BAC7006 Finance of International Business Best Assignment Sample
Introduction
The OCC’s risk-based approach to supervision defines a risk as the possibility that an incident, whether anticipated or unplanned, will have a negative impact on an institution’s earnings or capital. The administration of loan portfolios is the subject of Chapter 4 of the Comptroller’s Manual. The method taken by the OCC to bank supervision is based on nine types of risk that have been identified and are being closely monitored by the organisation. There are multiple parts of the Comptroller’s Handbook that discuss various risks such as credit risk, interest rate risk, liquidity risk, pricing risk, foreign currency risk, transaction risk, compliance risk, and brand risk, just to name a few. A range of risks, such as country risk and transfer risk, are faced by banks that perform international activities and must be managed by these institutions. (Mukherjee, 2019)
PART A
The risks associated with any product or service are not mutually exclusive; depending on the nature of the transaction, any product or service could expose the bank to a variety of hazards in the same transaction. A risk assessment and classification system such as that used by the OCC, on the other hand, helps to facilitate the analysis and debate of hazards.
The inability to understand how the nine risk categories are interconnected with one another is a major source of frustration in the field of risk administration. Perilous relationships between hazards will frequently be established, either for the benefit of the individual or for the detriment of the group, depending on the situation and the circumstances. There will be no difference between the impact of any actions taken or events that occur on correlated risks and the impact on uncorrelated risks when comparing the impact of any actions taken or events that occur. As an example, reducing the number of issue assets might be beneficial for lowering not only credit risk but also other risks like liquidity and reputation, among other things. When two hazards are adversely connected to one another, a reduction in exposure to one form of danger may result in an increase in exposure to the other type of danger. A bank’s overall credit risk may be reduced through the acquisition of one- to four-family residential mortgage loans rather than commercial loans, for example, but the bank’s interest rate risk may increase as a result of the interest rate sensitivity and optionality of the mortgages it has acquired as part of the transaction, as discussed above.
The risks involved with lending can expose a bank’s income and capital to a wide variety of possible outcomes.
Consequently, it is vital that the examiner assigned to the loan portfolio understands all of the risks connected with it as well as the potential repercussions for the institution as a whole before beginning work on the portfolio.
Additional resources include access to a competent loan staff that will be available to assist you. It is important to note that, due to a bank’s failure to swiftly overcome creditors of questionable capacity or character, the bank’s ability to quickly overcome borrowers of questionable capacity or character has a substantial impact on the overall credit quality of its loan portfolio. The likelihood that people who are experiencing financial difficulties, particularly those who have weak or marginal financial performance or whose repayment ability is dependent on unproven assumptions, will not meet their financial obligations within a reasonable time frame is increased in the event of an internal or external economic hardship. It is vital to manage credit risk after a loan has been made since strong credit judgments can be compromised by poor loan structuring or insufficient monitoring.
In order to properly manage their entire credit risk exposure, banks have traditionally been forced to devote the majority of their resources to monitoring individual loans. However, despite the fact that credit risk management is a top concern, it should be evaluated in terms of portfolio portions in addition to considering the entire portfolio when analysing credit risk. In the 1980s, individual credit risk reduction efforts focusing on preventing the credit crises that happened later in the decade were unsuccessful in mitigating those crises. Perhaps, if the portfolio approach to risk management had been utilised in conjunction with these traditional risk management procedures, banks might have been able to avert or at the very least reduce their financial losses.
For the board of directors and management to be able to effectively manage the credit risk associated with the loan portfolio, it is necessary for them to be aware of and control the bank’s risk profile as well as its credit culture. It is critical for them to have a thorough awareness of the portfolio’s composition as well as the risks connected with the investment process in order to function effectively. If they want to be effective, they must be aware of the product mix in their portfolio, along with industry and geographical concentrations, as well as the average risk ratings and other aggregate characteristics. In particular, when it comes to lending, they must ensure that the policies, procedures, and practises in place to limit the risks associated with individual loans and portfolio segments are sound, and that lending professionals adhere to these policies, procedures, and practises while lending.
Furthermore, banks that engage in international lending are exposed to country risks that are not encountered by domestic lending institutions. Nation risk is a term that is used in the financial sector to refer to any and all of the uncertainties that can arise as a result of a country’s economic, social, and political problems that have the potential to have an impact on the payment of foreign debt and equity investments in that country. The likelihood of political and social turmoil, nationalisation and expropriation of assets, state repudiation of foreign borrowings, exchange controls, and currency appreciation or depreciation in the future are all reasonable expectations. If a country’s external debt is not paid back because of these occurrences, it is still possible that a loan will be collected even if the situation remains the same. It is possible for a lending institution to suffer substantial financial consequences as a result of even the smallest delay in the collection procedure throughout the collecting process.
