Greensill Capital - many small businesses and thousands of jobs at risk

The potential collapse of Greensill Capital could put many small businesses and thousands of jobs at risk. The supply-chain financier’s troubles highlight overlooked risks in the system.

Greensill Capital has become a dominant player in supply chain finance, a once-staid method of corporate funding that exploded in popularity over the past decade. Lex Greensill has become a dominant figure in an increasingly important, corner of finance. But now, some of his biggest backers have severed ties. 

So, what has gone wrong?

Using techniques mastered by the former "slicers-and-dicers" of subprime mortgages, Greesill transformed the bills it took on into bond-like investments. These could be sold to outside investors, such as hedge funds, desperate to find some yield in a low-interest world. As long as the customers kept settling their invoices, a tidy profit could be made for investors—and the financiers behind all the alchemy. By 2019 Greensill claimed to have arranged financing worth more than $140bn to over 10m customers.

Questions over whether the money would indeed keep flowing were never far away. As concerns mounted over the creditworthiness of the companies Greensill had to collect money from, the value of the bonds underpinned by the invoices wobbled. On March 1st Credit Suisse froze $10bn of funds stuffed with paper sourced by Greensill. The Swiss investment bank warned of  “considerable uncertainties” with respect to the valuation of the bonds linked to Greensill.

Read more from The Economist HERE

How Billionaire Investors Are Protecting Their Wealth

It can take a lifetime to build a fortune of Buffett or Dalio sized proportions.

But, as all billionaires know, there is always risk present in the market – and even though a catastrophic geopolitical or financial event is very unlikely, it is important to be prepared for anything.

The Different Types of Risks Faced by Banks

By  Stanley Epstein -

Banks face a number of different types of risks in their day-to-day business activities. These different risk types and how they arise are not always clearly understood by the public at large, often giving rise to many misconceptions. This article serves to clarify what these risks are and what gives rise to them.

 

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One of the most misunderstood terms, especially when one relates it to banking, is that little word “risk”. Risk and banking seem to automatically go together just like a hand with a glove or Jack pairs with Jill.

Since the 2008 financial crisis and its aftermath, just putting the words “risk” and “bank” together conjures up the image of a monolithic bank rampaging through the economy wreaking havoc as it goes.

This image is of course totally unfair. Banks, like any other firm or even individuals are exposed to many different forms of risk. Banks too, in their own right, are a source of a number of risks as well. However this is outside of our present scope.

This article will explain what risk is and some of the different types of risk that banks and other financial institutions are exposed to in their everyday business activities.

Let us start our journey with a visit to the dictionary. Once upon a time this meant a trip to the bookshelf, but today thanks to the wonders of technology the “word” is at ones fingertips. The definition of “Risk” being “exposure to the chance of injury or loss” is typical (with thanks to Dictionery.com).

There may be other variations on this theme, but what we have is good enough. The key elements of “risk” are EXPOSURE to the CHANCE of LOSS. In other words the possibility that something will cause a financial or other loss. This is the basis for understanding the different types of risks that banks face.

Let us take a look at a typical bank. In its very simplest form, banks take in deposits and lend this out in the form of loans. Should the borrower not repay his or her loan the bank is faced with Credit risk. This is the possibility that a borrower will be unable to make payment of the amount due. Credit risk is absolute. It’s the chance that the borrower will never be able to repay the loan. Credit Risk implies bankruptcy.

Liquidity risk is on the other hand not absolute. It is the possibility that a borrower will be unable to make payment of the amount due at the time that it is due. However the reason for this could be timing issues. In other words he is “illiquid” on the payment due date. It does not imply that the borrower is insolvent as he may be able to repay the loan at a later time.

Between them, Credit risk and Liquidity risk are the major business risks that banks face because they are part and parcel of the business of banking (the loaning out of money).

In recent years there has been a growing realization that Operational risk is another source of danger to a bank. This was given voice and form in the Basel Accords, where Operational Risk has been defined as “the risk of direct or indirect loss resulting from inadequate or failed internal processes, people and systems or from external events”.

