Bank Risk Management and Basel III

This report evaluates the different types of risk managed by banks, specifically focusing on the Royal Bank of Scotland (RBS) and the impact of Basel III guidelines on risk management.

Running head: BANK RISK MANAGEMENT AND BASEL III
Bank risk management and Basel III
Name of the Student
Name of the University
Author Note

BANK RISK MANAGEMENT AND BASEL III
Table of Contents
Introduction:...............................................................................................................................3
Discussion:.................................................................................................................................3
Different types of risks managed by bank:............................................................................3
Evaluation of whether the risks have been sufficiently managed since 2005:.......................5
Explanation of regulatory relationship and its influence on the risks management of bank: 6
Analyzing the impact of guidelines of Basel III on the risk management of bank:...............8
Conclusion:..............................................................................................................................12
References list:.........................................................................................................................12

BANK RISK MANAGEMENT AND BASEL III

BANK RISK MANAGEMENT AND BASEL III
Introduction:
The report is prepared for evaluating the different types of risk that is managed by the
specific banks of Europe and how such risks have been managed since 2005. For this
purpose, one of the specific banks of Europe has been selected and evaluation of the risk
management has been demonstrated as well. The selected European bank is Royal Bank of
Scotland (RBS) which is the large international financial service and banking company.
Customers are provided with the financial products and services throughout the United
Kingdom and beyond and they are supported by providing access to international market in
Asia, Europe, Middle East and North America. Later part of the report also evaluates the
impact of regulatory relationship of the risk management system of bank. Furthermore,
critical analysis in reference to both micro and macro prudential regulation and policy has
been done by evaluating the impact of Basel III guidelines on the banks risk management.
Discussion:
Different types of risks managed by bank:
The external political, economic and regulatory environment of RBS faces a range of
uncertainties and significant risks which they have to deal with. There is continuous progress
on part of bank in reducing the risks faced by them and strengthening its position of capital.
Risks faced by RBS can be categorized into capital development risk, emerging risk
scenarios, reputational and litigation risk, external and other macroeconomic risk and risks
related to operations of RBS (Billings 2016).
Capital development risks- The capital position of bank is strengthened and risk is
reduced on part of good progress made by bank. Establishment of risk reduction measures
helped the bank in removing the risks associated with their balance sheet so that the volatile

BANK RISK MANAGEMENT AND BASEL III
outcomes are reduced and released of capital is accelerated. However, under the adverse
stress scenarios and despite of the adoption of risk measures, the capital position of bank was
in threshold.
Other developmental risks- Such risks include the following and they are listed below
 Operational risk- Management of operational risks faced by bank has been done by
implementation of a new functioning operational model and adopting a consistent
approach (Bianchi et al. 2018).
 Credit risk- Continuous efforts was made by RBS in the euro zone periphery countries
and commercial real estate.
 Litigation, regulatory and reputational risk- The costs related to litigation has
exceeded £ 9 billion since year 2011 and a considerable amount of management
attention is required to deal with such risks.
 Country risk- The debt levels of RBS has been on continuous reduction due to the
client’s effort and maintenance of continuous stance by bank. This resulted in
reduction of exposure of net balance sheet of periphery zone.
 Pension risk- The value of assets is lower than the value of liabilities in the main
scheme of funding violation. Elimination of such deficit by bank has been done by
making additional contribution (Investors.rbs.com 2019).
 Market risk- There was significant reduction in the traded market risk profile of RBS
with reduction in risk limit of market across all the business.
Some of the emerging risky scenarios are attributable to the following and they are as
follows:
 Political risk- The regulatory, fiscal, monetary landscape of bank and its operating
employment environment could be significantly impacted by general election of UK.

BANK RISK MANAGEMENT AND BASEL III
 Macroeconomic risk- The macroeconomic risks associated with the bank is mitigated
by strengthening of liquidity, capital and leverage ratios and by way of exiting some
capital intensive and higher risk portfolios (Flannery and Giacomini 2015).
Some of the risks related to operations of business of RBS are as follows:
 Information technology system failure- The resilience of such system has been
improved by a major investment program with an improvement in the sustainability of
back system.
 Cyber attacks impact- Bank has put in place a large scale program for improving the
access control of users. Management has tightened the number of external websites
and has strengthened the protections of antivirus (Business.rbs.co.uk 2019).
 Failure in successfully execution of major projects- Work is in progress for
implementation of change that is in line with the project plan that helps in assessing
risks associated with implementation.
Some of the litigation and reputational risks managed by bank are:
 Past business conduct impact- A comprehensive and strong compliance and risk
culture is intended to be embedded by embarking on program that would help in
managing the past conduct of business.
 Risks associated with business model, costs and income- The financial and strategic
plans take into account the implications of potential and proposed regulatory
requirements (Ertürk 2016).
Evaluation of whether the risks have been sufficiently managed since 2005:
RBS has been classified as a major bank with a significant increase in share of
market. Although, in recent years, many new programs have been implemented by RBS to
manage the risks on a sustainable basis, it failed in successfully managing the risks that led to

