The Intermediation Process and the Allocation of Resources

The importance of the financial system in facilitating economic development cannot be overstated. Banks and other financial institutions have a key role in the efficient allocation of resources and as such, sound financial systems are systemically important to the economic viability of a country.

The Asian Financial crisis of 1997-98 brought home the significance of financial sector soundness by highlighting the consequences of underlying weaknesses in the financial sector and the negative impact that weak financial sectors could have on stakeholders, particularly the depositors. Sound financial system is therefore not only important for the welfare of the financial entities themselves, but it is also of vital importance to the growth of individual economies.

In allocating resources in an economy, financial institutions must assess competing demands for funds and prioritize the analysis of risk. Improper decisions about financing activities, that is, which activities to finance and which not to finance, (depending on which activities will bring the best risk-adjusted return), can have a crucial negative long-term impact on economic prospects. Sound investment decisions are vital ingredients in fostering economic growth and development. These decisions therefore should produce feasible outcomes not only for the financial intermediary but also for the economy. Investment should be for productive purposes and should be deployed for the common good.

Financial intermediaries should also have a harmonious relationship with the macro-economic space within which they operate. For example, in the nineteenth century, Britain was seen as the most successful economy and was the home to the world's most successful financial centre at the time. This was not only due to the fact that London had developed expertise in assessing risk and in allocating financial resources efficiently, but also to the fact that the macro economic environment was conducive to the operation of financial intermediaries operating in the financial centre.

The assessment of risk also assists financial institutions to be individually more competitive with their peers. This results in a more efficient process of capital allocation in addition to engendering more prudent practices. Financial intermediaries that can assess risk and allocate resources efficiently will outperform those less skilled in this regard. Effective competition should reduce borrowing costs and help to diversify financial risk within the economy. However, to ensure that banks are performing as intended, an effective regulatory framework must exist. The importance of adequately capitalized financial institutions to underwrite appropriate risks in their portfolios cannot be over emphasised. If financial intermediaries undertake too little risk, then potentially efficient projects may be starved of capital and if they undertake too much risk, then less efficient projects may consume capital that could be used for more viable projects. The role of regulators in providing effective oversight for the sector and be able to respond appropriately to changes in the financial environment becomes even more important.

William J McDonough (1998) postulates that "a nation must be able to mobilize domestic savings and other sources of funds that are needed to finance investment and other productive expenditures[1]. This requires the development of an effective banking system that transfers surplus funds of households and businesses to borrowers and investors". He further argues that, "fair and impartial allocation of credit accommodates the economic development that results in improved national living standards".

According to McDonough:

"financial intermediation is particularly important in the context of most emerging market countries given the relative scarcity of savings, a relatively under-banked population, and large-scale investment needs. The banking sector in emerging market countries also tends to be more concentrated and represents a larger share of the domestic financial system. Consequently, issues in the banking sector have an amplified effect on the economy and on the fiscal costs associated with bank rescues".

Importantly, current developments in western economies are anchored in a robust financial sector development.. Consequently, the relationship between economic growth and financial sector health are now more closely linked than ever before.

Some of these linkages or interrelationships are further explored in this thesis from the perspective of risk relationships. The demands of the changing business environment emphasize the importance of effective risk management practices in banking institutions. Financial intermediaries continue to face tremendous unrelenting pressures regarding pricing decisions, increase in service expectations from customers, regulators and shareholders. There is also a demand for more sophisticated products and services, new regulatory requirements, improved capital standards, more capital injection and the introduction of new technologies and systems.

Technology is important in supporting new and flexible risk relationship structures in the areas of credit, market, liquidity and operational risk management. Advanced technologies are often used by intermediaries to identify, quantify and monitor risks. The employment of these technologies also comes with their own attendant risk exposures and as such significant investments and focus have been placed (particularly in recent times) on operational risk management issues from both regulatory and financial intermediary perspectives.

Risk management must be seen as an integrated process and as such managing existing relationships, developing new relationships and leveraging the value of all risks relationships are critical to the management of overall risk exposures. It is important therefore that the approach which institutions and regulators take in managing risk, be relational. Both the qualitative and quantitative aspects of risk management must find consensus within the same framework. No longer should institutions view risk as an isolated and individualized structure with separate and mutually exclusive elements but risk should be managed as a system, which is intricate, collaborative and bound by mutual responsibilities.

Banking Supervision

The identification, assessment, and promotion of sound risk-management practices have become central elements of good supervisory practice. Risk management has evolved as a discipline that is driven both by the private sector (made up of banking institutions and other market participants) and public sector (especially Regulatory Authorities and Banking Supervision). The relationship between the private sector's interest in economic capital and the public sector's interest in regulatory capital should be identified and managed in a framework that ensures optimization.

With regard to the management of risks and risk relationships, several key innovations have been made by the private sector over the years. These are evident in the way financial intermediaries have ordered their balance sheets to respond to various risk stimuli and impulses both internally and externally. Additionally, the private sector has been the driving force behind the development of sophisticated tools used to identify, measure and manage risk relationships. The public sector on the other hand, has been at the forefront in the development of best practice standards and principles used to guide financial intermediaries. For years, the public sector has been playing a pivotal role in preventing the total collapse of the entire financial systems in their capacity of lender of last resort. The regulatory and supervisory arms of the public sector have taken the lead in identifying emerging issues through their approach to supervision of financial intermediaries. Several regulatory bodies routinely performs on-site inspections and examinations as well as off-site monitoring and surveillance of banks and other financial institutions to assess risks and provide feedback to the financial intermediaries' board and management. These reviews include the assessment of policies and procedures in place to guide risk management; the assessment of governance and internal controls and the assessment of capital adequacy, asset quality, earnings and liquidity and sensitivities to risks. Reviews could also include comparisons of peer institutions coupled with the establishment of guidelines that codify evolving practices.

Yellen (2005)[2] argued that "although banks and bank supervisors have different motives, which certainly can lead to differing views about the appropriate levels of risks, they also have a common interest in having accurate measures of risk and in focusing on the processes and techniques for identifying and managing risks".

According to Alan Greenspan (2004),[3] "the growth in the size and complexity of the largest US and foreign banking organizations, in particular, has substantially affected financial markets and supervisory and regulatory practices". He further states that "authorities are required to focus more than before on the internal processes and controls of these institutions and on their ability to manage risk". According to Greenspan, "the regulatory authorities must provide the industry with proper incentives to invest in risk-management systems that are necessary to compete successfully in an increasingly competitive and efficient global market".[4]

The Basel Frameworks

Over the last two decades, the system of bank capital standards has been the Basel Capital Adequacy Standard, known as the Basel I framework, which was established internationally in 1988. The Basel I standard came out of the banking supervision sub-group of the Bank for International Settlement (BIS). The Banking subgroup is made up of supervisors from the G10 countries. This group has been charged with the responsibility for setting bank standards around the world, which it does predominantly through the development and implementation of the Basel Core Principles for Banking Supervision. The Basel I framework was particularly geared towards credit risks in banking institutions and resulted in higher capital levels, a more equitable international marketplace and the relating of regulatory capital requirements to risk appetite and risk profile.

