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Introduction
Bank of Americas (hitherto will be referred as BOA) management governance design facilitates it to administer all chief features of their business through review and planning process that involve risk, strategic, associate, customer and financial planning. BOA is able to enhance its profitability by administering risks on its clients transactions. BOA applies qualitative initiatives to minimize risk and recompense trade offs so as to attain growth objectives and financial goals while minimizing the volatility in earnings and thereby reducing unanticipated losses. BOA employs various risk metrics that facilitate them to evaluate their performance which include corporate risk limits and capital targets.
By apportioning economic capital to a segment of business, BOA efficiently administer the capacity to take on risk. Appraisal and endorsement of business plans integrate approval of economic capital utilization and economic capital apportionment which is supervised through risk and financial reporting. BOA risk management process appraises both the risk on ongoing process and the relevant metrics required to evaluate it. (BOA Annual Report, 2008, p54).
Capital Markets and Advisory Services (CMAS) of BOA offers risk management products employing equity, interest rate, currency, equity and distribution capabilities, and advisory services on merger related activities. (p40).
BOA is having liquidity agreements like SBLC with Special Purpose Entities (SPEs) under which BOA is under commitment to offer funding if there are any market disorders. Thus, BOA manages its market risk and credit risk on these understandings by submitting them to their normal risk management and underwriting process. (p49).
BOA in its business operations has vulnerability to the following major risks:
Liquidity risks
This risk is the failure to meet repayment of liabilities and withdrawal of deposits without any notice, growth in fund assets and to meet contractual commitments through unobstructed approach to funding at rational market rates.
Strategic risks
This risk is the peril that impact business decisions. In appropriate or ineffective business strategies or failure to retort to any changes in the competitive scenario , customer preferences , business cycles , execution , product obsolescence and other inherent risks of business that affect banks capability to meet their goals.
Market risks
This is the risk that assessments of liabilities and assets or profits that would be negatively impacted by volatility in market conditions like movements in interest rates.
Credit risks
This risk is the peril of loss emanating from counterparty or borrowers incapacity to meet their financial obligations.
Operational risks
This is the risk of financial detriment due to failed or inadequate internal processes, systems, people or exterior events.
Compliances risks
This is the risk caused by the failure to control legal, regulatory and ethical issues that could end in monetary losses, damages or injury to the banks image or reputation. (BOA Annual Report, 2008, p54).
Identifies the major risks facing their employer. This will include a detailed description of each risk and the general important of each.
BOA interest rate risk management stratagem involves the employment of interest rate contracts to administer any volatile changes in earnings that are created by interest rate movements. The main aim is to mitigate the impact of volatility in interest rates that would adversely influence the net interest income of the bank.
BOA has established and is improving its control process continuously and employs different strategies to align risk management and risk taking throughout its banking operations. These control methods and processes are devised on the fundamental of three lines of defense namely enterprise functions, lines of functions and Corporate Audit.
The foremost lines of defense is the lines of business and are responsible for recognizing, measuring , monitoring and mitigating all perils within the BOAs lines of business and some enterprise wide perils are administered centrally. For instance, except for traditional oriented business activities, interest rate peril connected with their business functions is administered centrally as part of their asset-liability management (ALM) practices.
Management of line of business makes and carries out the banks business plan and is very proximate to the varying nature of perils and hence, the bank can initiate actions immediately to administer and control these risks. Moreover, banks lines of business organize self evaluation reports periodically to recognise the status of the risk issues, including risk avoidance and mitigation strategies. These risk evaluation reports are submitted to banks executive management to make sure that proper risk oversight and management and to recognise enterprise wide risk issues.
Moreover, BOAs management structures, processes and policies help them in adhering with regulations and laws and offer clear lines for accountability and decision making.
As a risk mitigation process , the bank is empowering its officials to make decisions as and when a transaction occurs while keeping out the supervisory oversight activities from both outside and in of its lines of business.
BOAs second line of defense for risk management is their Compliance, Risk Management, Human Resources, Finance and Treasury and Legal functions. These departments are independent of lines of businesses and are devised on both enterprises wide and on line of business basis. For instance, for Risk Management, a senior risk executive is deputed to each of the division of the bank and is accountable for the administration of all the risks linked with that line of business. Risk executives of the bank on Enterprise-level have onerous to formulate and implement practices and policies to evaluate and administer enterprise-wide market, credit and operational risks.
