"I was pleased to see that the new journal is aimed at managers in the field to better understand the benefits of supply chain management thinking. The journal is focused on delivering these developing best practices to practicing managers. There is a vast gulf between academic’s theory and managerial practice [and] your journal should be a timely addition."
Volume 16 (2023)
Each volume of Journal of Risk Management in Financial Institutions consists of four quarterly 100-page issues. Articles scheduled for Volume 16 are available to view on the 'Forthcoming content' page.
The papers and case studies included in Volume 16 are listed below:
Volume 16 Number 2
-
Editorial
Julie Kerry, Publisher -
Practice papers
Pricing of climate transition risks across different financial markets
Dirk Broeders, Senior Financial Risk Manager, Bernd Schouten, Economist, Isabelle Tiems, Economist and Niek Verhoeven, Economist, De Nederlandsche Bank
As the global economy transitions towards net zero, it is conjectured that efficient financial markets reflect the risks involved with this transition. This hypothesis is empirically tested in this paper and signals are found of climate transition risk pricing in options, equity and bond markets, based on greenhouse gas emission levels. The analysis of recent developments in the option market suggests that investors perceive the oil and gas sector to have an elevated risk profile. In the equity and bond market for, particularly, the energy sector, investors appear to demand higher returns to compensate for a higher transition risk. In addition, it is found that the average maturity of newly issued bonds in the carbon intensive coal sector decreased, while the average maturity increased strongly in the renewables sector with low carbon emissions. The reduction of investors' long-term exposure to the coal sector signals concerns about its long-term viability, while the opposite is the case for the renewables sector. Nonetheless, it is not possible to conclude that climate risk pricing is consistent, as the statistical evidence is not overwhelming and not fully aligned across different markets. Furthermore, as climate indicators and emission data still contain important flaws, climate pricing based on these indicators could also be inadequate. Therefore, this paper aligns with the literature arguing that climate risk pricing is inconsistent and inadequate and that this is important for investors and risk managers to acknowledge. In addition, policymakers are urged to ensure that transition information, like emission data, is correct, timely and comparable to ensure its information value and usability.
Keywords: climate change; climate transition risks; equity market; bond market; option market -
The impact of climate risk on the insurance industry: Recent developments and emerging risk mitigation approaches
Sonjai Kumar, Certified Fellow of the Institute of Risk Management and Purnima Rao, Associate Professor, Fortune Institute of International Business
The present paper discusses the key emerging risks in the insurance industry due to the worsening of the global climate. First, the paper identifies the adverse impacts that have already taken place in the recent past in the insurance industry. Further, it discusses the various tools the industries utilise to manage their risks, such as underwriting, risk management and public disclosures. Finally, some key measures taken by the industry are discussed that include not providing insurance to polluting industries, tightening risk management governance and mandatory disclosures recommended by different insurance regulators.
Keywords: climate risk; insurance industry; underwriting; risk management; disclosure -
The marginal impact of predicted climate risk scenarios on portfolio credit risk stress testing
Jonas de Oliveira Campino, Lead Strategic Risk Management Specialist, The Inter-American Development Bank
This paper adapts the methodology developed by de Oliveira Campino et al. (June 2021) to account for predicted climate risk shocks' impact on a sovereign portfolio's credit quality on a forward-looking basis and in probabilistic terms. In particular, the portfolio stress testing capability is enhanced by adjusting the severity of the credit shocks to account for climate risk-related events on an additive basis. The benefit to risk managers is that it allows understanding of the impact of climate risk in marginal terms in relation to the original credit shock. The recently created NGFS (the Network for Greening the Financial System) database makes this exercise possible. Moreover, the described approach translates the marginal impact of climate risk scenarios on the portfolio's credit risk stress testing into capital adequacy metrics dislocations, which facilitates communicating the marginal impact of climate risk scenarios as capital consumption amounts. The paper presents an overview of the underlying model, and the methodological approach developed to adapt the credit risk stress-testing capabilities to account for climate risk using the NGFS database. Moreover, it applies the methodology to a hypothetical sovereign loan portfolio and discusses the results. Over the period considered, the study finds that the transition aspect of climate risk has a more pronounced marginal impact on a sovereign portfolio's credit risk than the chronic physical aspect of climate risk. Moreover, the results indicate that as the world takes action to transition away from carbon, the credit risk of sovereign portfolios may be exacerbated, especially if there are delays and a lack of coordination across countries and sectors.
