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On the appropriate function of trading risk management units: Primary roles and rational use of internal models

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Abstract

The intent of this paper is to evoke hands-on policies for trading risk units operating within financial entities. As such, this paper discusses the principal objectives of proprietary trading units and how they should originate adequate internal risk management models. Moreover, it provides a number of viable industry recommendations along with proper internal regulations and policies. The attempt is to provide several guidelines that can assist emerging markets in the establishment of reliable internal trading risk management models within a prudential framework of in-house regulations. The aim of this paper is to share with financial markets’ participants, regulators and policy makers some of the author's real-world know-how as a derivatives trader and later on as a trading risk manager in emerging economies. A number of key internal risk management rules that should be considered in strengthening trading risk management units are examined and adapted to the specific needs of emerging markets. This is with the objective of setting up a practical framework for trading risk measurement, management and control. The suggested internal regulations can be implemented in almost all emerging economies, if they are tailored to relate to each market's initial level of complexity and the fundamental needs of internal risk management models. The main contribution of this paper is in the introduction of practical trading risk management internal regulations that can aid in the proper implementation of the Basel II committee requirement on banking supervision. Although significant literatures have examined the statistical and economic usefulness of Value at Risk and other internal trading risk management models, this paper provides rational and down-to-business guidelines that can be applied for the establishment of adequate trading risk management units in financial markets. The paper will be of significance to those involved in the design of successful and consistent trading risk units in emerging markets.

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Authors and Affiliations

  1. Department of Economics and Finance, College of Business and Economics, United Arab Emirates University, PO Box 17555, Al-Ain, United Arab Emirates

    Mazin A M Al Janabi

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  1. Mazin A M Al Janabi
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Correspondence to Mazin A M Al Janabi.

Additional information

1 Mazin A.M. Al Janabi is Associate Professor of Finance and Banking and has several years of real-world experience in financial markets and banking sectors. He has held a number of senior positions, such as Head of Trading of Financial Derivative Products, Head of Trading Risk Management, Director of Asset and Liability Management and Director of Global Market Risk Management. He has written extensively, in leading scholarly journals, on trading, market and credit risk management. His research and consulting activities address practitioner and regulatory issues in risk management and derivative products.

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Al Janabi, M. On the appropriate function of trading risk management units: Primary roles and rational use of internal models. J Bank Regul 10, 68–87 (2008). https://doi.org/10.1057/jbr.2008.18

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