The third line of defense namely Corporate Audit offers an independent evaluation of banks internal and management control systems. Corporate Audit functions are intended to offer rational assurance that resources are safeguarded adequately, significant managerial, financial and operating information is materially accurate, complete and dependable and functions of employees are in tune with the banks standards, policies, applicable regulations, laws and procedures.
BOA is employing various strategies to manage its risks at the various lines of its business and enterprise-wide. Some examples of such risk management strategies are risk committees, planning and forecasting, models, limits and hedging policies. Planning and forecasting tool helps to analyse the planned versus actual performance and offers a reading of unanticipated risk levels. Further, risk forums or committees are comprised of risk management, lines of business, compliance, treasury, finance and legal which actively supervise actual performance with that of planned, probable issues, limits and introduction of new services and products.
Limits which is the one of the risk control strategy is the quantum of exposure that may be taken in a service, product, region, relationship or industry try to amalgamate enterprise-wide risk goals with that of each line of business and are part of banks overall risk management strategies to assist to minimize the changes in the market value, operational and credit losses.
Models are employed to evaluate net interest income security and market value and to evaluate anticipated and unexpected losses for each services and products and lines of business wherever applicable.
Hedging is used to administer the risk of counterparty or borrower concentration risk and to administer market risk in the cluster. (BOA Annual Report, 2008, p54).
BOAs code of ethics offers a structure for all of its business partners to conduct themselves with the greatest integrity in providing services and products to its customers. Further, BOA implants a risk-witting culture through policies, training, communications, organizational responsibilities and roles and procedures.
Describes how the firm currently manages these risks
Liquidity Risk
BOA is managing the liquidity risk at two stages. The first stage is the liquidity of the parent company and the second stage is the liquidity of holding companies that comprises of both non-banking and banking subsidiaries. Liquidity management for both stages are essential since they have diverse funding requirements and subject to some regulatory requirements and guidelines.
BOAs ALCO (Asset and Liability Committee) is liable for framing the banks liquidity strategy and approval of both contingency and operating procedures by supervising liquidity on a continuing basis. Further, BOAs corporate treasury is accountable for devising and administering banks funding strategy and activities. (p55).
The current global economic recession has its impact on BOAs business also. BOA has availed funds from U.S. Treasury, Federal Reserve and FDIC mainly to improve its liquidity status. Though, these facilities are temporary in nature but it has offered BOA to maintain significant market stability and to have a robust liquidity profile.
It is to be observed that availability and cost of both secured and unsecured finances are affected by its credit ratings. Hence, BOA is under obligation to maintain a high credit rating by maintaining a diverse but a stable earnings inflow, robust credit quality, robust capital ratios and sophisticated risk administration controls, varied funding sources and conditioned liquidity supervising processes. Since October 2008, BOA is the capacity to issue AAA ranked debt supported by the full credit and faith of U.S. government despite of the fact of banks current credit rating.
Credit Risk Management
Financial market disruptions and housing market downturn which started in the second half of the year 2007 and is still continuing in the year 2009 has resulted in higher provisions and credit losses for BOA not only in the financial year 2007 , 2008 but also for the year 2009 and for the future period also. (p 61). Due to considerable deterioration of value of banks consumer real estates, bank has introduced underwriting changes on new loans advanced with higher FICO scores and lesser to loan-to-value loans. Further, BOA has lessened unfunded lines on depleting accounts with falling equity positions. In unsecured lending, BOA is now applying judgmental lending and stiffer account management and underwriting standards especially for higher risk geographies and customers. (Angelopoulos & Mourdoukoutas, 2001, p62).
BOA oversees the credit risk footed on the risk profile of the counterparty or borrower, the nature of underlying security and repayment sources. To mitigate the losses on its credit card division, BOA uses securitization for covering such risks. In their dealer associated and automotive portfolios, BOA has stiffened underwriting standard and enhanced the risk based pricing for purchased loans. (p61).
