Foundations of Financial Risk E-Book
76,99 €
Mehr erfahren.
- Herausgeber: John Wiley & Sons
- Kategorie: Fachliteratur
- Serie: Wiley Finance Editions
- Sprache: Englisch
Gain a deeper understanding of the issues surrounding financial risk and regulation Foundations of Financial Risk details the various risks, regulations, and supervisory requirements institutions face in today's economic and regulatory environment. Written by the experts at the Global Association of Risk Professionals (GARP), this book represents an update to GARP's original publication, Foundations of Banking Risk. You'll learn the terminology and basic concepts surrounding global financial risk and regulation, and develop an understanding of the methods used to measure and manage market, credit, and operational risk. Coverage includes traded market risk and regulation, treasury risk and regulation, and much more, including brand new coverage of risk management for insurance companies. Clear explanations, focused discussion, and comprehensive relevancy make this book an ideal resource for an introduction to risk management. The textbook provides an understanding of risk management methodologies, governance structures for risk management in financial institutions and the regulatory requirements dictated by the Basel Committee on Banking Supervision. It provides thorough coverage of the issues surrounding financial risk, giving you a solid knowledgebase and a practical, applicable understanding. * Understand risk measurement and management * Learn how minimum capital requirements are regulated * Explore all aspects of financial institution regulation and disclosure * Master the terminology of global risk and regulation Financial institutions and supervisors around the world are increasingly recognizing how vital sound risk management practices are to both individual firms and the capital markets system as a whole. Savvy professionals recognize the need for authoritative and comprehensive training, and Foundations of Financial Risk delivers with expert-led education for those new to risk management.
Sie lesen das E-Book in den Legimi-Apps auf:
Seitenzahl: 573
Veröffentlichungsjahr: 2015
Ähnliche
Foundations of Financial Risk
An Overview of Financial Risk and Risk-Based Regulation
Richard Apostolik Christopher Donohue
Cover Design: Maryann Appel Cover Image: ©iStock.com/Cobalt88
Copyright © 2015 by John Wiley & Sons, Inc. All rights reserved.
Published by John Wiley & Sons, Inc., Hoboken, New Jersey. Published simultaneously in Canada.
No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning, or otherwise, except as permitted under Section 107 or 108 of the 1976 United States Copyright Act, without either the prior written permission of the Publisher, or authorization through payment of the appropriate per-copy fee to the Copyright Clearance Center, Inc., 222 Rosewood Drive, Danvers, MA 01923, (978) 750-8400, fax (978) 750-4470, or on the web at www.copyright.com. Requests to the Publisher for permission should be addressed to the Permissions Department, John Wiley & Sons, Inc., 111 River Street, Hoboken, NJ 07030, (201) 748-6011, online at http://www.wiley.com/go/permissions, or fax (201) 748-6008.
Limit of Liability/Disclaimer of Warranty: While the publisher and author have used their best efforts in preparing this book, they make no representations or warranties with respect to the accuracy or completeness of the contents of this book and specifically disclaim any implied warranties of merchantability or fitness for a particular purpose. No warranty may be created or extended by sales representatives or written sales materials. The advice and strategies contained herein may not be suitable for your situation. You should consult with a professional where appropriate. Neither the publisher nor author shall be liable for any loss of profit or any other commercial damages, including but not limited to special, incidental, consequential, or other damages.
For general information on our other products and services or for technical support, please contact our Customer Care Department within the United States at (800) 762-2974, outside the United States at (317) 572-3993 or fax (317) 572-4002.
Wiley publishes in a variety of print and electronic formats and by print-on-demand. Some material included with standard print versions of this book may not be included in e-books or in print-on-demand. If this book refers to media such as a CD or DVD that is not included in the version you purchased, you may download this material at http://booksupport.wiley.com. For more information about Wiley products, visit www.wiley.com.
The Global Association of Risk Professionals has made every effort to ensure that at the time of writing the contents of this study text are accurate, but neither the Global Association of Risk Professionals nor its directors or employees shall be under any liability whatsoever for any inaccurate or misleading information this work could contain.
No employee of GARP is permitted to receive royalties on books or other writings he or she has authored or co-authored that are part of any program offered by GARP or which were authored as a part of their employment activities with GARP.
