Question

List methods financial institutions may disclose their exposure to each type of market risk and explain Value-at-risk approach

Answer 1

Market risk” is the risk that a financial institution will incur losses because of a change in the price of assets held (including off-balance-sheet assets) resulting from changes in interest rates, securities etc. prices, foreign exchange rates, and other market risk factors.

1) Interest-rate risk: the risk of losses because of changes in interest rates, and specifically, the risk of declining profits or losses because of changes in interest rates when an institution has a mismatch of interest rates and/or periods for its assets and liabilities.

2) Price fluctuation risk: the risk of a decline in asset prices because of changes in the prices of securities etc.

3) Foreign exchange risk: the risk of losses when an institution has a net asset or net liability position in its foreign-currency assets and liabilities and foreign exchange prices are different from the prices initially expected.

Inspectors will verify and inspect the market-related risk management systems of financial institutions using the Risk Management Systems Checklists (Common Items), and this checklist

This manual is only a handbook to be used by inspectors in the inspection of financial institutions. It is expected that, as part of their efforts to ensure sound and proper operations and in accordance with the principle of self-responsibility, individual financial institutions will fully exercise their creativity and innovation to voluntarily create their own detailed manuals. These institutional manuals should make note of the content of this manual and be adapted to the size and nature of the institution. The check points in this manual represent criteria to be used by inspectors in evaluating the risk management systems of financial institutions. They do not constitute direct statutory obligations to be achieved by institutions. Care must be taken that the manual is not employed in a manner that is mechanical and unvarying. There may be cases in which the letter of the checklist description has not been fulfilled, but the institution has nonetheless taken measures that are, from the perspective of ensuring the soundness and appropriateness of its operations, rational, and these measures are equivalent in their effects to the descriptions for the check point or are sufficient given the size and nature of the institution. In such cases, the institution’s measures should not be deemed inappropriate.

Inspectors will therefore need to engage in full discussion of relevant points with financial institutions during on-site inspections.

Explanation of check points 1) Unless explicitly stated otherwise, items expressed in the form of questions such as “does the institution” or “is the institution” are minimum standards that are expected of all financial institutions. Inspectors, as they go through their checklists, need to fully verify the effectiveness of these items.

2) Unless explicitly stated otherwise, items worded in the form of “it would be desirable that” constitute “best practice” for all financial institutions. Inspectors need only confirm these items.

3) Items that are a combination of the two represent minimum standards for internationally active banks (those financial institutions calculating their capital adequacy ratios according to the Basle standards) but serve only as best practices for other financial institutions (those calculating their capital adequacy ratios according to domestic standards).