Risk Management
Risk Governance
Risk Management
Effective risk management is fundamental to our core strategy. We aim to create a risk-aware, UAE-based retail and commercial bank that is the most valuable bank in the UAE in terms of total shareholder return. Our business models are guided by a documented risk appetite plan and influenced by our risk culture.
Our approach to risk rests on an effective control framework and a strong risk management culture that guides our employees in the way they do business. Our risk appetite is approved by the Board and is operationalised and embedded by the rollout of risk policies, risk limits, exposure tracking and proactive action on emerging risks.
Approach to Risk Management
ADCB’s approach to the risk management process comprises four basic components:
- identification and assessment of risk;
- measurement of risk;
- control of risk; and
- monitoring and reporting of risk.
The understanding, identification and management of risk are essential elements for a successful risk management function.
Risk Culture
Identification, assessment and management of risk are the responsibilities of every staff member within the scope of their work and assignments. Our standards set the tone from the top and are central to our approach to balancing risk and reward. Personal accountability is reinforced by our ADCB Values, with staff expected to act with integrity in conducting their duties.
Three Lines of Defence
ADCB employs three lines of defence for the management of risk, understood as a clear set of principles by which to implement a cohesive operating model across ADCB. The model’s main purpose is to define accountabilities and responsibilities for managing risk across the organisation.
Governance Structure
ADCB strongly believes in a disciplined approach to managing risk and has actively fostered an organisation-wide culture of prudent risk management. All risk management reviews, decisions and actions are based on an approved enterprise-wide risk management strategy framework supported by:
- a documented risk-appetite statement;
- a comprehensive set of policies and procedures;
- clearly enunciated broad underwriting criteria by segment; and
- a risk governance structure incorporating sufficient built-in challenges, checks and balances.
Our risk management framework fosters the continuous monitoring of the risk environment and an integrated evaluation of risks and their interactions. Integral to our risk management framework are risk appetite, stress testing, and the identification of emerging risks, as discussed in this section.
Our risk governance structure emphasises and balances strong central oversight and control of risk with clear accountability for and ownership of risk within each business unit. Under ADCB’s approach to risk governance, the business primarily owns the risk that it generates and is equally responsible for assessing risk, designing and implementing controls, and monitoring and reporting their ongoing effectiveness to safeguard ADCB from exceeding risk appetite.
Ultimate responsibility for setting risk appetite and the effective management of risk rests with the Board. This is managed through a number of Board-level committees, primarily the Board Risk & Credit Committee (BRCC) and Board Audit & Compliance Committee (BACC), which ensure that risk-taking authority and policies are cascaded down from the Board to the appropriate business units.
The Management Executive Committee (MEC) has primary responsibility for implementing, overseeing and taking ownership of the enforcement of risk strategy and internal control directives laid down by the Board and Board Committees.
The management-level committees also actively manage risk, particularly the Assets & Liabilities Committee, the Management Risk & Credit Committee and the Recoveries Committee, all of which report into the MEC. The Risk Management function, headed by the Bank’s Chief Risk Officer, reports independently to the Board Risk & Credit Committee. The Risk function is independent of the Origination, Trading and Sales functions to ensure that balance in risk-reward decisions is not compromised and to ensure transparency of decisions in accordance with standards and policies.
The Risk function exercises control over credit, market, short-term liquidity, operational and compliance risk.
The Board Audit & Compliance Committee provides assistance to the Board to fulfil its duties to ensure and oversee the Bank’s financial statements; independence and performance of the Bank’s external and internal auditors; compliance with legal and regulatory requirements; and internal policies and control over financial reporting.
The Internal Audit Group (IAG) aims to apply a systematic and disciplined approach to evaluating and improving the effectiveness of ADCB’s risk management, control and governance processes. IAG reports directly to the BACC. The IAG consists of a team of auditors whose tasks are, among other things, to evaluate the quality of ADCB’s lending portfolio, the controls in operational processes, and the integrity of ADCB’s information systems and databases. IAG auditors, alongside the Compliance department, also ensure that transactions undertaken by ADCB are conducted in compliance with applicable legal and regulatory requirements, and in accordance with ADCB’s internal procedures, thereby minimising the risk of fraudulent, improper or illegal practices.