The Basel framework is a dynamic one to which bank as supervisors continue to make important adjustments from time to time. For example, the 1988 Capital Accord was amended subsequently to incorporate a market risk component. Bernanke (2005)[5] argues that "advances in risk management and the increasing complexity of financial activities have prompted international supervisors to review the appropriateness of the regulatory capital standards under Basel I, particularly for the largest and most complex banking organizations".

Bernanke states further that "supervisors recognize that some of the largest and most complex banking organizations have already moved well beyond Basel I in the sophistication of their risk management and internal capital models". The gap between the determinants of minimum regulatory capital (under Basel I) and the levels of risks that financial institutions were taking on began to widen, as risk relationships continue to become more complex and risk-management practices continue to evolve.

Several innovations have sought to collectively reinforce this gap and indeed the relationship (regulatory capital/risk appetite) between the public sector and the private sector has also being mutually reinforced. These innovations have predominantly being originated by bankers in the private sector and not by Supervisors. Bankers and Risk Managers had developed models that encompass their processes, procedures, and techniques, including statistical models for assessing risks in their portfolios. These innovations by the private sector were seen as state of the art risk management tools which the public sector could use and as such Regulators began to leverage the risk management techniques that banks were using to address shortfalls in Basel I. This phenomenon helped to push the Basel Committee back to the drawing board to create the new capital adequacy standards for internationally active banks, known as Basel II.

Bernanke (2006)[6] argues that the new framework "links the risk taking of large banking organizations to their regulatory capital in a more meaningful way than does Basel I and encourages further progress in risk management. It does this by building on the risk-measurement and risk-management practices of the most sophisticated banking organizations and providing incentives for further improvements". When this framework is applied consistently across internationally active banks, Supervisors can easily identify shortfalls in the relationship between banks capital and risk levels. Banking institutions with capital levels that are not commensurate with their risk profile and risk levels would be subjected to closer assessment and monitoring. Additionally, Basel II has provided the Supervisor with an added tool, under the supervisory review process (Pillar II) to assess risks in the banking system.

The new capital accord, Basel II, with its three pillars, will hopefully enhance and strengthen the process of risk management in banking institutions. Internationally active banks, and other banks and investment businesses in jurisdictions in which regulatory authorities deem it prudent to bring these institutions in scope, should expect significant revisions and modifications in their internal policies used to identify, measure, manage and report on risks. Not only should improvements be seen in risk management policies, but the process and general procedural framework would also see improvements. In this regards, banks and other financial institutions should envisage changes in their system used to capture and report on risks. Under Pillar I, changes are expected I the risk weights assigned to the credit portfolios, particularly, residential mortgages and as such banks could see some reduction in charges as weights for some categories are reduced. The reporting of market risks and operational risks should also improve as banks garner more granular data on its expected losses and risk exposures. In preparation for the supervisory review process (Pillar II) to be conducted by the regulatory authorities, banks should see significant improvements in their risk management practices as they subject their internal capital adequacy models to greater levels of scrutiny to ensure that the capital cover is adequate for all the material risks identified, their risk appetite, and risk exposures.

The use of stress testing on both the banks investment and credit portfolios under the pillar II process should also seek to strengthen the institutions approach to deal with adverse down turn and general deterioration in some macro economic variables in the economies in which the banks operate. This should push banks to increase capital levels to cushion expected losses.

Pillar III implementation under the new capital accord should also foster greater improvements in the risk management, policies, processes, and procedures of banking institutions as banks become more transparent in their efforts to disclose more information on the profile of risks, risk exposures and capital levels to their stakeholders.

The Sub-prime Mortgage Crisis

The conditions that gave rise to the current sub-prime mortgage crisis provides ample evidence to support the pressing need for both private and public sector, financial institutions and supervisors, to understand the nature and nexus of risk relationships and regulatory capital. The crisis also provide an opportunity for financial institutions and regulators to explore the risk relationships and risk dynamics existing within and outside of financial intermediaries, as well as the impact that failure to properly identify and assess risk exposures in financial institutions can have on the global financial system and economic growth and development in a particular country.

The ongoing economic problem resulting from the sub-prime mortgage crisis has manifested itself through liquidity issues in the global banking system. The credit crisis has its genesis in the bursting of the US housing bubble and the subsequent high default rates on "sub-prime" or other adjustable rate mortgages, made to borrowers with higher risk profile and lower income levels, instead of to borrowers who are considered "prime" borrowers with higher income and good credit history. Borrowers were encouraged to take up mortgages based on the attractive housing incentives that led them to believe that notwithstanding the long term trend of rising housing prices, they would be able to refinance these mortgages at more favourable terms in the future. During 2006 however, the prices of houses started to fall, albeit moderately and as such, the possibility of refinancing was becoming more remote. Consequently, the interest rates on the adjustable rate mortgages (ARM) that the sub-prime borrowers were able to obtain began to reset at the higher rate resulting in a significant increase in defaults and foreclosures. In 2007, foreclosure activities increased by approximately 80 percent over the 2006 figures as nearly 1.3 million United States housing properties were subjected to foreclosure activities.

Major banks and other financial institutions globally reported losses of approximately US $379 billion towards the end of the first half of 2008. The first set of financial institutions to be impacted was mortgage lenders that retained the risk of payment default (credit risk). Several third party investors were also affected, as mortgage lenders had passed on the credit default risks arising from the rights to the mortgage payments through mortgage backed securities (MBS) and collateralized debt obligations (CDO). Individuals, institutional investors and other corporate entities holding MBS or CDO were now faced with significant losses as the value of the underlying mortgage assets declined.

The sub-prime mortgage crisis also exposed financial institutions to liquidity risks as lenders were forced to reduce lending activities or grant loans at higher interest rates. The higher interest rate loans restricted the ability of corporations to obtain funds through the issuance of commercial paper, thereby posing liquidity challenges for several institutions. As a result, central banks, in their role of lenders of last resort, were forced to take action to provide funds to the banking sector so as to stimulate the commercial paper market and to encourage the resumption of lending to borrowers with good credit profile.

The rate at which economies grew was also impacted by the credit crisis as business investments and consumer spending were curtailed due to the general unavailability of loans or the high cost of loans in cases where it was available. The United States government responded by cutting the federal reserve interest rates as well as proposing its economic stimulus package which was passed by congress in February 2008. This was necessary to alter the risk exposure to the broader economy brought on by the credit crisis and the related downturn in the housing market.

