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THE PROBLEM AND THE PLANIncidentals of Authorization and

SubmittalThis study of

risk management recommendations of Turk Eximbank is submitted to Mr. H. Ahmet KILIÇOGLU, General

Manager of Turk Eximbank, on Aprıl 30, 2001.As authorized on February 20, 2001,

the investigation was conducted under the direction of Barış Samana and GÜrkan Kocgar. Objective of Risk Management

RecommendationsThe objective of the study was to define

why risk management was needed in Turk Eximbank and how to adjust the risk

management system at the bank. The plan for achieving this objective involved

first determining the techniques used for risk measurements. This information

will then be used for Turk Eximbank?s risk evaluation process.Use of?

Techniques for Risk MeasurementThe methodology used in this investigation was an obsevational study of

defining the risk measurement techniques and then applying them to Turk

Eximbak?s risk evaluation process, if necessary.Investigations have been made at the Bilkent University Library and

Internet, also we have interwieved with the risk analysts of Turk Eximbank. INTRODUCTIONIn recent years, a number of programs

aimed at enhancing the effectiveness of supervisory process for banks. Although

effective risk management has always been central to safe and sound banking

activities, it has become even more important as new technologies, product

innovation, and the size and speed of financial transactions have changed the

nature of banking markets. In response to these changing market realities,

certain supervisory risk management processes have been refined, while others -

in particular, those that have proven most successful in supervising banks

under a variety of economic circumstances and industry conditions – have been retained.

The objective of a risk-focused examination is to effectively evaluate the

safety and soundness of the bank, including the assessment of its risk

management systems, financial condition, and compliance with applicable laws

and regulations, while focusing resources on the bank?s highest risks. The

exercise of examiner judgment to determine the scope of the examination during

the planning process is crucial to the implementation of the risk-focused

supervision framework, which provides obvious benefits such as higher quality

examinations, increased efficiency, and reduced on-site examiner time.UNDERSTANDING THE BANKThe risk-focused supervision process for

banks involves a continuous assessment of the bank. The understanding of the

bank developed through this assessment enables examiners to tailor the

examination of the bank to its risk profile. Understanding the bank begins with

a review of available information on the bank. In addition to examination

reports and correspondence files, each bank maintains various surveillance

reports that identify outliers when a bank is compared to its peer group. The

review of this information assists examiners in identifying both the strengths

and vulnerabilities of the bank and provides a foundation from which to

determine the examination activities to be conducted. Contact with the organization is

encouraged to improve the understanding of the institution and the market in

which it operates. A pre-examination interview or visit should be conducted as

a part of each examination. Such a meeting gives examiners the opportunity to

learn about any changes to bank management, bank policies, strategic direction,

management information systems, and other activities. Particular emphasis

should be placed on learning about new products or markets into which the bank

has entered. The interview or visit also provides examiner’s with management?s

view of local economic conditions, an understanding of the bank?s regulatory

compliance practices, its management information systems, and its

internal/external audit function. In addition, banks should contact the

state-banking regulator to determine whether they have any special areas of

concern that should be focused on during the examination. RELIANCE ON INTERNAL RISK

ASSESSMENTSInternal audit, loan review, and

compliance functions are integral to a bank’s own assessment of its risk

profile. If applicable, it may be beneficial to discuss with the bank’s

external auditor the results of the most recent audit it has completed for the

bank. Such a discussion gives the examiner the opportunity to review the

external auditor?s frequency, scope and reliance on internal audit findings.

Examiners should consider the adequacy of these functions in determining the

risk profile of the bank and the opportunities to reduce regulatory burden by

testing rather than duplicating the work of these audit functions. Transaction

testing remains a reliable and essential examination technique for use in the

assessment of an institution?s condition. The amount of transaction testing

necessary to evaluate particular activities generally depends on the quality of

the bank’s process to identify, measure, monitor, and control the activity’s

risk. Once the integrity of the management system is verified through testing,

conclusions on the extent of risks within the activity can be based on internal

management assessments of the risks rather than on the results of more

extensive transaction testing by examiners. If, however, initial inquiries into

the risk management system, or efforts to verify the integrity of the system,

raise material doubts as to the system’s effectiveness, then no significant

reliance should be placed on the system and a more extensive series of tests

should be undertaken to ensure that the bank’s exposure to risk from a

particular activity can be accurately evaluated. SCOPE

MEMORANDUMThe scope memorandum is an integral

product in the risk-focused methodology as the memorandum identifies the

central objectives of the on-site examination. The scope memorandum also

ensures that the examination strategy is communicated to appropriate

examination staff. A sample scope memorandum is presented in Appendix – A. This

document is of key importance, as the scope will likely vary from examination to

examination. Examination procedures should be tailored to the characteristics

of each bank, keeping in mind its size, complexity, and risk profile.