Keywords: climate risk; capital adequacy; sovereign risk; credit rating; stress testing; machine learning; LASSO; Monte Carlo simulation -
Approaches for quantifying the financial impacts of reputational damage from climate change
Michael Grimwade, Managing Director, Operational Risk, ICBC Standard Bank Plc
Climate change is an existential threat to humanity. As such it has the potential to create uniquely severe reputational damage for financial institutions by significantly altering both their stakeholders' expectations and their perceptions of firms. Changes in the behaviours of the current (or future) providers of capital, funding and revenues to financial institutions would have the most direct and significant influences on the financial performance of firms. These impacts can be systematically assessed, through scenario analysis, by evaluating the effects in terms of the scale, financial sensitivity and duration of stakeholder responses. For prominent reputational risk events, the consequences may be simultaneously felt across five different financial impacts, although the responses of different stakeholders may vary. As there is uncertainty as to how stakeholders may respond, and a scarcity of climate change data, then non-climate change related reputational risk case studies are used in this paper to illustrate the scale and duration, where known, of the financial impacts. As with all forms of scenario analysis, the value obtained from these activities for climate change related reputational risks may ultimately arise as much from the greater understanding gained through the process, rather than the precision of the predictions. This paper sets out more systematic approaches for evaluating this reputational risk by detailing: the nature of reputational risk, including sources of negative stakeholder perceptions, and the differing abilities of stakeholders to act upon their negative perceptions by changing their behaviours; the nature of the risks posed by climate change, and how they may lead to reputational damage for financial institutions; and how these changed stakeholder behaviours/reputational damage may translate into five different categories of financial impacts, and how each may be assessed.
Keywords: climate change; reputational risk; financial impacts; scenario analysis -
Research papers
ESG information integration into portfolio optimisation
Haoming Cao, Master of Mathematics degree student and Tony S. Wirjanto, Professor, University of Waterloo
A growing number of investors in recent years has focused on environmental, social and governance (ESG) factors in carrying out investment activities and the COVID-19 pandemic has only driven such trends of ESG investing at an accelerated rate. Many studies have examined the relationship between ESG scores and corporate financial performance, along with the effectiveness of ESG portfolios. This paper discusses various approaches to incorporate ESG factors into a portfolio optimisation and critically compares and contrasts the efficacy of these approaches on the Dow Jones Industrial Average constituents. It finds that thematic investing appears to be the best performer. In addition, it is also found that there is no evidence that ESG portfolios underperform the market.
Keywords: ESG; portfolio optimisation; best-in-class selection; thematic investing; ESG integration; Dow Jones Industrial Average; hybrid strategies; Sustainalytics -
The estimation of Value-at-Risk using a non-parametric approach
Amir Olfat, PhD Student of Statistics and Farzad Eskandari, Professor of Statistics, Allameh Tabataba’i University
This paper is concerned with estimating the risk measure, Value-at-Risk (VaR), without considering the usual hypothesis used in parametric methods. A non-parametric method is used to fit severity and frequency loss distributions in collective risk models. In addition, an optimum bandwidth is estimated. The model is then applied to insurance claims data from a particular insurance company. As a result of the new model, the outcomes show better accuracy, for both light-tailed and heavy-tailed distributions
Keywords: risk management; non-parametric models; VaR; cross-validation; kernel function -
Estimating Value-at-Risk and expected shortfall of metal commodities: Application of GARCH-EVT method
Maaz Khan, COMSATS University Islamabad, Mrestyal Khan, Lecturer and Muhammad Irfan, Associate Professor and Deputy Dean, Balochistan University of Information Technology, Engineering and Management Sciences
The metal markets have become extremely competitive and highly volatile due to financial globalisation. Therefore, in this study, the Value-at-Risk (VaR) and expected shortfall (ES) are estimated for the metal markets. A two-stage dynamic extreme value theory (EVT) method has been adopted along with the GARCH (1, 1) model to identify the pre-specified threshold for the metal market by using high-frequency returns data of 15-minute intervals ranging from 1st January, 2018 to 24th September, 2021, which provides accurate information about metal market volatility and tail distribution. Moreover, the empirical findings confirm the presence of a high level of volatility persistence in the metal market, especially in the financial returns of gold. Furthermore, silver metal returns exhibit the highest VaR compared to other metals in the market. The empirical results could assist financial investors and portfolio managers to minimise and control the potential risk in the market.
Keywords: Value-at-Risk; extreme value theory; GARCH; metal market
Volume 16 Number 1
-
Editorial
Eduardo Canabarro, Independent Financial Economist -
Opinion/Comment
Determining environmental and social risk rating in a multilateral development bank
Cristiane Ronza, Lead Specialist of Environmental and Social Risk Management and Stefanie Brackmann, Lead Specialist of Environmental and Social Risk Management, Inter-American Development Bank
The Inter-American Development Bank (IDB) is committed to managing environmental and social risks in all banking operations. To meet this commitment, the IDB applies a risk-based approach to environmental and social management for project development and execution to prioritise its interventions. The purpose of this paper is to describe the key concepts involved in determining the environmental and social risk rating of IDB operations and its value to the bank’s overall risk management framework.
