I. Executive Summary
Canadian
Imperial Bank of Commerce (CIBC) is one of the leading North American financial
institutions. It has over 140 years of serving clients in Canada and
around the world. Through its two distinct business lines, the CIBC Retail
Markets and the CIBC World Markets, CIBC provides a full range of products and
services to almost 11 million individual and small business clients and meets
the financial needs of corporate and institutional clients. In 2007, revenue
was $12.1 billion and net income was $3.3 billion. At year-end, market
capitalization was $34.2 billion and its Tier 1 capital ratio was 9.7%” (CICB
Annual Accountability Report, 2007).
However,
as of January of 2008 several investors of CICB are bailing out $2.75 billion
cash injections to infuse the bank with the necessary capital to survive the
global credit crunch. It has also caused significant drop in the bank’s stock
price. According to the bond rating service, CIBC’s rating is under review with
negative implications because of its risk management processes. On the other
hand, there are also major criticisms on the management of CICB by its chief
executive Gerry McCaughey (Silcoff, 2008) and other top management officers who
should not be in the risk committee.
Upon
review of the risk management of CICB, particularly the new Base II, it is more
likely that the present problem of the CICB due to subprime loan is not caused
by the mere policies and procedures of CICB risk management but by the few
individuals who should not be part of the risk committee.
II. Introduction
CIBC
announced a US$2 billion writedown due to the subprime losses (Corporate News,
2007). CIBC suffered in the same way as the banks in the US. Several top executives,
including its chief executive of World Markets and Chief Risk Officer were
fired because of the subprime write-downs of about US$3.3 billion (Duncan, 2008). Other
Canadian banks were not affected since by the subprime crisis of the United States.
Many blames the Canadian Imperial Bank of Commerce chief executive Gerry
McCaughey's and believe that he should be one of the top executives to go
(Silcoff, 2008).
The
changes in top management have earned several criticisms from the financial
industry except for the recruitment of director Nick Le Pan and chief financial
officer David Williamson (Silcoff, 2008). Changes in the Risk Management of
CIBC have also been implemented since December of last year. Both these factors
may greatly affect the outcome of CICB in terms of the problems of subprime
loans in the US.
At present, CICB manage risks by
following the guidelines and tolerance levels established by their Risk
Management (RM) Committee and Board of Directors. This is done by following the
set of procedures and standards set by the committee and the Board. The RM
assists the Board in identifying, measuring and controlling the business risks
of CIBC.
The
policies for key risk management are approved or renewed annually by the Risk
Management (RM) committee. It also measures, monitors and control the risks by
evaluating the risk if it is in accordance with the risk tolerance limits.
According
to the management guidelines of CIBC, stated in their Annual Accountability
Report 2007, the main priorities of the RM is the management and re-allocation
of risk resources to achieve the goals of CIBC; and to measure, monitor and
control the credit risks, market risks, liquidity risks and operational risks.
This also includes the legal risks of CIBC and its reputation (CIBC Annual
Accountability Report, 2007).
As of 2007, the RM reported that it
has achieved its target client satisfaction and financial results by
continuously enhancing the CIBC’s risk infrastructure. The RM is also
responsible in the implementation of Base II program of CIBC.
The different RM groups and other
groups of CIBC are also involved in the management of risks. These are the
treasury, Credit and Investment Risk Management Group, Market Risk Management,
Operational Risk Management, Balance Sheet Measurement, and Monitoring and
Control.
The Treasury provides the funding
and asset/liability liquidity, cash and collateral management for the
particular risk. It ensures that CIBC is fully capitalized and it also manages
the capital in legal entities, affiliates and subsidiaries. The Credit and
Investment Risk Management group provides the oversight of the adjudication,
monitoring and management of the global credit risks. It uses market based
techniques in measuring, monitoring and controlling of risks. The Market Risk
Management (MRM) provides oversight on management, monitoring and control of
the trading credit risk and trading and non-trading market risks. The
Operational Risk Management identifies, measures, monitors and controls the
CIBC’s operational risks.
The
Balance Sheet Measurement, Monitoring and Control provide oversight on
measurement, monitoring and control of the balance sheet resources, model risk
and economic capital. It is also responsible in overseeing the balance sheet
resource allocation process.
On November of 2007 CIBC adapted a
new framework for the management of its capital, the Base II Framework. This
framework is designed to enhance the risk sensitivity of regulatory capital
(CIBC Annual Accountability Report, 2007). The Basel II Framework consists of
three pillars: Pillar 1 prescribes the risk-focused regulatory capital
requirements, Pillar 2 deals with supervisory review, and Pillar 3 with market
disclosure (CIBC Annual Accountability Report, 2007).
The Base II Framework allows for
wider discretion for the individual banks in increasing or decreasing the
capital requirements. This allows for more transparency of risk management in
terms of capital adequacy and the risk.
