Financial Institutions
and Investors
Risk Management System
of Financial Institutions
Major factors contributing to the current financial crisis
are (i) the absence of a proper risk management
system for capital market institutions and (ii) the lenient
application of capital adequacy requirements by
the regulator. Because most financial institutions in
the country pursue high-risk, high-return strategies in
a fast-growing market environment, they have not paid
much attention to the proper management of business
risks. Financial institutions emphasized growth more
than profitability, and high risk inevitably accompanied
the growth-oriented strategy. Each financial institution,
however, has a standard operating procedure for
internal risk management. Internal regulations and directives
abound, and BOK has enforced accounting
and operating standards with respect to investment in
derivative products by financial institutions. Accordingly,
domestic financial institutions are supposed to
maintain an accounting function separate from a trading
function, and to impose restrictions on individual
open positions, monthly loss limits, and trading limit
per transaction for each dealer.
Commercial banks, among others, are implementing
a risk management program called asset liability
management (ALM). ALM’s main purpose is to estimate
the change in the asset or liability values due
to market risks, including interest rate movements,
and to adjust the asset and liability positions in order
to control overall risk. However, ALM techniques do
not provide for the possibility of extreme losses, which
may occur, although with a low probability. Value-atrisk
(VAR) is the new risk management concept introduced
to make up for the ALM’s weakness.
Failing financial institutions should apply VAR on
top of ALM. Troubled domestic financial institutions,
including a couple of commercial banks and dozens
of merchant banks, are suffering from depleted...