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I. Regarding RISK MANAGEMENT PRACTICES, for companies that trade in US markets this was a key area that was supposed to be addressed by one of the more controversial (among businesses) provisions of the Sarbanes Oxley Act.

SOX Section 404 requires companies' own financial reports to include an assessment of their own "internal controls" - including specific identification of any "material weaknesses" in controls that the auditor found, plus management's plans and schedule for correcting those weaknesses.

"Internal controls" primarily relate to operational risk, NOT market risk - that is, they involve things like who oversees who (making sure the same person can't approve their own trades, or both authorize outlays and sign checks - which could allow someone to pay checks to themselves, etc.)

Still, it seems to me that failures to properly manage market exposures will often be linked to poor internal oversight policies - which would have to be reported in the Section 404 disclosures referenced above.

So, your area of interest for "risk management practices" is US banking institutions, you would do well to read carefully the Section 404 disclosures, especially as regards "material weaknesses," in the next round of annual reports by financial companies.

Of course, since audits are confined to annual reports not quarterly ones, you'll have to wait until next March or so for these reports to be released.

Here is a relevant portion of the Summary of the SEC rule implementing this SOX provision (http://www.sec.gov/rules/final/33-8238.htm)

"As directed by Section 404 of the Sarbanes-Oxley Act of 2002, we are adopting rules requiring companies subject to the reporting requirements of the Securities Exchange Act of 1934, other than registered investment companies, to include in their annual reports a report of management on the company's internal control over financial reporting. The internal control report must include: a statement of management's responsibility for establishing and maintaining adequate internal control over financial reporting for the company; management's assessment of the effectiveness of the company's internal control over financial reporting as of the end of the company's most recent fiscal year......"

II. Regarding ASSET QUALITY, Wall Street analysts who cover the Financial Institutions sector seem to pay close attention to the classification of an institution's assets into 3 groups based on accounting method for valuing the assets on the balance sheet. Those groups are known colloquially as Levels 1, 2 and 3.

Level 1 is assets valued at market prices. Level 2 is "market-based" (the balance sheet value is determined by taking the market price for some similar asset or index and adjusting it or applying a formula to make it applicable to the particular asset). Level 3 is assets valued by discounting their expected cash flows - that is, a purely model-based value.

Throughout the crisis that began in summer 2007 there has been a tendency for the market to view Level 3 assets (or at least, the prices their owners assign to them) as lower in quality. The Level 3 approach is supposed to be used only for illiquid assets, for which no reliable fair market value exists. CDOs, for instance, often fall into this bucket.

Note that SEC and FASB guidance issued a few weeks ago encourages companies to make greater use of Level 3 valuations. Many people feel that such a change will lower the quality of banks' disclosures. I would hope and expect that markets will punish companies that do this in coming quarters.

So, in answer to this part of your question, I'd recommend looking at the ratio of Level 3 assets to total financial assets (or assets held for trading or available for sale) as a crude indicator of a financial institution's asset quality.

posted October 19, 2008

forget the standard rating agency nonsense.

Look up ""Z score" and "Q score" an easy find on the internet.

These are valid operational quantitative indicators or relative risk IMO

posted October 19, 2008