Risk Management Principles
The management of risks is based on the Bank’s general risk policy, and the more detailed policies on credit risk, market risk, operational risk, country risk, interest rate risk, liquidity and refinancing risk, directive on anti-money laundering, as well as the broader range of policies and procedures in place. The aim is to ensure that all significant risks associated with the Bank’s activities are identified, assessed and controlled, properly and on time, for the benefit of both clients and shareholders. The Bank therefore places great importance on the strength of its human resources, IT systems, infrastructure and internal risk culture, to ensure a sound and efficient risk management process.
The different types of risks are allocated specific limits and respect of such limits is monitored on a regular basis. The valuation of own account positions is carried out daily. Responsibilities for investments and risk control are clearly segregated within the Bank.
A comprehensive management information system (MIS) and specific regular reporting of the financial situation and performance, regulatory changes, and overall risk and compliance issues, allows the Executive Management Committee and the Board of Directors to be regularly informed on the Bank’s wealth and financial situation, its liquidity, its results and all types of risks.
In terms of organisational structure, the Bank has three levels of risk management/risk controlling responsibilities:
- Overall guidance and supervision, performed by the Board of Directors, which is responsible for determining the general risk policy and risk management strategy (risk vision, risk appetite and risk control standards).
- Management and operational supervision by the Executive Management Committee (formulation and implementation of risk management strategies). The Bank also has a Risk Committee and Asset & Liability Committee ('ALCO') which meet monthly, and a KYC & Compliance Committee and Credit Approval Committee which meet several times a month.
- Risk control, primarily by the independent Risk Management department (comprising the Credit and Risk control units) , as well as the Compliance department.
In addition to the risk management, a surveillance system is in place composed of organisation measures, the internal control system and various external and internal audits. The rigorous internal control system is fully documented and based on the industry best practice methodologies.
Credit risk is the risk that a client or counterparty to a financial asset fails to meet its contractual obligations and cause the Bank to incur a financial loss. It arises principally from the Bank’s loans and advances, amounts due from banks and financial investments. Credit risks include(s) default risks, transfer risks, country risks and excessive concentrations of exposure.
The Bank limits this credit risk for private banking clients by principally granting loans collateralized by securities and fiduciary deposits (lombard loans) and by the strict application of margin limits based on the quality of collateral. The quality of the clients is assessed according to standard, clearly defined and objective solvency criteria, which are applicable to all clients.
Regarding default risks, the credit policy covers all exposure which may entail losses if the counterparties are unable to reimburse part or all of their indebtedness towards the Bank. This includes current account loans and advances and risks arising from guarantees and derivatives transactions on foreign exchange, securities and other financial instruments.
Credit Risk - Overall Credit Risk Management Framework
The Bank’s credit risk management framework includes:
- Authorisation Structure
The Bank has in place an authorisation structure and limits for the approval and renewal of credit facilities. This ensures the precise and objective assessment of all risks involved, through complete and efficient decision-making channels. A Credit Committee is responsible for approving credit proposals under authority delegated by the Board of Directors with high value credit proposals exceeding the authority of the Credit Committee being referred to the Board of Directors. The Board of Directors is also responsible for the formulation of credit policies and processes in line with growth, risk management and strategic objectives. In addition, the Bank respects Group wide credit policies.
- Comprehensive Approval Criteria and Ratings (Obligor level)
Loans are granted according to the client's capacity to service the debt and the pledged value of the collateral held by the Bank, prior to facilities being committed to clients. Renewals and reviews of facilities are subject to the same review process. Credits are also given an internal risk rating based on the credit quality of the the borrower and collateral in place. The risk rating system has 11 grades, further segregated into 24 notches. Grades 1-7 are performing, Grade 8 is Other Loans Especially Mentioned (OLEM) and Grades 9-11 are non–performing each with a rating description.
For Sovereign and Banks, rating grades are mapped to Long-Term External Credit Assessment Agency Ratings (Moody's, S&P).
Each grade in the rating system is linked to a statistical Probability of Default (PD). The risk rating system plays a significant role in efficient use of credit risk measurement and management including:
- Risk based pricing and determination of Risk adjusted return on capital
- Risk based monitoring (frequency and intensity of monitoring)
- Impairment testing
In addition, the overall assessment on a credit exposure takes into account any collateral obtained.
In certain cases, the Bank may also close out transactions or assign them to other counterparties to mitigate credit risk.
Limiting concentrations of exposure to geographic locations and counterparties
Transfer risk and country risk are mitigated by country limits, and pre-approval analysis, in conjunction with post-approval limit monitoring. The country risk policy also provides for the creation of a country risk provision in certain cases. Counterparty limits are also implemented at both obligor and portfolio levels, and controlled by pre-approval analysis and post-approval limit monitoring.
