A Critical Review of the Current Risk Management Activities of Barclays - Essay Example

?Risk Management of Barclays Introduction Barclays is a leading global financial service provider that is engaged in retail banking, investment and corporate banking, wealth management and credit cards with an extensive presence in the international market. With more than 300 years of expertise and history in banking, the organization operates in more than 50 countries and employs 140000 people (Barclays, 2012). The universal banking model of Barclay provides it with continuous competitive strength. Revenue earned by the bank remained resilient reflecting the strength of the customers of the bank and mixture of balance in their business. The organization has intensified their cost disciplines while investing in some selective growth areas that support the priorities of execution. Risk management is the process through which potential risks of the organization is identified, analysis is done and then precautionary steps are taken in order to reduce or cut down the risk. In the world of finance this practice is a very common one and is followed by almost every financial institution. Whenever an entity goes with some investment decision they are exposed to a large number of financial risks. The degree of risk involved depends on the type of financial instrument involved in the investment. These financial risks can be of various forms like recession, volatility in the capital market, high inflation and bankruptcy. Therefore, in order to control and minimize the exposure of the investment to such risks, the investors and the fund managers are seen to practice risk management. If adequate attention is not given to the risk management while making important investment decisions then disastrous situation may result during the financial turmoil in the economy (Webster, 2010; The Economic Times, 2013). Different categories of asset classes are attached to different levels of risk. Risk management is a vital function within Barclay, which is operating globally and enjoys great visibility. The risk team formed with the organization plays a significant role by aiding the senior management to incorporate informed decision taking the implications into account. The risk management team of Barclays operates across the organization protects the reputation of the organization by ensuring and securing the financial performance of the organization. The organization has dedicated team of experts who carries out valuable work in managing the issues that causes significant impact on the business (Barclays, 2013a). This study focuses on the risk management of Barclays bank, measures it risk appetite and discusses whether corporate governance supports these risk management activities. Figure 1 Source: (Youngberg, 2010) Risk Appetite Good risk management does not signify avoid all types of risk at any cost. It indicates the various types of informed choices that the organization makes related to the risk in pursuit of its measures and objectives that lead to mitigation of risk. Defining the risk appetite of an organization is an integral part of risk management. Best-of-class companies does not design or discuss their risk management as an isolated add-on process but it is viewed as an important part of their strategy execution and design. The new strategic initiative taken by the organization may open attractive opportunities for the organization but the rewards should be balanced properly with the risk that is generated. In order to integrate risk dimensions fully in the strategy design the company needs to be aware of how much risk it is willing to take and how it is planning to balance between opportunities and risks. Foe enterprise risk management defining the risk appetite is very essential (Barfield, R., n.d.). While deciding on the risk appetite of the organization the board of directors should categorize the different types of risk and decides on the capacity. This includes the type and amount of risk the organization is capable of supporting in pursuit to the business objectives and taking into account the access to the financial market, capital structure and the non-financial equity such as loyalty and flexibility of the work force. If the company decides on the risk appetite and strategy that sits inappropriately with the financial risk capacity; the company can decide to increase that risk. In this manner the risk appetite of the organization can establish a direct link between the risk management, performance and strategy management and the capital structure of the organization (Crouhy, Galai and Mark, 2006; Damodaran, 2008; Culp, 2001; Doherty, 2000; Fraser and Simkins, 2010; Berglund, 2007). The top management and the board of directors are responsible for defining the risk appetite of the organization and it is directly linked to the overall strategy of the organization. The board should contain some members who are aware of the terms like risk management and are clear with the concepts of risk appetite. Risk appetite is a very broad topic that includes subtopics like human resource, corporate governance and compliance, environmental impact, acquisition, supply chain management, expansion of new customer base and product, reputation and brand, credit rating, earnings and its volatility, liquidity and solvability. It is balancing act and in this process the board should also take care about the expectations of the regulators, shareholders and other stakeholders of the organization. Moreover, the risk appetite of the organization should be consistent with the organizational culture and capacity of the organization to manage risk inherent in the business activities. The true risk appetite of the organization is decided by the board and the executives after considering the factors outside and within the organization that can impact their business (Ernst & Young Global Limited, 2013a; Ernst & Young Global Limited, 2013b). Risks Exposure and Appetite of Barclays The credit risk of the Group arises mainly from the retail and the wholesale loans and advances along with the counterparty credit risk that arises from the clients entering into derivative contracts. Other sources of credit risks arise from credit activities that include debt securities, reverse repurchase agreement. It also arises if the credit rating of an entity gets downgraded. Apart from this, the credit risk can also arise from economic downturn, increase in the unemployment in some of the countries where the group