Operational risk can be subdivided into seven distinct categories. In what follows we examine each of these categories and briefly explain what types of risks they cover.
Internal Fraud. Generally this covers fraud by bank staff such as the stealing of assets, theft of client information, covering up errors, intentional mismarking of positions, bribery etc.
External Fraud. Where non-bank staff are involved such as in computer hacking, third-party theft, forgery.
Employment Practices and Workplace Safety. Discriminatory staff policies, workers compensation claims, employee health and safety issues.
Clients, Products and Business Practice. This is a very wide field and generally covers market manipulation, antitrust issues, improper trading activities, bank product defects, fiduciary breaches, account churning. The sub-prime Mortgage debacle is a clear example of a product defect.
Damage to Physical Assets. This covers things like natural disasters, terrorism and vandalism – anything that results in actual damage or destruction of the bank’s physical assets.
Business Disruption and Systems Failures. Power failures, computer software and hardware failures. A hurricane or a flood that results in banking services being disrupted also falls into this category.
Execution, Delivery and Process Management. This covers things like data capture errors, accounting errors, failure to meet legal reporting requirement, negligent loss of client assets.

There are other risks too, such as legal, reputational, market – the list goes on. But that is another story (and perhaps another article).

 

Dr. Doom: This 'time bomb' will trigger next financial collapse

From CNN Money –

“Nouriel Roubini, who has been dubbed "Dr. Doom" for his dark predictions, warned in an Op-Ed in The Guardian on Monday about the existence of a "liquidity time bomb" that he fears will eventually "trigger a bust and a collapse."

The New York University economist joins a growing number of observers who are worried about the issue. Liquidity is the lifeblood of financial markets. It measures how easy it is for investors to quickly sell stocks and bonds. When investors get fearful but can't sell their stocks, it causes even more panic.”

Read more>> 

 

Why managing operational risk is so important

By Stanley Epstein - Principal Associate - Citadel Advantage

One of the most misunderstood terms, especially when one relates it to banking, is that little word “risk”. Banks, like any other firm or even individuals are exposed to many different forms of risk

This short article will explain what risk is and some of the different types of risk that banks and other financial institutions are exposed to in their everyday business activities.

The definition of “Risk” being “exposure to the chance of injury or loss” is a typical one (with thanks to Dictionary.com).

There may be other variations on this theme, but what we have is good enough. The key elements of “RISK” are EXPOSURE to the CHANCE of LOSS. Put another way; the possibility that something will cause a financial or other loss. This is the basis for understanding the different types of risks that banks face.

In its basic form, banks take in deposits and lend these deposits out in the form of loans. Should the borrower not repay his loan the bank is faced with what is called “credit risk”. Credit risk is the possibility that a borrower will be unable to make payment of the amount of the loan when it falls due. Credit risk is absolute. It’s the chance that the borrower will never be able to repay the loan. Credit risk and bankruptcy are closely linked.

Liquidity risk is on the other hand not absolute. Liquidity risk is the possibility that a borrower will be unable to make payment of the amount due at the time that it is due. However the reason for this could be cash flow issues. It does not imply that the borrower is insolvent as he may be waiting for funds due to him to arrive. In terms of Liquidity risk the borrower may still be able to repay the loan at a later time.

Between them, Credit risk and Liquidity risk are the major business risks that banks face because they are the major part of the business of banking.

Over the last few years there has been a growing awareness that Operational risk is another source of danger to a bank. This was given “official” voice and form in the Basel Accords, where Operational Risk has been defined as “the risk of direct or indirect loss resulting from inadequate or failed internal processes, people and systems or from external events”. 

Take note of this definition – it is very important.

Operational risk in terms of the Basel Accords has been subdivided into seven separate categories. We examine each of these categories and briefly explain what types of risks they cover.