Regular on-going monitoring of all credit exposures
Regular monitoring is performed on credits in terms of :
- Review of actual exposures against agreed exposure limits relating to counterparties (portfolio and obligor level) and countries,
- Collateral values are periodically controlled by types of security and latest value, with any shortfalls identified in daily exception reports,
- The inancial standing of borrowers is also regularly reviewed and updated throughout the year based on appropriate documents and regular communication with the clients,
- Daily monitoring of any exposures existing beyond their maturity date,
- Daily monitoring of any overdue payments of interest,
- Monitoring of potential loss accounts (OLEM): This category comprises of accounts where principal or interest are past due for more than 30 days or accounts which show some potential weakness in the borrower’s financial position and credit worthiness, which requires greater follow-up and monitoring,
- Daily review of overdrafts arising which are not covered by approved credit lines.
Immediate corrective action is taken by the Bank if any issues are identified.
In addition to the daily monitoring by the Risk Management Department, reporting is made on a weekly basis to the Credit Committee, on a monthly basis to the Risk Committee and on a quarterly basis to the Board of Directors. This reporting covers large exposures, the number of client limits and any breaches, bank limits and actual exposures, other credit indicators, trade finance exposures (by client rating and whether secured, partially secured or unsecured), and transfer risk / country risk indicators.
For banking and similar counterparties, the credit risk is managed by setting limits for treasury deposits, nostro positions, guarantees,foreign exchange & derivatives, and brokerage. These limits are monitored on a daily basis, and are included in the imit monitoring mentioned above.
The Bank mitigates credit risks by obtaining collateral security when required. Collateral being classified as 'mortgage collateral', and 'other collateral'. 'Other collateral' is as per the internal guidelines of the Bank which limit acceptable collateral to instances when reliable prices and reasonable liquidity exist. As a general rule, investments such as private equity are not taken as acceptable collateral. Lending values based on collateral are determined based on pre-defined percentages depending on the nature of the collateral.
Collateral is mostly valued daily on the basis of pricing feeds from major pricing providers. For those assets which are not priced via automatic pricing feeds, alternative pricing sources are obtained by an independent middle office unit. In cases when regular prices are not available then these are not eligible as collateral.
Derivative related credit risk
The Bank does not engage in speculative use of derivative financial instruments. All derivative financial instruments are either positions taken on behalf and at the request of clients, and the offsetting of these client positions with other counterparts in the market, or positions taken by the Bank to hedge its on-balance sheet foreign currency exposures or financial investments. Given that these transactions constitute natural hedges, formalised hedge accounting treatment has not been deemed necessary for the smaller transactions, and the Bank elects to classify these derivative financial instruments as trading instruments and take at fair value.For one financial investments position, the Bank is utilising hedge accounting with fair value changes being recorded in the compensation account unless there is a book value adjustment in the hedged item.
Credit risk in respect of derivative financial instruments arises from the potential for a counterparty to default on its contractual obligations and is limited to the positive market value of instruments that are favourable to the Bank, which are included in other assets. The positive market value is also referred to as the “replacement value" since it is an estimate of what it would cost to replace transactions at prevailing market rates if a counterparty defaults. The majority of the Bank’s derivative contracts are entered into with other financial institutions.
Market Risks - General
Market risk is the risk that the Bank’s income and / or value of a financial instrument will fluctuate because of changes in market prices such as interest rates, foreign exchange rates and market prices of equity.
The Board of Directors has set risk limits based on sensitivity analysis and notional limits which are closely monitored by the Risk Management Department, reported monthly to the Risk Committee and quarterly to the Board of Directors.
Market Risks - Interest rate risks
Interest rate risk arises from interest bearing financial instruments (mostly deposits with other Banks) and reflects the possibility that changes in interest rates will adversely affect the value of the financial instruments and the related income. The Bank manages this risk (from both on- and off-balance sheet operations) principally through monitoring interest rate gaps and by matching the repricing profile of assets and liabilities. This is managed and supervised centrally on a regular basis by the Bank via the ALCO.
Overall significant interest rate risk positions are managed by using derivative instruments. The substantial portion of the Bank's assets and liabilities are re-priced within three months, and no trading book exists. Accordingly there is a limited exposure to interest rate risk. As a general rule, most client deposits are at sight, and there are no on-balance sheet callable or time deposits, as these are typically handled by off-balance sheet fiduciary deposits.
Interest rate risk is also assessed by measuring the impact of reasonable possible change in interest rate movements. The Bank assumes a fluctuation in interest rates of 100 basis points and estimates the following impact on the net profit for the year and equity at that date.This computer generated sensitivity analysis is monitored on a regular basis by the Risk Management department, and is compared against internal limits for both the maximum exposure tolerated on the equity, and the maximum exposure tolerated on the income of the Bank. The interest rate sensitivities set out above are illustrative only and employ simplified scenarios. The sensitivity does not incorporate actions that could be taken by Management to mitigate the effect of interest rate movements.
Market Risks - Foreign exchange risks
Currency risk is the risk that the value of a financial instrument will fluctuate due to changes in foreign exchange rates and arises from financial instruments denominated in a foreign currency. The Bank’s functional currency is the Swiss Franc.