BANK RISK MANAGEMENT AND BASEL III
its collapse. Bank in the aftermath of financial crisis 2007-2009 was highly exposed to the
liquidity risk and degree of leverage along with exposure to highly risky mortgage backed
financial products. After the crisis, bank well positioned themselves to make repayment to
debtors and has a very strong leverage movement. However, with the passing of time, there
was sufficient development of programs that focused managing different types of risks faced
by bank. RBS took continuous efforts in strengthening capital position and risk reduction
(Mckinsey.com 2019).
Explanation of regulatory relationship and its influence on the risks management of
bank:
In the European context, banking regulation is the issuance and formulation of
specific rules by authorized agencies under governing law for structure and conduct in
banking. The stability of the global financial system has been enhanced by banking sector
regulation since the financial crisis. Decisions of the banks are significantly impacted by any
change brought in by new regulations. Regulation is considered as the external force in the
optimization process of capital as it helps the bank to comply with the minimum capital ratio
by simultaneously setting the amount of risky assets and the level of capital. The risk and
capital decisions o bank is effectively influenced by the regulation. However, the
effectiveness of banking regulation being dependent upon several factors such as type of
capital country and economic cycle. The conduct and regulatory risks faced by bank can be
successfully mitigated by effective change management and early identification.
The regulatory requirements is associated with generation of risks related to costs,
income and business model and it is further exposed to increased regulatory capital
requirements and new regulation risks affecting its business model. The key elements of
corporate governance help in controlling the oversight and control for effective risk
management along with complying with the regulations. Since the business of the group are

BANK RISK MANAGEMENT AND BASEL III
subjected to oversight and substantial regulations and such regulatory developments are
likely to increase the risks and its compliance and conduct.
The operation of bank is dependent upon the ability to accurately and efficiently deal
with transactions by effectively complying with the applicable regulations and rules.
Historical compliance of RBS with the applicable regulation and rules is being discussed for
conducting review of its procedures and policies. The European banking authority covered a
number of important areas in a banking organization such as risk management and internal
governance. For dealing with the credit risk, RBS has adopted an advanced and standardized
approach for calculating risk weighted assets to which the application of capital charges has
been done. For tackling with the market risk, regulation requires to adopt a building block
approach under which the capital is held against different risks such as commodities risk,
counterparty risk, position risk and large exposure risk. Furthermore, a leverage framework
ratio is implemented by prudential regulation authority that helps in addressing excessive
leverage for the firms providing critical services. All the PRA regulated banks need to apply
the prescribed leverage ratio and maintaining a minimum of 3% (Yushko 2016). Any further
amount of common equity Tier 1 capital which is greater than countercyclical ratio should be
reported. All such facts and figures are reported by RBS in its annual report along with
stating the fact that they have complied with the regulations or not. A variety of model is used
by RBS group as a part of activities and process of risk management. The assessment of risks
in various facets is supported by using output model. For assessing the prospects of risks
whether they are appropriate or not, bank conduct qualitative review including the risky
portfolios quality, adherence to risk appetite and policy compliance. Any emerging risks can
be identified in early stage by testing the exposure of bank to market risk and credit portfolio
(Langfield and Pagano 2016). Moreover, the group is involved in targeted work so that they
meet with the regulatory requirements.

BANK RISK MANAGEMENT AND BASEL III
The risk management framework of RBS include three lines of defense out of which
one line relies on ensuring that the business culture of bank supports compliance with the
laws, policy and regulations and support the balanced risky decisions. Risks associated with
regulation and conducts are effectively managed by the early identification of change in
legislation. New regulation which the bank is required to comply with helps in managing
change to the requirements of capital that has the ultimate impact on the common equity tier
1 ratio alongside the strategy of de leveraging and reduction of risks (emeraldinsight.com
2019). Such strategy of risk management is achieved buy the group by way of making
transfers to interested parties and continued disposal and run off of assets that enables the
bank to focus on the productive returns generated on capital. Any failure to account for
changes in the regulations or laws can result in operational risk. The internal control system
and the risk management process of RBS have been designed to ensure that they are able to
obtain reasonable assurance in terms of complying with the regulations and laws (Jones and
Pollitt 2016).
One of the key elements of the regulatory relationship is that the companies in the
regulated sector should provide information in events of suspicions about provenance of
assets and funds. However, it is acknowledged that the business have tremendous regulatory
burden that is required to be reduced. Business should be refocused to concentrate their
resources in smartly deploying it to the greatest risky areas and adopting a risk based
approach to compliance and regulations (Cohen et al. 2016).
Analyzing the impact of guidelines of Basel III on the risk management of bank:
Basel accords are the set of rules on the regulations of banking concerning capital and
banks as per the guidelines of the Basel III are required to hold higher quality capital as
against traditionally computed risk weighted assets. It is so because such criteria help in
ensuring that there is n excess leverage and there is sufficient capital during stress. Greater

