13 Questions on Risk Management
   
   Is there a limit system in place?
   


















 

13 Questions on Risk Management

Is there a limit system in place?

All firms must have a comprehensive risk limit system consistent with the firmís philosophy, effectiveness at managing risk as well as its capital position. Senior management must construct an integrated institution-wide limits system in accordance with the risk philosophy laid down by the board of directors. They must calculate the risk limits for each type of position as well as each major risk category. The limit system should provide the capability to allocate limits down to individual business units. Authorised limits in the form of transaction type, term, currency and size allocated to individuals should be based upon their expertise and experience. Limit exemptions (including the authorisation procedures before such transactions are executed) must be clearly spelt out. Only senior managers should deal with limit excesses, and requests to go beyond set limits can only be approved by authorised personnel. All employees must be made aware of the penalties and disciplinary action they face if risk limits are broken; on its part senior management must ensure that these penalties are carried out to the letter. Limit breaches and their dispositions must be reported to the executive board and periodically to the supervisory board who must also check that senior management is ensuring compliance with the established disciplinary rules.

In addition, senior managers may draw up stop/loss limits for each individual trading group and possibly each individual trader. These limits set the maximum amount of loss the firm would tolerate before liquidating a position.

The entire limits process must be reviewed regularly - individual, business and risk-category limits, limit utilisation, procedures for limit exemptions and penalties for breaching limits. Senior managers should bear in mind the average utilisation of limits as well as the maximum when they review limits.


The answers to the following questions are more technical because they discuss the risks of financial instruments, together with their measurement and management. Readers may find certain terms unfamiliar; however, they are essential to understanding the risks of financial instruments.

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Case Studies * 13 Questions on Risk Management