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Disclosure of risk management strategies and practices

Category: Corporate Governance

Risk management has become a key factor in assessing the future performance and condition of a bank and the effectiveness of management.

Disclosures may include discussions of overall risk management philosophy, overall policy and methodologies, how risks arise, how risks are managed and controlled, and whether and how derivatives are used to manage risks. It may also be useful to discuss the risk management structure and risk measurement and monitoring (e.g., models, value-at-risk, simulation, credit scoring, capital allocation, etc.), monitoring process, model validation process, stress testing, back testing, the use of risk-mitigating tools (collateral/guarantees, netting agreements, managing concentrations), limits (e.g., credit limits, market risk limits), and periodic review of exposures.

Disclosure of risk exposures

Market participants and bank supervision need qualitative and quantitative information about bank’s risk exposures, including its strategies for managing risk and the effectiveness of those strategies. Understanding of the nature and extent of an institution’s risk exposures helps assess stability of an institution’s financial position and the sensitivity of its earnings potential to changes in market conditions.

Traditionally, banks have focused on disclosing information about credit risk and market risk, including interest rate and foreign exchange risk, and, to a lesser extent, liquidity risk.

In discussing each of these risk areas, a bank should present sufficient qualitative (e.g., management strategies) and quantitative information (e.g., position data) to help readers understand the nature and magnitude of these risk exposures. Further, comparative information of previous years’ data should be provided to give the financial statement user a perspective on trends in the underlying exposures.

Other risk exposures such as operational, legal and strategic risk are less easy to quantify, but may be highly relevant. Qualitative information should be given about the nature of the risks and how they are managed.

For many banks, credit risk is the most significant exposure. Although typically it arises primarily from the loan portfolio, credit risk also arises in the investment and trading portfolios and in other banking activities (e.g. asset securitization, interbank lending, overnight deposits).

Credit risk

To achieve transparency, a bank should provide descriptive information about the business activities that create credit risk, its strategies regarding those business lines, and the nature and composition of the exposures that arise. Useful disclosures include a discussion about business strategies, risk management processes and internal controls relating to activities that generate credit risk.

Example of required credit risk disclosures:

— gross position on loan exposure;

— industry/sector concentrations;

— individual credit exposures;

— amounts of problem/impaired loans;

— details and movements in provision for impaired loans;

— policies and details about use of collateral and guarantees;

— use of credit assessment methods;

— portfolio risk measurement tools;

— organization of credit risk function; and

— other relevant discussions about activities on managing credit risk exposure

Market risk

As with credit risk, an institution should provide both quantitative and qualitative information regarding its market risk exposures. Market risk arises from the potential for changes in market rates and prices, including interest rates, foreign exchange rates, and equity and commodity prices. A bank’s disclosures about each of these types of risk should be comparable with the degree of exposure.

Since interest rate risk is especially relevant to banks, disclosure should provide detailed quantitative information about the nature and extent of interest rate-sensitive assets and liabilities and off-balance sheet exposures. Examples of useful disclosures for this information include breakdowns of fixed and floating rate items and the net interest margin earned.

Other useful disclosures include the duration and effective interest rates of assets and liabilities.

Disclosures should also provide information about the interest rate sensitivity of a bank’s assets and liabilities.

For example, disclosures about the effect on the value of assets and liabilities given a specific range of changes (increase or decrease) in interest rates can provide a useful summary measure of the bank’s risk exposure.

To facilitate understanding of foreign exchange risk exposures, banks should provide summarized data for significant concentrations of foreign exchange exposure by currency, broken down by hedged and unhedged exposures. It is also helpful to disclose information about investments in foreign subsidiaries (foreign currency translation risk). This quantitative information should be supplemented with discussion about the nature of the currency exposure, how that exposure has changed from year to year, foreign exchange translation effects, the earnings impact of foreign exchange transactions and the effectiveness of risk management (hedging) strategies.


The extract from the 2002 UBS Group’s annual report is provided below for the best practice example for market risk disclosure (page 131 of annual report):

Market Risk


Market risk is the risk of loss arising from movements in observable market variables such as interest rates, exchange rates and equity markets. In addition to these and other general market risk factors, the risk of price movements specific to an individual issuer of securities is considered market risk.

Market risk is incurred in UBS primarily through trading activities which are centered in the Corporate and Institutional Clients business of UBS Warburg. It arises primarily from market making, client facilitation and proprietary positions in equities, fixed income and interest rate products, foreign exchange and, to a lesser extent, precious metals and energy. Such activities are mainly in OECD markets, with some business in emerging markets.

Group Treasury assumes non-trading risk positions that arise from its balance sheet management activities. Further market risks arise, but to a much lesser extent, in other businesses primarily from the facilitation of customer business. Market risk measures are applied to all foreign exchange, precious metal and energy positions, to the trading books of UBS Warburg, to interest rate risk in the Group Treasury book and the private banks, and to any other material market risk arising. The principal risk measures and controls on market risk are Value at Risk (VaR) and stress loss. VaR expresses the potential loss on the current portfolio assuming a specified time horizon before positions can be adjusted (holding period),and measured to a specified level of confidence, based on historical market movements.

Stress loss is assessed against a set of forward-looking scenarios, approved by the Board of Directors, using stress moves in market variables. Complementary controls are also applied where appropriate, to prevent undue concentrations, including limits on exposure to individual market risk variables, such as individual interest or exchange rates, and limits on positions in the securities of individual issuers. These controls are set at levels which reflect variations in price volatility and market depth and liquidity.

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