• Internal Fraud. By and large this covers fraud by bank staff such as the stealing of assets, theft of client information, covering up errors, intentional mismarking of positions, bribery etc.
• External Fraud. This occurs where non-bank staff is involved such as in computer hacking, third-party theft, forgery.
• Employment Practices and Workplace Safety. Inequitable staff policies, workers compensation claims, employee health and safety issues.
• Clients, Products and Business Practice. This is a very wide field and generally covers market manipulation, antitrust issues, improper trading activities, bank product defects, fiduciary breaches, account churning. The sub-prime Mortgage debacle is a clear example of a product defect. The LIBOR rate rigging scandal falls into this category as well.
• Damage to Physical Assets. This covers things like natural disasters, terrorism and vandalism – anything that results in actual damage or destruction of the bank’s physical assets. These actions may be deliberate or purely accidental.
• Business Disruption and Systems Failures. Power failures, computer software and hardware failures. A hurricane or a flood that results in banking services being disrupted also falls into this category.
• Execution, Delivery and Process Management. This covers things like data capture errors, accounting errors, failure to meet legal reporting requirement, negligent loss of client assets.

There are other risks too, such as legal, reputational, market – the list goes on. But that is another story.

The Reasons for the Different Types of Risks Faced by Banks

One of the most misunderstood terms, especially when one relates it to banking, is that little word "risk".

Read what one of our Principal Associates has written in a new article published in Ezene Articles – CLICK HERE.

TRAINING COURSE - Risk Management - Focus on Fraud

Join us in JOHANNESBURG, South Africa on 2 & 3 August 2010 for our 2-day training course “RISK MANAGEMENT - FOCUS ON FRAUD”

Fraud is on the increase. Recent studies have shown a surge in economic crimes. The statistics reveal that the three most common forms of crime are theft, accounting fraud and corruption.

Of these, fraud has shown a particularly sharp rise. The rise in fraud stems from a mixture of increased opportunities and growing incentives. Companies have been reducing the number of people employed to monitor workers at a time when employees are more tempted to break the rules because their living standards are eroding and their jobs are looking shakier. The proportion of frauds committed by middle managers has shown a particularly sharp rise, from 26% in 2007 to 42% today.

Just consider the following questions;

* Can your bank or organization cope with fraud?
* Can you identify a fraud in your working environment?
* Are you maximizing your staffs’ potential to reduce fraud and error in your systems?
* How aware are you or employees of fraud?
* Do they have a clear understanding of the role they play in detecting fraud?
* Do they understand you organization’s fraud policies and procedures?

The “Risk Management - Focus on Fraud” course in Johannesburg on 2 & 3 August 2010 is a 2-day intensive course on fraud and how it presents huge challenges for banks, requiring them to radically modify behavior and increase their vigilance in many of the traditional risks associated with banking activities.

Ensure that your staff are able to cope with the growing fraud threat. For more details including a fully descriptive course brochure e-mail us at courses@citadeladvantage.com today. Please indicate FRAUD-JHB in the subject line.

CPSS-IOSCO Review of Standards for Payment, Clearing and Settlement Systems

The Committee on Payment and Settlement Systems (CPSS) and the Technical Committee of the International Organization of Securities Commissions (IOSCO) have launched a comprehensive review of their existing standards for financial market infrastructures such as payment systems, securities settlement systems and central counterparties.

There are currently three sets of standards involved, namely:
• the 2001 Core principles for systemically important payment systems
• the 2001/2 Recommendations for securities settlement systems
• the 2004 Recommendations for central counterparties.

Financial market infrastructures generally performed well during the recent financial crisis, and did much to help prevent the crisis becoming even more serious than it actually was. Nevertheless, the committees believe that there are lessons to be learned from the crisis and, indeed, from the experience of more normal operation in the years that have passed since the standards were originally issued. It thus seems timely to review the standards with a view to strengthening them where appropriate.

Robust financial market infrastructures make an essential contribution to financial stability by reducing what could otherwise be a major source of systemic risk. Moreover, insofar as they enable settlement to take place without significant counterparty risk, they also help markets to remain liquid even during times of financial stress.

The review will be led by representatives of the central banks that are members of the CPSS and those of the securities regulators that are members of the IOSCO Technical Committee. The International Monetary Fund and the World Bank are also participating in the review. The review is part of the Financial Stability Board's work to reduce the risks that arise from interconnectedness in the financial system.

