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Risk supervision is a hot topic in the financial sector especially in the light of the up-to-date losses of some multinational corporations e.g. Collapses of Britain's Barings Bank, WorldCom and also due to the incident of 9/11. Rapid changes in business condition, restructuring of organizations to cope with ever increasing competition, amelioration of new products, emerging markets and growth in cross border transactions along with complexity of transactions has exposed Financial Institutions to new risks dimensions. Thus the understanding of risk has captured a growing importance in modern financial society.

By facilitating transactions and development prestige and other financial products available, the financial sector is a crucial construction block for inexpressive as well as public sector development. In its broadest definition, it includes all things from banks, stock exchanges, and insurers, to prestige unions, microfinance institutions and moneylenders. As an productive assistance provider, the financial sector simultaneously fulfils an foremost function in the thorough economy. Assorted types of Financial Institutions actively working in Financial Sectors contain Banks, Dfis, Micro Finance Banks, Leasing Companies, Modarabas, Assets supervision Company, Mutual Funds, etc.

Thus today's operating environment demands systematic and more integrated risk supervision approach.

Risk:

Risk by default has tow components; uncertainty and exposure. If both are not present, there is no risk. Definition of Risk as per Guidelines on Risk supervision issued by State Bank of Pakistan is, "Financial risk in a banking club is possibility that the outcome of an activity or event could bring up adverse impacts. Such outcomes could whether ensue in a direct loss of wage / capital or may ensue in imposition of constraints on bank's ability to meet its business objectives. Such constraints pose a risk as these could hinder a bank's ability to guide its ongoing business or to take advantage of opportunities to heighten its business."

Types of Risks:

Risks are regularly defined by the adverse impact on profitability of several inevitable sources of uncertainty. More or less all financial institutions have to manage the following faces of risks:

1. Credit Risk

2. Market Risk

3. Liquidity Risk

4. Operational Risk

5. Country Risk

6. Legal Risks

7. Compliance Risk

8. Reputational Risk

Broadly speaking there are four risks as per Risk supervision Guidelines which surround Financial Sector i.e. prestige Risk, market Risk, Liquidity Risk and Operational Risk. These risk are elaborated here under:

i. Credit Risk

This is the risk incurred in case of a counter-party default. It arises from lending activities, investing activities and from buying and selling financial assets on profit of others. This risk is linked with financing transactions i.e.:

a. Default in reimbursement by the borrower and

b. Default in obliging the commitment by another Financial institution in case of syndicated arrangements.

It is the most requisite risk in banking and one that must be managed carefully. It is also the risk that requires the most subjective judgment despite constant efforts to heighten and quantify the prestige decision process.

ii. Market Risk

Market risk is defined as the volatility of wage or market value due to fluctuations in underlying market factors such as currency, interest rates, or prestige spreads. For market banks, the market risk of the stable liquidity speculation briefcase arises from mismatches between the risk profile of the assets and their funding. This risk involves interest rate risk in all of its components: equity risk, change risk and commodity risk.

iii. Liquidity Risk

The liquidity risk is defined as the risk of not being able to meet its commitments or not being able to unwind or offset a position by an club in a timely fashion because it cannot liquidate assets at uncostly prices when required.

iv. Operational Risk

This risk results from inadequacies in the conception, organization, or implementation of procedures for recording any events about bank's operations in the accounting system/information systems.

Need for Risk supervision and Monitoring:

There are a number of reasons as to why there is so much emphasis given to Risk supervision in Financial Sector now a day. Some of them are listed below: -

1. Present structure of joint stock companies, wherein owners are not the mangers, hence risks increase; therefore proper tools are required to achieve the desired results by surface the risks.

2. The financial sector has come out of easy deposit and lending function.

3. The world has come to be very complicated so the financial transactions and instruments.

4. Increase in the number of cross border transactions which caries its own risks.

5. Emerging markets

6. Terrorism Remittances

Risk monitoring in financial sector is very crucial and an inevitable part of risk management. Risk Monitoring is foremost in the financial sector due to the following reasons:

1. Deals in others' money

2. Direct stake of deposit holder.

3. Much riskier sector than trading and manufacturing.

4. Previous / up-to-date problems faced by banks i.e. Stuck briefcase that is prestige risk.

5. Bankruptcy of Barings Bank due to short selling / long position that is market risk.

6. Operational risk does not has immediate impact, but foremost for continuity and improve of organization.

7. Appetite of a financial institution to take risk is linked with the capital base of the compose so it caries a huge risk of over exposure.

