What do you mean by liquidity management and what are its different strategies? Or what are the ways of maintaining liquidity of commercial bank? Discuss.

Liquidity management refers to those activities within a financial institution to ensure that holdings of liquid assets (e.g. cash, bank deposits and other financial assets) are sufficient to meet its obligations as they fall due, including unexpected transactions. Banks are primarily in the business of raising deposits and making loans that transform liquid liabilities into liquid assets.

Liquidity, or the ability to fund increases in assets and meet obligations as they come due, is crucial to the ongoing viability of any banking organization. Therefore, managing liquidity is among the most important activities conducted by banks. Sound liquidity management can reduce the probability of serious problems.

Maintaining cash reserves is a fundamental liquidity management strategy. It involves holding a certain amount of cash or highly liquid assets that can be readily converted into cash. These reserves act as a buffer to cover unexpected expenses, manage fluctuations in cash flows, and provide funds for short-term needs. Cash reserves can be held in bank accounts, money market funds, or short-term government securities.

The main strategies that bank takes positively for effective liquidity management are as follows:

1. Each bank has to formulate a suitable but specific liquidity policy

2. Based on the past information or data, ALCO or liquidity management committee must bring desired changes in the composition of assets and liabilities.

3. Continuous customer relationships with large borrowers, depositors, and other liability holders, etc. will help the bank to secure required funds during a liquidity crisis.

4. The bank should prepare a contingency plan including arrangements for line of credit with large banks and suppliers of credit adverse liquidity position arising from banks specific crisis or general market crisis.

5. The internal norms/limits may be fixed for certain types of transactions that will have an adverse impact or liquidity position. For example:

 

i) Borrowing from the call money market as well as from the repo market,

 

ii) Desired ratios for short-term liabilities to short-term assets, loans to total deposits.

6. Cash flow forecasting is a proactive strategy that involves projecting future cash inflows and outflows to assess liquidity needs accurately. By analyzing historical data, upcoming financial obligations, and business projections, organizations can estimate their cash positions for specific periods. Cash flow forecasting enables better planning, helps identify potential cash shortfalls or surpluses, and allows businesses to take appropriate actions to manage liquidity effectively.

7. Effective management of working capital is crucial for maintaining liquidity. Strategies for working capital management include optimizing inventory levels, managing receivables and payables, and controlling costs. By efficiently managing working capital, businesses can free up cash and improve their overall liquidity position.

 

So, banks must visualize and evaluate liquidity needs under different business scenarios. Liquidity represents the ability to deal with shortage of funds and surplus of funds. Irrespective of the size of a bank, adequate liquidity is essential to meet commitments when due and to undertake new transactions when desirable.

Explain the two concepts of fund management and liquidity management. Or, what do you mean by fund management of a bank? Explain liquidity management.

 Fund management in the banking sector refers to the process of efficiently managing the financial resources (funds) of a bank to achieve its financial objectives while minimizing risks. This involves making strategic decisions about how to allocate, invest, and deploy funds to maximize returns and ensure the stability and growth of the bank

Bank "funds management" is the key to short-to-intermediate decision-making in the dynamic and volatile banking environment. It involves managing the maturity schedules of deposits and loans and ensuring the proper liquidity of funds.

There are two main methods of managing funds: active and passive management. Active management involves consistently monitoring the market and buying or selling assets to maximize profits. Passive management, on the other hand, is a more hands-off approach where the fund manager does not actively buy or sell assets.

Asset/liability management is the primary focus of bank funds management today. While bank asset/liability committees differ in their approaches to funds management, the essence of asset/liability management is to coordinate the interrelationships between the sources and uses of funds in short-term financial planning and decision-making.

Liquidity management refers to those activities within a financial institution to ensure that holdings of liquid assets (e.g. cash, bank deposits and other financial assets) are sufficient to meet its obligations as they fall due, including unexpected transactions. Banks are primarily in the business of raising deposits and making loans that transform liquid liabilities into liquid assets.

 It has two broad aspects:

 a. Asset Liquidity: It measures the ease with which a bank can convert its assets into cash.

 b. Market Liquidity: It measures ability to raise capital form other market participants at short notice.

