The Banking Supervision Department is regulating the management of risk derived from trading activity in derivatives and securities by banking customers
The Banking Supervision Department published a draft directive regulating the management of credit risk derived from customers’ trading activity in derivative instruments and securities. The requirements are intended to strengthen and improve risk management at the banking corporations, in order to reduce the likelihood of future failures. The directive particularly emphasizes the method of risk management of customers engaging in speculative activity—customers with a significant volume of trading activity in derivatives and securities at especially high risk levels.
Customers' activity in the capital market, including in derivatives, exposes the banks to losses when the activity is financed by the bank, or when the bank does not make sure that the customer will be able to cover future losses in respect of the activity. The Global Financial Crisis exposed weaknesses at banks around the world in managing the risk inherent in trading in the capital market, both in the banks’ nostro portfolios and in customer activity. The banking system in Israel also experienced failures in the past in managing the risk inherent in such activity. As part of the on-going activity to strengthen risk management in the banking system and the requirement to meet accepted international standards, and based on the knowledge accumulated in Israel and around the world in recent years, the Banking Supervision Department is regulating risk management in customers' derivatives and securities trading activity, in order to make sure that the lessons have been internalized and to reduce the likelihood of additional serious failures taking place.
The main points of the directive include:
· The bank’s Board of Directors shall determine the risk appetite and risk tolerance levels for customers' trading activity in the capital market. In particular, the Board of Directors shall determine the type and scope of activities to be conducted at the bank vis-à-vis customers engaging in speculative activity.
· The bank shall set an over-all risk management policy, and shall use accepted risk management tools commensurate with the volume and complexity of activity. Among other things, activity limits shall be set and monitored through frequent measurement and reports.
· Managing the risk inherent in trading activity on the capital market by customers engaging in speculative activity should be tightened and more frequent, in view of the complexity and risk in such activity. As part of this, special attention is paid to customers who have non-financial business activity and also engage in speculative activity, not for the purpose of hedging their non-financial activity: The bank will be required to separately and equally manage the business risk and the risk derived from market fluctuations, while dividing control and risk management responsibilities among the various departments in the bank, according to their specialization (the business department and the department responsible for customers’ capital market activity).
· The bank will require customers engaging in speculative activity to provide it with liquid collateral against the potential and existing risks derived from activity in over-the-counter derivatives in order to mitigate the risk of losses on the part of the bank. Later on, the collateral requirement will be expanded to include additional types of customers engaging in derivatives activity, including supervised entities such as banks and institutional investors.
The Banking Supervision Department will continue regularly examining the adequacy of risk management in the banking system, and will revise its guidelines on the matter in accordance with the international rules being developed in this area