in order to achieve its objectives.

Who establishes risk appetite?

The Board of Directors.

How can risk appetite be expressed?

Through quantitative limits and qualitative guidelines.

What is risk mapping?

The process of identifying, classifying, evaluating, analyzing exposure, and determining how risks should be treated.

What are the five steps of risk mapping?

Identification, Classification, Evaluation, Exposure Analysis, and Treatment.

What factors are considered in risk evaluation?

Probability and potential damage.

What are the possible treatments for risk exposure?

Insurance, hedging, or acceptance.

What is natural or internal hedging?

Using normal business operations or matching positions to offset risk.

What is financial hedging?

Using financial instruments such as futures, options, swaps, and other derivatives to manage exposure.

What is the difference between exchange-traded and OTC instruments?

Exchange-traded instruments are standardized and traded on public exchanges; OTC instruments are privately negotiated and can be customized.

What is static hedging?

A buy-and-hold or matching approach that requires less monitoring and rebalancing.

What is dynamic hedging?

An approach that continuously or periodically rebalances the hedge as the exposure changes.

Why can accounting effects matter in hedging?

If the derivative does not match the underlying exposure in quantity and timing, mark-to-market volatility can appear in earnings.

How should a hedge be evaluated?

By whether it reduced the intended risk, not simply by whether the derivative itself made money.

What is an important consideration when choosing a risk-management instrument?

Costs, benefits, liquidity, and the level of risk.

Why are banks regulated?

Banks hold deposits, provide payments and credit, and can create systemic problems if they fail.

What is the BCBS?

The Basel Committee on Banking Supervision, which coordinates international banking standards.

What was Basel I?

The first international banking capital standard, introduced in 1988, focused primarily on credit risk.

What was Basel I's minimum capital requirement?

8% of Risk-Weighted Assets (RWA).

What did the 1996 Basel I amendment add?

Market risk.

What was Basel II?

A more risk-sensitive framework introduced in 2004.

What are the three pillars of Basel II?

Pillar I: Capital Adequacy. Pillar II: Supervisory Review. Pillar III: Market Discipline.

What is Pillar I?

Capital adequacy: banks hold capital according to their risks, including credit, market, and operational risk.

What is Pillar II?

Supervisory review: regulators evaluate risk measurement, capital adequacy, and stress testing.

What is Pillar III?

Market discipline through disclosure of capital, risks, capital adequacy, and risk assessment techniques.

Why was Basel III developed?

After the 2007–2009 financial crisis to make banks more resilient and better able to absorb financial shocks.

What are major Basel III reforms?

Higher-quality capital, higher capital requirements, liquidity requirements, leverage ratio, countercyclical buffer, and additional requirements for systemically important banks.

What is CET1?

Common Equity Tier 1, a high-quality form of bank capital emphasized by Basel III.

What is the Basel III CET1 requirement highlighted in the presentation?

4.5% core risk-weighted asset requirement.

What is the capital conservation buffer?

2.5%. Together with the 4.5% CET1 requirement, it gives 7%.

What is the LCR?

Liquidity Coverage Ratio. It measures whether a bank has enough high-quality liquid assets to survive a 30-day stress scenario.

What is the NSFR?

Net Stable Funding Ratio. It addresses long-term structural funding mismatches over approximately a one-year horizon.

What is the Basel III leverage ratio minimum?

3%. It relates Tier 1 Capital to Total Exposure.

What is the countercyclical capital buffer?

A buffer designed to reduce procyclicality. It ranges from 0% to 2.5%.

What is procyclicality?

The tendency of banking activity and risk-taking to reinforce economic booms and downturns.

What is VaR?

Value at Risk, a tool used to estimate potential losses under specified conditions.

What are limitations of VaR mentioned in the presentation?

Short historical data, changing market volatility, changing correlations, and potential increases in systemic risk.

What is Dodd-Frank?

A U.S. law enacted on July 21, 2010, to strengthen financial stability and reduce systemic risk.

What is the Volcker Rule?

A Dodd-Frank provision restricting bank holding companies from proprietary trading and large investments in hedge funds or private equity.

What is the CFPB?

Consumer Financial Protection Bureau, which protects consumers in financial products such as mortgages and credit cards.

What are CoCos?

Contingent Convertible Bonds that can convert into common equity or be written down when a predefined trigger is reached.

What are the two types of CoCo triggers mentioned?

Accounting-based triggers and market-based triggers.

What accounting scandals are highlighted?

Enron, WorldCom, Global Crossing, and Parmalat.

What problems were associated with these scandals?

Misleading information, financial engineering, risk nondisclosure, fraud, and poor information reaching the board.

What is the Sarbanes-Oxley Act (SOX)?

A 2002 U.S. law that strengthened financial controls and financial reporting.

What did the 2007–2009 financial crisis reveal about governance?

Risk management sometimes received insufficient senior attention, hidden risks existed in structured products, and some boards did not understand risks adequately.

What is the main governance relationship the board must oversee?

The alignment between strategy, capital, and risk.

What should the Board of Directors do regarding risk?

Understand strategy and risks, define risk appetite, oversee management, ensure risks are identified and communicated, and verify alignment between strategy, capital, and risks.

What is liquidity risk?

The risk of being unable to obtain cash quickly enough to meet short-term obligations.

What are the four basic risk management choices?

Avoid, Transfer, Mitigate, and Accept.

What does Avoid mean?

Do not engage in activities involving unacceptable risk.

What does Transfer mean?

Transfer risk to another party through tools such as insurance, hedging, or outsourcing.

What does Mitigate mean?

Reduce risk through controls and preventive measures.

What does Accept mean?

Accept a risk when it is considered appropriate and can create value for shareholders.

What is the difference between risk appetite and risk limits?

Risk appetite is the overall amount and type of risk the organization is willing to accept; risk limits are specific restrictions used to control exposure in business areas.

What is the role of the Audit Committee?

Oversight of financial reporting, regulatory compliance, internal controls, and risk-management processes.

What is the role of the Risk Management Committee?

Review risk policies and systems, monitor credit, market and liquidity risks, review portfolios and risk trends, and report important matters to the board.

Why is the Compensation Committee important for risk management?

It helps prevent compensation structures from encouraging excessive short-term risk-taking.

What compensation controls are mentioned?

Deferred compensation, clawbacks, removal of guaranteed bonuses, and bonus bonds.

What is the role of the CRO?

To design risk strategy, develop policies and methodologies, monitor limits, make risk decisions, communicate decisions, and require positions to be reduced or closed when necessary.

What should the CRO be able to do?

Act as a strategist, have direct access to the Board, remain independent, flag risk-appetite breaches, and evaluate new products.

What is the purpose of a Business Risk Committee?

To ensure business decisions are consistent with the desired risk/reward balance.

How often should market risk positions be valued according to the presentation?

Daily.

What should risk reports be like?

Timely, meaningful, based on independently verified assumptions, and useful for assessing compliance with risk limits.

What happens when a risk limit is exceeded?

The excess should be reported; managers should not exclude a breach from the daily exception report.

What is the difference between Risk Management and Internal Audit?

Risk Management identifies, measures, and monitors risk; Internal Audit reviews controls, tests processes, and evaluates effectiveness.

Basel I capital requirement

8%

Basel III CET1 minimum

4.5%

Capital conservation buffer

2.5%

CET1 + conservation buffer

7%

Basel III leverage ratio

3%

Countercyclical capital buffer

0–2.5%

SIFI additional surcharge

1–2.5%

LCR stress horizon

30 days

NSFR horizon

1 year

Dodd-Frank

July 21, 2010

Financial crisis

2007–2009

Basel I

1998

Basel II

2004