 Liquidity, or the ability to fund increases in assets and meet obligations as they come due, is crucial to the ongoing viability of any banking organization. Therefore, managing liquidity is among the most important activities conducted by banks, Sound liquidity management can reduce the probability of serious problems. So, banks must visualize and evaluate liquidity needs under different business scenarios. Liquidity represents the ability to deal with shortage of funds and surplus of funds. Irrespective of size of a bank, adequate liquidity is essential to meet commitments when due and to undertake new transaction when desirable.

 Considering the importance of managing liquidity risk, each bank is required to have a suitable policy in this regard which must cover objectives of liquidity management, framework for assessing and managing liquidity, funding strategies and internal norms including delegation of authority etc.

 

Explain the risks in the financial institutions. How they can be managed? or What are the core risks in banking? Discuss key elements of a sound risk management system as prescribed in Risk Management Guidelines for Banks by BB:

The banking industry has been tremendously changing the lives of ordinary people. The banks have become much more advanced, and the security aspect has been improved to a large extent.

However, with the increase in growth of the banks, banking operations have become much more complicated. The risks involved with the adoption of disruptive technologies called for the change in regulatory environments and business procedures.

 In banking, various risks can impact the financial stability and operations of financial institutions. These risks can be broadly categorized into core risk types. Here are some of the core risks in banking:

Risks Involved in the Banking Industry:

 1. Credit Risk: One of the most significant threats faced by banks is credit risk. In simpler words, credit risk is defined as the inability of a borrower or a counterparty to meet contractual obligations. In other words, when a borrower fails to pay the appropriate amount to the lender due to any financial crisis. The banks have suffered huge losses in the past from credit risks, and are still prone to such losses.

 Although credit losses are primarily defined by the inability of the borrower to repay loans to the lenders, it also includes the delay in payments of the borrower. That means if any borrower does not make timely payments, then such types of cases also come under credit risks.

·        Ways of managing credit Risk: Such types of losses commonly occur due to borrower insolvency. Hence, banks should conduct proper investigations before granting the loans and should only sanction loans to individuals and businesses that are not likely to run out of their income during the payment period.

 2. Market Risk: Market risks are defined as the risks involved in the fall of a company's share or decrease in the value of the stock of third-party companies where the bank has invested. We all know that apart from sanctioning loans, the banks also hold a certain amount of shares in the market. In that case, if by any means, the share price of the banks decreases, then they will suffer huge losses, and these types of losses generally come under market risk.

The market risks can vary depending on the type of commodity a bank holds. in the case of gold, silver, or real estate, they are exposed to commodity risks, etc. similar is the case with equity risk.

•         Ways of managing Market Risk: To mitigate market risks, banks usually leverage hedging contracts. They use contracts like forwards, options, swaps, and many more, to eliminate the various market risks.

  3. Business Risk: Business risks are a significant result of credit risk. To put it simply, when a bank fails to generate profits during a specific period, then it is called business risk. Many times, a business takes a loan from a bank and then fails to repay it. In such a scenario, the banks lace losses due to business risk.

 The result of business loss is either being acquired by some other banks or collapse in big banks. Examples of such banks that suffered huge losses due to the wrong business strategy are Washington Mutual and Lehman Brothers.

•         Ways of managing Business Risk: Although there are no sure-shot methods of eliminating business risk, the adoption of the right strategy might do the work.

 4. Security Risk: Now that's a considerable risk that has been on the top of the list for the global market, irrespective of their domains. Cybersecurity has been impacting the financial industry for quite a few years, and the problem is still prevalent in the banking sector. We witnessed many cases where hackers penetrated the security layers of some big banks and stole a large sum out of it.

Banking institutions are still making considerable investments in the security aspect to make their customer's data and their systems more secure than ever. The industry is leveraging the latest technological advancements of Al, ML, Blockchain, big data, etc. to yield positive results in terms of security.

•         Ways of managing security Risk: The banks need to invest in top-notch fintech software and mobile apps that are way more secure and impenetrable. They should keep their private information safe using a technologically advanced electronic medium. 

5. Compliance Risk: When a bank does not follow proper regulatory standards put down by the financial institutions, then such type of risk is known as Compliance risk. These are usually a not much greater risk but surely have some significant outcomes. When a bank does not comply with proper regulations formed by the banking institutions in their certain branch, then they face financial and legal losses.

The banks get severely affected by these losses and suffer losses in their daily banking targets. They had to bear legal penalties and might face significant challenges from the regulatory committee.

