|
|
|
|
6. Recommendations for Enhancing Bank Transparency
(d) Risk exposures
- Market participants and supervisors need qualitative and quantitative information about an institution's risk exposures, including its strategies for managing risk and the effectiveness of those strategies. Together with the disclosure of a bank's financial position, these help reflect its financial strength and viability and ultimately its ability to continue its business in times of stress. A bank's risk profile, i.e., the risks inherent in its on- and off-balance-sheet activities at a point in time and its appetite for taking risk, provides information about the stability of an institution's financial position and the sensitivity of its earnings potential to changes in market conditions. Moreover, an understanding of the nature and extent of an institution's risk exposures helps assess whether a bank's returns are appropriate for the level of risk it has assumed.
- Disclosures of risk information assist in assessing the amount, timing and certainty of future cash flows. Given the dynamic financial markets in which banks operate, and the influences of increased global competition and technological innovation, a bank's risk profile can change very quickly. Therefore, users of financial information need measures of risk exposures that remain meaningful over time and which accurately reflect sensitivities to changes in underlying market conditions.
- Traditionally, banks have focused on disclosing information about credit risk and market risk, including interest rate and foreign exchange risk, and, to a lesser extent, liquidity risk. In discussing each of these risk areas, an institution should present sufficient qualitative (e.g., management strategies) and quantitative information (e.g., position data) to help users understand the nature and magnitude of these risk exposures. Further, comparative information of previous years' data should be provided to give the financial statement user a perspective on trends in the underlying exposures.
- Other risk exposures such as operational, legal and strategic risk are less easy to quantify, but may be highly relevant. Qualitative information should be given about the nature of the risks and how they are managed.
(i) Credit risk
- For many institutions, credit risk is the most significant exposure. Although typically it arises primarily from the loan portfolio, credit risk also arises in the investment and trading portfolios and in other banking activities (e.g. asset securitisation, interbank lending, overnight deposits).
- Disclosures should help the reader understand the magnitude of an institution's credit exposure on an aggregate basis as well as its significant components. Further, the user of financial information should be able to understand how an institution manages credit risk and whether or not those strategies have been effective.
- To achieve transparency, an institution should provide descriptive information about the business activities that create credit risk, its strategies regarding those business lines, and the nature and composition of the exposures that arise. Examples of useful disclosures include a discussion about business strategies, risk management processes and internal controls relating to activities that generate credit risk. In addition, quantitative information should be provided regarding gross positions (e.g., loans, investments, trading and off-balance-sheet exposures), information about the types of counterparties (e.g., exposure to banks, commercial, and government entities; domestic and international exposures; subordinate assets, and secured and unsecured exposures), and significant concentrations of credit exposure. Further, information on potential credit risk exposure arising from existing derivative contracts is useful, since that exposure may change rapidly and substantially.
- Disclosures about the quality of the current loan and investment portfolios and other significant counterparty exposures provide important information about an institution's future earnings potential. Quantitative disclosures should include the amount of problem loans and other assets, an ageing schedule of past due loans and other assets, concentrations of credit, and aggregate exposures by counterparty credit quality. In addition, information should be provided about the allowances for credit losses and how those allowances have changed from period to period.
- An understanding of an institution's credit risk position is facilitated through disclosure of risk management strategies. For example, disclosures about the use of collateral and guarantees, the use of credit scoring and portfolio risk measurement models and the organisation of the credit risk function and similar discussions about activities undertaken to manage credit exposures provide background information useful in assessing the significance of risk exposures. Information about the use of credit limits and internal credit ratings is also useful.
(ii) Market risk
- As with credit risk, an institution should provide both quantitative and qualitative information regarding its market risk exposures. Market risk arises from the potential for changes in market rates and prices, including interest rates, foreign exchange rates, and equity and commodity prices. An institution's disclosures about each of these types of risk should be commensurate with the degree of exposure.
- Since interest rate risk is especially relevant to banks, management should provide detailed quantitative information about the nature and extent of interest rate-sensitive assets and liabilities and off-balance sheet exposures. Examples of useful disclosures for the banking book include breakdowns of fixed and floating rate items and the net interest margin earned. Other useful disclosures include the duration and effective interest rates of assets and liabilities. These disclosures should also identify assets and liabilities, and related gains and losses.
- Disclosures should also provide information about the interest rate sensitivity of an institution's assets and liabilities. For example, disclosures about the effect on the value of assets, liabilities and economic equity given a specific change (increase or decrease) in interest rates can provide a useful summary measure of the institution's risk exposure.
- To facilitate understanding of foreign exchange risk exposures, institutions should provide summarised data for significant concentrations of foreign exchange exposure by currency, broken down by hedged and unhedged exposures. It is also helpful to disclose information about investments in foreign subsidiaries (foreign currency translation risk). This quantitative information should be supplemented with discussion about the nature of the currency exposure, how that exposure has changed from year to year, foreign exchange translation effects, the earnings impact of foreign exchange transactions and the effectiveness of risk management (hedging) strategies.
- For larger institutions, "value-at-risk" (VAR) or "earnings-at-risk" (EAR) disclosures can provide summarised data about a market risk exposure. Typically, VAR and EAR disclosures are provided for interest rate and foreign exchange risk, but these models could also be used to summarise equity and commodity risk exposures. Specific disclosures relating to these models include the magnitude of the exposure on a daily, weekly or monthly basis, maximum and minimum values, and end-of-period values. To help the user understand such model-generated information, the assumptions used in calculations (e.g., confidence level, holding period, etc.) should also be disclosed. In addition, a histogram of the daily profits or exposures over the reporting period may facilitate an understanding of the volatility of risk exposures.
(iii) Liquidity risk
- Liquidity is the ability to have funds available to meet the commitments of the bank. To enable market participants to understand an institution's liquidity risk exposure, an institution should provide information about its available liquid assets, as well as its sources and uses of funds. For example, disclosures about short-term assets (e.g., cash and cash equivalents, repurchase agreements and interbank loans) and short-term liabilities (e.g., reverse repurchase agreements, commercial paper) provide basic information about an institution's liquidity profile. A cash flow statement shows the sources and uses of funds and provides an indication of an institution's ability to generate liquid assets internally. Information about concentrations of depositors and other fund providers, maturity information about deposits and other liabilities, and the amount of securitised assets, are useful in assessing an institution's liquidity. Descriptive discussion about the diversity of funding options and contingency plans provides additional perspective on the potential impact of liquidity risk to the institution.
(iv) Operational and legal risks
- Institutions should also provide disclosures about operational and legal risks. Operational risk disclosures should include information about the main types of such risk and should identify any specific problem (e.g., Year 2000) considered to be individually significant. Legal risk disclosures include legal contingencies (including pending legal actions) and a discussion and estimate of the potential liabilities. Qualitative information about how the bank manages and controls these risks should be given.
|
Contact us *
Risk Library *
Documents by Author *
Committees at the Bank for International Settlement (BIS) *
Enhancing Bank Transparency *
6. Recommendations for Enhancing Bank Transparency
|
