The role of assertive supervision

Dr B K Mukhopadhyay & Dr Boidurjo Mukhopadhyay

(Dr B K Mukhopadhyay is Professor of Management & author of

India’s Economy: Under a Tinsel still Tough; Dr B Mukhopadhyay is

an international development and management economist based in London)

MEASURING, MITIGATING AND MANAGING RISK

Judging by the current trends time is ripe for all of the players – government-controlled or privately / jointly controlled – to identify, measure, price and exert all sorts of stricter monitoring and control so as to ensure that the financial health of the organization does not suffer from an incurable disease. And naturally, early detection and degree assessment help set right the entire going.

The question to explore would be to what extent our corporate sector is really ready for this departure and at the same time what steps do individuals need to take so far as capital management, compliance and risks are concerned. With volatile markets coupled with high attrition rates, it can quickly get critical to effectively contain risks – political, country, currency, foreign exchange, operational and market. The price of compliance oversight in today’s business environment can be colossal.

So far as the financial sector is concerned the fundamental role in the maturity transformation of short-term deposits into long-term loans makes them inadvertently vulnerable to liquidity risk. This risk can be both institution-specific and also that can affect markets in entirety. Virtually every financial transaction or commitment has implications for a bank’s liquidity. With the generalized opening of trade and capital movement across the world as being noticed especially during the last couple of years, in particular, risk management has become all-pervasive across the realms of the financial sector. Essentially, financial risks are uncertainties resulting in adverse variations of profitability or outright loss.

Globally, the growing risk that the executives face is the over-dependence on traditional methods of risk measurement – ROA [Return on Assets] and ROE [Return on Equity] – which may not be quietly effective for significant business risks addressing. However, Fortune 500 evaluation suggests that about 80 per cent of the companies assess the existing and proposed business activities uses these two methods. With a continually evolving business environment, the question of adaptability based on continuous feedback loop has become a crucial consideration in decision-making so that the institution can keep the head over water through locating whether any missing risk is there and if so, anticipating ambush risks that may pop up.

Traditional tools are not fully ineffective in terms of their universal application and comparability, equally important it is to be aware the very omission of certain intangible risks – operational, social and political, regulatory, reputation and legal risks – may result in erroneous inferences or flawed business decisions. Therefore, the urgency lies in examining the adequacy of the risk management system followed. Thorough observations/opinion on the vibrant areas are to be furnished so that early detection system could be made available timely and adequately. Credit risk management systems followed a call for adequate scrutiny especially considering the main activity of the banks / financial institutions hover around this specific field. The credit appraisal, monitoring systems and the credit recovery systems are the pillars and as such any big gap or inadequacy on these scores capsizes the growth process.

Simultaneously, the adequacy of policies and procedure for write off of loans, adequacy of policies, guidelines and controls over off-balance sheet items call for detailed scanning. Concentrations in the credit and investment portfolio are another important area that should not lose sight of. Effectiveness of risk management committee is to be assessed along with overall audit opinion on credit risk management.

Closer scrutiny of market risk (interest Rate, Liquidity and Foreign Exchange), management systems [adequacy of policies, procedures and guidelines for the market risk management as well as the adequacy of the system for measuring, monitoring and mitigation of Market risk] are needed along with assessing the functioning of risk management committees and their effectiveness. The overall audit opinion on market & liquidity risk management is required to be incorporated.

So far as an operational risk management system that is being followed calls for intensive analysis of the adequacy of policies, procedures and guidelines for the operational risk management along with the adequacy of the system for measuring, monitoring and mitigation of operational risk. These should be inclusive of assessing the effectiveness of risk management committees in order to thus arriving at overall audit operational risk management level.

With the target set on risk minimization with a bit of space left for uncertainty, early detection or reviews of the practices followed could mitigate forthcoming disasters. Hence, mechanism followed to minimize liquidity risk; use of GAP Analysis and other mechanisms to measure and manage interest rate risk and the mechanisms to minimize foreign exchange risk is to be looked into with high degree of seriousness.

In this context, the ultimate objective is to ensure the effectiveness of the risk-conscious internal control system. This arena, in turn, also calls for assessment of the related aspects - effectiveness of the audit committee; effectiveness of the internal audit function; rectification of the deficiencies identified in the audit reports; adequacy of the controls in credit operation/controls exercised; adequacy of the controls in treasury operations, adequacy of the controls in operation of distribution channels; adequacy of the controls in procedures related to expenditure as well as adequacy of the control over fixed assets.

Adequacy of the controls to prevent and/or minimize fraud and forgeries, specific instances of fraud and forgery in the review period and other control issues, if any, are to be furnished by Auditors while arriving at an overall assessment of the internal control system. Equally important is the area of Investments in Shares and Debentures - investments in unlisted companies, investment in companies with a financial interest, investment in shares of other bank/Fls, investments arising out of underwriting Commitments, and investment in shares and debentures exceeding the limits must be examined. Review of the Investment portfolio, adequacy of Provisioning requirements is thus very vital.

The way the risks are managed in any particular institution actually reflects its very position in the market place, the range of products or services it delivers and truly at the top of it - its culture and unfailingly effective risk management ultimately decides the ability to withstand the pressure of futuristic challenges mainly emanating from ever-increasing intense competition. With each line of business, the sub-groups are there and each sub-group, in turn, has to deal with a variety of financial activities. While carrying all such business operations, any mismatch between assets and liabilities result in different types of risks.

Therefore, reporting requirements demand utmost attention: comment upon the reliability of the mechanism used for reporting and the accuracy of returns. Evaluations are to be submitted on the compliance with the prevailing Statute, Act, Directive and Regulations, especially in vital areas like profit appropriation to General Reserve: appropriation to Exchange Fluctuation Reserve, Distribution of Dividend, whether prohibited activities are pursued and control/notification of dormant deposit, among others.

High performing organizations have to ensure better management of capital and at the same time for minnow’s underperformance will put the pressure more and more to keep the head above water. Financial administration in the 21st century is much more complicated – walking on the tight rope indeed! So, ever-increasing responsibilities are on the auditors.