Friday, October 06, 2006

Moody's on Banks' Risk Management Practices

Investment Executive, James Langton, 6 October 2006

Risk management practices at the major Canadian banks position them well to manage through stress situations that could emerge from either internal or external factors, says Moody’s Investors Service.

The report focuses on the six largest Canadian banks. It identifies and discusses several credit strengths in risk management practices at the Canadian banks, including strong risk governance practices overall, an appreciation of the need for risk management input at senior management levels, and a complete toolbox of risk measures at most banks.

Moody’s also identifies several areas of concern. The rating agency observes that some banks’ approach to risk management issues is somewhat reactive and that some institutions have had difficulty in converting their risk-taking activities into stable earnings. Moody’s ties both of these issues, in particular, to the 2001-2003 period in which several banks suffered large losses in their wholesale banking operations.

In the report, Moody’s also identifies the systemic risk resulting from a transfer of credit risk from traditional banks to hedge funds as an area of concern, noting that this is a global, not strictly Canadian, phenomenon. Moody’s believes that Canadian banks’ exposure to these funds is manageable, with individual lending limits and collateral requirements strictly enforced. In the interests of greater transparency, however, Moody’s supports increased disclosure by the banking sector about the size and nature of their exposures to hedge funds and the revenue and earnings they generate.

“Despite a few continuing concerns over specific risk management practices at some institutions,” says vice president and senior analyst Peter Routledge, “we view risk management disciplines at the major Canadian banks as a credit strength overall and as consistent with our expectations for highly-rated banking institutions.”

“Although we see some economic uncertainties when looking forward in time,” Routledge adds, “we remain comfortable that the Canadian system is well positioned to endure stress.”