Research Problem and Hypothesis

While the benefits of risk management and positive risk relationships have been increasingly recognized in financial sectors worldwide, this study postulates that (i) risk relationships have not been sufficiently explored in the region and current risk management practices in the Caribbean have not kept pace with international trends on financial risk management and (ii) levels of capital being held by financial intermediaries in the Caribbean could be deemed inadequate to mitigate risk exposures. It could also be argued that where there are high levels of risk exposures in financial intermediaries in the region, the impact of risk mitigating factors are low and risk management policies, processes and procedures are less than robust. Additionally, risk exposures and regulatory capital might vary according to core business activities, risk categories or geographic location.

In recognition of the existence of these relational gaps and the need to bridge them, this study will introduce principles, procedures, approaches, models and concepts in risk management, and concentrate on those risks inherent in the financial intermediaries' balance sheet or risks associated with various elements of financial activities and environment. The writer will analyse the risk profile of financial intermediaries and their exposure to credit risks, funding/liquidity risks, interest rate risks and operational risk.

The study also seeks to develop benchmarks for measuring risks in the region as well as a risk management scoring model with particular emphasis on the risk profile of Caribbean financial intermediaries.

Sub-problems

The first sub-problem is to ascertain the risk profile and relationship evident in financial intermediaries in Jamaica, Trinidad and Barbados, as well as those which may evolve consequent to the new Basel Capital Accord, Basel II, which is scheduled to be fully implemented by 2015 across all jurisdictions. The intention is to assess the risk profile and relationship in operation as a dynamic process and the likely impact of the capital accord on relevant financial entities.

The second sub-problem is, using both the relevant and existing literature concerning risks, risk relationships and risk management and observation of current techniques, to ascertain throughout the course of the study, types of risk relationships that exist in credit, liquidity, interest rate and operational risk management in financial intermediaries.

The third sub-problem is to provide the financial sector with a set of sound testable ideas that are systemically desirable and consistent with the future development of risk assessment. This will be done by reviewing the analyses outlined in the first two sub-problems, generating relevant model/framework of risk assessment, comparing the model/framework with real situation, identifying systemically desirable changes and documenting the results for the benefit of relevant stakeholders who are capable of applying change to the banking sector in general.

Hypothesis

The first hypothesis is that risk exposures (credit, liquidity, interest rate and operational risks) in financial intermediaries in Jamaica are relatively high when compared with Trinidad and Tobago and Barbados and could exhibit parasitic tendencies. This could impair the financial intermediaries' ability to identify, measure, mitigate and monitor risks due to the fact that the internal control framework could be seen as less than robust.

The second hypothesis is that there will be shortfalls in capital requirements specifically as a result of the introduction of the new Basel Capital Accord and more generally after taking account of specific risks not previously considered by financial intermediaries.

The third hypothesis is that the cycle of analysis, application and testing will result in the implementation of rigorously defined early warning system for modelling and scoring risks and that this system will be adaptable to change, both outside and within the environment, and extendable to additional use.

Justification for the Research

Sound risk management practices, which include appropriate tools and techniques and the employment of relevant steps to assess risk exposure are at the heart of effective financial intermediation. However, many institutions are exposed to high levels of risks in their operations and few have put in place the relevant infrastructure to appropriately capture their risk exposures. According to the Government of Jamaica, Ministry of Finance (1998)[7]: "the financial distress experienced in the mid nineties was in several ways due to the fact that many domestic financial institutions did not have the necessary risk and financial management capabilities to carefully assess the risk. As a result, they were left holding real estate and other long-term assets that could not be easily disposed of to meet their short-term obligations".

The Ministry highlighted the fact that: "banks in Jamaica tended to invest in enterprises that were outside the scope of their core business which had the following implication:

  • The banks entered sectors in which their management did not have the requisite skills or expertise.
  • The banks, when lending to related parties or parties under common control either (i) made poor and biased credit decisions; or (ii) invested in companies on less than arm's length terms resulting in poorly secured loans.
  • The banks, in many instances had fund investments in non-core businesses with short-term borrowing instruments with guaranteed high interest rates. As a result, many non-core business had to contend with an unsustainable capital structure that relied heavily on high cost loans with relatively short maturities"[8].

Many studies have highlighted the risk management practices, including techniques and tools used to identify, measure, mitigate and monitor risks in industrial countries. However, few studies (note the researcher is not aware of any at the time of preparing this thesis) have sought to understand and explain the risk exposures, risk relationships and risk management practices in financial intermediaries in the Caribbean, particularly Trinidad and Tobago, Jamaica and Barbados.

The study utilizes a novel approach to analyse risk exposures and risk relationships, which has not been evidenced in the literature generally and definitely not seen in research on risk management in the Caribbean region. The risk profile of financial intermediaries are analysed using ratio analysis and statistical techniques including the standard deviation and arithmetic mean coupled with a five-point scale response to determine risk relationships based on a biological science description. This study will document over a ten-year period, sectoral differences in risk exposure reflected in the balance sheets and income statements of commercial banks, merchant banks, trust companies and building societies in three Caribbean countries.

The results of the research will provide a sound set of ideas for the management of risks in these institutions in emerging markets. It will also provide an enduring account of risk relationships and the implications of sound risk management practices in general.

Thesis Outline and Methodology

The study examines the risk management framework in emerging markets in the Caribbean region. The focus will be limited to three jurisdictions in the Caribbean region. These are Jamaica, Trinidad & Tobago and Barbados. This paper takes account of four types of deposit taking financial institutions - Commercial Banks, Trust & Merchant Banks, Finance Companies and Building Societies. There are 8 financial intermediaries across the three jurisdictions.

Elite interviews were also conducted with senior management in sixteen (16) financial institutions in Trinidad and Barbados. Interviews were held with select senior management executives in the financial institutions. Among the executives interviewed were CEOs, Senior Vice Presidents, Risk Managers, Credit Managers, Operations Managers and Treasury Managers. In Jamaica, detailed surveillance were done of all the in scope financial institutions ie, commercial banks, trust and merchant banks and building societies. Reviews of annual reports and websites of all the financial intermediaries captured in the scope of the thesis were also done. The purpose of the review of the elite interviews and qualitative reviews of the websites, annual reports and other published data was to obtain information on four risk categories, particularly on the policies, procedures and processes in place to manage risk.

Twenty risk proxies were used to calibrate risk exposure across four risk types in the financial intermediaries and the countries. These risk proxies were further reduced to eight based on their relative weights and significance as a risk-sensitive measure. Additionally, eight macro-economic variables were used to assess the economic environment within each country as well as to determine the extent to which these macro-economic variables were correlated with the risk proxies.

Using a Likert-type index, correlation analysis and the results of the observation and interviews, the study developed risk benchmarks and risk scores, which were later used to determine risk relationships within financial intermediaries as well as within each country. The aim was to identify the risk relationships and to provide the managers of financial institutions and policy makers with an early warning system to calibrate and mitigate risks.