ISBN 978-1-119-09805-8 (Hardcover) ISBN 978-1-119-10639-5 (ePDF) ISBN 978-1-119-10640-1 (ePub)
This book is dedicated to GARP's Board of Trustees, without whose support and dedication to developing the profession of risk management this book would not have been necessary or possible, and to the Association's volunteers, representing thousands of organizations around the globe, who work on committees and share practical experiences in numerous global forums and in other ways, and whose goal is to create a culture of risk awareness.
CONTENTS
Preface
Acknowledgments
Introduction
CHAPTER 1 Functions and Forms of Banking
1.1 Banks and Banking
1.2 Different Bank Types
1.3 Banking Risks
1.4 Forces Shaping the Banking Industry
CHAPTER 2 Managing Banks
2.1 Balance Sheet and Income Statement
2.2 Loan Losses
2.3 Asset and Liability Management
2.4 Corporate Governance
Notes
CHAPTER 3 Banking Regulation
3.1 The Evolution of Risk Regulation in Banking
3.2 Foundations of Bank Regulation
3.3 International Regulation of Bank Risks
3.4 Deposit Insurance
Notes
CHAPTER 4 Credit Risk
4.1 Introduction to Credit Risk
4.2 Lenders
4.3 Borrowers
4.4 Characteristics of Credit Products
4.5 Types of Credit Products
4.6 The Credit Process
4.7 The Credit Analysis Process
4.8 Information Sources
Notes
CHAPTER 5 Credit Risk Management
5.1 Portfolio Management
5.2 Techniques to Reduce Portfolio Risk
5.3 Portfolio Credit Risk Models
5.4 Credit Monitoring
5.5 Credit Rating Agencies
5.6 Alternative Credit Risk Assessment Tools
5.7 Early Warning Signals
5.8 Remedial Management
5.9 Managing Default
5.10 Practical Implications of the Default Process
5.11 Credit Risk and the Basel Accords
CHAPTER 6 Market Risk
6.1 Introduction to Market Risk
6.2 Basics of Financial Instruments
6.3 Trading
6.4 Market Risk Measurement and Management
6.5 Market Risk Regulation
Notes
CHAPTER 7 Operational Risk
7.1 What Is Operational Risk?
7.2 Operational Risk Events
7.3 Operational Loss Events
7.4 Operational Risk Management
7.5 Basel II and Operational Risk
Notes
CHAPTER 8 Regulatory Capital and Supervision
8.1 Pillar 1—Bank Regulatory Capital
8.2 Types of Bank Regulatory Capital under Basel II
8.3 Bank Capital under Basel III
8.4 Pillar 2—Supervisory Review
8.5 Pillar 3—Market Discipline
8.6 International Cooperation
8.7 Beyond Regulatory Capital
CHAPTER 9 Insurance Risk
9.1 Introduction to the Insurance Industry
9.2 Property and Casualty Insurance
9.3 Life Insurance
9.4 Reinsurance
9.5 Other Types of Risk
9.6 Regulation and Supervision—Solvency 2 in the European Union
9.7 The Role of Lloyd's of London
9.8 Summary
Glossary
Index
EULA
List of Illustrations
Chapter 1
Figure 1.1
Examples of Bank Products and Core Bank Services
Figure 1.2
Asset Transformation
Figure 1.3
Money Creation (USD 801 in New Lending from Initial USD 100 Deposit)
Figure 1.4
Bank Risks
Figure 1.5
Gains vs. Losses for American S&Ls as Interest Rates Rise
Chapter 2
Figure 2.1
Bank A's Balance Sheet
Figure 2.2
Trading and Banking Books
Figure 2.3
shows Bank A's debt financing.