Administration of loan portfolios is the subject of Chapter 6 of the Comptroller’s Manual on Loan Portfolio Administration (Mabrouk,2021).
PART B
Specifically, when it comes to transfer risk, which is a more precise subset of country risk, the likelihood of non-payment relates to the possibility that an obligor will be unable to pay due to the fact that the currency of payment is not available to them. This indicates that a change in government directive has most likely resulted in the unavailability of the service in this situation. However, even if a single borrower is extremely successful and generates enough local currency cash flow to meet its international obligations (such as a United States dollar loan), it is possible that the borrower’s country does not have enough United States dollars on hand to facilitate repayment of the foreign obligations. This committee is responsible for identifying and analysing the transfer risk connected with bank exposures in foreign countries. It is comprised of representatives from various federal agencies. In light of banks’ participation in domestic financial markets, the committee examines the transfer risk associated with those exposures, which is known as transfer risk (ICERC). The International Criminal Enforcement Resource Center (ICERC) assigns a transfer risk rating to each country, and that rating is applied to any bank assets located in that country for the purposes of an investigation. Because of credit risk concerns, examiners may classify specific loans and other assets more severely than they would classify other types of assets, depending on the nature of the loan and other assets (Jaddoa,2019).
An upcoming companion product to the Comptroller’s Handbook, entitled “Nation Risk Management,” will go into further depth on the many techniques to limiting country risk that are available.
The market for interest rates is characterised by a certain amount of risk.
Interest rate risk associated with the bank’s lending activities is determined, among other things, by the composition of the bank’s loan portfolio and the extent to which loan terms (such as maturity date, rate structure, and embedded options) expose the bank’s revenue stream to fluctuations in interest rates.
When evaluating pricing and portfolio maturity estimates, it is important to take into account the funding costs and the maturity of the portfolio, as well as any other relevant factors. The danger of interest rate risk should be assessed on a regular basis for any substantial individual credits or portfolio segments that are particularly vulnerable to it. This will guarantee that they remain economically viable. The asset/liability management committee (ALCO), which is often responsible for managing the bank’s interest rate risk, must have sufficient information on the composition and trends of the loan portfolio and pipeline in order to properly manage the bank’s holdings in order to be successful. Some of the information that could be included in these reports would include the following items (Garicano,2019):
A strong coordination with the lending function, as well as the timely transmission of information from the lending function, is required in order to successfully manage liquidity risk due to the size of the loan portfolio. Surprisingly, loans are the most often employed method of disbursing funds in the United States of America. Apart from that, while controlling loan growth has always been an important component of liquidity management, the loan portfolio has not generally been viewed as a substantial source of cash for liquidity management reasons, which is a mistake. Practices, on the other hand, change with time when new information becomes available. Banks can turn their loans into a source of revenue by reducing the overall dollar amount of loans in their portfolios, which is accomplished through loan portfolio management. Loan sales, securitization, and portfolio run-off are just a few of the strategies that banks could use to attain this goal, amongst a variety of others.
The contrary is true: banks are becoming more and more involved in the management of their loan portfolios as time goes on, rather than the other way around (Posnaya,2019).
Even though these operations are often carried out to minimise credit risk, it has been demonstrated that they can also be used to boost liquidity in specific circumstances. A consequence of this is that banks are increasingly originating loans with the goal of reselling or securitizing the loans that they originate. The prevalent practise of originating consumer loans for quick securitization (mortgages, instalment loans, and credit cards) with the purpose of maximise profits characterises today’s market. As a result of increased efforts by a number of prominent financial institutions, the quantity of underwriting done for the syndicated loan market has increased significantly during the past several years. Federal Reserve officials claim banks are increasing the quantity of bad credits and other unwanted loans that they package and sell to investors, increasing the likelihood of failure.