The Bank aims to limit such risks via careful management of the treasury by the ALCO, imposition of intra-day and overnight limits, and a daily review of the foreign exchange gap analysis by the Risk Management department. When the initial trigger limit is reached, the Bank will use derivative instruments to mitigate the exposure. The Board of Directors has set a global limit on non Swiss franc currency exposure (including both intraday and overnight limits) and the stop-loss limits before hedging actions are required. The Bank does not engage in currency trading for its own account, and the main non Swiss franc element of its financial investments portfolio is hedged via funding in US Dollar.
Market Risks - Other market risks
The Bank is not significantly exposed to other market risks. Any pledged collateral held which may be subject to market risk is valued with an appropriate margin. On a monthly basis, the Risk Management Department monitors large client holdings, and reviews the follow up performed on unusual or unexplained price variations (as identified by system generated exception reports).The Bank's long term investments are controlled by a series of limits, which are controlled on a regular basis by the Risk Management department. The investments in alternative investments are subject to both monthly redemption possibilities and monthly pricing (except for one fund is being liquidated and has imposed some redemption restrictions). The Bank does not engage in short term trading, or speculative derivative positions. All derivative positions are for client accounts (with matching off-sets in the market), or for its own account for hedging purposes. Given that natural economic hedges occur, the Bank does not utilize complex hedge accounting treatments for smaller size hedges and instead designates directly into the trading book which is marked-to-market.
Liquidity or funding risk is the risk that the Bank will encounter difficulty in meeting obligations associated with financial liabilities. Liquidity risk can be caused by market disruptions or credit downgrades of the FAB Group which may cause certain sources of funding to dry up immediately. The Bank currently has a surplus of capital, and is not relying on external financing sources other than the FAB Group. Surplus capital is placed at a diversified range of well-rated Banks, and into treasury bills and highly rated bonds with varying maturities to enable quick access to funds should needs arise. In the event of forced liquidation of the Bank's financial investments, some of these would be sold on the secondary market at a discount, due to formal monthly redemption requirements.
The liquidity of both treasury and own account positions is monitored regularly, to ensure sufficient liquid assets are always maintained.The Bank has to comply with a number of regulatory liquidity requirements, and these were all met throughout the year
Operational risk is the risk of direct or indirect loss arising from a wide variety of causes associated with the Bank’s processes, personnel, technology and infrastructure, and from external factors other than credit, market and liquidity risks. Operational risks arise from all of the Bank’s operations and are faced by all departments. The Bank’s objective is to manage operational risk so as to balance the avoidance of financial losses and damage to the Bank’s reputation with overall cost effectiveness. This is handled by an established framework of policies and procedures to identify, assess, monitor, control, manage and report risks. Where appropriate, risk is mitigated by way of insurance. The framework also provides the interrelation with other risk categories. The key elements of the operational risk framework are operating loss incident management, risk self-assessment and key risk indicators.
The Board has oversight responsibility for operational risk management in the Bank. This responsibility is exercised through the Risk Management department, which acts as the central point in co-ordinating various efforts and initiatives that relate to operational risk management including alignment with other operational risk mitigating strategies such as Business Continuity Management, etc. Compliance with policies and procedures is supported by periodic reviews undertaken by the internal and external auditors. The results of these reviews are discussed with the management of the business unit to which they relate, with summaries submitted to the Audit Committee and senior management of the Bank.
The Risk Committee and Board of Directors receives regular reporting on operational risks including on levels of any transaction reversals, reconciliation differences, unsettled trades, transaction volumes, levels of manually sourced prices, any operational losses, any complaints, reviews of access rights to the IT system and other security matters, update/tests on the Bank's business continuity plan (including regular updates on disaster impact analysis, related planned measures and tests of these plans), both performance statistics and qualitative comments on the outsourcing provider, and lastly commentary on any personnel changes.
Compliance and legal risks
Regulatory risk compliance is of paramount importance to the Bank. The Bank views the regulatory compliance from the overall perspective of Enterprise-wide Risk Management.
The Compliance Department controls the Bank’s adherence to contractual agreements, existing relevant statutory regulations as well as to due diligence obligations incumbent on banks, and reports on this to the KYC & Compliance Committee on a regular basis, and to the wider Executive Management Committee and Board of Directors via detailed regular reporting covering compliance aspects on client accounts and transactions, the respect of the code of conduct, updates on compliance training, respect of public offering rules and fund distribution restrictions, review of any staff transactions, respect of compliance with Bank's list of restricted investments and insider trading policy, the follow up on any dormant accounts, cross border banking and other compliance matters. The Bank has also put in place a comprehensive approach to both detecting and following up on any private banking fraud indicators that may arise.
The Executive Management Committee also reviews new legislation being developed by supervisory authorities, the Government, the Parliament or other regulatory bodies. The Executive Management Committee also ensures that the Bank’s internal directives are updated according to new legislation or regulations. External legal counselors are used when necessary for legal questions or assistance.