Figure 2.4
The Bank's Interest Income
Figure 2.5
The Bank's Interest Expense
Figure 2.6
Bank A's Balance Sheet
Figure 2.7
Bank A's Balance Sheet after the Loss
Figure 2.8
Effect of Losses on a Bank's Equity
Figure 2.9
Simplified Balance Sheet—Smaller Equity Base or Higher Leverage
Figure 2.10
Typical Bank Balance Sheet
Figure 2.11
Creating a Loan Loss Reserve
Figure 2.12
Profits Reduced by Additional Provision
Figure 2.13
Additional Loan Loss Provision Creates Net Loss
Figure 2.14
Writing Back Loan Losses Increases Cash
Figure 2.15
Repurchase Agreement
Figure 2.16
The Use of Collateral
Figure 2.17
Typical Organizational Structure with Board of Directors
Figure 2.18
Typical Organizational Structure with Supervisory Board
Figure 2.19
Corporate Governance Techniques
Chapter 3
Figure 3.1
From Bank Run through Bank Panic and Contagion
Figure 3.2
BIS—Banking Risk and Regulation
Figure 3.3
Risk Weights Associated with Certain Credits
Figure 3.4
Calculation of Risk-Weighted Assets for Bank B
Figure 3.5
The Three Pillars of the Basel II Accord
Chapter 4
Figure 4.1
Major Types of Banks
Figure 4.2
An Overview of the Differences between Borrower Types
Figure 4.3
Short-Term, Medium-Term, and Long-Term Lending
Figure 4.4
Committed and Uncommitted Facilities
Figure 4.5
Loan and Lease Cash Flows (in USD)
Figure 4.6
Steps in the Credit Process
Figure 4.7
The Five Cs of Credit
Figure 4.8
Asset Growth and Financing
Figure 4.9
Credit Analysis Path
Figure 4.10
Business, Financial, and Structural Risks
Figure 4.11
Business and Structural Risks
Figure 4.12
Examples of Macro Factors
Figure 4.13
Microeconomic Factors
Figure 4.14
SWOT Analysis
Chapter 5
Figure 5.1
Securitization Process
Figure 5.2
Credit Ratings and Their Interpretations
Figure 5.3
Timeline of Sovereign Defaults—1998 to 2014
Figure 5.4
NRSROs as of August 2014
Chapter 6
Figure 6.1
Foreign Exchange Rates from September 2014
Figure 6.2
Direction and Size of Flows
Figure 6.3
The Relationship Between Interest Rates and Bond Prices
Figure 6.4
Yield Curve
Figure 6.5
Payoff Call Option
Figure 6.6
Payoff Put Option
Figure 6.7
Payment Flows in a Swap
Figure 6.8
The Relationship Between Risk and Reward
Figure 6.9
Risks and Rewards of Long and Short Positions
Figure 6.10
A General Comparison between OTC and Exchange Markets
Figure 6.11
Graphical Interpretation of Value-at-Risk
Figure 6.12
Value of Positions
Figure 6.13
Payoff Position in Acme Stock and Put Option
Figure 6.14
Yield-Spread Ratio
Figure 6.15
Market Risk Capital Requirements under Basel III
Chapter 7
Figure 7.1
Operational Risk Events
Figure 7.2
Loss Impact and Frequency Chart of Operational Risk Events
Figure 7.3
Steps in the Operational Risk Management Process
Figure 7.4
Operational Risk—Top-Down Approach
Figure 7.5
Operational Risk—Bottom-Up Approach
Figure 7.6
The Process of Depositing a Check at a Bank
Figure 7.7
Beta Factors to Calculate Operational Risk Capital in Standardized Approach
Figure 7.8
Comparison of Risk Capital Charge under the Basic Indicator Approach and Standardized Approaches for GammaBank
Chapter 8
Figure 8.1
Methods for Calculating Capital According to Basel II
Figure 8.2
Sample Regulatory Capital Reports
Chapter 9
Figure 9.1
Typical Industry Structure and Key Participants
Figure 9.2
Illustration of the Interaction of Significant Risk Categories
Figure 9.3
Example Types of Property and Casualty Insurance
Figure 9.4
Types of Maximum Losses
Figure 9.5
Solvency 2: Three-Pillar Approach
Figure 9.6
Example Schematic of an Internal Model Under Solvency 2
Figure 9.7
Solvency 2 and Basel II/III—Similarities and Differences
Figure 9.8
Lloyd's of London—Overview and Participants
Guide
Cover
Table of Contents
Preface
Pages
xv
xvi
xvii
xviii
xix
xx
xxi
xxiii
xxv
xxvi
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
26
27
28
29
31
32
33
34
35
36
37
38
39
40
41
42
43
44
45
46
47
48
49
50
51
52
53
54
55
56
57
58
59
60
61
62
63
64
65
66
67
69
70
71
72
73
74
75
76
77
78
79
80
81
82
83
84
85
86
87
88
89
90
91
92
93
94
95
96
97
98
99
100
101
102
103
105
106
107
108
109
110
111
112
113
114
115
116
117
118
119
120
121
122
123
124
125
126
127
128
129
130
131
132
133
134
135
136
137
138
139
140
141
142
143
144
145
146
147
149
150
151
152
153
154
155
156
157
158
160
161
162
163
164
165
166
167
168
169
170
171
173
174
175
176
177
178
179
180
181
182
183
184
185
186
188
189
190
191
192
193
194
195
196
197
198
199
200
201
202
203
204
205
206
207
208
209
210
211
212
213
214
215
216
217
218
219
220
221
222
223
224
225
226
227
228
229
