Enterprise Risk Management Framework (ERMF)

Dear Followers,

The Enterprise Risk Management Framework (ERMF) dictates how a bank identifies and handles risks. Effective risk management involves processes and activities that span the entire risk management lifecycle, taking an "enterprise-wide" perspective.

The ERMF has nine Principal risks:

1) Treasury and Capital Risk:

Liquidity risk - The risk that a bank cannot fulfil its obligations or lacks adequate funding and liquidity to support its assets.

Key reports submitted to banking regulators include the Liquidity Coverage Ratio (LCR), Net Stable Funding Ratio (NSFR), PRA110, and Asset-Liability Management Metrics (ALMM), among others.

Interest rate risk in the banking book - IRRBB refers to the potential for financial loss due to changes in interest rates affecting a bank's assets and liabilities. This risk arises from the bank's exposure to fluctuations in interest rates, which can impact the value of its financial instruments and overall profitability.

Key aspects include Repricing risk, Basis risk, Yield Curve risk and Options risk.

Capital risk - The risk that a bank's capital is insufficient in level or composition to support its business activities and meet regulatory capital requirements under both normal and stressed conditions.

Managing capital risk involves maintaining appropriate capital reserves, ensuring capital adequacy, and adhering to regulatory capital requirements to safeguard against potential financial challenges.

2) Market Risk:

The risk of loss resulting from potential adverse changes in the value of the bank's assets and liabilities due to fluctuations in market variables such as interest rates, foreign exchange rates, and equity prices.

The most common methods for measuring market risk include:

Value-at-Risk (VaR), Conditional Value-at-Risk (CVaR) and Beta, among others.

3) Credit Risk:

Credit risk in a bank refers to the potential for financial loss due to a borrower's failure to meet their contractual obligations.

In credit risk management, several key metrics are utilized to assess potential losses and manage risk effectively.

The most prominent among these are:

Probability of Default (PD), Loss Given Default (LGD), Exposure at Default (EAD), Expected Loss (EL), Capital Requirement Ratios, Cumulative LGD Accuracy Ratio (CLAR) and Recovery Rate.

4) Operational Risk:

The risk of loss stemming from inadequate or failed processes or systems, human errors, and external events (such as fraud), where the underlying cause is not related to credit or market risks.

5) Model Risk:

Model risk in banking refers to the potential for financial loss or adverse outcomes resulting from the use of incorrect or misapplied models. This risk arises when models used for decision-making, risk assessment, or financial forecasting produce inaccurate or unreliable results.

Key aspects of model risk include Model Specification risk, Model Implementation risk, Model Validation risk and Data risk.

6) Reputation Risk:

Reputation risk in a bank refers to the potential for negative perceptions or loss of trust that could harm the bank's public image and credibility. This risk can arise from various sources, including poor business practices, legal issues, regulatory violations, or unethical behaviour. It can impact customer confidence, investor relations, and overall business performance. Managing reputation risk involves proactive communication, transparency, and adherence to ethical standards to maintain and enhance the bank's reputation.

7) Compliance Risk:

Compliance risk in a bank refers to the potential for legal or regulatory penalties, financial loss, or reputational damage resulting from failure to adhere to laws, regulations, and internal policies. This risk arises from non-compliance with regulatory requirements, industry standards, and internal controls, which can lead to fines, sanctions, and operational disruptions. Effective management of compliance risk involves robust policies, regular audits, staff training, and monitoring to ensure adherence to all applicable regulations and standards.

8) Legal Risk:

The risk of loss or penalties, damages, or fines resulting from the firm's failure to comply with applicable laws, regulations, or contractual obligations, or from issues related to asserting or defending the bank's intellectual property rights.

9) Climate Risk:

Climate risk in a bank refers to the potential financial impact of climate-related factors, including physical risks from extreme weather events and environmental changes, as well as transition risks associated with shifts toward a low-carbon economy. This risk can affect a bank’s assets, liabilities, and overall financial stability, and may include impacts from regulatory changes, market shifts, and reputational damage. Effective management involves assessing and mitigating these risks through strategies such as climate risk assessments, sustainable finance practices, and incorporating climate considerations into risk management frameworks.

A question for my followers: Please identify and categorize which of these are financial risks and which are non-financial risks. Let’s start a discussion in the comments section!        

#ERMF #TreasuryRisk #CapitalRisk #LiquidityRisk #IRRBB #MarketRisk #CreditRisk #OperationalRisk #ModelRisk #ReputationRisk #ComplianceRisk #LegalRisk #ClimateRisk #Bank #RiskManagement