•         Ways of managing compliance Risk: To mitigate such types of risks, the banks should formulate, regulate, and manage all the regulations and compliance policies across all their branches.

6. Operational Risk: When there is a failure in the internal processes of the bank due to inefficient systems, then it is termed as operational risk. We all know that banks have to perform a wide array of banking operations like daily transactions, cross-border transfers, cash deposits, and much more. However, there are times when the internal systems or the central system slows down. In such a scenario, the bank faces losses due to operational risk. Not only that, when there are some other mistakes like payment transfer in the wrong account, or execution of an incorrect order, etc. also falls under operational risk. It is noteworthy here that banks do not directly get affected because of the operational risks.

•         Ways of managing operational Risk: The operational risks can be minimized by automating the workflows so that the human interventions reduce. Also, the banks should use software from a trustworthy development company to ensure smooth operations.

7. Reputational Risk: Reputational risk is a significant result of the operational risk and, to some extent, the security risk. In other words, when a company fails to provide security to their customers, or when they perform inefficiently in processing their requests, then they suffer loss in users. People began spreading rumors about the bank, and the bank's image gets spoiled The news channels interrogate the people and make false perspectives about the banks. In such a scenario, the daily revenue of the bank drastically reduces, and hence they suffer huge losses. They lose their stellar reputation in the global market, and their profits decrease.

•         Ways of managing reputational Risk: The banks should ensure smooth functioning and should provide safety and security to all of its customers. They should never participate in any unfair practices and should ensure customer satisfaction in every possible way.

8. Liquidity Risk: Liquidity risks arise because of the increase in the non-profitable assets in the bank. That is, if there is an increase in the credit losses and losses due to business risk, then liquidity risk arises. Due to the rise in the liquidity risk, the bank becomes insufficient to meet the obligations if any depositor comes to withdraw its money. Looking back in history, the losses due to liquidity risk was a significant concern of all the banks at that time. However, the present-day scenario has been completely changed. Now the banks have new regulations of keeping a minimum amount of reserved cash to mitigate liquidity risk. That implies that the depositors can be paid even during the time of credit for business loss.

•         Ways of managing liquidity Risk: The banks should follow proper regulations of the central banks and should keep a minimum requisite amount in the banks to eliminate the chances of losses due to liquidity risk.

9. Systematic Risk: Whenever there are some external issues involved with the bank like employee's strike, market fluctuation, non-stability of the government, and so on, then it is termed as Systematic risk. The systematic uncertainty is beyond the control of management since it entirely depends on the various external factors. The losses due to systematic risks are unpredictable and cannot be wholly avoided. Banks suffer huge losses due to systematic risk and may have to write off certain assets to compensate for their losses.

•         Ways of managing Systematic Risk: The systematic risks are entirely unpredictable, and so they cannot be eliminated. However, with smart skills, they can be minimized up to a certain extent.

 

10. Moral Hazard: Moral hazard is an entirely new type of risk when compared to the other mentioned risks. It came to light recently in the global market. The moral hazard occurs when a bank takes some risk, even when they know that someone else has to bear the losses. In other words, when a bank invests in a risky business, and it backfires, then it is the taxpayers who have to bear all the losses.

Although the central bank has been tracking the banks and their operations very carefully, some of them still take dreadful risks when not under the regulatory oversight. They get to indulge in the illegal practices and create an imbalance on the taxpayers when their planning fails

•         Ways of managing moral hazard: The central bank should pay more attention to the activities of the banks to eliminate the losses caused by moral hazards. The banks should also not indulge in risky businesses and should follow the proper path.

How can investment risk and operational risk be reduced?

 Investment risk: Investment risk can be defined as the probability of occurrence of losses relative to the expected return on any particular investment. Stating simply, it is a measure of the level of uncertainty of achieving the returns as per the expectations of the investor. It is the extent of unexpected results to be realized. Risk is an important component in the assessment of the prospects of an investment.

Most investors while making an investment consider less risk as favorable. The lesser the investment risk, the more lucrative the investment. However, the thumb rule is the higher the risk, the better the return.

Some of the tools at the disposal of an individual that he/she must consider to mitigate different investment risks include:

 ·        Due diligence: It is essential that before any call on investing, research should be carried out. For example, It is pertinent that before investing in a stock one checks earning growth, PE ratio, debt load, and management team and then compares it with other stocks in the same industry on key parameters. Stocks with high PE ratios, unstable management, and inconsistent profitability and revenue growth could be eliminated. 

