OREANDA-NEWS. July 19, 2012. Earlier, international banking giant JP Morgan suddenly announced that the bank has lost USD 2 billion in the past six weeks on a failed investment by a trader of the bank. The news of the JP Morgan's loss is like a bomb to the Wall Street causing turbulence to the global financial market.
To a commercial bank, good risk management not only determines the gain and loss and crucial to survival, but relates to the economic and financial safety of a country, reported the press-centre of ICBC.

In China, financial system is mainly indirect financing, which means capital is supplied through bank loans. Indirect financing was kept at over 90% of total social financing over a long period, around 80% nowadays. The main feature of indirect financing is the strong relationship between economic growth and bank loans. Exercising good risk management on loan assets is critical to a bank, but a key determinant of long-run economy growth as well.

From 2006 till 2011, bad loan balance and ratio of commercial banks in China have been declined, from RMB 1.25 trillion and 7.09% to RMB 427.9 billion and 1.0% respectively, while non-performing rate of top 10 banks in the world rose from 1.64% to 3.57% during the same period. Good risk management let Chinese banks weather the "big examination" of global financial crisis, maintain robust growth and gain visibility in the global market. The large few major banks in China are now in the rank of leading world banks. More important, the low risk of banks in China also creates a good foundation for the stable, efficient, higher quality growth of China economy.

Control Risk of Lending
Banks in China place highest priority in the control and management on the quality of loan assets since credit risk management is pivotal to China's banking sector and overall economy. ICBC is a case in point. Over the past few years ICBC ramps up its credit risk management framework in an effort to identify and measure the risk inherent in the Bank's lending processes, and to make constant improvements to improve the quality of loan assets. For the period ending first quarter of this year, ICBC's bad loan balance and ratio "both declined" for twelve years in a row, to 0.89% from 3.79% at the end of 2006.

Provision coverage rate soared to 280.88%. This means ICBC was better equipped to "cushion" against risk by having the provision for loan impairment already over 2.8-times of all outstanding non-performing loans. Regarding loans to local government financing vehicles and real estate developers which are of major concern in the market, ICBC also maintained good quality of loan assets. At the end of 2011, the non-performing rate of ICBC loans to local government financing vehicles was 0.73%. Over 97% loans can be repaid by borrowers with enough cash flow to cover all or minimum debt payments. In property loan, good control has been exercised on the non-performing amount and rate. Non-performing rate of property loans and personal housing loans at 0.82% and 0.35% respectively were under the non-performing rate of all ICBC loans.

Worthy of note is that, in the control and management on the quality of loan assets, amid a rapidly changing economic and financial landscape, ICBC establishes a mechanism centered on risk management to build a wall to protect against risks throughout the whole credit process.

More specifically, the first step to control credit risk is that ICBC customer managers must perform due diligence, check and manage each individual loan. Yet, it doesn't end here. This is far from enough to a large bank like ICBC which holds more than RMB 8 trillion of loan assets. Simply put, risk management means to diversify risks under one important principle of "Do not put all eggs in one basket". If a bank does not control who to lend to from an overall and strategic perspective and just lets the branches to make the decision based on the borrowers' conditions, this may end up higher systemic risk after granting excessive credit and allowing a proportion of credit risk in a certain sector.

In working towards credit soundness and diversifying the credit portfolio, ICBC as a large bank leverages its expertise in research and information to shift its lending policy where different ICBC loans are provided to different industrial sectors, in different regions, to different customers. As early as in 2002, ICBC set up an Industry Analysis Center - first such center in China dedicated to the study on the risks in lending to industrial companies. Industrial sector-based credit guidelines are laid down referencing the risk analysis and risk determination. As of today, ICBC has instituted credit guidelines for 43 industrial sectors covering around 80% loans to corporate clients. Special credit policies are also drawn up for 16 countries. ICBC is also the first bank in the country to launch "green loans" in order to control the risks in lending to companies that fail to meet the environmental protection standard from the very beginning.

During the last few years, providing loans to small-and-medium enterprises ("SMEs") remains a top priority of ICBC, which is a fulfillment of social responsibility and a necessity to control risk. ICBC's portfolio is diversified among a great number of SMEs who borrow relatively small amount. In terms of the probability of default, loss rate, loan tenor and correlation, loans to large corporations have lower default rate when compared to SME loans.

However, higher loss rate than SME loans would be expected since a majority of loans to large corporations are released without guarantee. If the long tenor of loans to large corporations is also taken into account, risks of lending to SMEs would not be higher than lending to large corporations. Based on this, ICBC eases its lending policy to extend more loans to SMEs.

 At the end of the first quarter this year, total outstanding SME loans in ICBC reached RMB 3.75 trillion, up RMB 2.65 trillion over end of 2006, or nearly 2.4 times. Total outstanding SME loans made up 64% of total outstanding corporate loans, 20 percentage points higher over end of 2006. In terms of asset ratio, ICBC's corporate loans are already targeting at small and mid corporate segment. Foundation for maintaining sound asset quality has been achieved through a balanced customer portfolio.

