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MGT604 - Management of Financial Institutions - Lecture Handout 41

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DFIs & Risk Management

Risks are usually defined by the adverse impact on profitability of several distinct sources of uncertainty. While the types and degree of risks an organization may be exposed to depend upon a number of factors such as its size, complexity business activities, volume etc, it is believed that generally the banks face Credit, Market, Liquidity, Operational,
Compliance / legal / regulatory and reputation risks. Before overarching these risk categories, given below are some basics about risk Management and some guiding principles to manage risks in banking organization.

Risk Management

Risk management is the human activity which integrates recognition of risk, risk assessment, developing strategies to manage it, and mitigation of risk using managerial resources. The strategies include transferring the risk to another party, avoiding the risk, reducing the negative effect of the risk, and accepting some or all of the consequences of a
particular risk. Some traditional risk managements are focused on risks stemming from physical or legal causes (e.g. natural disasters or fires, accidents, death and lawsuits). Financial risk management, on the other hand, focuses on risks that can be managed using traded financial instruments. Objective of risk management is to reduce different risks
related to a pre-selected domain to the level accepted by society. It may refer to numerous types of threats caused by environment, technology, humans, organizations and politics. On the other hand it involves all means available for humans, or in particular, for a risk management entity (person, staff, and organization). In every financial institution of
Pakistan, risk management activities broadly take place simultaneously at following different hierarchy levels.

  • Strategic level: It encompasses risk management functions performed by senior management. For instance definition of risks, ascertaining institutions risk appetite, formulating strategy and policies for managing risks and establish adequate systems and controls to ensure that overall risk remain within acceptable level and the reward compensate for the risk taken.
  • Macro Level: It encompasses risk management within a business area or across business lines. Generally the risk management activities performed by middle management or units devoted to risk reviews fall into this category.
  • Micro Level: It involves ‘On-the-line’ risk management where risks are actually created. This is the risk management activities performed by individuals who take risk on organization’s behalf such as front office and loan origination functions. The risk management in those areas is confined to following operational procedures and guidelines set by management.

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MGT604 - Management of Financial Institutions - Lecture Handout 38

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Agriculture Sector and Financial Institutions of Pakistan

 

What types of securities/collaterals are acceptable to the banks for providing agricultural credit to farmers/growers?

Agricultural land under the pass book system, urban/rural property, commercial property, Defense Saving Certificates, Special Saving Certificates, Gold & Silver Ornaments, personal surety, hypothecation of livestock and other assets e.g. motor boats / fishing trawlers, etc. are generally accepted by banks as collateral.

Is mark-up rate fixed by SBP on agricultural loans?

SBP does not fix any maximum/minimum mark-up rate to be charged on agricultural loans. Banks’ mark-up is based on their cost structure and risk profile of the borrowers and the sector. However, for benchmarking, Karachi inter-bank Offered Rate (KIBOR) is used by banks for the purpose.

Revolving Credit Scheme was introduced in 2003 in consultation with banks. Under the scheme, banks can provide finance for agricultural purposes on the basis of revolving limits for a period of three years with one-time documentation. The borrowers are required to clear the entire loan amount (including mark-up) once in a year at the date of their own choice.

Multiple withdrawals are allowed and the borrowers are also allowed to make partial repayments. Only the amount utilized by the borrower will attract mark-up. This facility can be availed by the farmers just like “running finance”. The limits under this scheme are automatically renewed on annual basis without any request or fresh application.

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