230
231
232
233
234
235
236
237
238
239
240
241
242
243
244
245
246
247
248
249
250
251
252
253
254
255
256
257
258
259
260
261
262
263
264
265
266
267
268
269
270
271
272
273
274
275
276
277
278
279
281
282
283
284
285
286
287
288
289
290
291
292
293
294
295
296
297
298
299
300
301
302
303
304
305
307
308
309
310
311
312
313
314
315
316
317
318
319
320
321
322
323
324
325
326
327
328
329
330
331
332
333
334
335
336
337
338
339
340
PREFACEThe New World of BankingBanking after the Global Financial Crisis
The global financial crisis of 2007-2009 will shape the ways banks are managed for many decades to come. It will also continue to affect the ways that politicians, regulators, analysts, and the general public think about banks and behave toward them.
Banking crises are not unusual. The Argentinian currency revaluation in 2001 led to a crisis for its banks, the Asian financial crisis of 1997 led to the insolvency of many of the region's banks, Sweden suffered a banking crisis in the early 1990s, and in the mid-1970s many second-tier British banks suffered huge losses as a result of a collapse in property prices.
Yet the 2007-2009 global financial crisis stands out from other banking crises due to its global extent, its impact on economic growth, and the far-reaching policy responses that have followed it. In all three respects, what happened in 2007-2009 resembles the financial crash and economic depression of the late 1920s and early 1930s more than it does any of the other banking system crises of more recent years.
The events of 2007-2009 challenged many of the widely held assumptions about how banks and banking systems worked. In simple terms, many things that would have been dismissed as unthinkable a few years before actually happened.
For example, it had always been assumed that banks and other commercial institutions would invariably make liquidity available to other financial institutions even if they charged very high rates for it. Yet during the days that followed the collapse of Lehman Brothers in September 2008, short-term financing markets dried up as banks refused to extend liquidity at any price. The level of uncertainty in financial markets was such that banks did not want to increase their exposure to anyone else, however strong they seemed to be.
Among the other ideas challenged by the crisis was the distinction between off-balance-sheet and on-balance-sheet items, the value of credit ratings, and the ability of many new capital instruments to absorb losses.
More generally, the long-term trend toward deregulation of financial markets that had begun in the 1970s and gathered pace during the 1990s fell out of favor. The belief that bankers themselves best understood the risks that they were taking was discredited. Politicians who had to explain to their voters why the failure of private sector banks had led to higher unemployment and public sector wage freezes wanted to exert control over the way banks operated in the future to try to ensure that a similar global crisis could not reoccur.
As a result, the level of regulation and public scrutiny of banks is far greater today than it has been for many decades, and this is unlikely to change in the near future.
Although the crisis was global in the sense that banks and economies throughout the world were affected, some were affected more than others. Emerging market banks that did not rely on global funding streams and had little exposure to assets and financial instruments originated in Western economies were barely affected. For example, in 2007-2009, the performance of Egyptian banks was driven more by the progress of their central bank's domestic financial reform program than by events in global financial markets.
Nevertheless, the fact that it was banks and economies in developed markets, particularly the United States and Europe, that were most affected has had far-reaching consequences for banks everywhere. Officials from North American and European countries and from the developed economies of Asia dominate bodies such as the Basel Committee on Banking Supervision that set standards for international banks and other financial institutions. It was banks from these countries that were most affected by the global financial crisis, so officials from these countries have been determined to put in place new standards—for example, on minimum capital levels and corporate governance—that they hope will reduce the possibility of another global financial crisis happening.
