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Step 2 - Define Risk Policy

Decide the basic risk policy that the organisation wants to have. This may vary from taking no risk (cover all) to taking high risks (open all). Most organisations would fall somewhere in between the two extremes. Risk and reward go hand in hand.

Cost Center Vs. Profit Center

A cost centre approach looks at exposure management as insurance against adverse movements. One is not looking for optimisation of cost or realisation but meeting certain budgeted or targeted rates. In a profit centre approach, the business is taking deliberate risks to make money out of price movements.

Step 3- Risk Measurement

There are a number of different measures of price or market risk which are mainly based on historical and current market values Examples are Value at Risk (VAR), Revaluation, Modelling, Simulation, Stress Testing, Back Testing, etc.

Step 4- Risk Control

Control of Price Risk

Position limits are established to control the level of price or market risk taken by the organization.

Diversification is used to reduce systematic risk in a given portfolio.

Control of Credit Risk

Credit limits are established for each counterparty for both Dealing Risk and Settlement Risk separately depending upon the risk perception of the counterparty.

Control of Operating Risk

Establishment of an effective and efficient internal control structure over the trading and settlement activities, as well as implementing a timely and accurate management information system (M.I.S.).

Tools to control operating risks

  • Comprehensive Systems and Operations Manuals

  • Proper Organizations structure and adequate personnel

  • Separation of trading function from settlement, accounting and risk control functions.

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  • Strict enforcement of authority and limits

  • Written confirmation of all verbal dealings

  • Voice recording

  • Legally binding agreements with counterparties ensuring proposed transactions are not ultra vires.

  • Contingency Planning

  • Internal Audits

  • Daily reconciliations

  • Ethical standards and codes of conduct

  • Dealing discipline

 


    
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