Business Model
ADCB’s main sources of earnings are interest income from lending and deposits and fee income from transactional and other services. Given the low-interest-rate environment in the UAE, the Bank’s net interest income, that is, the difference between the interest earned from lending and the interest paid on deposits, has been under pressure. In order to offset this pressure, the Bank is working to reduce costs and increase non-interest income without compromising the quality and standards to which ADCB is committed.
ADCB’s activities expose it to a number of risks — credit risks, concentration risks, market risks, operational risks, liquidity risks and interest rate risks. Various Bank sub-committees and working groups regularly manage and monitor these risks. The Bank’s Internal Capital Adequacy Assessment Process (ICAAP) assesses these risks and the capital required to manage them. Key risks are measured by risk-weighted assets (RWAs) and disclosed in our audited financial statements. Further, a detailed list of the risks related to investing in the Bank’s securities can be found in the Bank’s GMTN prospectus here.
The most significant of these is credit risk. Credit risk arises from lending activities. The second most significant source of risk in terms of RWA impact is operational risk. Its importance is increasing as a result of changes driven by regulation as well as the Bank’s strategy. Market risk arises from the Bank’s trading activities (traded market risk) and from the impact of changes in market prices on the value of the Bank’s other financial assets and liabilities (non-traded market risk), and is the third most significant risk as measured by RWA. ADCB is also exposed to a range of other risks discussed later in this section.
Our risk-weighted assets by risk type are disclosed in Note 50 of the audited financial statements.
Emerging Risk Scenarios
Identifying and monitoring emerging risks are integral to our approach to risk management. Emerging risks are events that, should they materialise, would lead to a significant unexpected negative outcome, thereby causing the Bank as a whole, or a particular division, to fail to meet one or more strategic objectives. In assessing the potential impact of risk materialisation, we take into account both financial and reputational considerations.
The broad categories of emerging risks that could materially impact ADCB are as follows:
Concentration risks
- Increased exposure to large client groups creates concentration risk. The most successful client groups will require increased credit support to sustain their growth.
Mitigation
The Bank monitors concentrations on a continuous basis by customer group, by industry, by geography and by credit risk profile. Risk-Adjusted Return on Capital is strictly enforced in business-screening criteria to ensure that all facilities proposed are appropriately structured and that client income generated is commensurate to the risk weight of assets booked. As a result of these measures, the top 20 largest customer exposures reduced from 41.44% of gross loans in 2013 to 37.04% in 2014 despite an increase in Net Loans and Advances overall. ADCB has one of the highest Capital Adequacy Ratios among UAE and GCC peers as at 31 December 2014.
Macroeconomic and geopolitical risks
- Any attack by militants would result in a fundamental reappraisal of both the UAE’s and the wider region’s risk profile.
- A further uptick in tensions between the West and Iran could result in deterioration in the UAE’s sovereign risk profile, given the close proximity and deep trade ties between Iran and the UAE.
- Downside risks to oil prices in 2015 are elevated, which could undermine the UAE’s macroeconomic recovery.
- Geopolitical risk remains high in the Middle East as a result of the continued violence and unrest in Egypt and the civil war in Syria, which may spill over into neighbouring countries. Tensions between Israel and Iran add to the risks in the region, although diplomatic contacts with Iran’s new administration may engender an improvement in relations.
Mitigation
The Bank has increased its monitoring of the geopolitical and economic outlooks. ADCB has hired a Chief Economist to centrally assess the economic impact of changing geopolitical risks and provide key inputs to drive the Bank’s strategy. Where necessary, we adjust our country limits and exposures to reflect our appetite and mitigate these risks as appropriate.
Regulatory and legal risks to our business model
- Regulatory developments affecting our business model and profitability arise from governments and regulators continuing to develop policies that may impose new requirements, including in the areas of capital and liquidity management, operational risk, central counterparty exposures and business structure.