The study analyzed the degree to which three major economies in the Caribbean region were exposed to credit, liquidity, interest rate and operational risks and the extent to which different countries are similar or different in light of these risk exposures.

The paper sought to determine the level of risk exposures across four different financial intermediary types in three Caribbean jurisdictions. It expounded on differences and similarities in the risk profile of financial intermediaries and sought to determine which intermediaries are likely to have higher risk profiles.

The paper also explored synergies and alliances between the four main categories of risk under study. These are credit, interest rate, liquidity and operational risk. It disaggregated proxies for risks based on risk types and highlighted risks drivers that are significant to different intermediary types or country.

Lastly, the paper explored relationship between the critical elements and proposed a model for the scoring of risks. The relational perspective to risk management envisaged risk within three basic constructs namely, Symbiotic, Parasitic and Saprophytic as well as the nexus between these constructs and the internal control framework as measured by financial intermediaries policies, procedures and processes used to manage risks.

The Saprophytic Construct

At this level, risk is calibrated as being relatively low. Risks outcome are systemically pleasing and financial intermediaries are making meaningful contribution to the common good. Risks and reward can thrive within a conducive macro environment and the profile of institutions' balance sheet and income statement contributes positively to the risk calibration outcome. A low level of risk exposure is usually attributed to a very robust internal control framework and more effective risk mitigation strategies.

The Symbiotic Construct

Within the Symbiotic construct, risk relationships are generally balanced. Risk is calibrated as moderate and the regulatory interest and the economic interest are neutral. Risk management is generally integrated and there is usually a connection between the process of risk identification, measurement, mitigation and monitoring. The profile of intermediaries' balance sheets and income statements are viewed as risk-neutral relative to risk outcome and the internal control framework and risk mitigation strategies used by financial intermediaries are generally adequate.

The Parasitic Construct

Within this construct risks are calibrated as high or very high. There is usually adverse macro-economic condition in existence and there is disconnect between the regulatory interest and the economic interest. There is a general state of disharmony in the qualitative and quantitative approaches and disunity in the way that risk is generally managed. The risk profile of institution's balance sheets and income statements negatively impacts risk calibration outcomes. A high level of risk exposure is usually attributed to less than robust internal control framework and less effective risk mitigation strategies.

The paper examined the macroeconomic environment and regulatory environment in the three major economies of the Caribbean - Jamaica, Trinidad & Tobago and Barbados. It discussed the extent to which these frameworks are similar or different and the correlation between select macro economic variables and sector specific micro variables used as proxies for risks.

Chapter 2 of the thesis reviewed existing literature on the topic of risk, risk relationships and risk management and best practices in these areas; Chapter 3 examines the dynamics of the three emerging markets being analysed in this study, Jamaica, Trinidad & Tobago and Barbados. Particular emphasis was placed on the macro-economic environment and the regulatory framework within which the financial intermediaries operate. The details of the methodologies and their effectiveness are discussed in chapter 4 and chapter 5 analyses the data and related findings. In chapter 6, conclusions are drawn about the research problem and hypotheses. Additionally, implications for theory, policy and practice are discussed and the implication for further research is also considered in this chapter.

Delimitations of Scope and Key Assumptions

Use of Financial Ratios

The thesis utilizes extensively, ratio analysis techniques to determine risk exposures and risk relationships. Financial ratios were used to arrive at the risk indices that were later used to calibrate the risk relationships in existence in financial intermediaries in the region.

The researcher is aware however, of the limitations inherent in the use of financial ratio analysis techniques to assess financial intermediaries, risk exposures and financial performance. Some of the major concerns are outlined below:

Lack of Consistent Definition for Financial Ratios

There is a general lack of definition of what is considered a "correct" ratio to use in analysing balance sheet and income statements of financial institutions. There are different ways and different figures used to calculate financial ratios depending on the objective. However, to a large extent, this could determine the outcome. For example, the thesis utilises twenty different financial ratios to assess risks, seven of which were used to assess liquidity risks in financial intermediaries. As expected, all seven financial ratios gave a different result. However, eight financial ratios covering the four risk categories under study were further selected and justified for use in the scoring methodology.

Financial Ratios are subjected to Manipulation

The lack of clarity surrounding the used of financial ratios, subjecs them to manipulation by business managers, students and other practitioner. In manipulating financial ratios, one can include or exclude particular line items from balance sheets or income statements to produce "good" results. Depending on the desired outcome, analysts can use different line items as the numerator or denominator for the ratios.

Financial Ratios are not Sufficiently Qualitative

Financial ratio analysis are predominantly numbers driven or quantitative and does not take account of other factors which could affect the intermediaries' risk profile, risk exposure or risk relationships. The collection of data from secondary sources such as annual reports, central banks' reports and other publications could be viewed as problematic as most of these publications and reports do not provide information on particular data that are easily traceable or consistently defined. Consequently the calculation of financial ratios could undermine the value of the information they provide.

The Inflation Effect

The effect of inflation rates and depreciation in foreign exchange rates could erode the value of longitudinal data for ratios calculated over several years, as the value of currency in more recent period could be different from that which obtained in earlier years. There is also the challenge of comparing financial information expressed in historical cost accounting formats with data prepared under new international financial reporting standards. The underlined base figures could be distorted as a result of information not being directly comparable with each other over time.

Financial Ratios are generally Backward Looking

Financial ratios tend to be backward looking in nature as they are based on historic information. As a result financial ratios do not have much predictive powers and must be combined with other techniques such as stress testing and scenario analysis to provide more robust results.

The Use of the Primary Ratio as the Benchmark for Regulatory Capital

The use of the Capital to Asset Ratio (otherwise known as the primary ratio) as the benchmark for regulatory capital could be argued as not being sufficiently robust. This benchmark has been in use by regulators several years before the move towards a revised capital adequacy frameworks for banks which is more risk sensitive. The use of the risk adjusted assets ratio would have been more ideal, however due to the unavailability of risk weighted assets breakout for sub-sectors under study, this was not possible. Future work should employ a more risk sensitive framework for assessing capital adequacy.

The Use of the Arithmetic Mean as the Benchmark for Moderate Risk.

One of the key assumptions made in this thesis is that the arithmetic mean of all outcome from the twenty financial ratios used to calibrate risk exposures represents a moderate risk position for the eight sub-sectors. The use of the mean could be viewed as not being sufficiently independent as it is derived from the population of the financial intermediaries in the region. The overall result provided by the risk indices could be skewed positively or negatively by low or high risk exposures in one sub-sector.

A more appropriate benchmark could be derived from the mean of financial ratios computed from balance sheet and income statement data sets of developed countries such as USA, UK and Canada. The mean from financial ratios from these countries external to the Caribbean region would provide a more independent benchmark and as such will the basis for future work.