Market Risk Management
If the changes in the market conditions affect the values of liabilities and assets or revenues then such risks are known as Market Risks. In case if there is market vulnerability, factors like liquidity and underlying market movements have an effect on the financial results of BOA. (Greuning & Bratanovic,2009,p227).
BOAs trading position is published at fair value with changes presently replicated in their income. Further trading positions are subject to many risk factors like interest rate perils which symbolizes exposures to financial instruments whose worth changes with the volatility or level of interest rates. Such instruments include derivative instruments, borrowings and deposits.Further, hedging instruments are employed to lessen these perils which include associated derivatives like futures, options, swaps and forwards. (p85).
Strategic Risk Management
BOA manages its strategic risk by employing one of the key tool namely economic capital allocations mainly to manage efficiently each line of businesss capability to take on risk. Appraisal and approval of business strategies incorporate authorisation of economic capital provision and economic capital usage which is supervised through risk and financial reporting. BOAs operation plan which is approved by the Banks board on annual basis includes the economic capital allocation strategies for the lines of business. (p55).
Foreign Exchange Rate Risk
This symbolises exposures to volatility in the worth of present holdings and cash flows arising in the future designated in other currencies. The kinds of tools exposed to this peril include investment in overseas subsidiaries, future cash inflows in foreign currencies due to forex transactions , loans and securities availed in foreign currencies , foreign currency forex derivatives and debts whose values will volatile due to fluctuations in foreign interest rates or forex rates. The main risk control technique employed is the hedging instrument which is employed to lessen this peril which includes forex currency swaps, options, forwards, future, deposits and debts in foreign currency. (p84).
Interest Rate Risk
This risk symbolises exposures to financial instruments whose worth differ with the volatility or level of interest rates. These financial instruments include debt securities, loans, deposits, some trading associated liabilities and assets, derivative instruments and borrowings. Hedging instruments are employed to lessen these risks which include associated derivatives like futures, options, swaps and forwards. (Crouhy, Galai & Mark, 2001, p544).
Marketing Risk
This symbolises vulnerabilities to changes in the value of mortgage associated instruments. BOA trade and involve in market making activities like pass-through certificates, whole loans, collaterized mortgage commitments and commercial mortgages which includes employment of mortgage as an underlying security. BOA uses hedging instruments to alleviate these risks which include futures, options, swaps, forwards, securities and swaptions. (p85).
Commodity Risk
This risk symbolises the vulnerability to instruments traded in the natural gas, power, and petroleum and metal markets. Various hedging instruments are employed to lessen the impact of this peril which includes forwards, futures, options, swaps and cash positions.
Issuer Credit Risk
This risk symbolises exposures to volatility in the credit worthiness of group or individual issuers. BOAs portfolio is vulnerable to issuer credit risk where the worth of an asset may be negatively affected by transformations in the quantum of credit spreads, by defaults or by credit migrations. Various hedging tools employed to alleviate these risks are CDS, bonds and other credit fixed income tools.
Market Liquidity Risk
This risk represents the peril that anticipated changes in market activity radically and in some instances may even cease to subsist. This risk is of serious nature as BOA cannot use mitigating tools due to its uncertainty and may affect the banks overall performance. This brunt may further be accelerated if anticipated pricing correlations or hedging is influenced by the inconsistent demand or absence of demand for some instruments.
Trading Risk Management
Trading oriented revenues are volatile in nature and are chiefly driven by customer demand and by general market scenarios. Further, trading associated revenues are reliant on the quantum and class of transactions, the quantum of risk taken for granted and unpredictability of rate and price movements at any given point of time within the ongoing changing market scenarios.
Global Markets Risk Executive of BOA will chair the GRC meeting (Global Risk Committee) and he has been delegated adequate powers by ALCO for the primary governance for GMRM (Global Markets Risk Management) which includes overseeing of trading risk. The main focus of the GRC is to take a forward looking overview of the primary market and credit risks affection CMAS and to give priority that require a proactive risk alleviation process.
The risk committee in its GRC meetings will study the significant profits and losses on daily basis along with the notes on prime drivers for such loss or revenue. A boundary is established for each of the BOAs business so as to decide if the loss or revenue is regarded to be noteworthy for that segment. If any of the boundaries has been crossed, a justification is to be presented to the GRC. The boundaries are established in consultation with the appropriate risk managers to underscore those losses or revenues which crosses what is regarded to be normal volatility in daily income statement. (p 85).
