Analyzing Banking Risk: A Framework for Assessing Corporate Governance and Risk Management (World Bank Training Series) by Hennie van Greuning (2009-03-31) by Hennie Van Greuning

1

Framework for Risk Analysis
KEY MESSAGES
This publication discusses the assessment, analysis, and management of banking risks, focusing on
the following aspects:
Banks are exposed to financial, operational, and environmental risks.
A series of key stakeholders (players) are accountable for corporate governance and various
dimensions of financial risk management.
The central components of risk management are the identification, quantification, and
monitoring of the risk profile.
The analysis of banks must consider the current status of a country’s financial system.
Financial sector development encompasses several steps to ensure that institutions operate in a
stable and viable macropolicy environment with a solid legal, regulatory, and financial
infrastructure.
Analytical tools provided in this publication include examples of ratios and graphs that provide
high-level management information.
1.1 Introduction: Banks in a Changing
Environment
This publication provides a comprehensive overview of topics related to the
assessment, analysis, and management of banking risks and offers a high-

level corporate governance framework aimed at nonspecialist executives.
The framework emphasizes the accountability of key players in the corporate
governance process in managing different dimensions of financial risk.
Rapid innovation in financial markets and the internationalization of
financial flows have changed the face of banking. The new practices are
almost unrecognizable compared with the banking practiced just a few
decades ago. Technological progress and deregulation have provided both
new opportunities for and increased competitive pressures among banks and
nonbanks alike. Margins from traditional banking business began to
diminish, and capital adequacy requirements have been increasing
constantly. Banks have responded to these new challenges with vigor and
imagination by entering new business areas focusing on superior information
and knowledge management capabilities.
The growth in international financial markets and a greater diversity of
financial instruments have given banks wider access to funds. At the same
time, opportunities have arisen to design new products and provide more
services. The pace of these changes does not appear to be slowing as banks
constantly develop new instruments, products, and services. Traditional
banking practice—based on the receipt of deposits and the granting of loans
—is today only one part of a typical bank’s business.
Today, the major sources of a bank’s profitability are information-based
activities, such as trading in financial markets and income generation
through fees. Financial innovation has also led to the increased market
orientation and marketability of bank assets, in particular through
securitization and more advanced derivative products.
The introduction of prudential capital requirements, which initially led to
a variety of new “off-balance-sheet” financial instruments, was originally
considered a prime motivator for such innovation. Financial derivatives
(such as guarantees and letters of credit) as well as derivative instruments
(such as futures and options) were not always disclosed on the face of
balance sheets as assets or liabilities, even though they exposed banks to
major risks. Accounting regulators and the International Accounting
Standards Board (IASB) have rectified some deficiencies in accounting
practices by requiring that all financial instruments be shown on the balance
sheets of entities trading in them.
The correlations between different types of risk, both within an individual
bank and throughout the banking system, have therefore increased and
become more complex. In addition, internationalization and deregulation
have increased the possibilities for contagion—as evidenced by the spread of
financial crises. In the late 1990s, financial crises spread from Thailand to

Analyzing Banking Risk: A Framework for Assessing Corporate Governance and Risk Management (World Bank Training Series) by Hennie van Greuning (2009-03-31) by Hennie Van Greuning