·        Capital allocation: Out of the total capital available for investment, assign amounts in different classes of investment such as debt, equity, or a mix of both depending on the growth requirements of capital. In case an individual starts investment at an early age, then investing in equities offering higher returns over a long duration of investment would mitigate volatility and inflation risk. 

·        Portfolio diversification: This entails the selection of various investment products, exposure to equity belonging to different sectors, and the mix of various options available for instruments. As a strategy, there could be a possibility of lower returns but would result in alleviating the risk of substantial capital loss. 

·        Monitoring portfolio: It is essential at periodic intervals. For instance, at times of lower interest, the price of debt securities moves up and could provide an opportunity for a switch in the portfolio. In case an individual cannot manage the monitoring, it is advisable to shift to Mutual Funds to protect the capital. 

·        Blue-chip stocks: In order to ease the loss of capital and avoid liquidity risk, it is ideal to stay invested in bellwether stock or fund. Investors should watch out for the credit rating of debt securities and invest in better-rated securities to avoid default risk. 

·        The quantum of money invested, period of investment, return and growth, expenses, associated with it, and risk tolerance impact our achievement of investment goals. All types of investment products/securities carry some or the other risk.

Operational risk: Operational risk summarizes the uncertainties and hazards a company faces when it attempts to do its day-to-day business activities within a given field or industry. A type of business risk, it can result from breakdowns in internal procedures, people, and systems as opposed to problems incurred from external forces, such as political or economic events, or inherent to the entire market or market segment, known as systematic risk.

Operational risk can also be classified as a variety of unsystematic risks, which is unique to a specific company or industry.

·        Get the backing of the organization's leadership. This is a critical first step. An ORM program will only be truly effective if it is championed at the very top of the organization.

·        Introduce risk accountability across the organization. Employees across every level of the enterprise need to be trained to incorporate risk-based thinking into their day-to-day activities and be held accountable for risks within their immediate area of control.

·        Agree to timely risk assessments. Risk assessments help ensure companies comply with new requirements and keep risk management a top priority. The frequency of these audits should be determined by the unique characteristics of each company and its operational footprint.

·        Quantify and prioritize risks. Managing an optimized ORM program requires that risks are quantified in terms of probability and severity, and calculated in terms of the costs and benefits of mitigating a risk versus allowing the risk to remain as is. This enables mitigation efforts to be targeted most effectively.

·        Establish appropriate metrics and key performance indicators to monitor and assess performance. This is one of the most important steps in a successful ORM program. It enables companies to ensure the appropriate effort and resources are expended based on the specific risk profile of the business.

Implement consistent, well-documented, and cost-effective controls. Such control measures are necessary to actively mitigate identified priority risks. While nearly all companies (98%) feel they already have adequate controls already in place, only about one in four (27%) considered them cost-effective, suggesting an opportunity for them to identify better options for managing and controlling identified risks

What is the risk-free rate of return? Explain risk premium.

The risk-free rate of return is the least rate of return earned by an investor from an investor who holds zero risks. This is a theoretical concept made by some experts because, in practice, there's no such investment that does not come with zero risks.

Basically, the risk-free rate is commonly considered to be equal to the interest paid on a 3-month government Treasury bill, generally the safest investment an investor can make. All investments have some degree of risk which means that it may not be practically possible for an investor to get a risk-free rate of returns while making an investment.

It can be concluded that a Risk-free rate of return is a hypothetical rate of interest that an investor would expect from an investment without incurring any risk. That means the investor is assured to get the principal amount and a minimal return over a specified period of time.

Risk premium represents the extra return above the risk-free rate that an investor needs in order to be compensated for the risk of a certain investment. In other words, the riskier the investment, the higher the return the investor needs.

The risk premium is measured as the total expected return minus the return on a risk-free asset, such as a treasury bill issued by the government or central Bank. For more, here input pictorial presentation of the Risk Premium formula.

Asset Return - Risk-Free Rate = Risk Premium

On the above discussion, we can see that risk premium means the additional return that investors expect from the based on its level of risk.

How are various risks of commercial banks judged through CAMELS ratings?