Components of Risk supervision Frame Work

Risk supervision Frame Work has five components. First of all risk is Identified, then it is Assessed to classify, seek solution and management, after assessing quick Response and implementation of solution and the last phase is Monitoring of the risk supervision improve and learning from this feel that such question never occur again. Whole process is to be well Communicated during the entire process of risk supervision if it is to be managed efficiently.

The International club for Standardization (Iso) has defined risk supervision as the identification, analysis, evaluation, treatment (control), monitoring, delineate and transportation of risk. These activities can be applied in a systematic or ad hoc manner. The presumption is that systematic application of these activities will ensue in improved decision-making and, most likely, improved outcomes.

Structure of Risk Management

Depending upon the structure and operations of organization, financial risk supervision can be implemented in different ways. Risk supervision structure defines the different layers of an club at which risk is identified and managed. Although there are different layers or level at which risk is managed but there are three layers which are coarse to all. I.e.

Risk Management

For managing risk there are inevitable basic principles which are to be followed by every organization:

1. Corporate level Policies

2. Risk supervision strategy

3. Well-defined policies and procedures by senior management

4. Dissemination, implementation and yielding of policies and procedures

5. Accountability of individuals heading Assorted functions/ business lines

6. Independent Risk delineate function

7. Contingency plans

8. Tools to monitor risks

Institutions can reduce some risks simply by researching them. A bank can reduce its prestige risk by getting to know its borrowers. A brokerage firm can reduce market risk by being knowledgeable about the markets it operates in.

Functionally, there are four aspects of financial risk management. Success depends upon

A. A inevitable corporate culture,

No one can manage risk if they are not ready to take risk. While private initiative is critical, it is the corporate culture which facilitates the process. A inevitable risk culture is one which promotes private responsibility and is supportive of risk taking.

B. Actively observed policies and procedures

Used correctly, procedures are superior tool of risk management. The purpose of policies and procedures is to empower people. They specify how people can accomplish what needs to be done. The success of policies and procedures depends critically upon a inevitable risk culture.

C. Effective use of technology

The former role technology plays in risk supervision is risk assessment and communication. Technology is employed to quantify or otherwise summarize risks as they are being taken. It then communicates this facts to decision makers, as appropriate.

D. Independence or risk supervision professionals

To get the desired outcome from risk management, risk managers must be independent of risk taking functions within the organization. Enron's feel with risk supervision is instructive. The firm maintained a risk supervision function staffed with capable employees. Lines of reporting were reasonably independent in theory, but less so in practice.

Internal Controls

Para one on first page of the 'Guidelines on Internal Controls' issued by Sbp provides:

"Internal control refers to policies, plans and processes as affected by the Board of Directors and performed on continuous basis by the senior supervision and all levels of employees within the bank. These internal controls are used to contribute uncostly insurance about the achievement of organizational objectives. The principles of internal controls includes financial, operational and yielding controls."

The current lawful definition of internal control was industrialized by the Committee of Sponsoring club (Coso) of the Treadway Commission. In its influential report, Internal control - Integrated Framework, the Commission defines internal control as follows:

"Internal control is a process, effected by an entity's Board of Directors, supervision and other personnel, designed to contribute uncostly insurance about the achievement of objectives in the following categories:

 Effectiveness and efficiency of operations.

 Reliability of financial reporting.

 Compliance with applicable laws and regulations.

This definition reflects inevitable underlying concepts:

 Internal control is a process. It is a means to an end, not an end in itself.

 Internal control is effected by people. It is not policy manuals and forms, but people at every level of an organization.

 Internal control can be expected to contribute only uncostly assurance, not absolute assurance, to an entity's supervision and board.

Internal control should help and never impede supervision and staff from achieving their objectives. control must be taken seriously. A well-designed principles of internal control is worse than worthless unless it is complied with, since the assemblance of control will be likely to convey a false sense of assurance. Controls are there to be kept, not avoided. For instance, exception reports should be followed up. Senior supervision should set a good example about control compliance. For instance, bodily entrance restrictions to gather areas should be observed equally by senior supervision as by junior personnel.

Components of Internal Controls

Components of internal control also depend upon the structure of the business unit and nature of its operation. The Coso record describes the internal control process as consisting of five interrelated components that are derived from and integrated with the supervision process. The components are interrelated, which means that each component affects and is affected by the other four. These five components, which are the requisite foundation for an productive internal control system, include:

I. Control Environment,

Control environment, an intangible factor and the first of the five components, is the foundation for all other components of internal control, providing discipline and structure and encompassing both technical competence and ethical commitment.