The standards that are set by bodies such as the Basel Committee are applicable to banks worldwide. So, for example, Egyptian banks may have been minimally affected during the financial crisis, but they are now judged against new international standards on bank capital and liquidity just like everyone else.
THE EUROPEAN FINANCIAL CRISIS OF 2009-2013
European banks and financial markets were badly affected by the global financial crisis, but from early 2010 European financial markets suffered additional problems specifically related to economic trends in Europe. These problems particularly affected the Eurozone—the group of 17 countries that had adopted the euro as their currency and whose monetary affairs were therefore governed primarily by the European Central Bank.
The difficulties experienced by European financial markets over this time were the result first and foremost of a sovereign debt crisis arising from unsustainable spending and borrowing by some governments. However, one of the features of the crisis was the close connection that emerged between the sustainability of government finances in a particular country and the health of that country's banking system.
The response to the crisis has had far-reaching consequences for the way in which banks are regulated and supervised in the European Union (EU)— for both Eurozone and non-Eurozone countries.
Ireland was the first EU country to need financial support from the European Union and the International Monetary Fund, although Ireland's problems arose from problems in its banking system that became apparent in 2007-2008, rather than from budgetary difficulties. As a result, the European crisis is deemed to have begun with Greece in 2009.
In late 2009, concerns began to grow that the Greek government would not be able to repay its debts, and in February 2010 the European Union announced a financial support package for Greece that was coupled with requirements that the Greek government drastically reduce public spending. Over the course of 2010, new figures revealed that the Greek government's financial situation was even worse than expected, and further support from international bodies was provided.
Although the Greek crisis originated with problems in the Greek government's finances, it quickly became clear that Greek banks would be affected. Most obviously, they held large amounts of their own government's bonds, and the government's ability to repay these bonds was now in doubt. Furthermore, as investors worried about the ability of the Greek government to repay its debts, they pushed up the cost of new borrowing to Greece and this in turn led to higher funding costs for Greek banks. More generally, the Greek government's budgetary crisis revealed broader mismanagement within the Greek economy, including state-owned enterprises that were not servicing the loans that they had received from banks.
As the problems in Greece unfolded, analysts turned their attention to other Eurozone countries that had been running large budget deficits, such as Portugal, Spain, and Cyprus. Although the fundamental problems lay with government budgets, banks based in these countries also experienced difficulties either as a result of their direct exposure to their governments, because international investors were refusing to provide funds to any institutions in that particular country, or because the problems at the government level were symptomatic of broader economic mismanagement whose full extent only came to light as a result of the crisis.
The difficulties of resolving the European financial crisis were exacerbated by a lack of clarity over who was responsible for solving the problems. It was clearly in the interest of the Eurozone as a whole to prevent financial collapse in any member country, but some countries were reluctant to commit their own taxpayers' money to resolve problems in other countries that had been caused by years of overspending. These issues have now been largely resolved though the implementation of a “banking union” among Eurozone countries, with a central fund to support troubled banks and centralized supervision conducted by the European Central Bank.
The European financial crisis illustrated not only how budgetary problems at the government level lead to problems for individual banks, but also how lack of clarity over who is responsible for resolving banking crises can result in those crises deepening and becoming more widespread.
THE RISE OF SHADOW BANKING
Until recent times, the provision of credit and the collection of deposits were performed almost exclusively by banks that were regulated by a central bank or an equivalent institution, and these banks could expect to receive support from their central bank in the event that they ran short of liquidity. In the mid-1980s in the United States, and shortly after that in other developed financial markets, a variety of nonbank institutions and investment vehicles began to conduct many of these banking activities alongside the traditional banks. This network of nonbank institutions and vehicles is known as shadow banking.
Examples include finance companies that make loans for specific purposes, such as car purchases; money market mutual funds that offer deposit facilities similar to those offered by banks, but with the prospect of higher returns than banks can pay; financial vehicles that are created by banks to issue short-term commercial paper and invest in longer-dated assets while remaining off the balance sheets of the banks themselves; and special purpose vehicles created to securitize assets such as mortgages and sell them to institutional investors.
Shadow banks perform many of the functions of banks but exist outside the regulated banking industry. A report published by the Federal Reserve Bank of New York in 2010 estimated that in March 2008 the size of the shadow banking industry in the United States had reached USD 20 trillion, almost twice the size of the traditional banking industry.
