Today, risk management is considered to be one of the most important components in the banking industry. Banks that have an efficient risk management system will have a competitive advantage. As a result, risk management can not be considered as an option, but a strategic necessity to banks.
The purpose of thesis is how to establish an efficient risk management system. This thesis focuses on the following questions; the needs of risk management, BIS and credit risk, BIS and market risk, measuring risks and how to manage them, integrated risk management system.
There are primarily 5 different kinds of risks in the banking industry, such as credit risk, market risk, liquidity risk, operational risk and legal risk. Yet these different risks should not be discussed in isolation, they are intimately integrated. In any transaction, one should consider multiple risks. When capital regulation was prevalent, credit risk was the main risk managed, while other risks were petty affairs. Yet when deregulation and the opening of capital market, liquidity risk and market risk faced to the forefront. Given the increase in the flow of international capital, bank face yet more risk factors such as changing exchange rates, interest rates, stock indices, etc. In addition, operational risks can not be ignored. The case of Nicholas Leeson, a former Barings trader, has shown the importance of understanding operational risk.
Leading banks are responding to this issue by creating integrated risk management systems to manage risks that affect the bank's market value. Unfortunately Korea is at the beginning stages of risk management. In addition, many banks do not have an independent risk management department. Even some of the bank's risk management is focusing only on BIS capital ratio notwithstanding it has its own defects. Many of the banks are managing risks on the level of individual department. For example, international department manages exchange risks and fund-operating department manages liquidity risks. Yet they are managing their risks passively and they don't integrate their risks. They have thought that risk should be avoided just because risk is risky.
Currently, some banks are slowly responding to these issues by establishing an independent department to prepare integrated risk management system. There are several ongoing progresses on these issues.
When considering setting an integrated risk management system, banks should consider risk-adjusted return on capital (RAROC) instead of simple return on asset (ROA). Banks can allocate their capital more efficiently with the RAROC system.
In summary, we can draw the conclusion that the goal of an integrated risk management is to increase the market value of the bank rather the BIS capital ratio.
