SENSITIVITY TO MARKET RISK-- CAMALS

Sensitivity to market risks is not taken into consideration by CBI at the present time

Market risk

Market risk is the risk that the value of a portfolio, either an investment portfolio or a trading portfolio, will decrease due to the change in value of the market risk factors. The four standard market risk factors are stock prices, interest rates, foreign exchange rates, and commodity prices. The associated market risk is:

• Equity risk, the risk that stock prices and/or the implied volatility will change.
• Interest rate risk, the risk that interest rates and/or the implied volatility will change.
• Currency risk, the risk that foreign exchange rates and/or the implied volatility will change.
• Commodity risk, the risk that commodity prices (e.g. corn, copper, crude oil) and/or implied volatility will change.

Measuring the potential loss amount due to market risk

As with other forms of risk, the potential loss amount due to market risk may be measured in a number of ways or conventions. Traditionally, one convention is to use Value at Risk. The conventions of using Value at risk is well established and accepted in the short-term risk management practice.

However, it contains a number of limiting assumptions that constrain its accuracy. The first assumption is that the composition of the portfolio measured remains unchanged over the specified period. Over short time horizons, this limiting assumption is often regarded as reasonable. However, over longer time horizons, many of the positions in the portfolio may have been changed. The Value at Risk of the unchanged portfolio is no longer relevant.

Risk management:

All businesses take risks based on two factors: the probability an adverse circumstance will come about and the cost of such adverse circumstance.

Rating factors

Market risk is based primarily on the following evaluation factors:

·         Sensitivity to adverse changes in interest rates, foreign exchange rates, commodity prices, fixed assets

·         Nature of the operations of the bank

·         Trends in the foreign currencies exposure

·         Changes in the value of the fixed assets of the bank

·         Importance of real estate assets resulting from loans write off

·         Ability of management to identify measure and control the market risks given the bank exposure to these risks

Composite rating:

The composite rating assigned is not an arithmetic average of the component ratings, but is based on a qualitative analysis of the factors comprising each component, the interrelationship between components, and the overall level of supervisory concern about the bank.

Composite rating 1:

Banks with a composite rating of “1” are sound in all aspects, generally have components rated 1 or 2 and are in substantial compliance with laws and regulations.  Any weaknesses can be handled routinely by the board of directors and management.  Banks are considered stable, well managed and capable of withstanding all but the most severe economic downturns.  Risk management practices are strong and minimal supervisory oversight is required to ensure the continuation and validation of the bank’s fundamental soundness. Banks rated “1” give no cause for concern.

Composite rating 2:

Banks with a composite rating of 2 are fundamentally sound; generally no component is rated higher than “3”, and is in substantial compliance with laws and regulations. Only moderate weaknesses are present and well within the capabilities of the board of directors’ and management’s capability and willingness to correct.

These banks are stable and can withstand most economic downturns. Overall risk management practices are satisfactory and there are not material supervisory concerns.            Supervisory response for “2” rated banks should be informal and limited.

Composite rating 3:

Banks rated “3” generally have weaknesses in one or more component areas that if not corrected within a reasonable time frame could result in significant solvency or liquidity concerns.

Management may lack the ability or willingness to effectively address weaknesses in a timely manner and these banks generally are less capable of withstanding business fluctuation and are vulnerable to outside influences. Risk management practices may be less than satisfactory and banks in this group may be in significant noncompliance with laws and regulations. The CBI should consider the need for administrative actions which provide clear guidance to management in addressing weaknesses.  Failure appears unlikely, however, given the overall strength and financial capacity of these banks.

Composite rating 4:

Banks rated “4” indicate serious unsafe and unsound practices and serious financial or managerial deficiencies that result in unsatisfactory performance. The weaknesses and problems are not being satisfactorily resolved by the board of directors and management. Risk management practices are generally unacceptable and there may be significant violations with laws and regulations.  Problems range from severe to critically deficient and require close supervision and specific remedial action. The overall solvency of the bank is threatened if immediate and specific supervisory action is not taken.

Composite rating 5:

Banks rated “5” exhibit extremely unsafe and unsound practices or conditions, critically deficient performance and their risk management practices are inadequate. The volume and severity of problems are beyond management’s ability or willingness to control or correct.   Failure is highly probable and immediate outside financial or other assistance is needed and on-going supervision is necessary.