II. Credit Risk Management of CICB
For Credit Risks[1],
the Capital and Risk Committee (CRC) is the group responsible for the oversight
of policies and limits which are subjected to annual review and approval of the
RM. The CRC is responsible for the implementation of the policies and in overseeing
the quality of credit portfolio. The senior manager repots at least once per
quarter to the RMC regarding the material credit risk matters. These include
the individual credit transactions, compliance with limits, portfolio trends,
impaired loans and credit loss provisioning levels. The RMC and the Audit
committee on the other hand are tasked to review the quarterly impaired loan
balances, allowances and credit losses (CIBC Annual Accountability Report,
2007).
Portfolio management decisions and
adjudications are then done based on the evaluation of risk as reflected by the
policies, standards and limits set by the committee. The risk appetite of CICB
is based on the policies, standards and guidelines, processes and controls and
risk concentration limits. The company’s credit risk is measured, monitored,
controlled and managed according to the set of policies, standards and
procedures created by the RM.
The approval of credit is controlled
centrally since all requests are submitted to the credit risk management unit
or to the RMC for approval. Once it is approved, credit exposures are monitored
regularly. Monitoring includes full risk assessment annually. While those that
are considered as higher risks are more closely monitored and reviewed
quarterly. Different groups, the specialized loan workout group and the
collections group, handle the management of the higher risk loans on a daily
basis.
The business and government loan
portfolios are managed against concentration limits and exposures. The concentration
limits are established for individual borrowers, industry sectors, selected
products or types of lending, groups of related borrowers and countries and
geographic regions. These are under strict underwriting standards. Higher risks
are reduced by using credit derivative hedges and direct loan sales.
To reduce risk in lending
portfolios, CIBC required third party guarantees and insurance, such as the
government’s guarantee on residential mortgages. Collateral pledges ensure risk
mitigation effects. Policies and standards for collateral management include
valuation, verification, legal certainty, and tracking, maintenance of
collateral and periodic updated valuations. Collaterals are in the form of cash
or securities, charges over inventory, receivables, real estate properties and
operating assets.
For Credit risk under the Base
II Framework, any institution may adopt any of the two approaches in
circulating regulatory capital. These two approaches are: (a) the standardized
approach which uses prescribed risk weights or (b) an internal ratings based
(IRB) approach which allows the use of a bank’s internal models to calculate
some, or all, of the key inputs into the regulatory capital calculation (CIBC
Annual Accountability Report, 2007).
In
the first approach, the standardized approach, eligible financial collateral
held by the institution reduces the amount of exposure and the exposures are
assigned the risk weights by the regulators. In the second approach, the IRB
approach, the institution may adopt the foundation approach or the advanced
approach.
Under the foundation approach, the
probability of default (PD), exposure at default (EAD) and loss given default
(LGD) are determined by the use of internal estimates. Under the advanced
approach, also called the AIRB, the probability of default (PD), exposure at
default (EAD) and loss given default (LGD) are determined by the use of
internal estimates and inputs to the calculation. This uses a more advanced
methodology and is more appropriate for the more sensitive risks since it
determines the needed capital requirement calculations for these risks.
III. Operational
Risk Management of CICB
Operational Risk[2] is
under the Governance and Control Committee (GCC). It oversees the management of
internal control framework and objectives set by the Senior Executive Team
(SET). On the other hand, the SET is the one answerable to the Board of
Directors, the RM and the Audit Committee in terms of internal control.
Under the internal control framework
the individual businesses have the full responsibility for the management of
the risk while the RM is the one responsible for the monitoring, controlling
and measuring of the operational risk. It is also the one responsible for the
businesses which manages the operational risks. They have to ensure that the
businesses comply with the policies and procedures set by the CRC and the RMC.
The people and processes operational
risks are moderated by the human resources policies and operational procedures.
The systems operational risks are managed through technology development and
change management.
CIBC has insurance programs to
reduce loses which might arise from operations risks, such as insurance against
property loss, criminal activities and damage and liability exposure. Aside
from insurance program, CIBC has global business continuity management program
to ensure continued normal operations in the event of major disasters. This
business continuity management program is subjected to regular review, testing
and updating.
For Operational Risk under the
Base II Framework, any institution may adopt any of the two approaches in
calculating risks: the basic indicator approach, the standardized approach and
the advanced measurement approach (AMA).
The basic indicator approached is in
accordance with the regulatory defined percentage applied to the annual gross
income of the institution. The standardized approach is the same as the basic
indicator approach except that instead of regulatory percentage, multiple
regulatory percentages are applied based on the regulatory specified business
line. The advanced measurement approach (AMA) is the application of qualitative
and quantitative criteria on both the internal and external data and scenario
analysis. On circulation of regulatory capital, CICB uses the AMA approach.
Under the Base II operational risk
measurement includes expected and unexpected losses which may arise from legal
liability, client restitution, regulatory compliance and tax violations, loss
or damage to assets, transaction processing errors and theft, fraud and
unauthorized activities.
IV. Market Risk Management of CICB
Market Risk[3] is
under the control of the CRC. Its internal control framework includes
individual market risk manager for each business. Aside from the market risk
manager, a regional risk manager is assigned to all four major trading centers.
This is to ensure comprehensive risk coverage.