The committees will coordinate with other relevant authorities and communicate with the industry, as appropriate, as the work progresses. They aim to issue a draft of all the revised standards for public consultation by early 2011.

Separately, as announced in the press release on 20 July 2009, the CPSS and the Technical Committee of IOSCO are already in the process of providing guidance on how the 2004 Recommendations for central counterparties should be applied to CCPs handling OTC derivatives. The guidance will also cover other relevant infrastructures handling OTC derivatives such as trade repositories. This aspect of the work has been put on a fast track because of the new CCPs for OTC derivatives and trade repositories that have recently started, or are about to start, operating.
A consultative document on the guidance will be issued within the next few months. This new guidance will not entail amendments to the existing recommendations for CCPsbut will of course be incorporated into the general review of the standards that has now begun.

The Committee on Payment and Settlement Systems (CPSS) serves as a forum for central banks to monitor and analyse developments in payment and settlement infrastructures and set standards for them. Its members are central banks from 24 countries and regions. The chairman of the CPSS is William C Dudley, President of the Federal Reserve Bank of New York. The CPSS secretariat is hosted by the BIS. More information about the CPSS, and all its publications, can be found on the BIS website at www.bis.org/cpss .

The International Organization of Securities Commissions (IOSCO) is a policy forum for securities regulators. The organisation’s membership regulates more than 95% of the world’s securities markets in over 100 jurisdictions. The Technical Committee is a specialised working group established by IOSCO’s Executive Committee and is made up of 18 agencies that regulate some of the world’s larger, more developed and internationalized markets. Its objective is to review major regulatory issues related to international securities and futures transactions and to coordinate practical responses to these issues. Kathleen Casey, a Commissioner of the US Securities and Exchange Commission, is the chair of the committee. More information about the Technical Committee can be found at www.iosco.org/ .

The review will be co-chaired by the chairs of the CPSS and the IOSCO Technical Committee, ie William C Dudley and Kathleen Casey.

RTGS Payment System Glitch – Operational Risk Vulnerabilities in India

A snarl in the real-time gross settlement (RTGS) system this past Monday, saw a few banks face a near default-like situation. This has yet again raised questions on the value and the soundness of the infrastructure supporting the Indian financial system.

RTGS, for the uninitiated is an almost instantaneous funds-transfer and settlement system. In the Indian RTGS system, it’s possible to transfer money to another bank account within a maximum of two hours. RTGS is mainly used for high-value clearing.

When contacted, a Reserve Bank of India (RBI) spokesperson said, “There was a glitch (in the system) on Monday, after we upgraded the RTGS software over the weekend.” She clarified that RBI had rectified the problem on the same day.

Bankers familiar with the RTGS system said that while clustering of payments is an often-enough occurrence (four to five times a year) this is the first instance of such large-scale malfunction. One large state-owned bank, in particular, faced an acute payment crisis that forced it to request assistance from other banks, to meet its obligations. After a considerable delay, funds were arranged.

“Many of the counterparties did not receive payment till as late as 1.00 am the next morning. And by virtue of one critical fund or counterparty not paying up, it would have had a cascading effect on other banks,” said the head of treasury at one foreign bank.

Customer payments can be processed through the RTGS facility only up to 4.30 pm on weekdays while inter-bank transactions are possible up to 6.00 pm.

People familiar with the matter maintain that central bank officials and computer staff worked towards moving the entire RTGS load to the back-up site of the system vendor. It was only after this switch that RTGS operations could be brought back on an even keel.

While some say, the incident highlights the inadequacy of the RTGS infrastructure, others were too quick to commend RBI for the promptness with which it acted to restore order. “Any system is open to the occasional risk. However, there should always be a fallback arrangement to cater to such eventualities,” said an irate banker who had to soothe quite a number of ruffled clients.

However, a section of the industry terms it as just a blip on account of the fact that RTGS users have grown many-fold. “RBI and several banks are still in the process of enhancing their servers to cater to the excess load. This has occurred, because banks have crossed normal threshold limits, hence, the bunching up of payments. However, in such times, the National Electronic Fund Transfer (NEFT) system can provide an alternate. The only difference is that the window would be slightly larger than 4-6 hours,” said a senior staff member of a leading public sector bank.

