Exchange Ideas
Risk Management in Emerging MarketsMy weblog will focus on risk management and modeling in emerging markets May 23, 2008 The Trillion Dollar Meltdown and the Three Trillion Dollar War: Linking Fiscal Policy and Risk ManagementRecently, I came across two books. The first one was an obvious choice,The Trillion Dollar Meltdown- Easy Money, High Rollers and the Great Credit Crash by Charles R Morris dealing with the Subprime crisis. The scond book "the Three Trillion Dollar war: by Stiglitz and Blimes discussing the true cost of the Iraq war. Reading both in sequence sets me thinking about the linkages of fiscal policy, macroeconomic management and risk management. It appears that the contents of the two are linked to each other, like perfect fits in a jigsaw puzzle. The messege that comes across in the book is something like this- State, even with all the hype about market capitalism, is a big ticket spender in the economy. Its fiscal policy results in the rise in consumption, savings and credit worthiness of millions. If state spending is distributed well, the credit worthiness of many in the economy go up and they are able to service their accumulated debt in a better manner. In a society already stooped in debt, the impact is even higher. If on the other hand, the spending, trillions of dollars in this case , are diverted to replacing military machinery and similar stuff, distributional impact of fiscal policy is uneven. The fiscal policy then creates the unwanted impact, decline in savings of population and consequent erosion of creditworthiness, something which the average credit/gdp ratio will definitely hide. Thereby, fiscal policy create conditions for a financial crisis, which banks and financial institutions , in their zest for greater market share, may lose sight of. Financial crisis, can, thus be seen as a fallout of lack of distributive justice in fiscal policy. Posted by Sunando Roy at 09:20 AM | Comments (3) April 18, 2008 Growth of Private Equity in the Gulf regionThe rise of Islamic Banking, sharp rise in oil income, increased private sector financing of industrial and service sector development, real estate boom has led to the model of private equity investment in the gulf region, a model that seems well poised for a big leap. The private equity model diverges from conventional debt financing model, but has the same result of leveraging the business. Thus, it is the convenient route for islamic finance , that cannot adopt interest baring securities to ensure compliance to the Shariah. By being imperfectly correlated with other asset classes such as equity, this enables diversification of overall portfolio risks in the Banks.
Continue reading "Growth of Private Equity in the Gulf region" Posted by Sunando Roy at 10:58 AM | Comments (0) April 05, 2008 The Power of Central Bank CommunicationsIn Chris Whalen's interesting blog ( April 4,2008) on the Subprime crisishttp://www.prmia.org/Weblogs/Regulation/ChristopherWhalen2/) "As BSC was being shut out of the interdealer market, LEH was also being shunned by other dealers and attacked by the hedge fund hordes in the same fashion as BSC. Several veteran traders in the CDS market say that LEH was essentially in danger of failing as well. One hedge fund veteran, who was and is short LEH, complains to The IRA that LEH was essentially dead in the water on Monday, March 17, but the Fed intervened. When the markets opened after the Easter holiday, clients and other dealers were backing away from LEH and the shorts were swarming in for the kill, he claims. This apparently explains the unusually long conference call with investors by LEH CFO Erin Callan, who has only held that position since September. Indeed, the only reason that LEH did not fail as well, claims this well-connected trader, was a conference call on that Monday with the top ten dealers organized by the Fed of New York. During that call, the Fed of New York reportedly told the other dealers that it would lend LEH "whatever is necessary" to keep that leading mortgage-backed security underwriter and CDS house afloat. That open-ended promise, not the Fed's new lending facility, reportedly saved LEH from collapse - for now." This open ended promise, is nothing but an increasingly powerful instrument in the hands of Central Banks, its signaling policy. A credible central bank, through the use of the media, can effectively and quickly transmit signals in the market.This obvious and very promising tool , which can be used (and abused), is not adequately researched in the context of financial regulation. The academic research, however, dates back a few decades. Jurgen Habermas' critical theory of law is essentially based on the argument that communication channels can be used to reform law and it need not always be driven by official dictat, as Max Weber had earlier suggested. In one of his later accounts of this power of communication, Habermas wrote about the "liberating power of symbols", where communication creates symbols that travels through media, changes public mind and as a result , transforms policy. Continue reading "The Power of Central Bank Communications" Posted by Sunando Roy at 05:24 AM | Comments (0) April 04, 2008 The rise of SukuksThe global market for Sukuk has exploded