 CAMELS Rating: CAMELS rating is the rating system wherein the bank regulators or examiners evaluate an overall performance of the banks and determine their strengths and weaknesses.

CAMELS rating is based on the financial statements of the banks, Viz. Profit and loss account, balance sheet, and on-site examination by the bank regulators. In this Rating system, the officers rate the banks on a scale from 1 to 5, where 1 is the best and 5 is the worst. The parameters on the basis of which the ratings are done are represented by an acronym "CAMELS".

Capital Adequacy: The capital adequacy measures the bank's capacity to handle the losses and meet all its obligations towards the customers without ceasing its operations. This can be met only on the basis of an amount and the quality of capital, a bank can access. A ratio of Capital to Risk-Weighted Assets determines the bank's capital adequacy

Asset Quality: An asset represents all the assets of the hank. Viz. Current and fixed, loans, investments, real estate and all the off-balance sheet transactions. Through this indicator, the performance of an asset can be evaluated. The ratio of Gross Non-Performing Loans to Gross Advances is one of the criteria to evaluate the effectiveness of credit decisions made by the bankers

Management Quality: The board of directors and top-level managers are the key persons who are responsible for the successful functioning of the banking operations. Through this parameter, the effectiveness of the management is checked out such as, how well they respond to the changing market conditions, how well the duties and responsibilities are delegated, how well the compensation policies and job descriptions are designed, etc.

Earnings: Income from all the operations, non-traditional, and extraordinary sources constitute the earnings of a bank. Through this parameter, the bank's efficiency is checked with respect to capital adequacy to cover all the potential losses and the ability to pay off the dividends. Return on Assets Ratio measures the earnings of the banks.

Liquidity. The bank's ability to convert assets into cash is called liquidity. The ratio of Cash maintained by Banks and Balance with the Central Bank to Total Assets determines the liquidity of the bank.

Sensitivity to Market Risk: Through this parameter, the bank's sensitivity towards the changing market conditions is checked, which is how adverse changes in the interest rates, foreign exchange rates, commodity prices, and fixed assets will affect the bank and its operations.

Thus, through CAMELS rating, the overall financial position of the bank is evaluated and the corrective actions, if any, are taken accordingly.

What is meant by interest rate spread?

 Net interest rate spread refers to the difference between the interest rate paid to depositors and the interest rate they receive from loans. In other words, it is the difference between the borrowing and lending interest rates of the bank. The interest rate spread is a key determinant of the financial institution's profitability and is similar to a profit margin.

To better understand the net interest rate spread, we first must understand how financial institutions operate. The financial institutions referred to here are mostly banks. Banks issue a variety of loans to customers, which include mortgages on a property, student loans, and auto loans. They charge interest on the loans.

Banks generate income through deposits in the form of savings and checking accounts, shareholder equity, or debt issuance and payout interest. Typically, the interest paid out on deposits is at a lower rate than the interest the bank charges on loans, meaning that the bank generates income. As such, the larger the interest rate spread, the higher the income the bank earns.

The interest rates themselves are a key determinant of the interest rate spread and are affected by several factors. Government policy plays a key role in determining the interest rates, as do market transactions in the open market.

Importance of the Net Interest Rate Spread

The net interest rate spread is especially important because it is essentially a measure of the profit margin for the institution. It is because the larger the spread, the more money the bank earns. Both rates can fluctuate over time, which means that the bank needs to keep a close eye on them to prevent a substantial decrease in income.

The net interest rate spread is reported by hanks and other publicly-traded corporations that are responsible to shareholders as disclosure in their financial statements for quarterly and year-end fiscal reports

The spreads of different banks are closely examined by international organizations, such as the World Bank, which releases data from different countries around the world to provide users with information on the average lending and deposit rates worldwide.

 

For investments, the interest rate spread is used to evaluate the rates of investments versus the benchmark rates in a particular industry. It commonly occurs for securities and bonds. The spread rates are compared according to the credit rating and enable bonds of the same rating (such as AA or BB) to be compared against each other for more accurate results

 

What do you mean by the credit risk of a commercial bank? How it can be mitigated? Or what are the credit risk mitigation techniques of a Financial Institution

 Credit risk: Credit risk is the possibility of a loss resulting from a borrower's failure to repay a loan or meet contractual obligations. Traditionally, it refers to the risk that a lender may not receive the owed principal and interest, which results in an interruption of cash flows and increased costs for collection. Excess cash flows may be written to provide additional cover for credit risk. When a lender faces heightened credit risk, it can be mitigated via a higher coupon rate, which provides for greater cash flows.

