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