- Increased costs and reputational damage arising from a failure to achieve fair customer outcomes also pose risk to our business. We are customer-centric by design. In order to achieve our strategic objectives, ADCB puts the customer at the heart of the business. Failure to do so would cause the Bank to fail to achieve strategic objectives, which would affect earnings, liquidity, capital and shareholder confidence adversely. The risk of failure affects all divisions.
Mitigation
We ensure that new requirements are properly considered and can be implemented in an effective manner. We also ensure that our capital and liquidity plans take into account the potential effects of any changes. Capital allocation and liquidity management disciplines have been expanded to incorporate future increased capital and liquidity requirements and to drive appropriate risk management and mitigating actions. ADCB plays an active role in trying to influence the regulatory landscape of the UAE. ADCB either chairs, or is a key member of, several UAE Banks Federation forums.
The Bank has launched several initiatives:
- A new management-level committee, the Customer Experience Committee, ensures customers enjoy a superior and consistent experience.
- Net Promoter Scores (NPS) are part of every employee’s core objectives.
- Fast feedback loops have been incorporated for every customer-facing activity, with defined response times.
Risks related to IT/data security
- Increased losses arising from cyberattacks: such attacks are increasing in frequency and severity across the industry. This risk affects all divisions. A successful cyberattack could lead to fraudulent activity or the loss of customer data. The Bank could experience significant losses as a result of the need to reimburse customers, pay fines or both. Furthermore, a successful cyberattack could cause significant damage to the Bank’s reputation.
Mitigation
The Bank has initiated a large-scale programme to improve controls over user access. In addition, we have reviewed our websites and taken steps to rationalise them; put additional anti-virus protection in place; obtained insurance to cover data-security risk; and taken steps to educate staff on information protection.
Stress Testing
Overview
At ADCB, stress testing is recognised as an essential risk management tool by the Board, senior management, the businesses and the Risk and Finance functions. Stress testing is embedded in the planning process of the Bank. Our risk appetite has strong links to the stress tests and expresses the Bank minimum capitalisation rate under stress conditions.
BRCC and MRCC receive reports detailing stress tests undertaken as part of the financial planning process. These Committees review and challenge the stress scenarios and consider their impact on ADCB’s financial position. ADCB does both Bank-level balance sheet stress tests and specific portfolio-based stress tests.
We use stress-test scenarios that target both firm-wide vulnerabilities and negative global impacts. The relevant stress-testing scenarios are selected based on likelihood and what we believe we must actively plan for, including the following:
Bank-level balance sheet stress tests and profit-or-loss stress tests
- Market crisis — Severe tightening of liquidity and decline in securities values
- Global recession — Decline in global demand, oil prices and securities value coupled with monetary flight to safer economies
- Real estate crisis — Sharp decline in real estate property values and increase in defaults coupled with tightening liquidity due to uncertain counterparty risks
Portfolio-based stress tests
- Real estate sector — Impact of real estate price drop/oversupply
- Share lending sector — Impact of share price drop
- Retail portfolio — Impact of job losses in the UAE market
Stress-Testing Methodology
Scenario: Market crisis
- International finance markets collapse, leading to limited interbank and wholesale borrowings.
- Corporates with exposure to international equity and financial markets face liquidity pressures.
Specific impact
- Significant decline in interbank borrowing
- Limited decline in large corporate deposits as clients shore up liquidity, drawing down term deposits
- Slight increase in retail probability of default (PD) as firms lay off
- Slight increase in corporate PDs
- Significant increase in share portfolio PD as equity trading volumes plummet.
Scenario: Global recession
- Global macroeconomic recession leading to downturn in global and regional demand.
Specific impact
- Decline in overall market growth rate both for retail and corporate.
- Average PDs increase by approximately 50%, resulting in increased non-performing loans
- International hot money withdrawn
Scenario: Real estate crisis
- Significant decline in real estate and construction sector, affecting Dubai and Abu Dhabi at varying levels.