BANK RISK MANAGEMENT AND BASEL III
flexibility was introduced by Basel III on part of banks when the risks associated with the
assets have to be determined (Black et al. 2016). The risk management capabilities of bank
has improved with the improvement in depth and quality of capital and focusing on liquidity
management. Introduction of the stressed value at risk under the new model will help in
bringing most of the changes in short term. RBS to identify the core driver of their market
risk and hedging them against the exposure to reduced stressed value at risk. Under the Basel
III guideline, banks are required to adopt a standardized approach for computing credit risk
and basic indicator approach for operational risk and for market risk, a standardized duration
method is used (Yan et al. 2016). The capital requirement of bank as per the guideline of
Basel III has been computed to be held at 10.75% for market, credit and operational risk.
Some of the important aspects of managing the risks of bank as per the Basel guideline is
well defined process, mechanism of robust risk approval and independent internal control
mechanism (Cabrera et al. 2017). All the key areas of risk such as market risk, operational
risk and credit risk and for the continuous and effective monitoring of risks, it is essential to
quantify these risks.
The framework of Basel III is based on three pillars which are listed below:
Pillar 1- The rules of minimum capital requirement is defined under this pillar and
such setting of limit helps in absorbing loss related to credit, operational and market risk.
Pillar 2- Bank under this pillar is required to undertake the risk assessment process
for assessing adequacy of internal capital.
Pillar 3- Under this, disclosure is published by individual banks that help market
participants in understanding the risk profiles (Laeven et al. 2016).
RBS has taken number of steps to improve the stress resilience of its capital position
along with reduction in certain credit portfolios, resolution of regulatory investigations and

BANK RISK MANAGEMENT AND BASEL III
various litigation cases. A revised capital plan was not requite to be submitted to the regulator
by bank in light of strengthening the capital position in year 2017 (Molyneux 2016).
In relation to the amount of capital hold by the group as against risk weighted assets,
there are some minimum requirements which the group is subjected to.
Capital adequacy ratio of RBS:
(Source: Investors.rbs.com 2019)
Under PRA, UK leverage framework, the group must meet the minimum ratios of
capital to leverage exposure. Computation of capital adequacy ratio, capital and risk weighted
assets has been done in accordance with the definition and transitional rules set by PRA
(Paulet 2018).
Minimum leverage ratio of RBS:
Source: Investors.rbs.com 2019

BANK RISK MANAGEMENT AND BASEL III
The proposals of Basel III have been implemented by European Union that has
introduced a number of important changes to the regulating framework of banks through
CRD (Capital requirement directive) and CRR (Cash requirement regulation) and collectively
known as CRD IV package. RBS implemented CRD IV on 1st January, 2014 that required
change in capital equal to at least 8% of the risk weighted assets (Rbs.com 2019). Prior to the
implementation, the indicative impact of the reforms of Basel III has been estimated by the
group in terms of capital ratios and risk weighted assets (Ibrahimovic and Franke 2017).
For the computation of market risk capital charge, two broad methodologies are used
by RBS comprising of internal model approach and non modeled approach and computing
the capital at charge by the model of value at risk.
RBS group managed to change the requirements of capital by including model
changes in accordance with the new regulation. This change has a resultant impact on the de
leveraging and reduction strategy alongside the impact on common equity Tier 1. Usage of
management information by RBS is enhanced by linking to the appetite statement of relevant
conduct risk and they are being complaint with the Basel committee on principles of banking
supervisions. As a part of requirement of Basel III, the group assesses its own risks with the
intention of mitigation of such risks and necessity of future and current capital provided all
the mitigating factors are considered (Fca.org.uk 2019).
Bank has established a liquidity portfolio across sovereign bond holding and
correspondent banks with such changes helping in supporting the compliance with the rules
of incoming Basel III liquidity coverage ratio and continuity for the customers.
In order to ensure that all the material risks are identified and adequately managed and
capitalized, risk assessment is undertaken by the bank. No disclosures have been omitted by
RBS on the ground of confidential information. RBS continued to de risk and strengthen its

BANK RISK MANAGEMENT AND BASEL III
capital position by maintaining the minimum capital requirements as per the Basel III
(Gianfelice et al. 2015).
Conclusion:
The above report evaluates the impact of guidelines of new Basel on the risk
management capabilities of Royal bank Scotland. There are various types of risks faced by
the bank that is generally categorized into market risk, operational risk and capital risk. The
inadequate measures for identifying and dealing with the risks resulted in collapse of bank
during the financial crisis. With the introduction of the guidelines of Basel III, the market risk
models of bank have improved. In addition to the categorization of capital, any gone concern
of the capital requirement can be covered by issuing senior notes which is considered as
specific loss absorbing instruments. With the introduction of Basel III requirements, banks
have been able to appropriately design their risk framework for managing the risks associated
with their capital.
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