Unavailability of Granular Information

The general unavailability of granular data from financial intermediaries in the region, (for example duration and maturity structures for interest rates and liquidity risk assessment as well as information on foreign exchange exposures and positions) prevented a more detailed review on risk relationships. The absence of granular information on risk sensitive assets and liabilities as well the unavailability of information on off-balance sheet data, including contingent liabilities, also posed challenges. More detailed information would augur well for the development of a more robust regional risk index.

REVIEW OF EXISTING LITERATURE

Financial Institutions Risks and Risk Management

A substantive approach was taken to the review of literature relating to risk relationships and regulatory capital. The coverage of the subject ranged from a review of some generic risk types which includes systematic risks, credit risks, counterparty risks, operational and legal risks to more specific and current classification of risks including interest rate, foreign exchange commodity pricing as elements of market risks and liquidity risks. The literature review also takes account of the general oversight framework for risk management as well as the principal functions of risk management which seeks to insulate the firm from different types of risks such as liquidity, market, operational or credit risks.

Several steps in the risk management process were identified and explored in the literature review commencing with the definition of risk objectives and identification of loss exposures through to the measurement of potential losses and selection of risk procedures and tools and culminating with the implementation of policies, procedures and processes to manage and monitor risk exposures.

Sectoral similarities and differences in financial intermediaries were also reviewed in the literature as it was felt that different financial intermediaries could have different approaches to risk management and regulatory capitals. For example, it was noted that specialised and sophisticated approaches could be engaged for primary risks in a particular sector however this was not evident in the management of the same type of risks in another sector. This is because primary risks in one financial sector can be seen as secondary risk in another sector. Commercial banks for example focus primarily on credit and operational risks especially in cases where they have a wide branch network and significant investment in Information Technology whereas securities firms and merchant banks could focus more on market and liquidity risks based on the nature of their activities.

The effectiveness of policies, processes and procedures were also explored in the review and details of procedures or tools that a financial intermediary uses to measure and manage firm-level exposures were analysed. Some of the general tools in this regard include standards and reports, positive limits and values; investment guidelines and strategies and compensation and incentive contracts.

The importance of an enterprise-wide approach to risk management was emphasised with focus on key business processes in the firm and the required bottom-up approach that should be taken in risk management vis--vis risk identification, measurement, monitoring and reporting. The enterprise-wide approach includes the alignment of risk management to the organizational strategy and business plan as well as defining business activities in such a way as to facilitate risk identification, measurement and monitoring.

The literature review also explored several approaches to regulatory capital. The 1988 Basel Capital Accord which came into being at a time when banks were still concentrating on traditional banking functions and when credit risk was the single most important risk factor in banking institutions. The lack of risk sensitivity in the 1988 Basel Accord coupled with the absence of a market risk focus led the Committee of Bank Supervisors to develop and adopt a revised capital adequacy standard, known as the Basel II Capital Accord.

Other approaches to capital were also discussed in the literature review. These include leverage ratios or primary ratio (capital to asset), which utilizes a 6% international benchmark system however this was seen as a crude benchmark to measure the adequacy of capital to cover risks at the time. Interestingly, subsequent to the major financial crisis which started in 2007, many jurisdictions have been discussing the possibility of revisiting the primary ratios as a risk cover. The element of economic capital and the link between regulatory capital and economic capital was also discussed in the review of literature.

The use of economic capital can be proven to be an effective tool in the risk management process in so far as it ensures that financial organizations hold the required amount of capital to cover its exposure to all material economic risks or potential unexpected losses. The use of economic capital would not only assist in the proper assessment of capital requirements by large intermediaries to cover risk exposure, but would also seek to limit contagion risk in the financial system.

Several classical finance theories developed over the last fifty years were also explored in the review of related literature. These include theories on international finance, capital structures and asset valuations. The classical theories provided a useful foundation and general conceptual framework on which to anchor the discussions on risks and risk relationships that were later developed and applied in the thesis.

The review of related literature concludes with detailed discussions on approaches to (i) credit risk management, including structural and reduced form models and internal rating systems; (ii) liquidity risk management, including lender of last resort theories, structural and reduced form models of liquidity risks and value at risk (VAR) approaches. (iii) market risk management, including interest rate risk management, derivatives and foreign exchange risk management and (iv) operational risk measurement and management issues with details on select operational risk events in the Caribbean region (hurricane, financial sector consolidation, money laundering and correspondent banking relationships).

Generic Risks

Oldfield and Santomero (1997) shared the view that financial institutions face five generic types of risk:- systematic, credit, counter-party, operational and legal[9]. The descriptions of these risks are as follows:

Systematic risk is the risk of change in asset value associated with systemic factors. As such, it can be hedged but cannot be completely diversified away. In fact, systematic risk can be thought of as undiversifiable risk. Financial institutions assume this type of risk whenever assets owned or claims issued can change in value as a result of broader economic conditions. As such, systematic risk comes in many different forms. For example, as interest rates change, different assets have somewhat different and unpredictable value responses. Energy prices affect transportation firms' stock prices and real estate values differently. Large scale weather effects can strongly influence real and financial asset values for better or worse. These are a few types of systematic risks associated with asset values.

Some financial institutions decompose systematic risk more finely. Institutions that have significant balance sheet sensitivity to specific systemic changes may seek to estimate the impact of these particular systematic risks on their performance. They could also attempt to manage them, and thus limit their sensitivity to variation in these undiversifiable factors. Accordingly, many financial institutions actively involved in the fixed income market attempt to track interest rate risk closely and more rigorously than those that have insignificant interest rate risk in their balance sheet.

They measure and manage the firm's vulnerability to interest rate variation, although they cannot do so perfectly. Likewise, international investors are aware of foreign exchange risk and try to measure and restrict their exposure to it. In a similar fashion, investors with high concentrations in one commodity, need to concern themselves with commodity price risk and perhaps overall price inflation. On the other hand, investors with high single industry investments should monitor both specific industry concentration risk and the forces that affect the fortunes of the industry involved.

Credit risk arises from non-performance or default by a debtor. It may arise from either an inability or an unwillingness to perform in the pre-committed contracted manner. This can affect the lender who underwrote the contract, other lenders to the creditor, and the debtor's own shareholders. Credit risk is diversifiable but difficult to hedge perfectly. This is because most of the default risk may result, in fact, from the systematic risk outlined above. The idiosyncratic nature of some portion of these losses, however, remains a problem for creditors in spite of the beneficial effect of diversification on total uncertainty. This is particularly true for creditors that lend in local markets and take on highly illiquid assets.

Counterparty risk comes from non-performance of a trading partner. The non-performance may arise from counter-party's or trading partner's refusal to perform due to an adverse price movement caused by systematic factors, or from some other political or legal constraint that was not anticipated by the principals. Diversification is the major tool for controlling nonsystematic counter-party risk. Commercial banks are a clear example of such institutions. Therefore, they have devoted considerable energy to interest rate risk management. Counter-party risk is like credit risk, but it is generally considered a transient financial risk associated with trading, rather than a standard creditor default risk associated with an investment portfolio. Counter-party's failure to settle a trade can arise from many factors other than a credit problem.