since 2006, generating a huge international interest in the product and its risk and return profiles. The Islamic financial market is over USD 500 billion and growing at a rapid pace of about 15 per cent globally. From a small base in 2005, Sukuks have recordrd triple digit growth in many countries, with Malaysia, UAE and Bahrain emerging as key players in the Sukuk market. Continue reading "The rise of Sukuks" Posted by Sunando Roy at 07:45 AM March 29, 2008 Closer look at Intangibles need of the hourIn recent times, regulatory talk on productivity of organisations have zeroed in on one significant development of the "new economy" - the steady rise to prominance of intangible assets- assets that can not be seen physically or difficult to map on the balance sheet, but whose impact is felt in the performance of the organisation. Bernanke talks about its rise to prominance in the US ( Remarks by Mr Ben S Bernanke, Chairman of the Board of Governors of the US Federal Reserve System, before Leadership South Carolina, Greenville, South Carolina, 31 August 2006.) ; Svante Oberg, Deputy Governor of the Sveriges Riksbank, highlights the role of intangibles at a meeting arranged by Danske Bank, Stockholm, 29 January 2008; and Deutschebank comes up with a detailed analysis on intangibles " Value Intangibles" ( Deutsche Bank Research 7,October 19, 2005). As a matter of fact, financial accounting standards have improved significantly over the last decade or so and sort of converged on the view that intangible assets are as important as tangible assets. Any intangible asset that is associated with contractual or legal rights, such as a trademark, patent or copyright, must be recognized as value enhancing assets for the organisations. The treatment of intangible assets however vary from a capital adequacy perspective in so far they have to be deducted from Tier 1 capital when it comes to calculating the capital adequacy number. Expressing the overarching view that intangible assets should be deducted from Core capital for capital adequacy purposes as one is not sure how much of such assets can be effectively utilised to pay back depositors for a bank in distress, it explicitly leaves the issue for national discretion due to divergences in regional accounting standards and divergent role of intangibles in advanced and emerging economies. Thus, in the treatment of Intangible Assets for Capital Adequacy, regulators are left with two choices, a) to treat them as part of core capital or b) as part of other assets with appropriate risk weighting. While one would guess that in modern knowledge driven economies such intangible assets such as human capital will be treated as part of the capital base, surprisingly, Basel II has been static in this respect. And while a difference in the recognition of intangible assets can have enormous implications for the capital adequacy ratios, not significant attention has been paid by Basel II on this issue and the broad outline of the basel I guideline still previls. Continue reading "Closer look at Intangibles need of the hour" Posted by Sunando Roy at 11:07 PM | Comments (0) March 28, 2008 ICAAP Forecasting- The First Critical Step for Business PlanningMore and more banking regulators are coming up with their own versions of the high level Pillar 2 guidance provided under Basel 2. APRA came up with their guidance to ADIs in end 2007, Central Bank of Bahrain issued their Pillar 2 directive in January 2008 and the Reserve Bank of India has come up with their Supervisory review process circular yeaterday. Now we have Pillar 2 guidelinesfrom different part of the world and not just Europe, the leaders of the pack. The overarching philosophy in all these documents is the same - an effort to bridge the gap between regulatory and economic capital through a comprehensive assessment of all material risks facing the organisation and planning the capital as a cushion against unexpected risks. As you would expect, the work on ICAAP starts early on, alongwith the preparation of the business plan at the beginning of the year. It is important for any bank to have a fully integrated capitl forecast for the financial year that on one hand looks into capital availability based on expected growth of business, profits and dividends and projection of capital requirements for the firm based on the quantification of risks on the other hand . If capital requirement is onot in sync with the capital availability, the organisation may face trouble in the capital management process. Preparing an ICAAP forecast therefore is a forward loking process starting early on in the entire ICAAP initiative. It may not be as full blown an initiative as the ICAAP document in itself, but a first cut esimate based on several assumptions about businesss profile and estimated growth, emerging macro and micro risks, broad trends in each risks, some assumptions about their correlation structure . An ICAAP forecast should be an information in the hands of the Board while preparing the business plan while the ICAAP will be a document which will base itself on the business plan of the firm. The two documents are complementary to each other, fulfils different objectives, differ in their degree of details and assumptions. While there is