Under NEFT, the transfer takes place either on the same day or on the next day, depending on the time of instructions given. Yet, senior private sector bankers disagree. “NEFT can’t be an alibi for RTGS. The bottom-line is that any robust infrastructure should have a fall back. If this had occurred during the month end, we would have had a virtual stampede,” a senior private sector banker said.

Risk Management Lessons from the Global Banking Crisis of 2008

Senior financial supervisors from seven countries (collectively the “Senior Supervisors Group”) have issued a report that evaluates how weaknesses in risk management and internal controls contributed to industry distress during the financial crisis.

The report—Risk Management Lessons from the Global Banking Crisis of 2008—reviews in detail the funding and liquidity issues central to the recent crisis and explores critical areas of risk management practice in need of improvement across the financial services industry.

The report concludes that despite firms’ recent progress in improving risk management practices, underlying weaknesses in governance, incentive structures, information technology infrastructure and internal controls require substantial work to address.

The observations and conclusions in the report reflect the results of two initiatives undertaken by the SSG. These initiatives involved a series of interviews with firms about funding and liquidity challenges and a self-assessment exercise in which firms were asked to benchmark their risk management practices against a series of recommendations and observations taken from industry and supervisory studies published in 2008.

The report may be downloaded at http://www.newyorkfed.org/newsevents/news/banking/2009/SSG_report.pdf

Liquidity – New Risks In Uncertain Conditions

For the past 15 years at least central banks around the world have been pushing “just-in-time” intraday liquidity as the preferred method of banks funding their real-time settlement (RTGS) accounts. While the implementation of RTGS took the settlement risk out of the majority of financial systems, it adoption and use for more and more critical financial systems (such as CLS) has exacerbated another problem – liquidity risk. This weakness has been spotlighted by t the liquidity crises that affected markets in March 2008 and, more severely, in September and October 2008. It can no longer be taken for granted that just-in-time liquidity will be available to financial market utilities at a time when multiple market participants are in danger of defaulting. This is the findings of researcher made public in the “Chicago Fed Letter” (see http://www.chicagofed.org/publications/fedletter/cflnovember2009_268a.pdf )

The Informal Remittances Sector in Nigeria

An interesting piece of news from Nigeria. It looks like deceptive practices among some bank officials have created opportunities for the informal operators to thrive in the money remittances market.

Click on the Post heading to access the full article.

Liquidity and Wholesale Payments

The global financial crisis has yet again focused minds on the need for banks to provide their corporate customers with liquidity and risk management solutions. Additionally, while regulatory measures such as the Single Euro Payments Area (SEPA) and anti-money laundering (AML) legislation require the continuing transformation and investment in wholesale payments, the financial crisis means that heightened cost management is now a critical necessity. The industry has begun to question whether managing these conflicting requirements implies the need for a new approach to wholesale payments technology.

Datamonitor sponsored by ACI Worldwide and IBM, has just published a report that looks at business and technology responses in wholesale payments to the post-financial crisis landscape, and assesses whether a service-oriented architecture (SOA) approach could help to meet these challenges.

Their main findings are;

• Despite the global financial crisis, increasing compliance and customer requirements will continue to drive the need to change wholesale payments.
• Delivering both efficiency and innovation will require the convergence of so-called “siloed” payments operations and processes.
• The underlying IT platforms will need to support process standardization and simplification while achieving efficiency at the same time.
• The SOA approach can enable this change by facilitating extensibility and providing operational leverage while controlling costs.
  

To download the full Datamonitor report go to:
http://www.aciworldwide.com/downloads/PreparingWholesalePaymentsforthePost-FinancialCrisis.pdf

Key Issues in the Management of Liquidity Risk

By Stanley Epstein - Principal Associate & Director of Citadel Advantage.

This is the second of a series of articles on Liquidity and Liquidity Risk that we shall be publishing over the next few months.