ICBC has established the methods and structures necessary for managing credit risk while achieving a balanced customer portfolio. That included loan authorization, credit granting and approval management for better decision-making, centralized control and risk prevention capabilities. In loan approval, factors taken into consideration are the regional economy, management of the branches, asset quality and customer classification, instead of strictly following an approval hierarchy.

In loan approval, ICBC optimizes performance by setting up a monitoring mechanism and credit approval center charged with full responsibility to approve loans. ICBC manages credit risk as a whole, loans are approved by different teams of staff. In extending credit to corporate groups in line with their growth, ICBC sets forth administrative measures, quantitative measurement model and standardized procedures to determine the credit line. With an aim to control credit risks, loans to corporate groups, global credit facility to multinational corporations and their related customers are managed under one roof. Through the long-term effective measures, ICBC has improved its credit management significantly. Over the course of more than a decade, quality of loan asset has been improved indicated by under 1% non-performing rate of new loans every year on average.

In ICBC, information technology plays the irreplaceable role to embark a revolutionary change in credit risk management. To a large lender like ICBC, information asymmetry between all levels of branches and subsidiaries invite risk. As early as in 2003, ICBC built a group-wide credit management system ("CM2002") using cutting-edge internet technology. All data related to loan business are centralized using online data and procedures. CM2002 is a platform for all ICBC branches and subsidiaries to process, manage and control loans from one location.

Nowadays, the loan specialists in Beijing Head Office can check out any loan released by an outlet in Hainan Sanya, real-time through computer system. Decisions can be made in every detail step, from accepting the loan applications to approval. CM2002 standardizes all the procedures for every step - investigation during early period, reply and verify, review and approval, loan release, post-lending management, business analysis and archive management. The whole business flow is controlled online and centrally managed. System parameters are set for loan policy and different risk management requirements under hard control, monitoring the whole process (alert before the event, control during the event, monitor after the event) instead of management after the event. To control every risk, CM2002 directly "rejects" loan applications that fail to meet the credit management requirements, absolutely no "muddle through".

Internal Control Drives Risk Management
Operational risk management holds a key position in a bank's risk management since a bank is basically a company engaged in monetary trade. Looking at the banks in the world, one can find numerous examples that banks can collapse or even bankrupt because of illegal trading by the employees. Nick Leeson whose trading in Nikke index caused a 200 year-old institution, Barings Bank PLC, to lose USD 1.4 billion and go bankrupt in 1995 and Jerome Kerviel who lost USD 7.1 billion for Societe Generale in 2008. In 2011, UBS, lost USD 2 billion due to unauthorized trading by Kweku Aboboli, a trader with UBS.

All these lessons point to the importance of operational risk management in a bank. In this regard, ICBC sets up its own operational risk management scheme, internal control rules and scheme in order to enhance compliance operation and risk control capabilities. Number of new cases and amount involved has been reduced drastically. In controlling sudden cases, ICBC maintains good standard and leads the peers. Since 2009, loss rate due to operational risk keeps under 0.1% while cases in every one thousand employees are in decline. This provides a strong base for ICBC to move forward.

Operational risk is a kind of risk closely related to human behavior. Management of operational risk is a challenge to a large bank like ICBC with 430,000 employees. Years of practices indicate a better approach to control operational risk. Although the fundamental is to train up all employees as "good guys", but a more effective and more controllable way is to reduce the chance for "bad guys" to act wrongly. On this ground, ICBC establishes a comprehensive internal control scheme with rules and regulations incorporating with management philosophy and advanced internal control concept.

ICBC goes over all risk points in every business and compiles an operation guideline to identify the standard of each business step. The guideline covers 16 business segments, 947 flowcharts, 2,871 risky steps, 5,104 risky points and 5,892 control measures. The aim is to enforce sophisticated management on all businesses through standard procedures. On top of this, ICBC conducts internal evaluation, accountability system, internal audit and compliance review in line with the specific rules and systems, focusing on the compliance in major events, periodic checking and audit on related party transactions, financial and interest rate management.

Nothing can be accomplished without norms or standards. Rules and systems are the fundamental to a bank's operational risk management and internal control. Amid fast growth of business volume and increasing demand of faster services from customers, it is now a challenge to mange risk effectively while ensuring efficient operation. In this regard, ICBC uses modern IT to control operational risk and build an intensive operation management system. The focus is to embark reform on supervision, remote authorization and intensive operation in order to improve operation efficiency in tandem with risk management. New supervision system analyzes the data driven by a risk identification engine.

