CORPORATE GOVERNANCE
Risk Management
The year 2020 proved to be one of the most challenging risk environments in history as the COVID-19 global pandemic heightened uncertainty and upended the way we view risk. While no material additional risk-taking took place, it escalated due to the economic downturn resulting from the health crisis.
Amid the difficult environment banks had to navigate, they are expected to remain in service while protecting themselves from the adverse effects of the pandemic. This prompted us at EastWest to shift our risk strategy from growth to capital preservation. Our risk and capital management strategies have become more prominent, with our risk-adjusted performance measure at the forefront, as we work our way towards economic recovery.
As the pandemic challenges were unprecedented, risk models derived from past experiences need to be redesigned as these can no longer adequately predict future losses. This forced us to adopt modeling techniques, rely on very limited data and our expert judgments to pursue the risk estimation process. This made 2020 a year of continuous risk model refinement, with particular emphasis on credit risk. With the ongoing pandemic, the risks continue to unfold, so we will continue to keep a close eye on emerging developments.
Risk management takes place in many different processes and operations throughout the organization. Our Board of Directors is ultimately responsible for the governance of risk management while our Senior Management ensures there is a common and efficient process in place. Part of the Board’s requirements are clear and transparent information about our enterprise risks and mitigating activities from all parts of our business operations.
We remained generally compliant with the risk-relevant regulations issued in 2020. While the new mandates from the Bangko Sentral ng Pilipinas (BSP) pose some challenges to our operations, we are committed to remain compliant.
Credit risk remains to be the principal risk exposure in our business, followed by operational risk, interest rate risk in the banking book, and market risk in the trading book. We also recognized marginal risk exposures to liquidity, credit concentration, compliance, reputational, and strategic risks. In addition to these risks inherent in banking, we also consider other risks borne out by more stringent industry regulations.
This is the risk faced when a company loses the value of its capital, which consequently puts it into a situation of having inadequate capital to cover for its risk exposures. We mitigate this risk by implementing capital risk management to ensure capital is preserved, and shareholder value is maximized while maintaining capital ratios above the minimum prescription of the BSP.
This arises when borrowers fail to meet credit obligations based on agreed terms, may it be repaying a loan or meeting a contractual obligation. In recent years, credit risks were classified based on the age of the loan portfolio or their doubtfulness, but under Philippine Financial Reporting Standards 9, banks should produce models on estimating losses on the portfolio. This obliges banks to forecast potential loss up to the entire life cycle of a loan account or portfolio.
Our credit risk remains manageable in 2020, underpinned by the satisfactory levels of asset quality, credit concentration, collateral, loss rate levels but more importantly adequacy of loss coverage.
We mitigate this risk by applying credit scorecards and minimum acceptance criteria for every customer product, and the Internal Credit Risk Rating System (ICRRS) for corporate clients. We also use a Board-approved Credit Risk Management Manual as guidance in performing credit evaluation for retail customers and credit underwriting for corporate clients. We regularly monitor key credit risk indicators and conduct stress tests based on internally determined and BSP-prescribed stress scenarios.
BSP CIRCULAR NO. 1093 – Amendments to the Real Estate Limits of Banks
This raised the limit on real estate loan exposure to 25% of banks’ total loan book from the current 20%. The prudential limit will also cover loans extended to corporate borrowers with real estate-related loans such as brokers, lessors, property management companies, and holding companies, among others. The BSP also mandated a real estate stress test (REST) to gauge banks’ exposure to commercial real estate loans, specifically to individual households, sole proprietorships, land developers and construction companies.
A universal/commercial bank which does not meet either or both the REST limits must also incorporate assessment of risks from this exposure in its internal capital adequacy assessment process (ICAAP).
Market risk arises as the fair value or future cash flows of financial instruments fluctuate due to changes in market variables such as interest rates, foreign exchange rates, and equity prices. Interest rate risk is the risk to current or anticipated earnings or capital arising from movements in interest rates. This can potentially hurt the financial results and capital of the bank arising from positions in the banking book. Interest rate risk arises due to changes in market interest rates, which have an impact on profitability. The major factors that lead to increased interest rate risk are the volatility of interest rates and mismatches between the interest reset dates on assets and liabilities.
While 2020 proved to be a year of dramatic movement in prices, overall, the very low interest environment helped cushion the foreseen impact of increased default for the Bank.
This risk relates to potential loss arising from systems, people, processes, and external events while in the conduct of our business and operations. Lapses and failures in delivery and performance of our functions and operations, after all, are not without consequences.
We address this risk by espousing close collaboration among the different units of the Bank, gathering pertinent operational risk data, producing the likelihood and business impact matrix for every risk category, and simulating the operational risk loss for individual events. An Operational Risk Management Manual also prescribes our risk appetite and tolerance for operational risk. Every month, there is monitoring and reporting of key risk indicators to the Risk Management Committee.
In 2020, the government’s implementation of lockdown restrictions and social distancing protocols forced us to shift the majority of our non-customer-facing workforce to work-from-home mode and virtual meeting platforms. While these remote setups presented some physical constraints, our risk management remains uncompromised. We invested in preventive measures as well as operated with defined risk tolerances as processes were adjusted to cater to customer demands under the new environment of remote banking services.
BSP CIRCULAR NO. 1085 – Sustainable Finance Framework
This provides high-level expectations on the integration of sustainability principles in the corporate governance, risk management systems, business objectives and operations of banks. The BSP expects banks to embed sustainability principles, including those covering environmental and social risk areas, in their corporate governance framework, risk management systems, and strategic objectives consistent with their size, risk profile, and complexity of their operations.
Further, operational losses, including compliance-related fines and penalties, are kept within financial loss limits, while liquidity remained ample as liquidity surplus was maintained and regulatory minimum prescriptions were exceeded.
While the development of vaccines holds much promise, our risk outlook for 2021 remains relatively the same as 2020, if not worse. This is because the brunt of the economic downturn is expected to be fully felt only in 2021 and recovery may happen only in the latter part of the year.
We will continue to prioritize capital preservation and do not foresee any incremental risk outside the effect of the pandemic. We will review our risk management strategy as we prepare to gear up for economic recovery by 2022.
Having an enterprise-wide risk management culture, where people running their respective business and/or operations are able or enabled to manage the risk/s that comes with their business and/or operations, has yet to be realized in the Bank. While we have already made progress in increasing awareness and recognition, we still need to embed a culture that goes beyond compliance or risk recognition, particularly in our day-to-day business or operational processes.