Although it's impossible to know exactly who will default оп obligations, properly assessing and managing credit risk can lessen the severity of a loss. Interest payments from the borrower or issuer of a debt obligation are a lender's or investor's reward for assuming credit risk.

Steps to mitigate the bank's credit risk: Loan portfolios typically have the largest impact on the overall risk profile and earnings of community banks. A strong credit culture provides a platform for the Bank to compete successfully in its market. Although credit risk is inevitable, banks can mitigate the risk by taking steps to strengthen its lending program. The following steps can help assist in providing a framework for a sound lending program:

·  Written Credit Policies-A well-written and descriptive credit policy is the cornerstone of sound lending. Credit policies should address the inherent and residual risks in lending.

·      Standardized Credit Packages-Documented credit request packages should be uniform. Most credit packages will consist of a request, required supporting documentation, and an analysis/financial review.

·        Experienced Underwriting/Decision Making-Underwriters should   effectively apply the Bank's credit policy and risk guidelines to determine the degree of risk involved in the credit request. Too many exceptions to policy may suggest that current underwriting guidelines may not be in line with the Bank's priorities or financial goals.

·        Loan Approval Authority-The Bank should document loan approval authorities which are approved by the Board of Directors. In order to maintain a balance between credit quality and profitable loan portfolio growth, appropriate lending authority controls must exist. Each loan file should contain documentation of proper approval.

·   Well-Managed Credit Risk Rating System-Well- managed credit risk rating systems promote bank safety and soundness by facilitating informed decision making. The Bank's risk rating system should form the foundation for credit risk measurement, monitoring and reporting and should support the board's objectives.

·   Accuracy of Loan Documentation-Properly executed loan documentation is necessary to ensure the bank has an enforceable claim for repayment, including liquidation of collateral or the right to demand payment. Documentation must be properly drafted, completed, executed, filed, and stamped. A secondary review of this documentation should be in place.

·   Monitoring/Reporting Loan Performance is important to identify trends within the loan portfolio and isolate potential problem areas. Reports to senior management should provide sufficient information for an independent evaluation of risk and trends.

·  Problem Asset Management-When collection problems persist and risk ratings deteriorate, many banks find it beneficial to transfer problem loans to an independent work-out team.

Loan portfolio and risk management is not just about avoiding risk. It is also about balancing risk while seizing opportunities in your marketplace and serving your community well. So, go for the opportunities while balancing your risk management strategy. It can help make your organization even more successful.

Describes the different types of risk Conducting Banking Business. or Describe the types of risk reporting in the context of Bangladesh.

Interest rate risk refers to the potential risk that changes in interest rates could impact the value of an investment or the financial performance of an organization. Here are a few examples of interest rate risk:

 1. Bond investments: Bond prices are inversely related to interest rates, which means that when interest rates rise, bond prices tend to fall, and vice versa. If an investor holds a bond with a fixed interest rate and interest rates rise, the value of the bond will decrease, and the investor may incur a loss if they sell the bond before its maturity.

2. Bank loans: If a bank issues loans with fixed interest rates, and interest rates rise, the bank may face a situation where the cost of funding the loans increases, but the interest rate charged to borrowers remains fixed. This can impact the profitability of the bank and potentially result in defaults on loans if borrowers cannot afford to pay the higher interest rates.

These are just a few examples of how interest rate risk can impact investments and organizations. It's important for investors and organizations to understand the potential impact of interest rate changes and to develop strategies to mitigate this risk.

 Foreign exchange risk is the potential risk that changes in exchange rates could impact the value of an investment or the financial performance of an organization. This risk arises due to fluctuations in the exchange rates between different currencies.

 Foreign exchange risk can impact both individuals and organizations who have international business dealings, investments or assets, and liabilities denominated in foreign currencies. Here are a few examples of how foreign exchange risk can impact different entities:

1. Multinational corporations: Multinational corporations that operate in multiple countries are particularly susceptible to foreign exchange risk. They may have assets and liabilities denominated in different currencies, which can be impacted by changes in exchange rates. For example, if a company has a subsidiary in a country with a weak currency, a rise in the value of that currency relative to the parent company's currency could result in a decrease in the value of the subsidiary's earnings.