Ii. Risk Assessments,

Organizations exist to achieve some purpose or goal. Goals, because they tend to be broad, are regularly divided into specific targets known as objectives. A risk is anyone that endangers the achievement of an objective. Risk assessments is done to determine the relative inherent for loss in programs and functions and to compose the most cost-effective and productive internal controls.

Iii. Control Activities,

Control activities mean the structure, policies, and procedures, which an club establishes so that identified risks do not preclude the club from reaching its objectives.
Policies, procedures, and other items like job descriptions, organizational charts and supervisory standards, do not, of course, exist only for internal control purposes. These activities are basic supervision practices.

Iv. Information and Communication, and

Organizations must be able to gather trustworthy facts to determine their risks and delineate policies and other facts to those who need it. facts and communication, the fourth component of internal control, articulates this factor.

V. Monitoring

Life is change; internal controls are no exception. Satisfactory internal controls can come to be obsolete straight through changes in external circumstances. Therefore, after risks are identified, policies and procedures put into place, and facts on control activities communicated to staff, superiors must then implement the fifth component of internal control, monitoring.

Even the best internal control plan will be unsuccessful if it is not followed. Monitoring allows the supervision to recognize whether controls are being followed before problems occur. In the same way, supervision must delineate weaknesses identified by audits to determine whether linked internal controls need revision.

Tools for Monitoring of Risk

Management facts System

M.I.S or supervision facts principles is the variety and determination of data in order to reserve management's decision with respect to the achievement of objectives mentioned in the policies and procedures and the control of Assorted risks therein.

It is this area i.e. M.I.S, where I.T can play a vital and productive role as with the help of I.T large facts may be analyzed efficiently and with accuracy, so that productive decision may be taken by the supervision without the loss of any time.

Asset-Liability supervision Committee (Alco)

In most cases, day-to-day risk assessment and supervision is assigned to a specialized committee, such as an Asset-Liability supervision Committee (Alco). Duties pertaining to key elements of the risk supervision process should be adequately separated to avoid inherent conflicts of interest - in other words, a financial institution's risk monitoring and control functions should be sufficiently independent from its risk-taking functions. Larger or more complicated institutions often have a designated, independent unit responsible for the compose and supervision of balance sheet management, along with interest rate risk. Given today's thorough innovation in banking and the dynamics of markets, banks should recognize any risks inherent in a new product or assistance before it is introduced, and ensure that these risks are promptly carefully in the assessment and supervision process.

Corporate Governance Principles

Corporate governance relates to the manner in which the business of the club is governed, along with setting corporate objectives and a institution's risk profile, aligning corporate activities and behaviors with the anticipation that the supervision will control in a safe and sound manner, running day-to-day operations within an established risk profile, while protecting the interests of depositors and other stakeholders. It is defined by a set of relationships between the institution's management, its board, its shareholders, and other stakeholders.

The key elements of sound corporate governance in a bank include:

a) A well-articulated corporate strategy against which the thorough success and the gift of individuals can be measured.

b) Setting and enforcing clear assignment of responsibilities, decision-making authority and accountabilities that are proper for the bank's risk profile.

c) A strong financial risk supervision function (independent of business lines), adequate internal control systems (including internal and external audit functions), and functional process compose with the requisite checks and balances.

d) Corporate values, codes of guide and other standards of proper behavior, and productive systems used to ensure compliance. This includes special monitoring of a bank's risk exposures where conflicts of interest are expected to appear (e.g., relationships with affiliated parties).

e) Financial and managerial incentives to act in an proper manner offered to the board, supervision and employees, along with compensation, promotion and penalties. (i.e., recompense should be consistent with the bank's objectives, performance, and ethical values).

f) Transparency and proper facts flows internally and to the public.

Tools mentioned above can be utilized in identifying and managing different risks in the following manner:

I. Credit Risk

It is managed by setting economical limits for exposures to private transaction, counterparties and portfolios. Due limits are set by reference to prestige rating established by prestige Rating Agencies, methodologies established by Regulators and as per Board's direction.

o Monitoring of per party exposure

o Monitoring of group exposure

o Monitoring of bank's exposure in contingent liabilities

o Bank's exposure in clean facilities

o Analysis of bank's exposure product wise

o Analysis of attention of bank's exposure in Assorted segments of economy

o Product profitability reports

Ii. Market

Financial Institutions should also have an adequate principles of internal controls to oversee the interest rate risk supervision process. A underlying component of such a principles is a regular, independent delineate and assessment to ensure the system's effectiveness and, when appropriate, to propose revisions or enhancements.