CIBC has policies for market risks
and these policies includes identification and measurement of different market
risks, eligibility for inclusion in trading and non trading books and
establishing of limits. The policy in risk tolerance level is clear and well
defined since they are measured according to the Value-at-Risk (VaR) and
potential worst-cases losses.
In
determining market risk and in setting limits on the amount of risk, CIBC uses
its three-tiered approach. Tier 1 limits are the overall market risk and worst
case scenario limits, Tier 2 limits are in controlling the risk profile in each
business and Tier 3 limits are the desk level and to monitor risk concentration
and impact of book specific stress events (CIBC Annual Accountability Report,
2007).
To
ensure that only authorized activities are undertaken, daily monitoring of
market risk exposures are done on approved risk limits. The daily risk and
monitoring report are based in the previous day’s repot. Limit compliance
reports and market summary risks are submitted weekly. These are reviewed by
the RMC every quarter and by the SET every week.
CIBC
uses different risk measurements: VaR, stress testing and scenario analysis and
backtesting. VaR compares the risk in different businesses and asset classes;
stress testing and scenario analysis gives insights on portfolio behavior; and
backtesting validates the effectiveness of risk measurement by using actual and
theoretical profit and loss outcomes (CIBC Annual Accountability Report,
2007).
In Market Risk Analysis under
the Base II, the market risks are subjected to the Market Risk Amendment to the
Basel Accord provision. CIBC continues to use the Internal Models Approach
(IMA) which was already approved by the Office of the Superintendent of
Financial Institution. According to the CIBC Annual Accountability Report of
2007, the IMA model has 99.865% efficiency rate for perceiving liquidity of
different trading portfolios.
IV. Recommendation
With the problems created by the
subprime crisis in the US,
many speculate on the effectiveness of CIBC’s risk management processes. Since
Gerry McCaughey took over the bank he aimed to change its reputation for the
better. One of the results of his actions is the failure of CICB’s proper
management of risks.
Since
the problem has emerged, CIBC has taken several steps into eliminating capital
market risks. It has also created changes in its risk management procedures, as
discussed above, since it was downgraded to negative ratings because of risk
management failings. McCaughey himself admitted that CIBC had “underestimated
the extent to which the subprime market might deteriorate and the degree to
which that would impact securities that were structured to be very low risk” (Duncan, 2007).
Based
on these, it is easy to assume that the failed risk management procedures of
CIBC stems from the individuals who should be more in control and knowledgeable
about what they are doing. The Board of Directors along with the RM committee
had failed in its role of protecting the bank against this financial risk.
The
first thing that CIBC should do is to understand the importance of having
reliable and able chief risk officer. The chief risk officer should have
financial and people skills. This is because the chief risk officers must be
able to coordinate effectively his people into implementing the policies and
procedures of the new risk management division. Of course, the financial skills
are necessary so that he can evaluate the potential cost of the risks on the
capital.
The
massive layoff of top executives of CIBC only shows that the bank did not have
an effective and able chief risk officer. Such massive financial loss also
shows that these individuals did nothing to protect the bank on such risk.
Moreover, the criticisms that the top executives were not really expert bankers
are proven to be true with this billion dollar loss.
Lastly,
CIBC is one of the leading banks in Canada and since it is the only
bank affected by the subprime crisis, it is impossible that the bank failed on
its risk management procedures alone. In conclusion, the problem of CIBC’s risk
management is not its guidelines, policies and procedures but the people who
are part of risk management. The Board of Directors and investors should start
taking a close look on the people behind the reign and see if they are capable
of fulfilling their appointed tasks.
Appendix 1
Appendix 2
Works
Cited
CIBC Annual Accountability Report. 2007. CICB.com
Retrieved 8 March 2008 from
http://www.cibc.com/ca/pdf/about/aar07-en.pdf
Corporate News Release. 2007. Micro.newswire.ca
Retrieved 8 March 2008 from
http://micro.newswire.ca/release.cgi?rkey=1512194538&view=14730-0&Start=0
Duncan Mavin. 2007. CIBC faces more questions about subprime.
Financial Post
Retrieved 8 March 2008 from
http://www.nationalpost.com/news/story.html?id=158782
Duncan, Mavin, 2008. Investors prop up CIBC
with $2.75B injection. National Post
Retrieved 8 March 2008 from
http://www.nationalpost.com/news/story.html?id=237388
Silcoff, Sean. 2008. It's McCaughey
who should be gone. Financial Post.
Retrieved 8 March 2008 from
http://www.financialpost.com/analysis/story.html?id=1c9eeb01-5eec-4b6f-b1dd-36d9f1f69902&k=18323
[1]
The risk of financial loss due to a borrower or counterparty failing to meet
its obligations in accordance with agreed terms (CIBC Annual Accountability
Report, 2007)
[2] The
loss resulting from inadequate or failed internal processes, systems, or from
human error or external events (CIBC Annual Accountability Report, 2007)
[3] The
potential for financial loss from adverse changes in underlying market factors,
including interest and foreign exchange rates,
credit spreads, and equity and commodity prices (CIBC Annual Accountability
Report, 2007)
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