Risk Management Project Coursework:

Imagine you are the Chief Risk Officer of a newly-formed bank, with a focus on corporate lending in Slovakia. The bank is largely funded by local deposits. The CEO (and so does the regulator) wants to know if sufficient capital has been allocated against assets, and what provisioning policy should be. He would also like your views on pricing of loans and deposits, so that the bank can make a decent profit while making competitive headway without excessive risk. The bank takes small positions in trading local government bonds. The CEO would also like you to assess the bank’s VAR, as well as liquidity, to be sure no undue risks are being taken.

Following is the financial position of the bank after the first year of operations:

Assets (Euro millions)

Cash                                    194
Due from banks                      86
Securities                             1200
Gross loans                           2700
Loan loss reserves (LLRs)        -150
Fixed assets                          75
Other assets                         175
Total assets                          4280

Liabilities & Equity

Deposits                              2573
Due to banks                        782
Market funds                        200
Other liabs                           196
Equity                                 529
Tot liabs & equity                  4280

Income Statement

Int inc                                 300
Int exp                                -170
=Net int inc                          130
Trading inc                           20
Net fee & comm. Inc              30
=Optg inc                            180
Personnel exp                      -55
Other optg exp                    -70
D&A                                   -13
=Pre-prov inc (PPI)                42
Loan loss provisions (LLPs)      -29
=P-t inc                               13
Tax                                     -3
=Net inc                               10

In addition to the above requests from the CEO, he would also like your input on measures to reduce operational risk, and what dividend policy should be.

The bank’s €2.7 billion gross loan book is rated as follows:

€1 billion of BBB rated loans,
€1 billion of BB rated loans
€500 million of B rated loans
€200 million of CCC rated loans. There are no collateralized loans or off-b/s items.

Securities of €1.2 billion are all invested in A rated government bonds.

VAR = 553 mm

Loans are evenly divided between 1, 2 and 3 years’ maturity.

Deposits are 50% demand (due at any time), 25% in 9 months, and 25% over 1 year.

Market debt is of 2 years’ maturity.

Please formulate your recommendations to the CEO