It was often the case that activities were conducted through shadow banks in order to avoid the regulatory scrutiny accorded to banks and to take advantage of lower capital requirements than those imposed on banks.
One of the many causes of the global financial crisis of 2007-2009 was that regulators and bankers did not understand how important these shadow banking institutions had become to the everyday functioning of financial markets. Since the financial crisis, regulators have moved to impose rules and standards on shadow banking activity as well as reporting requirements that enable them to monitor the extent and influence of shadow banking on global financial markets.
The volume of shadow banking activity declined as a result of the global financial crisis. (The Federal Reserve Bank of New York report mentioned above estimated that the size of the market had fallen to about USD 16 trillion by the first quarter of 2010.) Factors contributing to this decline included reduced activity in securitization markets and the winding up of many structured investment vehicles.
Despite increased regulatory scrutiny, shadow banking is here to stay. As a result, those analyzing banks and financial markets must take account of competitive pressures on banks from nonbank financial institutions, and the effect that the behavior of large nonbank financial institutions could have on the health of a financial system as a whole.
EXAMPLE
On September 16, 2008, Reserve Primary Fund, a U.S. money market fund, announced that the net asset value of its shares had fallen below USD 1 per share and that it was therefore not able to repay investors in full if they asked for their money back. This was the first time since 1994 that a money market fund was not in a position to repay depositors in full.
Money market funds had grown rapidly in the United States as an alternative to bank deposits. Money market funds offered customers instant access to their money but paid higher interest than that offered by banks. On the eve of the global financial crisis, the amount of money invested in money market funds in the United States was more than the amount of money placed in commercial bank deposits. Reserve Primary's asset size of USD 125 billion at the end of June 2008 was equal to that of the biggest and best-known U.S. banks.
Coming just one day after Lehman Brothers had filed for bankruptcy, Reserve Primary's announcement that it had “broken the buck” (meaning that it was not able to repay customers a full dollar for every dollar invested) added to the panic that was engulfing U.S. and international financial markets. The effect was not confined to those investors who had placed their money in Reserve Primary and similar institutions. Money market funds had been major buyers of short-term bonds issued by banks and other financial institutions and as such had been important providers of liquidity to the financial system as a whole. As investors withdrew their money, the funds were no longer able to buy new financial instruments and as a result liquidity tightened across the financial system.
The difficulties of Reserve Primary also demonstrated the effect of interconnectivity and contagion in financial markets (see next section). Reserve Primary had bought large amounts of bonds issued by Lehman Brothers. When Lehman declared bankruptcy, signaling that it would not be able to repay its investors, Reserve Primary knew that it would not be able to fully repay its own investors.
INTERCONNECTIVITY AND CONTAGION
As international financial markets have become larger and more complex in recent decades, they have become interconnected, and the risk of contagion has increased (see Section 3.2.1). For example, a banking crisis in one country, or even problems within a single large institution, can lead to problems in other countries and other institutions. Although problems can arise as a result of direct financial relationships—for example, when the failure of Lehman Brothers led the Reserve Primary money market fund to announce that it would be unable to pay investors in full—they can also arise as a result of perceptions and fear rather than actual financial exposure and risk.
For example, when Thailand devalued its currency in mid-1997, banks and investors began withdrawing money not only from Thailand but also from other Southeast Asian countries. In the aftermath of the crisis questions were raised about the strength of these other Southeast Asian economies, but in most cases the withdrawal of investment funds from these countries and the currency crises that they suffered were triggered directly by investors' fear that what was happening in Thailand might also happen in neighboring countries. In effect, investors did not want to run the risk that other regional economies might be harboring the same problems that had appeared in Thailand, but when they took the initiative to reduce their exposure, they precipitated the very crisis that they were seeking to avoid.
As financial systems become more international (for example as a result of companies and banks in one region raising bonds and deposits from investors in other regions) and electronic payment systems become more sophisticated, the ability of banks and investors to move money quickly from one place to another is increasing. In turn, this increases the risk that problems in one region will spread quickly to others.
INTERNATIONAL BANK REGULATION
The global financial crisis discredited the approach, prevalent before the crisis, that banks and banking systems work best if regulation and supervision are kept to a minimum. (In the United Kingdom this approach was known as “light touch” regulation and supervision.) As a result, the years since the crisis have seen a large number of initiatives to extend the scope of financial regulation worldwide and to intensify the scrutiny imposed on banks. This new regulatory landscape will continue to govern how banks are run well after memories of the crisis have faded and the people who were running banks at the time have retired.