operates that have weaker economies, rise in the interest rate and inflation that impacts the debt affordability of the customers and the corporate profitability, fall in the prices of the residential property in Western Europe, South Africa and UK and debt ceiling negotiation and US Fiscal Cliff. The Euro zone crisis can also impose the credit risk on the Group such as deteriorating sovereign credit quality particularly refinancing capabilities and debt servicing, exit of some of the countries from the Euro due to the European debt crisis, deterioration of the Credit market Exposure, shortage in the liquidity and single name losses. Barclays is operating in many countries around the globe, which has exposed it to risk due to the weaker economies in many of the countries. The portfolio of the organization is exposed to the growth and more particularly to the weaker growth rate of Europe. Moreover, the profitability of the organization is also subjected to uncertainty due to the Chinese economy. The rate of unemployment due to the Euro zone crisis has increased in many countries particularly high in Spain. However, the rates have declined in US and UK and the business has created job despite of weak economies. The bank has ?115 billion as home loan portfolio in UK, which exposes Barclays to adverse development in the property sector of UK. However, the credit quality of the portfolio is considered to be good with 76 percent of the loans having a Loan-to-Value (LTV) of less than or equal to 75 percent. ?53 billion portfolio remain subjected to weak property prices since on the on the maturity of the loans the customers need to pay back the entire amount at the time when the loan to value might be high (Barclays PLC, 2012). The market risk of the organization can arise due to reduction in the capital or earnings of the organization due to the traded market risk, non-traded market risk and pension risk. Traded market risk is resulting from the volatility in the trading books resulting from the changes in the foreign exchange level, bond prices, commodity prices, property prices, credit spread, inflation rates and interest rates. Non-traded market risk arises from the inability of the group to hedge its banking book balance sheet at a prevailing market level. The credit risk of the organization gets enhanced due to the reduction in the activities of the clients, decrease in the market liquidity, pension fund risk and fluctuation in the interest rates. In this context the Barclays bank is adversely affected by the interest rate risk and pension fund risk. Most of the developed economies are operating at historically low rates. This leads to the reduction in the net interest margin of Barclays. The margins can be further affected by the rate cuts by central bank. Apart from this, the benefit of pension net position defined by the bank has been already negatively affected and is expected to be further adversely affected by the reduction in the discount rates and increase in the assumption of the long term inflation. Thus, significant amount of market risk is there for Barclays (Barclays PLC, 2012). Funding risk is experienced by the organization due to the capital risk, liquidity risk and structural risk due to which the organization fails to accomplish its pre-designed plans. Capital risk occurs if the organization fails to maintain appropriate capital ratio that leads to inability to support business activities and fails to meet regulatory requirement. The factors that may lead to this risk are increase in the capital requirement, maintaining the capital strength, alterations in the cost and availability of funding, down gradation in the credit rating and local balance sheet management. The credit rating of Barclays bank PLC was downgraded by Moody’s from Aa3/P-1/C to A2/P-1/C- due to the rating repositioning of the bank and other securities firms with global capital market operations by the firm. Along with this the rating of DBRS was changed from AA High/R-1 High to AA/R-1 High due to the resignation of senior management of the organization during the summer (Barclays PLC, 2012). Thus, the organization has substantial amount of risk related to funding. The bank experiences operational risk from a large number of sources like legal risk, regulatory risk, implementation of Basel 3, recovery and resolution plan, reputation risk and infrastructure resilience. In context to the operational risk, the organization is exposed to legal risk and reputational risk related to interchange investigation, London Interbank Offered Rates (LIBOR) investigation, products related to interest rates, Federal Energy Regulatory Commission (FERC) investigation and other regulatory investigation (BBC News, 2013). The above discussion shows that the risk appetite of Barclays bank is high since it is exposed to a large amount of risk. Barclays defines risk appetite as the level of risk that the organization is ready to accept while following its business strategy and recognising a range of outcomes that the business plan will generate on being implemented. The framework that decides on the risk appetite combines both top-down view of their capacity to take risk along with bottom-up view of the business risk profiles associated with each of the business areas. The risk appetite needs to be approved by the board members of the organization. Since 2004, Barclays has been running their risk appetite process. The process comprises of ‘Mandate and Scale’ and ‘Financial Volatility’. The business activities and strategies that are reflected in the performance metrics, which is largely dependent on the risk performance of the organization. Figure 2 Source: (Barclays PLC, 2012) Reports revealed that in the year 2011, the chief of Barclays, Bob Diamond decided to increase the risk appetite of the organization due to the expectation that the profitability of the bank will either fall or remain stagnant due to increasing pressure of risk. The bank set a target of achieving 13 percent return on equity by year 2013. However, since in the year 2010, the ROE was seen to fall below 7 percent so the bank started to rethink about increasing the risk appetite (Jenkins, 2011). At present also the bank is subjected to various amounts of risks, which has compelled the organization to maintain a strong liquidity pool of ?150 billion that is considered well within the liquid risk appetite of the organization (Barclays PLC, 2012). In summers of 2012, the Group has reduced their risk appetite by expanding the time