Identifying loans or loan portfolio sections that may be converted into cash with a minimal amount of time and expenditure should be a priority when a bank does liquidity planning as part of its overall liquidity strategy, according to the Federal Reserve. A number of factors influence the liquidity of a loan, including the loan’s quality, its pricing, its scheduled maturities, and whether or not the loan was underwritten in conformity with market norms at the time of its underwriting, among other things. In addition to serving as collateral for borrowings, loans can also function as a source of liquidity if they are structured properly. When considering how easy it is for banks to originate or sell loans to other lenders or investors, it is critical for banks to take into consideration market conditions, loan kinds, and credit quality, among other factors (as well as the terms on which a bank can do so). Providing information on these features, as well as an assessment of their performance under a variety of conditions, is required prior to the completion of a liquidity study project (Ferreira,2018).
Chapter 8 of the Comptroller’s Manual contains a chapter on loan portfolio management, which may be found under the Financial Management section.
When borrowers withdraw money from their loan agreements, the amount and quantity of money that lenders receive is a factor in determining their liquidity (or how much money it has available to lend). In order for a bank to be successful, it must set and maintain tracking metrics for commitments and borrower usage.
As an example, it is critical to understand the kind of commitments and agreements that are currently being negotiated and implemented in order to determine whether or not existing liquidity will be sufficient to meet normal, seasonal, or emergency demands, among other factors. A difference should be made by information and communication technology systems used for banking administration between commitments that the bank is legally compelled to finance and commitments that the bank is not legally obligated to finance (such as guidance or advisory lines).
In addition to a bank’s legal obligation to lend, the bank’s ability to reduce or eliminate present commitments must be taken into account when evaluating the bank’s ability to reduce or eliminate existing liabilities, as described above. When making this selection, it is important to consider the likelihood of negative publicity as well as the possibility of lender liability claims. It is probable that banks could be pushed to withdraw from or minimise their commitments to their clients, which will have major ramifications.
It’s possible that a bank’s capacity to keep or grow its customer base could be affected as a result of a strategic commitment being tightened, and the bank’s ability to do so will suffer as a result. When credit conditions are tight, it is especially critical for the bank to avoid being perceived as a less-than-reputable lender. Having a financial institution’s reputation damaged as a result of its perceived unwillingness to cooperate with community credit rules is a bad thing for everyone involved.
The rising level of worry requires bank management to carefully assess the ramifications of cutting lending limits in the future.
Price Uncertainty Is an Unavoidable Reality of Life
Price risk has been affected by the majority of the modifications that have been implemented in order to boost the liquidity of the loan portfolio as a result of their implementation, according to the report. Because of the danger of price changes, many years have passed with little or no impact on the lending activities of the vast majority of banks in the United States. A requirement arising from the fact that loans were frequently held to maturity imposed the requirement that they be recorded at book value rather than their market value at the time of recording, as required by accounting regulations.
Note that while banks’ loan portfolios will become increasingly sensitive to price risk as they apply more active portfolio management procedures and as the loan market grows in depth and breadth, this will not occur overnight.
Pricing risk applies to loans that are planned for sale as part of a securitization or for direct placement in the secondary market during the time period in which they are in the pipeline, pending packaging and sale, and have not yet been packaged and sold, as well as to loans that are planned for sale as part of a securitization or for direct placement in the secondary market.
For loan portfolio management and other elements of the business, it is necessary to understand a bank’s credit culture and risk profile in order to be effective. It is reasonable to expect that the credit culture of a financial institution will have an impact on the operations of the institution’s other departments, given how important lending activities are to the institution. Members of the bank’s management team should be aware with the credit culture and risk profile of the organisation. Account officers should be trained in credit policy knowledge, which should then be passed on to administrative support employees as needed. As the credit policy knowledge flow goes downward, the chief credit policy officer should train his or her subordinates in credit policy knowledge. It is the board of directors and senior management’s job to instil a credit culture in their organisations. The credit standards that form the cornerstone of a credit culture should not only be publicly accepted, but they should also be included into strategic planning and the control of portfolio management practises, among other things.
In the context of financial institutions, this word refers to the credit ideas, attitudes, and practises of the institution as a whole, which collectively comprise the institution’s credit culture.
The activities done, as well as the way in which they are carried out, are both significant considerations.
A bank’s credit culture has a substantial impact on the institution’s lending and credit risk management practises, which is important if the bank is concerned with lending and credit risk management practises. When you reward values and activities that are recognised and accepted, you are developing norms, and these values and behaviours will eventually take precedence over the policies and procedures that have been put in place to obtain those rewards.