a fair degree of clarity o how an ICAAP document should be arrived at, there is a lack of clarity on ICAAP forecasting as a first step for business planning. As Banks soli their hands in ICAAP preparation, and regulators enter the field for the supervisory review, the issue of forecasting the ICAAP will inevitably come to the fore. Posted by Sunando Roy at 08:31 AM February 29, 2008 Pillar 2 : The road less travelledThe supervisors have stepped in as a key actor in the Basel 2 drama that is unfolding in front of the financial community. The second act of the Basel 2 drama has thus just about commenced in the emerging world. Regulatory guidelines are , always, strong signals to the financial market. Guidelines put financial entities in alert mode. Guidelines with action plans and deadlines puts the markets into active mode. Pillar 2 guidelines are guidelines with some action plan as it promts the supervisor to step in and decide whether banks' calculation of economic capital is in line with its risk appetite , with the proviso that any misalignment between the two may call for supervisory action. Continue reading "Pillar 2 : The road less travelled" Posted by Sunando Roy at 09:01 AM | Comments (0) February 23, 2008 New Directions in Liquidity Risk ManagementThe market turmoil of 2007 has once again highlighted the crucial importance of market liquidity to the banking sector.What started as weakness in the sub prime markets ( residential mortgage backed securities which were then mopped up by managers of CDOs and asset backed securities)led to Investor's loss of faith arising out of growing arrears in such structured products. This led to tightening of liquidity as banks wanted more liquidity to meet their obligations and a similar necessity for greater liquidity was also seen among asset managers to guard against increased redemption risks. It is now recognised that liquidity risk management is not as easy as earlier and financial institutions need to devise strategies to tackle liquidity shocks such as the one emanating from US sub-prime market. Continue reading "New Directions in Liquidity Risk Management" Posted by Sunando Roy at 04:00 AM | Comments (1) February 22, 2008 Central Banking and Risk ManagementThe actions and signals of Central Bankers are gaining importance in the market driven economies of the 21st century. The 20th century saw the rise of the State in many emerging markets as they became free from colonial occupation. In three or four decades after the end of the second world war, the flaws of these command economies became apparent. In many economies, the gap between potential and actual growth trajectories diverged, owing to excessive controls and regulations. Then the emerging economies chose the path of liberalising markets and many economists and commentators started writing obituaries of the State. The initial euphoria with markets have now subsided and there is an acceptance that unrestricted markets can be as detrimental as the excessive regulation by the State. The regulators are thus back in the new role of facilitating markets in their potential to achieve higher growth paths. As finance is the fuel for economic expansion, central bankers as the regulators of the financial world have resurfaced, and their faces are friendlier than ever before. They are back not just to regulate, but to facilitate , guide and protect the financial sector from a variety of shocks. With the onset of the 21st century, Central Banking has entered into a communicative mode where signals are stronger. Continue reading "Central Banking and Risk Management" Posted by Sunando Roy at 07:10 AM | Comments (1) November 24, 2007 Can Booming Emerging Markets Save the World Economy?Shocking as the heading may seem, this time it comes not from some Saturday afternoon weird dream but from the well respected mag The Economist ( November17th-23rd, 2007). The picture in the cover of the issue reminds you of The Jaws, the movie that kept us at the edge of our seats in the golden days of childhood. It shows the wild beast of finance coming from the depths to gobble up the beautiful economy growing at a rocking 3.9 per cent as of Q3,2007. The Economist ( worth every fil of the three and a half dinars I spent on it) tells us that Q3 is past and with subprime shocks getting crystallised into losses, the American economy is slowing down noticeably. Joblessness, homelessness, coupled with a tightening of credit availability has pushed the consumerist households in a difficult position. The broader question raised is what concerns us in this part of the world, booming at present thanks to a multitude of factors triggered by economic reforms. What will be the effect if US goes into recession mode and Europe and Japan grow rather slowly. Can the world economic engine go puff-puff pulled by the economic growth of China , India, Middle East and East Asia? Statistics shows us that emerging markets contribute half the global GDP now, provides assured returns to global investors with stable financial markets and hence seen unprecedented capital inflows through FDI and Portfolio routes. A good guess would be that things look good , the emerging markets can pull it off. But, when joys of risk comes, can the jaws of risk be far behind?