This is the second article in a series of articles on the management of Liquidity Risk. In my first article “Managing Liquidity Risk – The 2007 Crisis” I dealt with the severe liquidity problems experienced by banks worldwide, which began in the summer of 2007 and which heralded the current financial crisis. I then examined the concept of Liquidity Risk Management, and in reviewing the events of that summer I explored the reasons why many banks came under severe stress.

The crisis revealed that important issues had been overlooked and ignored. The “Basel Committee on Banking Supervision” in its 2008 review of the situation provided additional guidance in areas like;

• the acceptability of liquidity risk by banks,
• ensuring liquidity levels are maintained,
• the allocation of liquidity costs, benefits and risks to a bank’s activities,
• identifying and measuring all the liquidity risks,
• stress testing,
• contingency funding plans,
• managing intraday liquidity risk, and
• public disclosure as a means to promote market discipline.

In this article I deal with the guidance provided in February 2008 Basel Committee document entitled “Liquidity Risk Management and Supervisory Challenges”.

This guidance has been set out in the form of seventeen individual “principles”. In turn these principles have been grouped into five major categories. I will deal with category and the principle or principles that they each contain in turn.

Fundamental principle for the management and supervision of liquidity risk
This is made up of a single principle that essentially places the responsibility of the management of liquidity risk squarely on the bank. There are a number of actions that the bank needs to take to do this, such as ensuring that a strong risk management framework exists and that a bank is obligated to see that it maintains an appropriate level of liquidity to meet its trading requirements. Within the same principle Bank Supervisors are enjoined to ensure the adequacy of the individual banks liquidity risk management framework.

Governance of liquidity risk management
This section comprises three principles. All relate to the level of liquidity risk that a bank is prepared to take. This includes setting a level of required liquidity to meet the individual banks business strategy, the establishment of an appropriate management structure to manage this risk and the duty of the bank’s board of directors to review and approve all issues relating to liquidity at least annually. The third principle in this section deals with the need for liquidity costs, benefits and risks to be incorporated in product pricing and for the need for all new products to be approved with a view to understanding the effect they have on and how they are affected by the bank’s liquidity position.

Measurement and management of liquidity risk
This is the “meat” of the proposal. It is made up of eight individual principles. I will deal with each of these principle in turn.

• Banks must have a sound process to identify, measure, monitor and control their own liquidity risk.
• Bank must take a total active liquidity view. This means that they must manage their exposures and their funding across all their business lines, currencies and legal entities at the same time. And they also need to allow for legal, regulatory and practical limits to moving liquidity between business the various entities that make up their business.
• Banks must diversify their sources of funding and they should regularly test their ability to raise adequate funds from these sources at short notice.
• Intraday (as opposed to overnight) liquidity must be actively managed so that it can meet the bank’s obligations as they arise. Furthermore a bank needs to plan to do this under both normal and strained conditions.
• Collateral must also be actively managed and care should be taken to separate assets which are already tied-up and those that are free.
• Regular stress tests must be undertaken, using different scenarios. This is important as it will help determine if the bank can keep its liquidity requirements and usage within the previously set limits.
• The bank must have a formal emergency liquidity plan. This should also include clear lines of responsibility and escalation procedures. This plan should also be tested regularly.
• Banks are also required to maintain a buffer of unencumbered, high quality liquid assets to meet emergency situations. These assets must also be free of any barriers to their use.

Public disclosure
There is a single principle here – that a bank should disclose information regularly that will permit market participants to form their own opinion as to the bank’s liquidity and its liquidity risk management structure.

The role of supervisors
The final four principles deal with the role of the bank supervisor. Firstly supervisors need to do a regular check of the bank’s risk management structure and its liquidity position. On top of this they should be getting additional information like internal reports and current market information. If supervisors find problems they should also intervene to make certain that these problems are addressed promptly.

There is also a requirement for supervisors to communicate with other supervisors and public authorities, like central banks, both within and across national borders. This is to ensure that there is effective cooperation regarding the supervision of liquidity risk management. This communication needs to take place regularly during normal times. In times of stress this sharing of information needs to increase appropriately.

This guidance was published for initial consolation and comment. In a subsequent article I will deal with some of the “hows”, “whys” and “what to look for” in applying some of these principles.