2. Importers and exporters: Importers and exporters also face foreign exchange risk due to fluctuations in exchange rates. For example, if an importer has a contract to purchase goods from a supplier in another country and the value of the importer's currency falls relative to the supplier's currency, the importer may have to pay more for the goods than initially anticipated.

To manage foreign exchange risk, individuals and organizations can use strategies such as hedging, diversification, and monitoring of currency fluctuations. These strategies can help to mitigate the potential impact of foreign exchange risk and help to ensure the financial stability and success of the entity.

Commodity risk is the potential risk that changes in the prices of commodities, such as metals, energy, agriculture, and other raw materials, could impact the value of an investment or the financial performance of an organization. This risk arises due to fluctuations in the supply and demand of commodities, which can be affected by various factors, including weather patterns, geopolitical events, economic conditions, and technological developments.

Commodity risk can impact both individuals and organizations who have investments or operations that involve commodities. Here are a few examples of how commodity risk can impact different entities:

1. Producers: Producers of commodities, such as farmers, miners, and oil producers, are particularly susceptible to commodity risk. The prices of commodities can fluctuate due to changes in supply and demand, and this can impact the profitability of producers.

2. Consumers: Consumers of commodities, such as manufacturers, retailers, and households, are also impacted by commodity risk. For example, if the price of oil rises, the cost of producing and transporting goods may increase, and this can result in higher prices for consumers.

Credit risk can be classified into two main categories: individual credit risk and portfolio credit risk. Individual credit risk refers to the risk associated with a single borrower or counterparty, while portfolio credit risk refers to the risk associated with a group of borrowers or counterparties.

Banks and other financial institutions are particularly exposed to credit risk, as their business models are heavily reliant on lending activities. To manage credit risk, banks use a variety of risk management techniques, including credit scoring, credit limits, collateral, and credit derivatives. Credit scoring is a common technique used by banks to assess the creditworthiness of borrowers. This involves analyzing a borrower's credit history, income, and other factors to assign a credit score that reflects the likelihood of default. Banks also use credit limits to control the amount of credit extended to a borrower and may require collateral, such as property or assets, to secure a loan.

Credit derivatives, such as credit default swaps (CDS), are also used to manage credit risk. These instruments allow banks to transfer the credit risk associated with a loan or portfolio of loans to another party, such as an investor or insurer. By transferring the credit risk, banks can reduce their exposure to potential losses from borrower defaults.

Overall, managing credit risk is essential for banks and other financial institutions to ensure their financial stability and profitability. Effective credit risk management involves assessing and monitoring credit risk exposures, implementing appropriate risk management techniques, and maintaining robust risk management processes and controls.

 

Briefly describe the importance of risk management and the risk management process. Or discuss the importance of risk management and risk analysis process from the viewpoint of a treasury manager.

 Risk management is an essential process that helps individuals and organizations identify, assess, and mitigate potential risks that could impact their operations, reputation, and financial stability. Risk management involves identifying potential risks, analyzing their likelihood and potential impact, and developing strategies to mitigate or manage them.

 As a treasury manager, risk management and risk analysis are of paramount importance for ensuring the financial stability and success of the organization. Here are some key reasons why risk management and risk analysis are crucial from the viewpoint of a treasury manager:

 1. Protection of Assets: Risk management helps protect the organization's assets, including cash, investments, and financial instruments. By identifying and assessing various risks such as market risks, credit risks, liquidity risks, and operational risks, the treasury manager can implement strategies to mitigate those risks and safeguard the organization's financial resources.

 2. Financial Stability: Effective risk management promotes financial stability within the organization. By analyzing and understanding the potential risks associated with treasury activities, the treasury manager can take appropriate measures to reduce the likelihood and impact of adverse events. This contributes to the organization's ability to meet its financial obligations, maintain liquidity, and avoid financial distress.

 3. Regulatory Compliance: Risk management is essential for ensuring compliance with regulatory requirements and industry best practices. Treasury activities are subject to various regulations, such as capital adequacy standards, liquidity requirements, and reporting obligations. By implementing robust risk management processes, the treasury manager can ensure compliance with these regulations, thereby avoiding penalties and reputational damage.

