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ACF308 Risk Management in International Banking,
Insurance and Finance 2016/17
Assignment 2 Guidance
This should be around 100 words
Explain which bank you are looking at and which risk type (Market, Credit or Operational Risk).
Explain that you are looking at the 3 elements of the question only.
Include no background or definitions. Even a sentence or two of this will lose marks.
The appropriateness of the evaluation techniques that they are using
Around 600 words
Start by identifying whether your bank is using quantitative risk models (this will be always for market and credit risk) or qualitative approaches (only for operational risk, but even here not all banks use qualitative approaches, so check what your bank does).
If using quantitative models then use the following sources to help you discuss the advantages and disadvantages of these models:
P Jorion (2009) “Risk Management Lessons from the Credit Crisis”, European Financial Management, Vol 15, No 5, pp923-933.
R Stultz (2009) “6 Ways Companies Mis-Manage Risk” Harvard Business Review, March, pp86-94.
Apply this to your chosen bank. If it only uses VaR models then the weaknesses identified in the literature will be significant. If however VaR models are complemented with other risk assessment approaches, notably scenario analysis and stress testing, then this is much better.
There is no need to compare different evaluation techniques or to discuss their individual advantages and disadvantages. In any event this would take far more than 600 words!
If your bank uses qualitative models for operational risk then use Cox 2008. This has now been uploaded to Moodle (look under operational risk).
Again there is no need to compare different evaluation techniques or to discuss their individual advantages and disadvantages.
Whether their appetites for market, credit or operational risk are too high or too low
About 600 words
This is a more practical element, there is no significant theory needed. All you need do is explain that an appropriate risk appetite level is about balancing risk and return. The article by Ashby and Diacon can be used here (this is uploaded onto Moodle).
Look for evidence of whether their risk appetite is too high or too low. The general factors that you can use to assess this were covered in the lecture on risk appetite (near the end). For each risk type specific items you might look at were covered in the relevant lecture.
Do not look to define risk appetite or comment on your bank’s risk appetite framework. If you do you will lose marks.
You may use data from the annual report/pillar 3 document (e.g. risk weighted assets) for this element, as well as qualitative information, such as recent newspaper reports on key risk issues for your bank. Use up to date news articles from 2014 onwards.
Be sure that the information you use is relevant for your chosen risk type.
Whether they are holding sufficient capital resources to protect themselves against their market, credit or operational risk exposures
Use the following academic sources to explain why banks need risk capital:
I Erel, S Myers and J Read (2015) “A Theory of Risk Capital” Journal of Financial Economics, Vol. 118, No. 3, pp.620-635. (Focus on the words not the maths)
A Kashyap, R Rajan and J Stein (2008) “Rethinking Capital Regulation” Federal Reserve Bank Kansas City Symposium on Maintaining Stability in a Changing Financial System, Jackson Hole, Wyoming.
Note that the arguments are very similar to those in the literature on why risk management can add value.
Use this literature to consider whether your bank has sufficient capital.
Focus on the level of surplus capital your bank has relative to the minimum for your risk type. If this is not reported, then you can use the capital ratio figures. Notably the CET1 ratio and the total capital (tier 1 and 2) ratio. These should be around 12-15% and 19-23% respectively.
Also look at whether the level of surplus capital is increasing or reducing. Plus whether the level of risk (for your chosen risk type) is increasing or reducing. Here you can use Risk Weighted assets as well as minimum capital requirements.
Look at the narrative on risk capital also – what is your bank saying? Is it concerned about the level of capital it has, or confident it has enough? What are the reasons for this? You may also find other sources which comment about your banks risk capital (e.g. rating agencies or quality newspapers, like the FT).
Do not spend time discussing the regulation of risk capital. This is not part of the question.
About 200-300 words
Provide a final answer to each of the elements, highlighting the key evidence you have for this conclusion. Never say ‘I think’. Remember opinion counts for nothing. You must have evidence.