horizon and tightening the limits of the Liquidity Risk appetite (LRA) (Barclays PLC, 2012). This reduction was implemented as precautionary and pre-emptive measures in response to the market conditions, resignation of the senior management and announcement of LIBOR. Risk management of Barclays The Barclays bank believes that getting right risk management implemented in the organization is very important for a universal bank and in order to achieve this exposure should be well understood by the organization. The different types of risk that the Barclays bank is exposed to are credit risk, market risk, funding risk and operational risk. In order to mitigate those risks the risk management team of the organization is working. Barclay has clear risk management objectives and well framed strategies to deliver them. The risk management strategies of the organization at the strategic level are firstly to identify the significant risks of the organization. Secondly, to create the risk appetite of the organization and ensure that the business plan and profile as consistent to that. Thirdly, the risk and return decisions are optimised by closely to the business as far as possible and establishing an independent and strong review and challenge structure. Fourthly, the effective risk infrastructure should support the business growth plans. Fifthly, risk profile of the business should be managed in such a way that the financial deliverables remain well below the range of adverse business conditions. Last but not the least; the planning should be done as such that it assists the executives to improve the co-ordination and control of risk taking capabilities across the business. Through the strategic risk management the Group provides direction in understanding the significant risks that can be achieved; establishing the risk appetite and communicating and establishing the risk management framework. The whole process is conducted through five major steps shown below, such as identifying, assessing, controlling, reporting and managing the challenges. However, Finance volatility and mandate and scale are two important components that helps in risk management by deciding on the risk appetite. Figure 3: Steps of Risk management Source: (Barclays PLC, 2011) Financial Volatility Financial volatility is the degree of potential deviation from the expected financial performance of Barclays that it has prepared to sustain in some points of risk profile. While setting the appetite the management decides on the strategy of the Group and summarises the objectives in terms of financial metrics. The risk profile of the Group is assessed through “bottom-up” analysis of their business plan in order to establish volatility in the key metrics. If the projection reveals that the level of risk is too high then the management will force each area to rebalance their risk profile such that they bring the bottom-up appetite back to the top-down appetite. The performance against the risk appetite usage is evaluated and reported to the Executives committee and the Board throughout the year on a regular basis. The top-down appetite of Barclays is quantified through an array of capital metrics and financial performance that is reviewed on a regular basis. For the year 2012 the strategic metrics is shown in the figure below and are set at three levels like budget and stressed ‘one in seven’ and ‘one in twenty-five’. Figure 4 Source: (Barclays PLC, 2012) Mandate and Scale The second element that is used by Barclays to set the risk appetite of the organization is the extensive system of Mandate and Scale limits. This is a risk management approach that looks at formally controlling and reviewing the business activities such that they are within the mandate that is aligned to the expectations and are to an appropriate scale that is relative to the risk and rewards of the underlying activities. The mandate and scale framework designed by Barclays helps in Limiting the concentration of risk. Keeping the business activities within the Group and mandate of individual businesses. Ensuring that the risk remains within the appropriate scale relative to the underlying reward and risk. Ensuring that the risk taking ability of the organization is supported by appropriate capabilities and expertise. Effectiveness of the Enterprise Risk Management Framework The above discussion shows that the organization has a well defined risk management system, which helps them in mitigating and reducing the amount of risk. The funding, market and credit risks are the most vital risks that need to be considered under the risk management of the bank and were tested severely during the financial crisis. The performance of Barclays throughout the financial crisis suggests that the efforts taken by the bank in the risk management area is quite effective. In particular, the market lending practices followed by the bank, which includes the development of risk appetite process for financial risks, establishment of Mandate and Scales limits that is established across the group and the establishment of analytics of credit portfolio has gained special appraisal in the report. The report has further suggested that the joint sign-off between the credit and market risk, stress testing, reporting process and integrated Value at Risk (VaR) production on a daily basis. Apart from the positive picture the report has also emphasized on the negative aspect of the risk management team like exceeded limits of the front office because along with trading in customer transaction the front office has been also dealing in some other businesses that requires much more close supervision; losses in the credit business of US suggests that the risk taken was not assessed fully. Moreover, the portfolio of real estate business is more concentrated on the construction and property as in the case of Spain. These drawbacks reveal that the Risk Committee and the Group-wide management should improve their oversight about the risk within the company. The risk management team should consider a more granular assessment of the risk and compare the same against the appetite of the organization and identify the divergence (Wall Street Journal, 2013). Though the banking industry does not have a well defined operational risk management framework but Barclays has an operational risk framework that has helped the organization in developing capabilities to quantify the operational risk losses and capital. In order to mitigate operational risk the organization has improved their