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Enterprise Risk Management. Roadmap. Definition & Background Framework Benefits Challenges Future Action Points. Definition. “An integrated framework for managing credit risk, market risk, operational risk, economic capital, and risk transfer in order to maximize firm value.â€
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Presentation Transcript
Definition
- “An integrated framework for managing credit risk, market risk, operational risk, economic capital, and risk transfer in order to maximize firm value.”
- ERM is also referred to as:
- Integrated Risk Management (IRM)
- Holistic Risk Management (HRM)
- Global Risk Management (GRM)
Risk Management Dept.
Background – Basel II
- Pillar I: Minimum Capital Requirement
- Banks may choose one of the many approaches to calculate capital for credit, market & operational risk
- Pillar II: Supervisory Review Process
- Contains the key principles according to which bank supervision should be done:
- Board and management
- Risk management models and process
- Internal control
- Stress Testing
- One of the targets is also to try motivate banks to hold capital buffers in excess of the minimum requirement.
- Financial Supervision should be proactive before bank capital goes under the minimum requirement
Pillar III: Market Discipline
- Includes recommendations and requirements especially regarding disclosure information.
Risk Management Dept.
Evolution of Industry Practices
Early Adopters
Barclays
GE Capital
Citigroup
JP Morgan Chase
CIBC
Fidelity Investments
Goldman Sachs
Merrill Lynch
Deutsche Bank
Bank of Montreal
Enterprise
Risk Management
Organizational
Business
Financial
Risk Management
Operations
Credit
Risk Management
Market
Market
Credit
Credit
Credit
Risk Management Dept.
Silo Approach to Risk Management
Credit
Risk
Market
Risk
ALM
Risk
Operational
Risk
- Chief Credit Officer
- CFO
- Business Managers
- Treasurer
- Asset/Liability Manager
- Internal Audit
- Corporate Actuarial
Who
- Investment Limits
- Portfolio Return
- Growth Limits
- Exposure Limits
- Portfolio Measurement
- Securitization/ Derivatives
- Trading and ALM Limits
- Value at Risk Management
- Financial Derivatives
- Controls
- Validation
- Audit Review
- Insurance
How
Risk Management Dept.
Interdependence of Risks
Financial Risks
Credit Risk Associated with Investments
FX risk in a new foreign market
Enterprise-Wide Risks
MarketRisk
Asset Liquidity
FinancialRisk
CreditRisk
LiquidityRisk
Business Risk
OperationalRisk
Credit Risk Associated with Borrowers and Counterparties
Derivatives documentation and counterparty risk
Funding Liquidity
IT and business process outsourcing
Risk Management Dept.
Integrated Framework
Performance Measurement & Management
ALM and
Investment
Strategy
Business Portfolio Management
Risk and Economic Capital Measurement
Pricing
Limit Setting
Reinsurance Optimisation
- Common measurement standard leading to common language
- Common risk ‘currency’, interpretation as capital
Risk Management Dept.
Integrated Framework
1. Corporate Governance
Establish top-down risk management
3. Portfolio Management
4. Risk Transfer
2. Line Management
Transfer out concentrated risks
Business strategy alignment
Think and act like a “fund manager”
6. Data and Technology Resources
5. Risk Analytics
Develop advanced analytical tools
Integrate data and system capabilities
7. Stakeholders Management
Improve risk transparency for key stakeholders
Risk Management Dept.
Dashboard Approach
Board of directors
Executives
Strategic risk
Enterprise risk management and chief risk officer
Credit risk
Market risk
Operations risk
Boards, senior executives, internal audit, finance, compliance, insurance/underwriting, risk management, legal, business continuity, business operations
Users
Managed. Efficient use of capital, resource allocation, compliance, earnings volatility, operational integrity
Informed. Fewer surprises, communication of policies,less scrutiny, ability to meet strategic objectives and cope with change
Impact. Minimize loss, improve shareholder value, appropriateness and adequacy of control, accountability
Benefits
Risk Management Dept.
Dashboard Approach
ERM Dashboard
BUSINESS RISK
CREDIT RISK
MARKET RISK
OPERA-TIONAL
RISK
RISK “PILLARS”
Data Mining
Internal and External Data
- Basic ERM applications:
- Executive reporting
- Key risk indicators
- Loss/incident tracking
- Control self assessments
- Early warning indicators
- Risk mitigation projects tracking
- ERM content management
- Advanced ERM applications:
- Risk transfer
- Economic capital
- Scenario analysis
- Shareholder value management
Risk Management Dept.