Interest rate risk should be monitored on a consolidated basis, along with the exposure of subsidiaries. The institution's board of directors has extreme responsibility for the supervision of interest rate risk. The board approves the business strategies that determine the degree of exposure to risk and provides advice on the level of interest rate risk that is proper to the institution, on the policies that limit risk exposure, and on the procedures, lines of authority, and responsibility linked to risk management. The board also should systematically delineate risk, in such a way as to fully understand the level of risk exposure and to compare the doing of supervision in monitoring and controlling risks in yielding with board policies. Reports to senior supervision should contribute aggregate facts and a adequate level of supporting detail to facilitate a meaningful assessment of the level of risk, the sensitivity of the bank to changing market conditions, and other relevant factors.

The Asset and Liability Committee (Alco) plays a key role in the oversight and coordinated supervision of market risk. Alcos meet monthly. speculation mandates and risk limits are reviewed on a regular basis, regularly annually to ensure that they remain valid.

Risk supervision and Risk Budgets

A risk funds establishes the tolerance of the board or its delegates to wage or capital loss due to market risk over a given horizon, typically one year because of the accounting cycle. (Institutions that are not sensitive to each year wage requirements may have a longer horizon, which would also allow for a greater degree of leisure in briefcase management.). Once an each year risk funds has been established, a principles of risk limits needs to be put in place to guard against actual or inherent losses exceeding the risk budget. There are two types of risk limits, and both are requisite to constrain losses to within the prescribed level (the risk budget).

The first type is stop-loss limits, which control cumulative losses from the mark-to-market of existing positions relative to the benchmark. The second is position limits, which control inherent losses that could arise from time to come adverse changes in market prices. Stop-loss limits are set relative to the thorough risk budget. The funds of the risk funds to different types of risk is as much an art as it is a science, and the methodology used will depend on the set-up of the private speculation process. Some of the questions that affect the risk funds contain the following:

* What are the requisite market risks of the portfolio?

* What is the correlation among these risks?

* How many risk takers are there?

* How is the risk expected to be used over the policy of a year?

Compliance with stop-loss limits requires frequent, if not daily, doing measurement. doing is the total return of the briefcase less the total return of the benchmark. The estimation of doing is a requisite statistic for monitoring the usage of the risk funds and yielding with stop-loss limits. Position limits also are set relative to the thorough risk budget, and are branch to the same considerations discussed above. The function of position limits, however, is to constrain inherent losses from time to come adverse changes in prices or yields.

Iii. Liquidity Risk

The Basel Committee has established inevitable quantitative standards for internal models when they are used in the capital adequacy context.

a. Allocation of capital into Assorted types of business after taking into list the operational risks i.e. Disruption of business activity, which has especially increased due to inordinate Edp usage

b. Allocation of the capital is also made amongst Assorted products i.e. Long term, short term, consumer, corporate etc. Inspecting the risks complicated in each product and its life cycle to avoid any liquidity crunch for which gap determination is made. This is the job of Alco

c. For instance Contingent liabilities not more than 10 times of capital,

d. Fund based not more than 6 times of capital

e. Capital market operations not more than 1 time of capital

f. However these limits cannot exceed the regulations.

g. Parameters of controls

o Regulatory Requirements

o Board's directions

o Prudent practices

For liquidity supervision organizations are compelled to hold reserves for unexpected liquidity demands. The Alco has responsibility for setting and monitoring liquidity risk limits. These limits are set by Regulatory Bodies and under Board's directions retention in mind the market health and past experience.

The Basel Accord comprises a definition of regulatory capital, measures of risk exposure, and rules specifying the level of capital to be maintained in relation to these risks. It introduced a de facto capital adequacy standard, based on the risk-weighted aggregate of a bank's assets and off-balance-sheet exposures that ensures that an adequate number of capital and reserves is maintained to safeguard solvency. The 1988 Basel Accord primarily addressed banking in the sense of deposit taking and lending (commercial banking under Us law), so its focus was prestige risk.

In the early 1990s, the Basel Committee decided to modernize the 1988 accord to contain bank capital requirements for market risk. This would have implications for non-bank securities firms.

Thus, the method for determining capital adequacy can be graphic as follows:

= Tier I + Tier 2 + Tier 3 *- 8% .

Risk-weighted Assets + (Market Risk Capital charge x 12.5)

Iv. Operational Risk

To manage this risk documented policies and procedures are established. In addition, regular training is provided to ensure that staffs are well aware of organization's objective, statutory requirements.

o Reporting of major/ unusual/ exceptional transactions with respect to ensuring the yielding of the principles of Kyc and Anti-money laundering measure

o Analysis of principles problems