product approval process, which now required approval about the product at every point of product development. Moreover, they continuously review the suitability of the existing product. However, the acquisition of Lehman, complex system that requires manual intervention and underdeveloped operational risk indicators suggests that the operational risk management implemented by the organization needs to be much better. The articulation of Barclays towards their reputational risk was to make clear decisions taken by any individual will be impacting the organization; so every decision should be reviewed by the business-specific transaction committee, who will be considering the impact of each of the decision on the business (Wall Street Journal, 2013). Barclays has derived huge benefits from this framework. Furthermore, the framework of reputational risk management has been revised such that it considers the impact of the business decisions on the reputation in a more consistent and systematic way. Under this revised framework the responsibilities and roles for managing reputational risk of the functions and the businesses are better defined. Thus, the overall discussion shows that Barclays has an effective risk management framework and are constantly working to be making it better. Apart from this, if the organization faces or anticipates facing any risk related to any area then they take immediate actions related to that. For instance, Barclays issued ?5.8 billion in form of new shares as a step to compensate the shortfall in the capital of ?12.8 billion as a result of the new regulatory demand (Peston, 2013). Therefore, it can be concluded that the organization incorporates fast changes in their risk management system and strategy as the situation demands. Corporate governance Barclays has well-structured and well-defined corporate governance framework that supports the Board in achieving long term success and provide sustainable value to the shareholders. Though the framework is very robust but at the same time it is supported by the behaviour, values and culture of the management as well as the employees present throughout the organization. Barclays also believes that the corporate governance of the organization is not only dependent on the experience and skills of the individuals present in the board but also on the coordination and how well they work in order to achieve long term values for the shareholders. They provide huge importance and great expectation from the Directors who works in a systematic manner and it is considered especially important because of the impact it creates on the society and on the economy. The chairman of Barclays in well involved in the boards, which signifies that it includes not only people with right abilities in terms of both experience and technical qualification but also personal qualities that leads to commitment and dedication towards the company in times of stress (Muza, 2013). Good corporate governance practices in an organization also leads to good risk management. In order ensure good corporate governance structure within the organization Barclays have formed various committees among which Board Risk Committee is the most significant that focuses on the liquidity, capital, market, counterparty and credit risk. The major sources of losses in case of Barclays were operational risk and mis-selling of some of the financial products. The main aim of the bank is to erase these drawbacks and the risk associated to these. Moreover, in order to strengthen the corporate governance further the few more boards have been created related to the operational risk, reputation and boards conduct. The core responsibilities of these boards are to incorporate governance over corporate responsibility strategy, reputational matters, operational risk and conduct risk (Barclays PLC, 2012). Responsibility of the Board Financial risk committee was to review and advice the boards regarding the financial risk exposure to which the organization is currently subjected. According the Group decides on the financial risk strategy that includes the strategy related to liquidity management and capital. This committee will be responsible for considering the overall financial risk appetite of the organization and providing recommendations to the board through the Board Enterprise Wide Risk Committee taking into account the limits of individual types of financial risk including the credit and market risk after considering the prospective and current financial and macroeconomic environment. This committee is also responsible for approving the changes in the risk appetite of the organization and reviewing the risk profile of the Group, which includes the experience of the provision against budget, financial risk concentrations and trends and performance indicators of financial risks. Apart from the financial risk, the corporate governance of Barclays also pays equal importance to the conduct, operational and reputational risk for which a committee is also formed. The major task of the committee is to review the efficiency of the processes for the management and identification of risk on behalf of the board and also recommending the risk appetite related to the risk. Apart from this, it is also responsible for monitoring and reviewing the effectiveness of the strategies adopted by the organization, keeping in mind the environmental, social and economic contribution of the management of Barclays (Barclays Corporate Secretariat, 2013). Therefore, the overall discussion shows that the corporate governance plays a major role in risk management of the organization. The boards that are formed not only look at the effectiveness of the organization towards catering to the rules and the regulatory framework but also to the risk management of the organization so that the shareholders wealth can be maximised. The internal control of the Group and the assurance framework looks at the risk profile of the organization. Reference List Barclays Corporate Secretariat, 2013. Corporate governance in Barclays [pdf] Barclays. Available at < http://group.barclays.com/Satellite?blobcol=urldata&blobheader=application%2Fpdf&blobheadername1=Content-Disposition&blobheadername2=MDT-Type&blobheadervalue1=inline%3B+filename%3DCorporate-Governance-in-Barclays-PDF.pdf&blobheadervalue2=abinary%3B+charset%3DUTF-8&blobkey=id&blobtable=MungoBlobs&blobwhere=1330701705568&ssbinary=true> [Accessed 3 December 2013]. Barclays PLC, 2011. 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