Operational risk is associated with the problems of accurately processing, settling, and taking or making delivery on trades in exchange for cash. It also arises in record keeping, computing correct payment amounts, processing system failures and compliance with various regulations. As such, individual operating problems are small probability events for well-run organizations, but they expose a firm to outcomes that may be quite costly.

Legal risks are endemic in financial contracting and are separate from the legal ramifications of credit, counter-party, and operational risks. New statutes, court opinions and regulations can put well established transactions into contention even when all parties have previously performed adequately and are fully able to perform in the future. Environmental regulations have radically affected real estate values for older properties as well. A second type of legal risk arises from the activities of an institution's management or employees. Fraud, violations of securities laws, and other actions can lead to catastrophic loss, as recent examples have demonstrated.[10][11]

Oldfield and Santomero (1997) noted that all financial institutions face the above risks to some extent.

Risk Management Framework

There is a wealth of literature concerning risk management particularly within the context of industrial countries, due predominantly to the speed at which the field has developed in recent years. The literature generally addresses issues of risk oversight, functions and steps in the risk management process. These emphases in the literature can be subsumed within an effective framework for risk management which speaks to three pillars of the risk management process for example, the policy imperative, the processes or steps used in risk management and the tools/techniques used to identify measure, monitor, mitigate and report risks in a financial intermediary.

Beder (1994)[12] defines risk management as "the activities of the professional who price and transact the firm's products and retain or hedge away resultant risk". In this regard, six (6) features of an independent risk oversight framework were identified as follows:

  1. require board level audit and oversight
  2. require specific written policies
  3. institute proper internal controls
  4. perform mark-to-market at least once every day
  5. forecast cash and funding requirements
  6. stress test financial exposures

It is interesting to note that the first two features are components of the risk management policy framework, the second feature makes reference to the process framework or the steps used in the management of risks in financial intermediaries and the final three features relate to the tools/techniques used in the risk management process.

Patel (1990) in discussing risk management identified four principal functions[13]of risk management. These are:

  1. Insulating the firm from operational, legal, liquidity, credit, reputational and market risks in the pursuit of profit maximization.
  2. The protection from systematic risk to world markets and trade
  3. Protection of the firm's clients from non-market risks (such as fraud) of dealing with the firm
  4. Ultimately providing a framework for the operation of efficient markets.

Williams and Heins (1989) identified six steps in the process of risk management as follows[14]:

  1. Define the objective the firm wishes to achieve from the risk management process. These broad risk management objectives should be established by the board of directors with input from the risk manager.
  2. Identify the loss exposure of the firm. Risk identification is perhaps the most difficult function that the risk manager must perform.
  3. Measure the potential losses during the budget period associated with these exposures. This measurement includes a determination of;
  4. the probability or change that losses will occur;

    the impact these losses would have upon the financial affairs of the firm should they occur and

    the ability to predict the losses that will actually occur

  5. Select the best combination of tools to be used in attacking the problem. These tools include primarily:
  6. Avoiding the exposure;

    Reducing the chance that losses will occur;

    Transferring the potential losses to some other party; and

    Retaining or bearing these losses internally.

  7. Implementing the decision made.
  8. Monitoring - results must be monitored to evaluate the wisdom of those decision and to determine whether changing conditions suggest different solutions.

The discussion of risk oversight, functions and steps highlighted above were quite general and generic. Specific references were not made as to how these functions or steps might vary according to core business activities of banking organizations. Neither was reference made concerning whether the approaches to risk management oversight can be interpreted differently based on activity type.

Similarities and Differences in Core Business Activities

BIS (2001) assert that while there is "convergence between various sectors" of financial organizations. "There still remain significant differences in the core business activities and the risk management tools that are applied to these activities"[15]. The Forum states that "there are also significant differences in the regulatory capital frameworks, in many cases reflecting differences in the underlying businesses and in supervisory approaches, and sectoral differences in core business activities and risk exposures were well reflected in the balance sheets of firms within sectors".

It was found that "policies and procedures exist to ensure that an independent assessment of risks occurs, and that controls are in place to limit the level of risk that can be taken on by individual business areas. The substantial efforts taken across all sectors to develop quantitative measures of risk, including risks such as operational risks (that are significantly difficult to measure) reflects the priority placed on risk management in the sectors". The report alluded to the fact that "continuing pressures to deliver strong and sustainable risk-adjusted returns on capital motivate financial firms in all sectors to invest in improved methodologies for quantifying risk".

"The emphasis on risk measurement can be related to efforts to manage significant risks through hedging or holding capital and or provisions". The Joint Forum admitted that "because such measures and risk mitigation techniques are costly, a better understanding of what risks should be hedged as well as how much capital and/or provisions are truly needed to support their retained risk would tend to improve the firms' risk-adjusted returns".

The Joint forum argues however that "notwithstanding these broad similarities, there are significant differences reflecting the different business activities and risk exposures in each sector". In this regard, it was argued that "firms naturally tend to invest more in developing risk management techniques for the risks that are dominant in their business. Therefore, risk management will often be more specialized and sophisticated for the primary risks in that sector than would be the case for management of the same risk in another sector where it is a more secondary risk".

"Securities firms focus mainly on the market and liquidity risks associated with their activities. Hedging techniques and capital play dominant roles in their strategies for the management of these risks, and they frequently build on quantitative value-at-risk and stress testing methodologies. The securities firm, it was argued, typically attempt to reduce the amount of credit risk they take by requiring collateral and by closely monitoring the size of exposures relative to collateral. The report point out however that in recent years, credit risk has become a major concern as the firms have become more involved in over-the-counter derivative transactions".

In relation to banks, the Joint Forum states that: "the taking on of credit exposure is a defining element of their business and as such the risk management of lending activities is their major challenge. It was further stated that banking risk management are currently undergoing a significant transformation, entailing a greater emphasis on the systematic assessment of the quality of all credits and the production of detailed quantitative estimates of credit risk. These quantitative measures are being used by banks to inform their internal estimates of the amount of provisions and capital necessary to support these risks. Additionally, the increasing use of quantitative credit risk measures is helping to spawn a large and growing market to the trading and hedging of credit risk exposures".

Risk Management Procedures - Tools and Techniques

Oldfield and Santomero (1997) argue that: "if management is to manage risk, it must establish a set of procedures to reach this goal[16]. The goal of the risk management plan is to measure and manage the firm level exposure to various types of risks which management has identified as central to their operations. They continue by adding that for each risk category, the firm employs a four-step procedure to measure and manage firm level exposure. These steps include:

  • Standards and reports
  • Position limits or rules
  • Investment guidelines or strategies
  • Incentive contracts and compensation

In general, these tools are established to accurately define the risk, limit exposure to acceptable levels, and encourage decision-makers to manage risk in a manner that is consistent with management's goals and objectives. To see how each of these four steps of a risk management system achieve these ends, Oldfield and Santomero (1997) elaborate on each part of the process below.