Suggests ways for improving the present methods of managing risk
BOA is in the business of assuming risk by advancing credit both to the business and individuals to stimulate the economy. Further, BOA is having obligation to administer that risk. However, BOA as a whole performed poorly on that front which resulted in current financial crisis for the bank. Further, BOA has to compete with new market players like emerging hedge funds, sovereign wealth funds which offer structured products. (p6).
BOA has learnt that it is not too good to rely totally on mathematical risk modeling in evaluating the risks. Though, the models are too complicated but they hold good up to the hypothesis of the personnel who invented them and would yield result as per the data what has been feed.
At any given point of time, BOA has to poise their risk modeling capabilities about their clients, customers and portfolios. Risk management now relies on the rational appreciation of economic elementary and its appreciation about the business cycles.
BOA has to fine-tune its evaluations of risk factors like portfolio concentrations, customer credit-worthiness and market trends by cognizing the new economic realisms. Hence, BOA should employ new mechanisms to administer all these risks more successfully.
BOA should recognise that though banks organizational structure can be significant in the style they manage risk, however it is not the sole determinant of success as the most significant determinants are culture and people.(6).
Capital Markets and Advisory Services division of BOA is one department which is exposed to higher risk securities. BOA should venture out from the most dangerous security market mainly to minimize its loan losses.
BOA should tighten its underwriting requirements for higher-risk sectors and should employ judgmental underwriting in deciding applicants credit worthiness.
BOA should concentrate more on fixed income debt securities like municipal debt, foreign debt and should employ the debt security portfolio mainly to administer its liquidity and interest rate risks and to take benefit of market scenarios that generate more cost-effectively smart returns on these investments. (p26).
BOAs should fine-tune its ALM ( Asset Liability Management) activities to uphold an overall interest rate risk management policy that introduces the employment of interest rate contracts to administer any volatility in earnings that are created by interest rate fluctuations. Thus, BOAs goal is to administer interest rate sensitivity so that any fluctuations in interest rates do not poignantly impact adversely on its net interest income. (p32).
The financial market disruption that started in 2007 is prolonged to have its effect on financial services sector and economy as of date and due to this , BOAs liquidity for asset supported securities vanished and spreads escalated to momentous heights thereby affecting badly BOAs credit card securitization schemes. In case, if this unfavorable scenario continues, this will affect BOAs ability to approach these markets at most favorable terms. Hence, BOA should give top priority to cover such types of risks in future. (p35).
Further, BOA has recently acquired countrywide and Merrill Lynch in the year 2008. Both Countrywide and Merrill Lynch have been worst affected due to subprime mortgage crisis and were in the verge of bankruptcies. BOA should try to develop adequate risk managing techniques to cover the losses sustained by these merged organisations and to avoid the same in future. As a part of risk management strategy, BOA has modified about 230,000 mortgages during the year 2008 mainly to assist to thwart foreclosures. This is also a risk managing technique and BOA should avoid such type of mortgages in future.
BOA should give top priority for investing in short-run financial instruments to mitigate its operational risk which includes cash equivalent or cash , federal funds purchased and sold , time deposits ,commercial papers etc as these instruments have lesser vulnerability to credit risks as they have no short-run maturities or stated maturities and carry interest rates that coincide with the market rates.
Having access to a homogenous technology and set of facts significantly improves risk management, decision-making, balance-sheet management and finally, the customers satisfaction. Thus, it also connotes that BOA can better safeguard the privacy of its clients data which would be the top most priority for any banker to retain the clients base and to earn trust and reinforcing relationships. (Hurd & Nyberg, 2007, p40).
With effect from December 7, 2007, Basel II rules have to be adhered by BOA. These rules provide exhaustive capital requirements for operational and credit risk under Pillar 1. Under Pillar 2, BOA has to disclose supervisory obligations have to be disclosed. Under Pillar 3, BOA has to disclose the market risk obligations. If these rules are applied by the BOA immediately, then it would act as an excellent risk mitigation tool to minimize financial losses in near future. (p60).
