Microsoft Word Thesis Gent (1). doc

4.4 Risk Control 
Once the risk has been measured than the institution should make sure to embody the 
risk limits on policies, procedures, standards and clearly define who is the responsible 
for the execution of these limits. Such limits are created with the purpose of controlling 
various risks that arise on the activity of banking institutions. However, when 
institutions are warned, they can make exceptions and change the existing limits. On 
the other hand, if banking institutions want to minimize the exposure to different risks, 
they may use different mitigating tools, (RBOM, 2007). 
In addition, a risk management system should be safe and stable. In order to achieve 
that the system should have the following elements:
a. Board of directors and senior management supervision
b. Proper guidelines, techniques and restrictions 
c. Sophisticated risk quantity, management information system and monitoring 
4.5 Credit risk 
Credit risk is the possibility that the bank-borrower may not fulfill the requirements 
upon which was agreed. The credit risk management is highly important, because 

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through its operation the credit risk is meant to be minimized, while at the same time to 
“maximize bank’s risk adjusted rate of return” which would be achieved by keeping the 
credit exposed to the acceptable norms, (MFSA, 2002). 
Credit risk is composed of two elements that are quantity of risk and quality of risk. 
Quantity of risk is considered the large loan balance on the date of default. On the other 
hand, through quality of risk is explained the harshness level of losses which are 
identified by both probability of default (PD) and Loss given default (LGD). Therefore, 
credit risk results of default risk and exposure risk (ER), (Raghavan, 2003). One of the 
core functions that banks have always exercised is lending which of course has been 
realized by evaluating accurately borrower’s creditworthiness. However, the methods 
used differ depending from the borrower. Also, they will differ depending on the nature 
of lending that is being considered, (Gestel & Baesens, 2009).  
During 1990s because of the moral hazard and negative selection, banks in Czech 
Republic started to invest client’s money in poorly analyzed and monitored agreements. 
Moreover, many small banks where related personally with their clients, therefore the 
credits that they released where on bases of ‘political’ or personal relations, rather than 
economic attributes, (Matousek, 1998). Additionally, since during 1990s the loans and 
credits composed a high portion of banking assets, the CNB supervised closely the 
credit policies and credit risk management, (Gersl & Seidler, 2011). It is important to 
draw attention to the fact that Czech Republic compared to other countries in transition 
has the highest amount of loans granted to corporation, in relation to GDP. Many states 
like Germany and Belgium leave their banks to make and manage their own 
provisioning policy. On contrary, CNB was quite strict regarding the provisioning 
policy, and the rationale behind this action was that Czech banks were not enough 
reliable in making provision, which would reflect the expected credit loss, (Craigwell & 
Elliot, 2011). The method used by CNB was quite simple and it was a guarantee for a 
minimum level of provision. Furthermore, it is important to emphasize that the credit 
risk was not restricted only to small banks. 

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As other emerging economies, the Czech Republic banking sector has had continuous 
high level of classified loans. However, comparing Czech Republic small banks to 
other big or international banks, on average the Czech Republic small banks promised 
higher yields on deposits and granted high yield, risky loans. Furthermore, small banks 
had a restricted access to inter-banking market of Czech Republic and the international 
one, and were not eligible for sustainable financial aid from the government as they 
were small banks and considered as non-TBTF (too big to fail). The Czech Republic 
losses from the credit risk were valued to be 400 billion (or USD 19 Billion), which in 
per capita terms was CZK 40,000 (USD 1,900), (Mejstřík, Pečená & Teplý, 2008).