MORNBFI Vol. 1 - Planters Development Bank

APP. Q-4308.12.31III. Market risk management processAn FI’s market risk managementprocess should be consistent with itsgeneral risk management framework andshould be commensurate with the level ofrisk assumed. Although there is no singlemarket risk management system thatworks for all FIs, an FI’s market riskmanagement process should:1. Identify market risk. Identifyingcurrent and prospective market riskexposures involves understanding thesources of market risk arising from an FI’sexisting or new business initiatives. An FIshould have procedures in place to identifyand address the risk posed by newproducts and activities prior to initiating thenew products or activities.Identifying market risk also includesidentifying an FI’s desired level of riskexposure based on its ability and willingnessto assume market risk. An FI’s ability toassume market risk depends on its capitalbase and the skills/capabilities of itsmanagement team. In any case, market riskidentification should be a continuingprocess and should occur at both thetransaction and portfolio level.2. Measure market risk. Once thesources and desired level of market risk havebeen identified, market risk measurementmodels can be applied to quantify an FI’smarket risk exposures. However, market riskcannot be managed in isolation. Market riskmeasurement systems should be integratedinto an FI’s general risk measurement systemand results from models should beinterpreted in coordination with other riskexposures. Further, the more complex an FI’sfinancial market activities are, the moresophisticated the tools that measure marketrisk exposures arising from such complexactivities should be.3. Control market risk. Quantifyingmarket risk exposures help an FI alignexisting exposures with the identifieddesired level of exposures. Controllingmarket risk usually involves establishingmarket risk limits that are consistent withan FI’s market risk measurementmethodologies. Limits may be appliedthrough an outright prohibition onexposures above a pre-set threshold, byrestraining activities or deploying strategiesthat alter the risk-return characteristics of onandoff- balance sheet positions.Appropriate pricing strategies may likewisebe used to control market risk exposures.4. Monitor market risk. Ensuring thatmarket risk exposures are adequatelycontrolled requires the timely review ofmarket risk positions and exceptions.Monitoring reports should be frequent,timely and accurate. For large, complex FIs,consolidated monitoring should beemployed to ensure that management’sdecisions are implemented for allgeographies, products, and legal entities.IV. Definition and sources of market riskMarket risk is the risk to earnings orcapital arising from adverse movements infactors that affect the market value ofinstruments, products, and transactions inan institution’s overall portfolio, both on oroff-balance sheet. Market risk arises frommarket-making, dealing, and position-takingin interest rate, foreign exchange, equityand commodities markets.Interest rate risk is the current andprospective risk to earnings or capital arisingfrom movements in interest rates.FX risk refers to the risk to earnings orcapital arising from adverse movementsin FX rates.Equity risk is the risk to earnings orcapital arising from movements in the valueof an institution’s equity-related holdings.Commodity risk is the risk to earningsor capital due to adverse changes in thevalue of an institution’s commodity-relatedholdings.While there are generally four sourcesof market risk, as defined herein, the focusQ RegulationsAppendix Q-43 - Page 2Manual of Regulations for Non-Bank Financial Institutions