 4. Decision-Making Support: Risk analysis provides valuable insights and information to support decision-making processes. By assessing risks, the treasury manager can evaluate the potential impact on financial outcomes and make informed decisions regarding investments, funding, hedging strategies, and capital allocation. Risk analysis helps balance risk and reward, optimizing treasury operations to maximize returns while managing potential downside risks.

 5. Mitigation of Financial Losses: Risk management helps mitigate potential financial losses. By identifying and quantifying risks, the treasury manager can implement appropriate risk mitigation techniques, such as diversification, hedging, and risk transfer through insurance or derivative instruments. These measures help protect the organization from adverse market movements, credit defaults, and operational failures, minimizing potential losses.

 6. Stakeholder Confidence: Effective risk management enhances stakeholder confidence in the organization's treasury operations. Investors, lenders, and other stakeholders are reassured when they see that the treasury manager has implemented robust risk management practices to protect their interests. This can lead to increased investor trust, improved access to capital markets, and enhanced relationships with financial counterparties.

 7. Proactive Approach to Uncertainty: Risk management allows the treasury manager to take a proactive approach to uncertainty and volatility in financial markets. By regularly monitoring and analyzing risks, the treasury manager can identify emerging risks, assess their potential impact, and develop contingency plans. This enables the organization to respond swiftly and effectively to changing market conditions, minimizing disruptions and capitalizing on opportunities.

 The risk management process typically involves the following steps:

1. Risk identification: This involves identifying potential risks that could impact an organization's operations, reputation, or financial stability.

 2. Risk analysis: This involves analyzing the likelihood and potential impact of each identified risk.

3. Risk evaluation: This involves evaluating the identified risks and prioritizing them based on their likelihood and potential impact.

4. Risk mitigation: This involves developing strategies to mitigate or manage the identified risks.

5. Risk monitoring and review: This involves monitoring the effectiveness of the risk mitigation strategies and reviewing the risk management process on an ongoing basis to identify any new risks or changes in existing risks.

In summary, risk management and risk analysis are crucial for treasury managers to protect assets, ensure financial stability, comply with regulations, support decision-making, mitigate losses, instill stakeholder confidence, and proactively manage uncertainty. By implementing robust risk management processes, treasury managers can navigate the complexities of financial markets and contribute to the overall success of the organization.

Briefly describe the government security markets in Bangladesh. Or briefly discuss the Government Securities Market in Bangladesh

 The government securities market in Bangladesh is primarily comprised of treasury bills and government bonds issued by the Bangladesh Bank, the central bank of Bangladesh, on behalf of the government. These securities are used by the government to finance its budget deficit and other expenditure needs.

 Government securities market of Bangladesh is consisting of tradable and non-tradable securities.

Non-tradable securities include National Savings Certificates i.e. Sanchayapatras and Sanchayabonds which are only for retail investors.

 The tradable securities include Treasury Bills (T-Bills) of 91, 182 and 364-days maturities and Bangladesh Government Treasury Bonds (BGTB) of 2, 5-, 10-, 15- and 20-years maturities. T-Bills and BGTBs are issued through auctions.

 Only Primary Dealers (PD) can submit bids in the auctions. Other institutions and individuals can submit bids in auction but through the PDs. At present 24 banks are performing as Primary Dealer. T-Bills and BGTBs can be sold in the secondary market. Non-resident individual and institutional investors also eligible to buy BGTBs through a Non-Resident Foreign Currency Account and Non- Resident Investor's Taka Account maintained with commercial banks of Bangladesh.

Bangladesh Bank have its own depository system for the transaction and settlement of Government securities in the Market Infrastructure (MI) Module. In 2011 BB introduced this automated system to expedite the primary auction and secondary market. Bangladesh Bank initiated to automate the process of trading and settlement of Government securities transactions in October 2011. The secondary market of Government securities of Bangladesh is comprised of Over the Counter (OTC) and Trader Work Station (TWS). Both the procedure are the integral parts of Market Infrastructure Module (MI Module)-the automated auction and trading platform of government securities

The government securities market in Bangladesh is regulated by the Bangladesh Bank, which sets the terms and conditions for the issuance and trading of these securities. The market is also supported by a number of primary dealers who act as intermediaries between the Bangladesh Bank and investors, facilitating the issuance and trading of government securities.