Let's look at the US economy. Frankly speaking, the financisl sector was taking too many risks without adequate risk management practices ( read Chris Whalen's blog on Subprime crisis). Risk taking is not bad, not bad at all.On the contrary, taking no risk is actually the greatest risk of all! Risk is what makes our life worth living, giving rich rewards and vluable exposure. But it will be terribly wrong to underestimate the frightening jaws of risk even as you bask in its ecstacy. A personal account to explain the point. Few years back, I was doing research on financial modeling for emerging markets at UC-Irvine. Even though the beauty of Irvine and Orange County is something to cherish, I decided to see the whole of US. The prime objective was to learn the actual risk management practices used by financial experts. So I was travelling across the US on AMTRAK on a shoestring budget. As I met professional in all parts of the country ( while at the same time absorbing the country's grandeur an diversity) , I wondered how such simple systems of risk management sustains such a complex financial architecture. Simple models, with simpler assumptions, seemed to be delivered the results. While the going was good, there was no problem. Then the Black swan struck. Rest is history, or history in the making. Continue reading "Can Booming Emerging Markets Save the World Economy?" Posted by Sunando Roy at 08:16 AM | Comments (3) November 20, 2007 Damages caused by Risk Management PracticesThanks Beaumont for raising the issue of loss incurred as a result of risk management practices in the blog http://www.prmia.org/Weblogs/General/BeaumontVance1/2007/11/the_business_da.php In my experience, very standard RM practices often lead to huge losses to firms. Take the example of Stop Loss Limits. Treauries in Banks use this tool extensively to cut down losses. Back in the days of onset of the Iraq war, the Indian financial markets were shocked by the news of international financial instability. The debt market ( I was in the team that regulated and supervised the sovereign debt market) was shocked. Primary Dealers(PDs), who had unhedged exposures in the market faced sudden sharp downturn in the mark to market value of their portfolio. Stop Loss limits, duly approved by the Board few months back had to be applied.Distress sale of bonds started, lossed crystallised and the damage to the P&L account was done. Continue reading "Damages caused by Risk Management Practices" Posted by Sunando Roy at 10:13 AM | Comments (3) November 13, 2007 My Frustrations with Stress TestingThis blog is concerned with my general dissatisfaction with Stress Testing. While enormous theoretical and empirical work of diverse qualities have been done in many spheres of risk modelling and quantification, Stress testing happily lives in a world which is pathetically slow in which one variable moves at a time. This is surely not our world, a world in which subprime losses get transmitted to all corners of the globe even before the most bragged about sophisticated risk management systems wake up from slumber. Whom are we fooling? In a world of cointegrated movements in macro variables and risk factors, the standalone stress testing models are bound to be deficient. The defensive response citing absence of good alternatives may seem reasonable to those who live in the present but such line of argument badly fails to satisfy those who dream of a better tomorrow. There is no doubt we need good techniques for multivariate stress testing in a situation where credit risks and market risks are intertwined. We essentially need a good VaR estimate (my experience tells me this is not as easy as it may seem), coupled with a good model where risk factors can be efficiently shocked to predict future scenarios. Probing into financial econometrics, I have a feeling that the technique of Vector Autoregression holds promise. The technique of VAR ( not VaR) has several useful characteristics- the vector of variables move together ( thats real),and you have a fairly advanced technique of providing shocks( of your chosen intensity) with scientific choice of lag lengths that leads you to attractive impulse response functions. Used in inflation predictions, it has outperformed structural models routinely. It has been useful in judging the interrelations between segments of financial markets. Time to put this to good use in risk management and stress testing? I am trying out models using the following course of action a)Calculate VaR for various instruments in your portfolio b) conduct risk aggregation, if you wish to c) put possible variables that can shock the VaR values (do not put too many variables as things may go out of hand) d) instead of conducting standalone stress test, map the impulse response paths- those curves can throw much light on the shape of the things to come. Thats the broad idea. ( to my pleasant surprise, I find a presentation of Stress Testing from Monica Mars uploaded from Greece ! ) Posted by Sunando Roy at 11:25 PM | Comments (2) October 19, 2007 A Chat with PRM Candidate of the Year 2007, Mr. Vinayak Kamat, Pune, IndiaRecently, I had a chat with the PRM global topper , Vinayak Kamat from Pune, India. Vinayak has been named the 2007 PRM Candidate of the Year."This is a highly prestigious award, identifying the best of the best among our PRM holders," said David R. Koenig, former Executive Director of PRMIA. "We were highly impressed by Vinayak and congratulate him on this international recognition." Vinayak deserves our heartiest congratulations and appreciation for his achivement, considering the fact that he has achieved this distinction competing with candidates around the world and brought honour to a country which is now catching up ( fast, mind you) with risk management practices of the advanced economies. I hope this interview will be of some use to the growing group of PRM candidates.
Vinayak: I had some basic knowledge in the area of risk management due to previous exposure but I was looking for ways to validate and enhance the same. I also wanted to and upgrade my skills and exercise my learning ability in the process. The best way to achieve this was to go for an industry standard certification program like PRM. I was impressed with the PRM curriculum and its self-paced structure. This in turn allowed me to take the exam at my convenience. SR: How much time you devoted to preparation before taking the examination? Vinayak: I had attempted all 4 exams together. Overall I think I devoted around 200 hours (on an average 10 hrs per week for 20 weeks) for preparation. However, it took longer in terms of elapsed time, as I had to take a few extended breaks in preparation due to professional and personal reasons. SR: What resources/books/courses you find useful for study for papers I, II, III, IV? Vinayak: The PRM handbook was my primary study material. As an additional reference on some topics, I studied the FRM Handbook. For quantitative subjects, I also referred few standard reference books. In some cases, I found useful information on the web. I relied on self-study and did not take any courses. SR: Where did you appear for the exam? Did you find any difficulty in selecting an exam center? Vinayak: My preference was a center close to my residence. Also I needed a slot for 6.5 hours for the entire exam on my preferred dates. With these criteria, I selected a center at Borivali, Mumbai. I got their details from the Pearson Vue website and visited their premises once to see the facilities. I could book the slot with a couple of days notice. I did not face any particular difficulty in selecting the center.