Procedures should be completed to the degree necessary to determine whether the

bank?s management understands and adequately controls the levels and types of

risk that are assumed. In addition, the memorandum should address the banking

environment, economic conditions, and any changes that bank management fore

sees that could affect the bank?s condition. A preliminary estimate of staffing

required to perform the examination should also be prepared as part of the

scope memorandum.The key factors that should be addressed

in the scope memorandum include:Preliminary Risk AssessmentThe risks associated with the bank’s

activities should be summarized and based on a review of all available sources

of information on the bank, including but not limited to, prior examination

reports, surveillance reports, correspondence files, and audit reports. The

scope memorandum should include a preliminary assessment of the bank’s

condition and major risk areas that will be evaluated through the examination

process. Summary of the Pre-Examination MeetingThe results of the pre-examination

meeting should be summarized with particular emphasis on the meeting results

that affect examination coverage. Summary of Audit and Internal Control EnvironmentA summary of the scope and adequacy of

the audit environment should be prepared which may result in a modification of

examination procedures initially expected to be performed. Activities that

receive sufficient coverage by the bank’s audit system can be tested through

the examination process. Sufficient audit coverage could result in the

elimination of certain procedures if the audit and internal control areas are

deemed satisfactory.Summary of Examination ProceduresExamination modules have been developed

related to the significant areas reviewed during an examination. The modules

are categorized as being primary or supplemental. The primary modules must be

included in each examination. However, procedures within the primary modules

can be eliminated or enhanced based on the risk assessment or the adequacy of

the audit and internal control environment. The scope memorandum should specifically

detail the areas within each module to be emphasized during the examination

process. In addition, the use of any supplemental modules should be discussed.Summary of Loan ReviewBased on the preliminary risk assessment,

the anticipated loan coverage should be detailed in the scope memorandum. In

addition to stating the percent of commercial and commercial real estate loans

to be reviewed, the scope memorandum should also identify which speciality loan

references to the general loan module are to be completed. The memorandum

should specify activities within the general loan module to be reviewed, as

well as the depth of any speciality reviews.Job StaffingThe staffing for the examination should

be detailed. Particular emphasis should be placed on ensuring appropriate

personnel are assigned to the high risk areas identified in the bank?s risk

assessment.USE OF THE

EXAMINATION MODULESThe state-banking regulator has jointly

developed bank examination modules. This automated format was designed to

define common objectives for the review of important activities within the bank

and to assist in the documentation of examination work. It is expected that

full-scope examinations will include examiners? evaluation of six critical

areas that are necessary to determine the bank?s CAMELS rating. To evaluate

these areas, examiners must perform procedures tailored to fit the risk profile

of the bank. The seven primary examination modules are: Capital Adequacy Earnings Analysis Loan Portfolio Management Liquidity Analysis Management and Internal Control Evaluation Securities Analysis Other Assets and Liabilities There are six supplemental modules that

are available for use if any of these activities present significant risk to

the bank. The supplemental modules are: Electronic Funds Transfer Risk Assessment International Banking Credit Card Merchant Processing Mortgage Banking Electronic Banking Related Organizations In addition, there are ten Loan

References (for specialized lending areas) included in the general Loan

Portfolio Management module. The loan reference modules are: Construction and Land Development Commercial and Industrial Real Estate Residential Real Estate Lending Commercial and Industrial Loans Agricultural Lending Direct Lease Financing Floor Plan Loans Troubled Debt Restructuring Consumer and Check Credit Credit Card Activities The modules establish a three-tiered

approach for the review of a bank?s activities.The first tier is the core

analysis, the second tier is the expanded review, and the final tier is the

impact analysis. The core analysis includes a number of decision factors, which

should be considered collectively, as well as individually when evaluating the

potential risk to the bank. To assist the examiner in determining whether risks

are adequately managed, the core analysis section contains a list of procedures

that may be considered for implementation. Once the relevant procedures are

performed, the examiner should document conclusions in the core analysis

decision factors. Where significant deficiencies or weaknesses are noted in the

core analysis review, the examiner is required to complete the expanded

analysis for those decision factors that present the greatest degree of risk to

the bank. On the other hand, if the risks are properly managed, the examiner

can conclude the review and carry any comments to the report of examination.The expanded analysis provides guidance

to the examiner in determining if weaknesses are material to the bank?s

condition and if they are adequately managed. If the risks are material or

inadequately managed, the examiner is directed to perform an impact analysis to

assess the financial impact to the bank and assess whether any enforcement

action is necessary. The use of modules should be tailored to

the characteristics of each bank based on its size, complexity, and risk

profile. As a result, the extent to which each module should be completed will

vary from bank to bank. One of the features included in the automated format

for the modules allows examiners to select the appropriate procedures in the

modules that address t he area(s) of concern while eliminating unnecessary

procedures. The degree of expected completion of the modules should be

documented in the scope memorandum. The individual procedures presented for

each level are meant only to serve as a guide for answering the decision

factors. Each procedure does not require an individual response and each

procedure may not be applicable at every community bank. Examiners should continue

to exercise discretion in deciding to exclude any items as unnecessary in the

evaluation of the decision factors. Moreover, the listed procedures do not

represent every possible factor to be considered during an examination.

Examiners should reference supervisory and administrative letters for

additional guidance. CREDIT RISKBanks should have methodologies that

enable them to assess the credit risk involved in exposures to individual

borrowers or counter parties as well as at the portfolio level. For more

sophisticated banks, the credit review assessment of capital adequacy, at a minimum, should cover four areas:

risk rating systems, portfolio analysis/aggregation, securitisation / complex

credit derivatives, and large exposures and risk concentrations.Internal

risk ratings are an important tool in monitoring credit risk. Internal risk

ratings should be adequate to support the identification and measurement of

risk from all credit exposures, and should be integrated into an institution?s

overall analysis of credit risk and capital adequacy. The ratings system should

provide detailed ratings for all assets, not only for criticized or problem

assets. Loan loss reserves should be included in the credit risk assessment for

capital adequacy.The analysis

of credit risk should adequately identify any weaknesses at the portfolio

level, including any concentrations of risk. It should also adequately take

into consideration the risks involved in managing credit concentrations and

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