Standards and Reports

The first step of these control techniques involves two different conceptual activities, that is, standard setting and financial reporting. They are listed together because they are the sine qua non of any risk management system. Underwriting standards, risk categorizations, and standards of review are all traditional tools of risk control. Consistent evaluation and rating of exposure is essential for management to understand the true embedded risks in the portfolio, and the extent to which these risks must be mitigated or absorbed. The standardization of financial reporting is the next ingredient. Obviously, outside audits, regulatory reports, and rating agency evaluations are essential for investors to gauge asset quality and firm-level risk. These reports have long been standardized, for better or worse. However, the need here goes beyond public reports and audited statements to the need for management information on asset quality and risk posture. Such internal reports need similar standardization and much more frequent reporting intervals, with daily or weekly reports substituting for the quarterly GAAP periodicity.

Position Limits and Rules

A second step for internal control of active management is the establishment of position limits. These are imposed to cover exposures to counterparties, credits, and overall position concentrations relative to systematic risks. In general, each person who can commit capital has a well-defined limit. This applies to traders, lenders, and portfolio managers. Summary reports to management show counterparty, credit, and capital exposure by business unit on a periodic basis. In large organizations with thousands of positions maintained and transactions done daily, accurate and timely reporting is quite difficult, but perhaps even more essential.

Investment Guidelines

Third, investment guidelines and strategies for risk taking in the immediate future are outlined in terms of commitments to particular areas of the market, the extent of asset-liability mismatching or the need to hedge against systematic risk at a particular time. Guidelines offer firm level advice on the appropriate level of active management - given the state of the market and the willingness of senior management to absorb the risks implied by the aggregate portfolio. Such guidelines lead to hedging and asset-liability matching. In addition, securitization and syndication are rapidly growing techniques of position management open to participants looking to reduce their exposure to be in line with management's guidelines. These transactions facilitate asset financing, reduce systematic risk, and allow management to concentrate on customer needs that center more on origination and servicing requirements than funding position.

Incentive Schemes

To the extent that management can enter into incentive compatible contracts with line managers and make compensation related to the risks borne by these individuals, the need for elaborate and costly controls is lessened. However, such incentive contracts require accurate position valuation and proper cost and capital accounting systems. It involves substantial cost accounting analysis and risk weighting which may take years to put in place. Notwithstanding the difficulty, well-designed compensation contracts align the goals of managers with other stakeholders in a most desirable way. In fact, most financial debacles can be traced to the absence of incentive compatibility, as the case of deposit insurance illustrates".

Enterprise-wide Risk Management

Oldfield and Santomero (1997) suggest that: "implementing firm-wide risk management practice entails a significant commitment of management time and institutional resources. It requires a focus on the central businesses of the organization, bottom-to-top review of lending or origination, trading or market making, and intermediation with a risk management perspective. It leads to the construction of databases and reporting systems quite different from standard accounting systems. In this process, several guiding principles must be maintained for successful implementation of firm-level risk management practices".

Accordingly, they mention the following: "First, risk management must be an integral part of an institution's business plan. Decisions to enter, leave, or concentrate on an existing business activity require careful assessment of both risks and potential returns. Risk management practices must be defined for each business activity that is pursued. Finally, business activities not part of the institution's focus must be eliminated so that avoidable risks are not assumed due to lack of management oversight.

Second, the specific risks of each business activity of an institution must be defined and the means to measure the risks must be developed. Similarly, databases must be developed to obtain proper and consistent risk measurement across the entire organization. Credit risk evaluation techniques, for example, should be the same in corporate lending, as in correspondent banking. Only then will aggregate credit quality reports have meaning to senior management.

Third, procedures must be established so that risk management begins at the point nearest to the assumption of risk. This means that trade entry procedures, customer documentation, client engagement methods, trading limits, maximum loan sizes, hedging strategies, and a myriad of other normal business activities must be adapted to maintain management control, generate data in a consistent fashion, and eliminate needless exposure to risk.

Fourth, databases and measurement systems must be developed in accordance with the way business is conducted. For example, most accounting systems for trading operations record trades on the basis of settlement day. However, to measure trading desk risks, risk management systems must record positions on a trade date basis. This means that the risk management system must access the trade entry system directly. Moreover, for accurate daily reports, trades must be recorded, entered, and checked in a timely fashion. Next day corrections of bad trade information are not timely enough".

Oldfield and Santomero (1997) argue that: "none of the procedures or databases mentioned here are effective or meaningful until an overall risk management system is put in place and used by senior management. The system must be used to evaluate businesses, individual performance, and firm-level value added. It must be the focus of management analysis and discussion on an ongoing basis, and over time it will, and must, become part of board meeting presentations. To achieve this, the risk reports must be checked regularly by the business units being monitored; reports must be tailored for their users; and the system must be part of management's oversight, control, and compensation".

Regulatory Capital

The current international standards for bank capital requirements have its genesis in the Basel Accord of 1988[17]. This accord establishes for the first time an international framework for measuring regulatory capital and setting capital adequacy standards. The Capital Accord was drafted at a time when banks were still concentrating on traditional banking functions, and when credit risk was the single most important risk factor as such, the Accord ignored market risk.

The difficulties the Basel Committee encountered in producing a new set of comprehensive capital adequacy requirements have prompted it to consider a revolutionary change in the way banks are supervised and regulated. On April 12, 1995, the Committee issued for comment a new set of capital requirements to be implemented by the end of 1997. It moves bank regulation in a new direction by allowing banks to actively participate in the design of the framework for establishing capital requirements by using their own internal risk management models to estimate value-at-risk.[18]

Notwithstanding the advantages of the Basel proposal, which includes eliminating the need for banks to maintain two parallel systems (one for regulatory purposes and another for trading and portfolio allocation), and providing banks with additional incentives to improve their risk management systems the new approach also poses many challenges. For one thing, there is little agreement in the banking industry about how to model and measure risk.

Two banks holding the same portfolio could likely come up with different estimates of value-at-risk, implying different capital requirements for the same risks. Such an outcome violates a major objective of international capital requirements: the achievement of a level playing field.

Another problem with the new Basel approach is the emphasis on quantitative measures, such as value-at-risk, which might lead banks to over look major market elements that are not easily quantifiable. The approach also ignores legal and operational risk - both important elements in recent financial crises (such as the failure of U.K. based investment bank, Barings). Hence in July 1994, in recognition of the importance of high quality risk management systems by both banks and non-banks, the Basel Committee on Banking Supervision and the Internal Organization of Securities Commissions issued joint reports on risk management. These reports itemize many important elements of sound risk management.