Vinayak: Make a plan and commit to it. Avoid extended gaps in preparation. Devote some time daily. Try some practice questions and tests. Last but not the least, enjoy learning the subject. SR: What this Award means to you and how it has helped you so far? Vinayak: I am delighted and proud to receive this award. The evaluation process was quite challenging. Also the competition was global and of very high quality. Hence I rate it as one of my most special achievements. Professionally, the award has brought me recognition. Personally, it has given me added self-confidence and motivation. SR: Thanks Vinayak, for your time. If i receive more questions from PRM candidates, I'll get back to you for another interview. All the best ! Posted by Sunando Roy at 11:29 AM | Comments (16) Managing Risks in the Age of TurbulenceEmerging economies have entered the age of turbulence. Assets prices are far more volatile, markets are ultra sensitive to news and cross border shocks have started disrupting emerging markets with remarkable regularity. As traditional risks give way to new risks, let us explore the areas where financial entities should be more alert to address their risks. What are the key issues in this age of volatility?
Communication and Risk Cross Border Issues Global integration has increased in the last decade with many emerging economies getting linked in many ways to each other and advanced markets. Volumes in forex markets have grown. Size has become an important explanatory factor for higher returns and stability. The importance of liquidity has grown manifold as liquidity shocks arise not only from domestic but from beyond the borders. Cross border capital and financial flows have become important for systemic stability. As the recent subprime crisis shows , heightened credit risk leading to liquidity crunches can have huge impact in an interlinked global financial system.
2. Traditional analysis of risks in emerging econoies should be bolstered with a proper assessment of forex exposures and risks. Many software companies in india got badly hit by not looking into this during early months of 2007 when rupee rose from 46 to a dollar to about Rs 41 to a dollar. In other words, processing forex market information is crucial. 3. Embedding liquidity Risks in traditional risk measurement approach is crucial ( Pillar II of Basel II highlights this) 4. Concentrations should be properly monitored . concentration Risks are going to be a major source of risk. The well known benefits of diversification will be magnified in a globalised world. 5. A review of Stop Loss limits is a must first step for trading desks. There is a need to understand that markets will fluctuate around a trend. For example, in India, the trend is positive and as forecasts indicate ( IMF and others) India will continue to grow at 8.5 or even more. The rigidity in stop loss limits for traders will lead to a lot of distress selling and booking losses. Taking a flexible approach is the need of the hour in trading strategies. III. Role of Regulation As we are seeing, robust regulation of banks and weak regulatory structure of non-bank entities can lead to shocks in financial system. Non Banks, reinsurers, hedge funds , left in an unregulated space will lead to imbalances in financial systems. Second, co-ordination of home and host country regulators is important for quick reaction to adverse stress scenarios. Third, alignment of legal structures internationally is also critical for handling cross border risks.
Posted by Sunando Roy at 05:42 AM | Comments (1) October 18, 2007 Emerging Markets Driving Global Growth : IMFThe IMF in their recent World Economic Outlook notes that emerging markets China, India are for first time largest drivers of world growth . Strong emerging markets growth is attributed to sound policies, benign external conditions .China is now the single most important contributor to world growth, in terms of both market and purchasing-power-parity (PPP) exchange rates .Its economy continues to grow at breakneck speed, turning it into a driving force in the global economy. China's economy gained further momentum in 2007, growing at 11½ percent, and is expected to grow by 10 percent in 2008. Other emerging markets are also growing strongly. India continued to grow at more than 9 percent in 2007, and Russia grew by almost 8 percent. In fact, these three countries alone accounted for more than one-half of global growth over the past year. Other emerging market and developing countries have also maintained robust expansions. Rapid growth in these countries counterbalanced continued moderate growth in the United States . But despite these and other risks linked more directly to the global outlook, the IMF expects emerging markets to remain strong in the foreseeable future. Continue reading "Emerging Markets Driving Global Growth : IMF" Posted by Sunando Roy at 07:19 AM |
 CategoriesArchives
Recent Entries
|