Online Phishing and Cybercrime risk management
However, BOAs online banking is not completely free from hackers attack. A customer reported that there was unauthorized transfer from his account and later it was detected that an infection by a Trojan namely Coreflood had created this transfer. Affected customer blamed that though BOA is facing risk from Coreflood, it failed to inform its customers about it though it aware it posed a risk from Coreflood.. It is the contention of the customer that it is banks responsibility to safeguard its customers information. Coreflood is a Trojan programmed mainly for denial of-service attacks, which works by eavesdropping a programmed IRC channel for commands. Thus, the open ear permits back entrance into an infected system. There is still possibility that a hacker can access BOAs online banking facility and steal any username or password. (Smith, 2005).
To obviate this, Bank of America has made some online initiatives like implementing of Sitekey solutions to its online customers. This is mainly intended to manage the risk from huge online pool users. In Sitekey, BOA has employed a cluster of flash-enabled objects and cookies to corroborate both provider and user. (Barack, 2008, p.8).
BOA and HR Outsourcing risk
BOA has decided to outsource some of its non-core function like HR functions. It partnered with Exult for this purpose. The main concern of the bank was those how 700 employees who were employed in the HR department that is going to be outsourced is to be taken care of. Further, BOA is also concerned about any possible interruption of work due to transfer of payroll, accounts payable department to Exult. Further, Exult has been asked to take care of the employees status quo and there should not be any degradation of employees service on transfer to Exult. As a confidence building measure, it also invested in equity of Exult and subscribed nearly 10 million shares stake in Exault.
Thus, BOA is fully aware the risk of outsourcing its HR division and however it has taken all precautionary steps to avoid any pitfalls. BOA thus made equitystakes, gainsharing and other risk-payoff pricing arrangement mainly to improve the value that can be accomplished through outsourcing. However, BOA is aware that their definitive triumph is built on mutual faith and cautiously understanding what is needed. (Goolsby, 2002).
Employee Benefits Risk
In addition to salary, BOA offers incentive and bonuses on the basis of its associates performance. It offers a choice of vision, dental and medical plans to its employees and their families. Their insurance scheme offers income supplement in case of grievous death or injury to employees. For its associates, it offers bank-funded healthcare benefits.
Some other employee benefits include the following:
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Reimbursement of tuition fees
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Offering Employee Assistance programs and LifeCare facilities to its associates.
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It also offers 401(k) retirement scheme to its eligible employees
The Bank of America offers flexible benefits scheme from the year 2005 onwards to its associates. This facilitates its associates to select one from more than 20 options and almost about four-fifth of its staff are already enrolled in the scheme. This plan is also extended to recently acquired NBNA associates in Canada and in Ireland. This demonstrates the banks pledge to match staff contributions to health, learnig and wellbeing accounts and this is really a pioneer step to support its associates self-development and behavior change. Federal government intends to ban too high executive compensation by restricting the incentives for risk-assuming which has been designed into pay structures.
Further, there is a proposal by Stock Exchange Commission mandating companies to divulge how paypackages impacts risk-assuming in their yearly proxy statements. Reacting to this, BOA commented that its compensation committee had employed rational attempts to make certain that pay structures do not encourage its top executives to assume unwanted and too many risks that will jeopardize the value of the bank. ( www.bankofamerica.com)
References
Angelopoulos Panos & Mourdoukoutas Panos. (2001). Banking Risk Management in a Globalizing Economy. London: Greenwood Publishing Group.
Barack, L. (2008). Think Slow and Steady to Beat the Street. On Wall Street, 18(8), 49. Web.
Crouhy Michel, Galai Dan & Mark Robert. (2001). Risk Management. New York: McGraw-Hill Professional.
Goolsby, Kathleen. (2002). All or Nothing at All. An Outsourcing Drama of Contrasting Characters. Web.
Greuning, Hennie Van & Bratanovic, Sonja Brajovic. (2009). Analyzing Banking Risk. A Framework for Assessing Corporate Governance. New York: The World Bank Press.
Hurd Mark & Nyberg Lars. (2004). The Value Factor. How Global Leaders Use Information for Growth. New York: Bloomberg Press.
Smith Donald. (2005). Customer vs. Bank of America : Who is to Blame? Web.
www.bankofamerica.com (2009). Annual Report -2008. Web.
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