By contrast with a financial institution’s credit culture, a bank’s risk profile can be analysed more quickly and easily than it can in most other scenarios. Risk profiles must be produced in order to characterise the various degrees and types of risk that can be found in a portfolio of investments. Risk profiles can be found in the following documents: Credit culture, strategic planning, and day-to-day loan-issuing and loan-collection activities are all factors that contribute to the development of a credit profile.
Comment on portfolio
When it comes to credit culture, there are significant differences between different financial institutions that can be observed in different financial organisations. A extremely conservative approach to credit is taken by some financial institutions, who restrict their lending to clients who are financially secure and well-established in order to avoid taking on undue risk.
It is possible that the growth-oriented banks may adopt a more aggressive lending approach, which may include offering credit to borrowers who are more likely to default on their financial obligations in the future. According to asset quality, development potential, and profits goals of a bank, there is a strong association between these cultural qualities as well as the aims of the bank.
A larger priority being placed on one of these objectives in comparison to another does not impede the achievement of adequate outcomes in all three areas of concentration. While lending operations are concerned, the emphasis will have an impact on the way they are carried out, and it may also result in changes to credit policies and risk management systems as a result of the changes. A bank that is pushed to achieve aggressive growth ambitions may be necessary to establish stronger credit regulations, as well as more severe administrative and monitoring systems, in order to properly manage credit risk, according to the Federal Reserve. Let us consider profitably managed banks, which have maintained a good balance between asset quality, growth, and earnings over a protracted period of time by focusing on the long term. In the presence of all of the aforementioned variables, it is possible to identify principles of organisational culture, as well as credit rules and processes, that are mutually reinforcing, accurately defined, fully understood, and painstakingly applied.
Conclusion
It is essential for a bank to have a clear connection between its culture, risk profile, and lending policies in order for the institution to be successful. Credit practises and risk-taking activities of a bank must be in sync with the desired corporate culture and norms before management can address the reasons why they are out of sync with the desired corporate culture and norms. Employees who engage in behaviours that are at variance with the company’s goals and mission are more likely to be rewarded when business practises do not conform with business standards. Unless practises and policies are in sync, it is likely that lenders will have a limited understanding of the organization’s overall culture. If practises do not match to policies, credit controls may be ineffective, rules and procedures may be inappropriate for the credit environment, and lenders may be unaware of the culture if practises do not correspond to policies. The culture of a company may not be recognised by lenders if practises do not correspond to policies. When a risk profile deviates from cultural norms, risk tolerance levels should be reevaluated and adjusted accordingly. It is necessary to revise strategies in order to account for the variance.
References
Budi, W.P.S. and Wilhelmus, H.S., THROUGH THE PORTFOLIO FORMATION IN BANKING INDUSTRY: INSIGHT THE MODEL OF MARKOWITZ.
Ferreira, L., Borenstein, D., Righi, M.B. and de Almeida Filho, A.T., 2018. A fuzzy hybrid integrated framework for portfolio optimization in private banking. Expert Systems with Applications, 92, pp.350-362.
Garicano, L., 2019, December. Two proposals to resurrect the Banking Union: the Safe Portfolio Approach and SRB+. In ECB conference on “Fiscal Policy and EMU governance”, Frankfurt (Vol. 19).
Garicano, L., 2019, December. Two proposals to resurrect the Banking Union: the Safe Portfolio Approach and SRB+. In ECB conference on “Fiscal Policy and EMU governance”, Frankfurt (Vol. 19).
Jaddoa, M.H., Kadhim, S.M. and Abdulhasan, S.H., 2019. Performance of the Banking Investment Portfolio According to the Indicators Applied Research. Opción: Revista de Ciencias Humanas y Sociales, 35(20), pp.516-531.
Jordan, D.J. and Sanchez, J., 2019. The potential impact of CECL effect on the banking industry: Using portfolio duration estimation. Available at SSRN 3397306.
Mabrouk, A. and Farah, L., 2021. Liquidity Risk Management in the Islamic Banking: Portfolio of Ijara and Murabaha. European Journal of Islamic Finance, (18).
Mukherjee, S., Deyasi, A., Bhattacharjee, A.K., Mondal, A. and Mukherjee, A., 2019. Role of Metaheuristic Optimization in Portfolio Management for the Banking Sector: A Case Study. In Metaheuristic Approaches to Portfolio Optimization (pp. 198-220). IGI Global.
Posnaya, E.A., Semenyuta, O.G., Dobrolezha, E.V. and Smolander, M., 2019. Modern features for capital portfolio monitoring.
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