Managing your exposure

Whether it’s deciding to grant a credit card application or extending a $100 million loan to a corporate, every financial institution needs risk management procedures. Regional institutions are at last recognising the need to be more sophisticated in how they approach the subject

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By  Massoud Derhally Published  September 1, 2002

|~||~||~|How would you describe the act of fastening a seatbelt, a construction worker wearing a helmet, hazard procedures at oilrigs, a worker cleaning a skyscraper’s windows with various means of support, and a bank’s criteria for assessing credit card applicants? They are examples of people and companies taking measures to manage risk and their exposure to risk.

If still uncertain as to what risk management (RM) is, Jason Sharples, manager of risk services for AON, one of the top two largest insurance and risk management brokers and consultants in the world, explains it in simple terms. “RM is something that goes back to the first ever unforeseen event that caused somebody a loss in some way or another,” says Sharples.

RM is about identifying exposures that either an individual, or a company or a country would face and looking at what impact those exposures would have, should they actually come to pass. The next step would be to look at how that exposure can be reduced or completely withdrawn or transferred across to somebody else in terms of the loss. “RM is identification and then measurement of exposure and then transferring, reducing or minimising that exposure. It can work in any area of everyday life,” says Sharples.

There are several areas of risk management. According to Charles Stewart-Jenssen, head of HSBC’s risk management operation in the UAE, one example is in the treasury, where you look at the interest rate risks associated with the bank’s balance sheet, and the investment portfolio. Another example is that of the corporate bank, which in the event that companies like Emirates Airlines want to buy a Boeing 777, would assess the application of the airline and decide whether to grant or deny the request. Another example would be in the instance of project financing for developments like Palm Island that would be classified as corporate or institutional risk management.

“Corporate banking has to be very careful to avoid any form of risk at all because it is lending US $150-250 million at a time and obviously if you get one wrong you are betting your balance sheet every time you do a deal,” says Stewart-Jenssen.

At the personal banking end of things, Jensen believes a totally different approach from corporate risk assessment is needed. “We have to manage risk and we have to recognise that we are going to lose money. But we have to make sure that we minimise that rather than try and avoid it entirely, because if we don’t take some losses we are not going to make enough profit.”

Most Middle East businesses know that obtaining a bank loan can hinge on a person’s last name. A family’s reputation and standing in the community is considered ahead of payment history and other factors. This is a characteristic of how business is conducted in many countries in the region. Wissam Khoury, a solutions specialist at Reuters’ Middle East regional headquarters in Dubai, believes that institutions need to have a higher standard and threshold for managing risk.

With respect to the financial sector, risk management entails many instruments or money standards and ways of calculating risk. In the Middle East and North Africa, banks have realised that RM is important, according to Khoury. “You have a lot of international banks here that have to comply with international standards,” he says. “Two, local banks are looking at globalisation and in order to be global you have to comply with international standards, otherwise no one would trade with you if you are not a safe bank or institution. Banks over here have worked hard along with regulatory bodies of governments to comply with international standards.”

Banks here want to comply with international standards set under Basle I (1988) and Basle II (2005), not because they are obliged to but because this will give them more knowledge of the market, according to Khoury. “We have a reasonable amount of awareness in the country about the importance of risk management. You have banks that have dedicated systems in place in order to measure risk. Some banks measure risk according to their risk appetite and according to their way of doing business,” Khoury explains.
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Local banks might not need a risk management system if they are trading in small amounts, according to Khoury, but they have to comply with market standards so that international banks can understand their records. “Some banks in the region are so sophisticated that they are comparable to international banks and they have well known systems in place like Reuters systems, which help them to manage their risk,” says Khoury. Regulatory authorities in the UAE, KSA, and Bahrain have all requested their banks to put in place a procedure or a phased approach in order to reach the Basle II requirements for risk management when it is ready, says Khoury.

Personal credit risk management is probably the most complex of all the areas, according to Jensen, because it deals with people. It is dynamic because people in various countries are the ones that change and have a constant need to do things. The opportunities for developing skills and techniques in the personal area is very different and that is because the requirements for credit risk management between personal and corporate are completely different, says Stewart-Jenssen.

According to Sharples, in commerce or in the operational area in the Middle East, the main problems are with safety procedures, fire fighting equipment and procedures. “It tends to be an area where people will skimp on expenses. If they can get away with less they will get away with less.”

Aside from the upkeep of buildings and similar areas that are potential fuel for fire and catastrophic losses, Sharples believes the human resources side of things has a poor track record when it comes to risk management in the region. “You wander around Dubai and you see guys working on signs, on tall buildings, and they have no real protection. A lot of companies are getting ISO qualifications and implementing strict guidelines for employees. If they are dealing with hazardous chemicals they have to wear the gloves, the boots, the goggles the whole thing,” says Sharples.

“But there are so many companies around that don’t seem to appreciate the fact that the people that are the company are the employees and they don’t protect them as well as they should. And this is not common to the UAE, it is a worldwide thing. You see that change when you get into the US and Europe because the employers don’t want to get sued.” The number of litigious employees is very small, according to Sharples, but employers will have to look at protecting their employees far more than they do.

In more complicated situations such as lending large amounts of money to individuals or organisations, a different type of approach is needed. The common approach at the moment is lending on the basis of certain criteria, often related to who the person works for.

That type of lending has been going on for some time in the region, according to Stewart-Jenssen. “We are more interested in who someone works for than the individuals themselves because we have a very large expatriate work force — this is something that needs to change,” he says.

“We need to be much more aware of the individual rather than who they work for, and base our lending decisions on the person, the person’s ability to repay and what they want to do with the money.”
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Jensen also believes that lending institutions need to move away from the rules based processes, because most organisations have a big enough lending portfolio that they can start to create their own terms and conditions of lending, which can be transparent to the customer. But at the same time an organisation’s own terms permit it to deal with almost anyone who comes through the door and offer them something. “Rather than saying provided one’s salary is such and such, we will lend you so many times your salary. That model must change very shortly; otherwise there is a very big danger that the market will just go pop,” says Stewart-Jenssen.

But that’s not all that needs to change in the Middle East. The region needs credit agencies. “We need one in the Emirates. There is one being started in Saudi Arabia; one set up in Kuwait, there is an interest in starting one in Egypt. Saudi Arabia has formed a company that is financed and funded by banks and it is in the process of seeking bureau services from professional bureau service providers,” says Stewart-Jenssen.

Al Jisr, which exists in KSA, is owned by Abdel Latif Al Jamil [LAJ] Group of Companies. In Egypt there is a central bank database where lenders are required to contact the central bank in the event that lending exceeds 40,000 Egyptian pounds. That is an inefficient process because it can take up to three weeks to make a lending decision.

There is a bureau in Kuwait, which was set up by Experian from the UK. The bankers association in Bahrain has also initiated a credit bureau project. The UAE Central Bank, according to some industry insiders, is keen to see a credit bureau set up in the next 18 months. The benefits of a credit bureau may translate into more than merely helping lenders assess who does not represent a credit risk.

Once the foundations for making an assessment of who is a good credit risk are in place, the possibility of who can use it is endless. Retailers and anyone doing big-ticket sales like furniture stores, motor vehicle outlets, banks, debt collection agencies, lawyers, and governments will have reasons to employ risk management measures, perhaps finally making fraud less of an occupational hazard.
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