The intelligent supervision model, based on the customer transaction behavior, can automatically identify the risky exceptional transactions. "A sea of staff" is no longer required to check out each transaction. The new supervision system is able to discover and identify risk. In other words, this translates to a better and effective risk identification process, instead of passive management that depends on post-supervision, business checking and on-site management, which are mutually independent and insufficient. Through the new supervision system, ICBC risk specialists in Head Office can monitor in real-time all the steps taken by each teller in every low-level outlet in China. Every risky point discovered can be verified in real-time. This results in standardized steps and management on the business in low-level branches apart from gaining better risk control. Another example.

Through analysis on a great number of risk incidents, the risky step lies in the credit authorization in the outlets. Hence, ICBC overhauls its credit authorization system and uses imaging transmission technology for remote authorization. Under this new management approach and automatic, random allocation in remote authorization system, authorized persons are separated from handling the business in order to enhance risk control.

While enforcing strong risk control in business operation, ICBC sets up a new model - risk control throughout the process + compliance management. In "Before the event", "Embedded" and "Service" are new approaches in setting up compliance mechanism. Compliance risk control is embedded in the design and development of new businesses, new processes. "One veto" system is deployed in the compliance checking of new rules, new measures, new products. In "During the event", the focus is risk monitoring and countermeasures in readiness for the materialization of risks.

Risk monitoring is expanded to all business segments and operation flows including loan, global market and asset management with an aim to monitor and control risk effectively. In "After the event", the key is checking, accountability and corrective measures. ICBC conducts risk assessment once every year to examine all major business areas and revise workflows, standards. Through this process, ICBC identifies risks and responds appropriately.

Risk Management on Par with International Standard
Effective management on credit risk and operational risk lays a solid ground for ICBC's stable operation. However, amid the financial globalization and innovation, banks cannot simply concentrate on the management of one type of risk. The correct approach is to place under one management all the credit risks, market risk, liquidity risk and other risks, as well as financial assets and asset portfolio related to these risks, to estimate, control and manage all these risks using standard formula. Since 2003, ICBC started a program to set up internal rating method and prepare for the implementation of New Basel Accord. Since then, ICBC's risk quantification is getting closer to the international standard marked by the forward-looking and "scientific" risk management. ICBC takes the lead to enforce international-standard risk management and paves the way to be the first bank to implement New Basel Accord.

During the early period of shareholding restructuring and going public, ICBC established a risk management framework including an organization structure with committees charged with different responsibilities under a common goal. Later, ICBC sets up a group-wide risk management framework which seeks to: strengthen the Bank's ability to identify and assess risks, aggregate group-wide risks and define the corporate risk appetite. Mechanisms are in place for the coordination between risk, capital and return, reporting of different types of risks in all ICBC branches and subsidiaries, as well as measurement of group-wise concentration risk. Moreover, to cater for global expansion, ICBC institutes administrative measures for country risk management and credit rating, emphasizing on the statistical analysis of country risk exposure. In the face of the changes in international regulatory regime after the financial crisis, ICBC takes the implementation of New Capital Accord as one important approach to improve risk management, corporate governance and turn into a modern financial firm. A roadmap has been drawn up for setting up different risk quantification systems and business applications. ICBC is now well-prepared to implement New Capital Accord.

In credit risk management, ICBC started the internal rating based-approach in end-2007. All related systems have been online. Internal rating based-approach is now widely applied throughout risk management process - credit authorization, loan pricing and approval, limit management, economic capital allocation and performance assessment. Internal rating based-approach is crucial to improve credit risk management. Besides, ICBC started the internal rating for retail banking to meet the regulatory requirement. Credit scoring is used as reference to approve personal housing loans and credit card loans, manage credit limit and collection after lending. On top of this, to push further the innovation in internal rating based-approach and improve risk management, ICBC developed the credit risk portfolio model, credit risk stress test model and EAD derivative quantification model.

In market risk management, in 2010, ICBC completed the project and became the only bank in China as of today, to develop independently internal model approach to measure and manage market risks. ICBC's market risk system which measures and monitors market risks in global market investments, has three databases (reference data, transaction data, market data) and risk measurement and management functions for market risk measurement, stress test, recursive test, capital calculation, limit management and risk reporting. The new system achieves the goal of managing group-wise market risk and raises the level of ICBC market risk management.

In operational risk management, in recent years ICBC spends efforts on the identification and classification of operational risks. Loss data are accumulated for accurate measurement of operational risks. At present, ICBC has completed the development of operational risk Advanced Measurement Approach ("AMA") and system architecture. Internal loss event collection system ("ILD"), risk and control self assessment system ("RCSA") have been in production, AMA system is now in pilot run.

Internal Capital Adequacy Assessment Process ("ICAAP") is an important part of ICBC's implementation of New Capital Accord. The project has already kicked-off to improve ICBC risk management and meet regulatory review in areas of governance structure, risk assessment, capital assessment and planning. According to the assessment of current risk management, ICBC streamlines its assessment flow, quantitative methods and management policies for substantial risks such as interest rate risk, concentration risk, liquidity risk, reputation risk, strategy risk, asset securitization risk. ICAAP, risk assessment process and a strategy for maintaining necessary capital level have been in place.