What Is a Market Risk Analysis?

Market risk refers to the risk of changes in the price or value of derivative instruments due to adverse changes or sharp fluctuations in the market price of the underlying assets. Changes in the market price of basic assets include changes in market interest rates, exchange rates, stocks and bonds. ^[1]

Market risk

Interest Rate Risk

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Market risk is the hardest of all the risks faced by stockholders, and its consequences for shareholders are sometimes disastrous. In the stock market, the market changes rapidly, and it is difficult to predict the direction and magnitude of market changes. Companies whose income is rising steadily, but their stock prices have fallen. We can often see this; there are some companies that have good operating conditions and stable income, but their stocks have risen sharply in a short period of time. fluctuation. The reason for this abnormal phenomenon is mainly due to changes in investors' general views on stocks or on certain types or groups of stocks. The volatility of most ordinary stock returns caused by changes in investors' views on stocks (mainly their expectations of stock returns) is called market risk.

Bank market risk

Market risk is actually the risk of bank losses due to changes in interest rates, exchange rates, stocks, and commodities. As the name implies, market risk actually includes four major parts: interest rate risk, exchange rate risk, stock market risk, and commodity price risk. As Chinese banks have limited stock and commodity business, their market risks are mainly represented by interest rate risk and exchange rate risk.

Interest rate risk is the most important risk in the entire financial market. Because interest rate is the opportunity cost of funds, the exchange rate, the price of stocks and commodities are inseparable from the interest rate. At the same time, because the credit relationship is the most important relationship between a bank and its customers, interest rate risk is the main risk faced by banks in their operating activities. In China, because the economic transformation has not yet been completed, the degree of marketization still needs to be improved, and the process of marketization of interest rates has just begun, and the issue of interest rate risks has only become apparent. Although the interest rate marketization process marked by deposit and loan interest rates has been advanced, the marketization of China's benchmark interest rate has not yet begun. The market factors affecting interest rates are still unclear, and the market still does not have an effective yield curve. Interest rate risk will gradually become The main market risk in China's financial industry.

Exchange rate risk is an important component of market risk.

As China s economy continues to grow,

More and more domestic companies will go abroad to invest overseas,

Exchange rate risks have also increased. At the same time, since the reform of the RMB exchange rate formation mechanism in July 2005, the risk of RMB against foreign exchange has increased significantly. From July 2005 to mid-May 2006, the appreciation of RMB against the US dollar has exceeded the psychological price of 8 yuan. With the further improvement of the RMB exchange rate formation mechanism, the role of market factors in the exchange rate formation mechanism will further increase, and the exchange rate risk of China's banking industry will further increase. Strengthening exchange rate risk management and supervision has become increasingly important.

Supervision

The Basel Capital Accord of 1988 only considered credit risk, but ignored market risk, and failed to pay enough attention to many new and complex OTC derivatives market risks. However, a series of major risk events in the 1990s made the Basel Committee aware of the importance of market risk, and then accelerated the pace of incorporating market risk into the scope of capital regulatory requirements. In January 1996, the Basel Committee promptly launched the "Amendment to the Capital Agreement on Market Risks". This amendment changed the simple method of determining off-balance sheet business against on-balance sheet assets in the 1988 Basel Capital Agreement to determine risk weights and accruing capital accordingly, and proposed two methods for measuring risk: standard method and internal model method .

The Basel Committee launched the Core Principles of Effective Banking Supervision in 1997. So far, market risk, credit risk, and operational risk have become the focus of bank supervision. In 1999, the Basel Committee began to amend the 1988 Basel Capital Accord. On January 26, 2004, the Basel Committee released the Basel New Capital Accord framework to replace the 1988 Basel Capital Accord. The new agreement incorporates the principles of comprehensive risk management including market risk in the 1996 "Amendment" and 1997 "Core Principles", and expands the definition of risk to various factors including credit risk, market risk and operational risk. It covers the risks faced by the banking industry at this stage to ensure that the sufficient capital performance of the bank is sufficiently sensitive to changes in the degree of risk caused by the development of banking business and changes in the structure of assets and liabilities. At this time, market risk factors are fully reflected in the various regulatory provisions of the Basel New Capital Agreement. In November 2005, the Basel Committee re-revised the 1996 edition of the "Capital Agreement's Amendment on Market Risks" to more clearly and detailed capital regulatory requirements for market risks.

Since the implementation of the "Amendment" in 1996, banks in most countries and regions have paid enough attention to market risk management. After 10 years of development, they have a relatively sound market risk management system.