Keywords: environmental and social risk management, impact assessment, ESG risk management, ESG portfolio management, ESG integration, engagement, environmental and social policy -
Practice papers
Should investors rely on central bank asset purchases to backstop markets?
Colin Ellis, Professor of Finance, Hult International Business School
During the global financial crisis, central banks in advanced economies cut policy rates to near zero, and then provided further stimulus via balance sheet expansion. In many instances this took the form of quantitative easing — central banks creating new money with which to purchase securities. With years of quantitative easing behind us, and aggressive measures from central banks during the COVID-19 pandemic, should investors now expect central banks to backstop financial markets? This paper examines asset purchases from the twin perspectives of monetary and financial stability, and argues that investors should not expect central banks to always come to their rescue.
Keywords: central banks; quantitative easing; financial stability; moral hazard -
Failure of strategic risk management in a life insurance company in India
Sonjai Kumar, Certified Risk Management Professional, IRM and Purnima Rao, Associate Professor, Fortune Institute of International Business
This paper discusses the importance of strategic risk management in avoiding an adverse effect on performance in the life insurance sector if long-term risks are ignored. The case considered here is the rise and subsequent fall of a life insurance company in India. The company initiated the sales and distribution of products in collaboration with banks (Bancassurance) but ignored the market momentum of the emerging distribution trend and did not change its distribution strategy. As a result, the company, which played a pioneering role in establishing the Bancassurance model, is now performing poorly, being at the bottom of the ladder on new business premium income.
Keywords: strategy; risk management; strategic risk management; life insurance; Bancassurance; sales and distribution -
Research papers
What can we learn about repurchase programmes and systemic risk? Evidence from US banks during financial turmoil
Foued Hamouda, Assistant Professor, Higher Institute of Management of Tunis GEF2A-Lab, and Higher Institute of Management of Gabès
This paper contributes to the debate on systemic risk by measuring and comparing systemic risk and interconnectedness when banks repurchase shares during financial turmoil. It assesses the extent to which buyback programmes within banks contribute to systemic risk, relying on several measures of systemic risk and connectedness in a sample of 112 US banks during both a tranquil and an unstable period. Empirical results reveal remarkable increases in systemic risk in repurchasing banks compared to non-repurchasing banks and they are more exposed to it in difficult periods such as the European debt crisis and COVID-19. Banks that repurchased shares strengthened indirect links during systemic events and are potentially riskier. The results also classify and rank banks in terms of systemic risk involvement and connectedness and contribute to the identification of systematically important banks.
Keywords: financial crisis; systemic risk; bank networks; interconnectedness; buyback programmes; COVID-19 -
A coherent economic framework to model correlations between PD, LGD and EaD, and its applications in EaD modelling and IFRS-9
Peter Miu, Professor of Finance, DeGroote School of Business, McMaster University and Bogie Ozdemir, Co-Founder, RiskVision
This paper proposes an economic framework recognising EaD as a stochastic variable and capturing the PD–LGD, PD–EaD and LGD–EaD correlations. It explains how these correlations can be estimated from historical data, and how PD, LGD and EaD can then be simulated in determining credit VaR. The framework allows credit losses to be more accurately captured, both in terms of the expected credit losses (ECL under IFRS-9 and CECL) and the unexpected tail events in measuring Credit VaR. The framework quantifies the potential underestimation of the tail risk in Credit VaR and the IFRS-9 ECL if the full correlation structure is not captured. By explicitly modelling EaD in a correlated fashion with PD and LGD, lenders can understand and model the increase in funding requirements during downturns. Application in back-testing IFRS-9 ECL is discussed and supplemented by a numerical example.
Keywords: ESG; risk management; climate risk; credit risk; liquidity risk; operational risk; regulatory risk -
Assessing risks in international investments using hesitant fuzzy linguistic term sets
Ayfer Basar, Visiting Lecturer, Özyeğin University
The world economy, global markets and competition for international investments have undergone great change in recent years. Changes in the economy of a society affect many countries as a result of international commerce and agreements with other countries. This has given rise to many risks that governments have to deal with; hence, the importance of risk management has increased for all countries, especially in the finance sector. Global economics means that financial institutions need to make decisions about investment in other countries (eg opening a new bank branch or a participation company), so they need to measure the financial risks of candidate countries in fuzzy conditions. This study presents a novel method to meet that need. First, the most common financial risks are determined by means of a literature survey and consulting expert opinion. Secondly, the relative weight of each main and sub-risk is determined by expert opinion and hesitant fuzzy linguistic term sets (HFLTS). These weights are used to measure the financial risks of 30 countries to select the best four and the results are approved by the experts. Finally, the proposed method is implemented to aid the investment decision of a large financial institution. This paper proposes a new method to assess financial risks in fuzzy conditions.
Keywords: financial institutions; investment decisions; risk management; hesitant fuzzy linguistic term sets; case study