Compliance with risk policies and regulations
Exposures vs. policy limits
Regulatory compliance
Earnings-at-risk
Major internal drivers
Key external variables
Risk/return performance tracking
Business units
Customer segments
Products
“Right time” risk reporting
One touch visibility
Drill down capabilities
24x7 escalation
Early warning signals
An ERM dashboard should provide full Risk TransparencyRisk Management Dept.
How much value are you creating and where?
Where is your equity capital invested?
Economic Capital Allocation
Risk Management Dept.
Business Integration
Executive Committee
Risk/Return Analysis
Credit
Market
Operational
Organizational
Other
Total
Risk
Risk
Risk
Unit
EconomicCapital
Rs
Rs
Rs
Rs
Business Unit
%
%
A
%
%
RAROC
Business Unit
B
•
•
- Product/relationship management
- New product/business development
- Business strategy and planning
- Mergers and acquisitions
- Compensation strategy
- Resources allocation
•
Business Unit
N
Rs
Rs
Rs
Rs
Rs
TOTAL
%
%
%
%
%
Risk Management Dept.
ERM is driven by Best Practices, not Regulations
Proactive Approach
Reactive Approach
Currentstate
CEO
?
?
?
- Benchmarking
- Gap analysis
- Recommendations
?
?
Desired state (best practices or best-in-class practices)
Sarbanes- Oxley
Basel II
- Common themes
- Unique standards
New industry standards
Sarbanes- Oxley
New industry standards
Basel II
Governance Requirements
Governance Requirements
Risk Management Dept.
Benefits
- Broadens risk awareness
- Aligns risk profile and strategy
- Minimizes surprises and losses
- Rationalizes capital requirements
- Assures regulatory compliance
- Improves ROE and shareholder value
Risk Management Dept.
Banks should integrate ERM into Business Processes and Value Drivers
Risk Management Impact
- Risk-based pricing
- Target customer selection
- Relationship management
Revenue
-
Expenses
-
Losses
- Risk oversight costs
- Insurance/hedging expense
- Credit, market operational write-offs
ROE
- Capital management
- Risk transparency
Equity
Shareholder Value
New Business
- New business development
Growth
M&A
- M&A/Diversification strategy
- Risk Management by Silos (5, 6)
- Integrated risk management (4–7)
- Enterprise risk management (1-10)
Risk Management Dept.
Challenges
- Data availability & integrity
- Data warehousing/ mining
- Building up processes & systems
- Developing Human Resources
- Strengthening skills
- Model validation – requires greater collaboration with regulator
- Cost - investment in risk analytics and risk technology – getting management buy-in
- Stress testing, scenario analysis – building capabilities
Risk Management Dept.
Balancing the Hard and Soft side of Risk Management
Hard Side
Soft Side
- Measures and reporting
- Risk oversight committees
- Policies & procedures
- Risk assessments
- Risk limits
- Audit processes
- Systems
- Risk awareness
- People
- Skills
- Integrity
- Incentives
- Culture & values
- Trust & communication
Risk Management Dept.
Future
- ERM will become the industry standard
- Chief Risk Officer will be a visible figure in risk-sensitive banks
- Audit committees will evolve into risk committees
- Emergence of Economic capital
- Risk transfer executed at Enterprise level
- Technology key to advancement
- Measurement standards will emerge for Operational Risk
- Risk-based/ Economic reporting becomes a Standard
Risk Management Dept.
Challenges
- Data Availability (as per Basel II requirements)
- IT Systems (non-networked environment, integration with legacy systems, software)
- Change Management & Culture Shift (Risk and Corporate Governance systems, Operational Risk Measurement and Management, Emphasis on independence of risk from business etc)
- Analytical Skills (Modeling of default histories, Statistical analysis, Banking knowledge, VaR calculations etc)
- Retention of Human resources (specifically resources related to implementation i.e., IT specialists, Risk specialists etc)
Risk Management Dept.
Action Points
- The business units to decide on strategy/ timeframe
- The strategy could be growth or consolidation
- The Finance/ Planning to decide on capital allocation to business units and assess the risk as well as the return
- Risk Management to measure & monitor risks and enable estimation of risk premium
- Risk Management should not be biased by consideration of profits or performance evaluation
- I T infrastructure to enable data being provided for various analysis for risk evaluation and monitoring
Risk Management Dept.