Efforts to reform the global financial system were initially led by the G20 group of developed market economies. Finance ministers and central bankers from the G20 countries set the agenda, defined the priorities for financial market reforms, and delegated specific tasks to more specialized bodies, such as the Basel Committee on Banking Supervision (whose work has included new capital and liquidity standards for banks) and the International Organization of Securities Commissions (IOSCO) (whose work has included new rules on how to trade financial instruments). The Financial Stability Board has also undertaken work on issues such as corporate governance and best practices for bankers' pay. Standard setters, such as the Basel Committee, do not have the power to enforce their recommendations. Their recommendations carry a lot of weight, because they have been drawn up by representatives from many countries after a lot of consultation, but to take effect they need to be incorporated into the laws and regulations of individual countries.
In the United States, many of the new standards governing financial activity were defined in the Dodd-Frank Wall Street Reform and Consumer Protection Act (named after the two congressmen who sponsored the legislation), although the process of writing the detailed rules is delegated to specialized agencies such as the Federal Reserve Bank and the Securities and Exchange Commission. In Europe, new standards have been adopted by the European Union and then transmitted down to the Union's member states through directives and regulations.
Acknowledgments
GARP's Foundations of Financial Risk has been developed under the auspices of the Banking Risk Committee of the GARP Risk Academy, who guided and reviewed the work of the contributing authors.
The committee and the authors thank Alastair Graham, Amanda Neff, Graeme Skelly, Christian Thornas, Mark Dougherty, and Editor, Andrew Cunningham, for their contributions to the 2015 revision. Foundations of Financial Risk builds upon a previously published book titled, Foundations of Banking Risk, co-authored by Richard Apostolik, Christopher Donohue and Peter Went. We would like to specifically acknowledge that Peter Went's work along with the Foundations of Banking Risk other co-authors provides a material basis for the Foundations of Financial Risk, and would like to thank Peter on his much appreciated contributions.
Introduction
This textbook, previously published in 2009 as the Foundations of Banking Risk has been revised, updated and expanded. GARP has renamed the book to reflect the additional content which includes a new chapter on insurance risk.
The role of risk management is becoming more important as banks, insurance firms, and supervisors around the world recognize that good risk management practices are vital, not only for the success of individual firms, but also for the safety and soundness of the financial system as a whole. As a result, the world's leading supervisors have developed regulations based on a number of "good practice" methodologies used in risk management. The banking regulations, outlined in the International Convergence of Capital Measurement and Capital Standards, known as the Basel Accord, and the insurance regulations, known as Solvency 2, codify such risk management practices.
The importance of these risk management methodologies as a basis for regulation is hard to overstate. The fact that they were developed with the support of the international financial community means that they have gained worldwide acceptance as the standards for risk management.
The implementation of risk-based regulation means that staff, as well as supervisors, will need to be educated and trained to recognize risks and how to implement risk management approaches. Consequently, GARP offers this program, the Foundations of Financial Risk, to provide staff with a basic understanding of banking, banking risks, insurance risks, regulation and supervision. This study text has been designed to assist students in preparing for the Foundations of Financial Risk assessment exam. It is presented in a user-friendly format to enable candidates to understand the key terms and concepts of the industries, and their risks and risk-based regulation.
This study text concentrates on the technical terms used in banking and risk management, while providing an insight to the similar risk in the insurance industry. These terms are defined either in the text or in the glossary. As the material is at the introductory level, candidates are not expected to have a detailed understanding of risk management or significant experience in banking. In this text, they will gain an understanding of the commonly used terms in the finance industry.
Each chapter contains a number of examples of actual financial events, as well as case study scenarios, diagrams, and tables aimed at explaining banking, banking risks, and risk-based regulations. This study text has adopted the standard codes used by banks throughout the world to identify currencies for the purposes of trading, settlement, and displaying of market prices. The codes, set by the International Organization for Standardization (ISO), avoid the confusion that could result as many currencies have similar names. For example, the text uses USD for the U.S. dollar, GBP for the British pound, EUR for the euro, and JPY for the Japanese yen.