IMF (1995) highlighted the fact that regulation and supervision of banking activities have been impacted by advances in technology, the rapid growth of OTC (over the counter) derivative markets, the shift in banking activity from lending to heavy involvement in these markets and the globalization and liberalization of financial markets[19]. In particular, the financial services industry has undergone a number of fundamental structural changes. Market and operational risk have become more important for banks. Linkages between financial markets and institutions have strengthened, and banks now have the ability to restructure their portfolios and risk exposures quickly, which ideally should be simple, extendable and applicable. Capital standards therefore should be structured in a way that encourages improvements in internal risk management. However, by the time the Accord came into force, the minimum standards it defined were already inadequate, partly because of changes in the nature of banking and in the financial services industry as a whole.

IMF (1994) capital market study[20] argues that the major challenge facing the industry at the time, was to find a single measure of risk that captures comprehensively all the risks inherent in the financial activities of a single financial institution. An important impediment to greater transparency and disclosure is the absence of consensus about what information to disclose, when to disclose it and to whom to disclose it to. According to the article, recent initiatives have been undertaken by major financial industry and regulatory bodies (the Institute of International Finance, the Bank for International Settlements, and the U.S. Financial Accounting Standards Board) to improve transparency and disclosure. But as the IMF study notes, these initiatives leave unresolved many issues including: Risk Aggregation, Non-quantifiable Risks and Trade-off between uniformity and flexibility.

Basel (July 1988[21]) in its discussion on the constituents of capital, states that "the key elements of capital on which the main emphasis should be placed, are equity capital[22] and disclosed reserves. The key element of capital is the only element common to all countries' banking systems; it is wholly visible in the published accounts and is the basis on which most market judgments of capital adequacy are made. It also has a crucial bearing on profit margins and a bank's ability to compete".

BIS (2001)[23] in discussing regulatory capital in the Banking, Securities and Insurance sectors, indicated that "the primary approaches in place in the three sectors reflected underlying differences in the time horizons most appropriate to the risks in each sector, as well as differences in supervisory objectives and emphasis". Importantly, the issues relating to capital vis-a-vis provisions or reserves across the three sectors were discussed.

According to BIS, "technical provisions for insurance companies perform the role of providing an estimate of foreseeable claims (policy benefits). Securities firms on the other hand, generally do not maintain reserves because assets and contractual obligations can generally be valued accurately on a mark-to-market basis, and there should be no expected losses if market prices fully reflect current information. Capital therefore serves as the primary cushion against losses in the securities sector. Banks on the other hand hold both loan loss reserves to cover foreseeable losses and capital to cover unanticipated credit losses".

The BIS Report (2001) suggests that when a closer look at the underlying differences in starting points was taken, it was found that the "specific capital regulation or solvency regime frameworks are themselves quiet distinct. For banks, the dominant approach is based on the Basel Accord". The paper discusses the two main approaches for securities firms namely "(1) the Net Capital

  1. McDonough, William J Remarks by William J McDonough for presentation in Mexico City on July 22, 1998 (10 January 2007)
  2. Yellen, Janet L , Presentation to the Western Independent Bankers Association Annual Conference, Kauai, Hawaii March 2005 , (12 January 2007)
  3. Testimony of Chairman Alan Greenspan, The state of the banking industry , Before the Committee on Banking, Housing, and Urban Affairs, U.S. Senate , April 20, 2004 http://www.federalreserve.gov/boarddocs/testimony/2004/20040420/default.htm
  4. The Federal Reserve Board: Testimony of Chairman Alan Greenspan, the state of the banking industry, before the Committee on Banking, Housing, and Urban Affairs, U.S. Senate, April 20, 2004.
  5. Ben S Bernanke: Modern risk management and banking supervision. - Remarks by Mr. S Bernanke, Chairman of the Board of Governors of the US Federal Reserve System, at the Stonier Graduate School of Banking, Washington, DC, 12 June 2006.
  6. Ben S Bernanke: Modern risk management and banking supervision. - Remarks by Mr. S Bernanke, Chairman of the Board of Governors of the US Federal Reserve System, at the Stonier Graduate School of Banking, Washington, DC, 12 June 2006
  7. See Ministry of Finance (1998) Financial Sector Crisis at http://www.mof.gov.jm/budget memo/1998/appendix5.htm. for further information on Government intervention in Jamaica's financial sector in December 1994 when the Ministry of Finance assumes temporary management of the Blaise Financial Entities and the Century Financial Institutions in July 1996.
  8. Ministry of Finance(Jamaica) 1998 - Financial Crisis
  9. Oldfield, George S and Santomero, Anthony M. (1997) Risk Management in Financial Institutions. Sloan Management Review Fall
  10. Oldfield and Santomero (1997) :The Place of Risk Management in Financial Institutions.
  11. Oldfield, George S and Santomero, Anthony M. (1997) Risk Management in Financial Institutions. Sloan Management Review Fall.
  12. Beder, Tanya (1994) Three key challenges in independent risk oversight. Derivatives Use, Trading & Regulation, Volume One, Number One, 1995, 9-13
  13. Patel, Alpesh (1999) Training risk: The unrecognized operational risk management problem, Derivatives Use, Trading & Regulation, Volume Five, Number One, 29-30
  14. Williams, C. Arthur and Heins, M. Richard .JR (1989) Risk Management and Insurance 6th Edition, pp 8.
  15. Basel (2001) Joint Forum Risk Management Practices and Regulatory Capital - Cross Sectoral Comparison - Bank for International Settlement (BIS)
  16. Oldfield, George S and Santomero, Anthony M, The Place of Risk Management in Financial Institutions (Wharton Financial Institutions Center, 1997)
  17. The 1998 Basel Accord was formulated by Basel Committee on banking Supervision which represents supervisory authorities from 12 major countries and operates under the auspices of the Bank for International settlement.
  18. Value-at-risk is the Basel Committee's standard measure for risk exposure. It is an estimate of the maximum loss in the value of a portfolio or financial position over a given period, with a built-in probability that the actual loss will not exceed a pre-specified maximum.
  19. IMF Survey (September 14, 1995) - Managing Risk in a new financial environment
  20. The IMF's annual review of developments in capital markets and the implications of the December 1994 financial crisis in Mexico for other emerging markets; and the challenges for international financial supervisors and regulators posed by the continuing growth of international derivative markets and their impact on the activities of he major money-centre banks (see the June 19 issue of the IMF Survey for an overview)
  21. Basel Committee: International convergence of capital measurement and capital standards (updated to April 1998), p 3.
  22. ssued and fully paid ordinary shares/common stock and non-cumulative perpetual preferred stock (but excluding cumulative preferred stock).
  23. International Association of Insurance Supervisors; The Joint Forum RISK MANAGEMENT PRACTICES AND REGULATORY CAPITAL CROSS-SECTORAL COMPARISON; November 2001; THE JOINT FORUM.