Specific impact
- Significant increase in PD related to wholesale real estate sector
- Some decline in retail assets due to layoffs
Balance sheet–based stress tests are done on a semi-annual basis and are part of the annual ICAAP exercise. The results of this exercise are taken into consideration in our capital planning process. These stress test results are part of the ICAAP exercise and are shared with the Central Bank of the UAE. ADCB’s capital adequacy ratio remains well above the UAE Central Bank 12% requirement. In all cases, ADCB’s internal risk appetite requires the Bank to meet a 15% target capital adequacy ratio even under the most severe stress scenario.
In terms of real estate stress-test results, ADCB’s portfolio loan-to-value (LTV) ratio remained below 100%, even with a 40% drop in prices. Similarly for share lending, the ADCB’s portfolio LTV remained below 100%, even with a 40% drop in prices.
Liquidity Risk
The general sources of stress on liquidity in banks emerge from the following factors:
- Over-dependence on more volatile funding sources, such as wholesale funds and interbank funds
- Depositors’ ability to switch funds among accounts by electronic means
- Ratings downgrades or other negative news that causes, among other things, reduced market access to unsecured borrowings from the call money market; a reduction or cancellation of interbank credit lines; and/or a reduction of deposits.
- Off-balance-sheet products can give rise to sudden material demands for liquidity at banks, including committed lending facilities to customers, committed backstop facilities, and committed backup lines.
A contingency funding plan is in place to mitigate the potential impacts of the above scenarios on ADCB’s liquidity profile. While undertaking the calculations, the following liquidity stress scenarios have been factored in:
Scenario: 1. GCC-specific market stress Market crisis
Locally generated market stress scenarios; e.g. political tension in GCC/worries over government support to banks
Assumptions
- All loans and overdraft are rolled over
- Loss of some deposits to international banks
- Some contingent claims on undrawn credit lines and liability behavioural assumptions
Scenario: 2. Global stress
Globally generated stress
Assumptions
- All loans and overdrafts are rolled over
- Significant loss of deposits to other banks
- Some contingent claims on undrawn credit lines and severe liability behavioural assumptions
Market Risk
Within ADCB, an independent Market Risk function is responsible for market valuation and implementing market risk policies. The function vets and approves all valuation models and measures and monitors market risk within a 99% confidence level through value-at-risk (VaR), stressed structural value-at-risk (SVaR) and Greeks. Losses beyond the 99% confidence interval are not captured by a VaR calculation, which therefore gives no indication of the size of unexpected losses in those situations. Therefore, the Market Risk function carries out daily stress tests/sensitivity analyses of the Bank’s portfolio to simulate conditions outside normal confidence intervals in order to analyse potential risk that may arise from extreme market events that are rare but plausible.
Stress testing is an integral part of the market-risk-management framework and considers both historical market events and forward-looking scenarios. A consistent stress-testing methodology is applied to trading and non-trading books. Stress scenarios are regularly updated to reflect changes in risk profile and economic events. The Assets & Liabilities Committee has the responsibility for reviewing stress exposures and, where necessary, enforcing reductions in overall market risk exposure. The Market Risk function considers the results of stress tests as part of its supervision of risk appetite.
Regular stress-test scenarios are applied to interest rates, credit spreads, exchange rates, commodity prices and equity prices. This covers all asset classes in the banking and trading books. Ad hoc scenarios reflecting specific market conditions and for particular concentrations of risk that arise within the businesses are also prepared. Market Risk runs over 300 stress tests daily distributed by risk factor per the table below:
| Risk type | # of stress tests |
|---|---|
| Interest rate (IR) | 92 |
| IR volatility | 6 |
| Foreign exchange (FX) | 77 |
| FX volatility | 36 |
| Historical | 9 |
| Bonds | 34 |
| Bond volatility | 2 |
| Commodity — Energy | 18 |
| Commodity — Energy volatility | 6 |
| Commodity — Metals | 12 |
| Equity Index | 14 |
