Supervision by Risk is a regulatory approach which is based on risk-identification through assessing and controlling the different areas of financial entities, in order to implement the prompt and effective countermeasure to reduce the negative influences, and risk-based supervision is opposed compliance based supervision which involves checking compliance with a set of written rules in law,[1] and the safety and soundness supervision has been improved through the adoption of "supervision by risk" by Eugene Ludwig and many other supervisory agencies. [2]
Supervision plays a big role in creating and maintaining the fairness and stabilization of the market to protect the development and benefits of businesses. Nowadays, more and more companies are starting to adopt RBS (risk-based supervision) rather than the traditional way of compliance based supervision because RBS has been evolved to a more efficient tool to take measures as soon as possible through predicting the risks, and the companies are looking for a robust supervisory system to identify and control potential risks more accurately and quickly by assessing four factors which are inherent risk, controls, residual risk and additional support[3]. Furthermore, there are various types of risks that need to pay attention to, especially for bank supervision, which are credit risk, market risk and operational risk[4]. Additionally, risk-based supervision of pension funds is a special type but can have the same features as bank supervision and insurance supervision.
Factors edit
Inherent Risk edit
Inherent risk refers to the risk of crisis situation occurring and the risk will be different according to the different scenarios in the fickle market, and the supervisors need to avoid these the inherent risk as soon as possible by concerning and exploring a large number of different probabilities.[3] The inherent risk as a factor of risk management has been defined as the risk of an account or class of transactions to material error irrespective of the system of internal controls which can influence the supervisors' decisions to a very high extent[5], so the supervisors can change their system of risk assessment according to the accuracy of inherent-risk identification.
Controls edit
Control is the action and methods that supervisors adopt to reduce the probabilities of a risk occurring, for example, and supervisors will implement different degrees and ways of control for different risks[3]. The strong control system can mitigate the effects of high levels of risks[5], and that is why the effectiveness of controlling can directly decide whether a business succeeds or fails.
Residual Risk edit
Residual risk is the risk that occurs due to uncontrollable conditions even though the control system and monitoring management are effectively working[3]. Residual risk is unavoidable, and the remedial measures and capacities of flexibility are more important to pay attention to.
Additional support edit
Additional supports refers to the methods or adoptions that use afterwards to deal with the outcome of an occurred risk in order to minimize the negative impact and loss for the companies or person to a possible extent. [3] Occurred risk is inevitable in the process of development of a company, and additional support is more critical for perfecting the control system and the future of the businesses.
Roles edit
Comparing with the traditional supervisory approach, supervision by risk can identify the higher risk areas and prevent problems from developing. Supervisors can have deeper understanding and awareness of the potential risk and the effectiveness of current control system to cause more supervisory concern[6] which is an important ability to predict the probability of the inherent risks.[7]
For bank supervision, this approach can optimize utilization of regulatory resources[7] and it also encourages a bank to have a risk profile which enables a self-assessment to ensure continuous monitoring and minimize the negative influences of a crisis situation in the financial system. [8] It is effective to protect the stable operation of banks.
Types of Risk edit
Credit Risk edit
Credit risk is the risk of losses due to borrowers' default or deterioration to meet the obligations on agree term.[9] It commonly occurs, so credit risk management is significant for banks to reduce losses. Credit risk management tools have to work at both individual and portfolio levels.[4] Portfolio management assists in gathering information to identify the concentration of credit weaknesses in advance, such as the using of balance sheet. Also, credit rating can predict inherent risk, and pricing on a scientific basis can effectively avoid the occurring of costumers' dissatisfaction. [8]
Market Risk edit
The market is always active and needs to use risk supervision for monitoring the change at all time. Scenario analysis and stress testing is an effective tool to predict potential problems before the risk occurs.[8]
Operation Risk edit
Operation risk involves the financial loss caused by error, fraud, performance in record keeping, processing system failures, and it will break down in internal controls to bring quiet costly expense even though individual operating problems are small probability events for mature businesses or banks.[10] It is unavoidable but controllable, risk-based supervision can help banks to identify the weakest part of the operation process and implement related control to reduce the impact of the potential risk.
Above these, there are also counterparty risk, liquidity risk, legal risk and so on as the types of risks that need to be considered in supervision by risk management.[10]
Risk Based Supervision of pension fund edit
Risk-based supervision for pension funds is aiming to ensure that the pension fund members can receive a stable pension income which can be able to support their lives after they retire, and this approach is provided by the supervisory authority which directs its scarce resources towards the main risks posed to them.[11]
The supervision approaches have evolving to risk-based supervision in both banks and insurance, as well as pension funds because it enables to focus on risk management in daily life in order to build a more complete pension system and effective outcome.[12] Different countries have different pension systems and diverse implementing of risk-based pension funds supervisions due to the particular environment and development of the pension system in each country.[1]
References edit
- ^ a b Brunner, Greg; Rocha, Roberto; Hinz, Richard, eds. (2008-04). "Risk-Based Supervision of Pension Funds". doi:10.1596/978-0-8213-7493-1.
{{cite journal}}: Check date values in:|date=(help); Cite journal requires|journal=(help) - ^ Ludwig, Eugene. Assessment of Dodd-Frank financial regulatory reform strengths, challenges, and opportunities for a stronger regulatory system. OCLC 1099980117.
- ^ a b c d e Randle, Tony (2009-12). Risk Based Supervision. World Bank.
{{cite book}}: Check date values in:|date=(help) - ^ a b Arora, Diksha; Agarwal, Ravi Kumar (2009). "Banking Risk Management in India and RBI Supervision". SSRN Electronic Journal. doi:10.2139/ssrn.1446264. ISSN 1556-5068.
- ^ a b MALETTA, MARIO J. (1993-03). "An Examination of Auditors' Decisions to Use Internal Auditors as Assistants: The Effect of Inherent Risk". Contemporary Accounting Research. 9 (2): 508–525. doi:10.1111/j.1911-3846.1993.tb00895.x. ISSN 0823-9150.
{{cite journal}}: Check date values in:|date=(help) - ^ Arora, Diksha; Agarwal, Ravi Kumar (2009). "Banking Risk Management in India and RBI Supervision". SSRN Electronic Journal. doi:10.2139/ssrn.1446264. ISSN 1556-5068.
- ^ a b Stevens, Ed (2000). Evolution in banking supervision. Federal Reserve Bank of Cleveland.
- ^ a b c Raghavan, R.S. (2003). Risk management in banks. CHARTERED ACCOUNTANT-NEW DELHI-. pp. 841–851.
- ^ Bessis, Joël (2015). Risk management in banking. Wiley. ISBN 9781118660218. OCLC 910585324.
- ^ a b Santomero, A. M. (1997). Commercial bank risk management: an analysis of the process. Journal of Financial Services Research. pp. 83–115.
- ^ Randle, Tony (2014). Pension risk and risk-based supervision in defined contribution pension funds. World Bank, Financial and Private Sector Development, Global Capital Markets Non-Bank Financial Institutions Group. OCLC 931519907.
- ^ Thompson, Graeme (2008-03-04). "Risk-Based Supervision Of Pension Funds In Australia". Policy Research Working Papers. doi:10.1596/1813-9450-4539. ISSN 1813-9450.