Analytical Decision Support for Banking – the New ‘Normal’ Context

1. Make Smarter Decisions Faster Analytical Decision Support for Banking – the New ‘Normal’ Context Abigail Gammie IBM UKI

2. Context – Tough Economic times set to continue and may worsen • Here we are 4 years in to the ‘crisis’ with no real end in sight. How is this likely to play out and what are the implications for the global banking industry? • The Eurozone continues to experience problems and there is no apparent solution • Growth is stagnant and access to capital markets constrained • More countries may require external assistance • Interest rates in the UK are effectively reset at a historically low new ‘normal’ - a Japanese scenario that is likely to persist • Lower interest margins and old hedges roll off reducing margins further • Reduced lending volumes due to sluggish economy and lack of consumer confidence – house prices and jobs • Funding difficulties for banks continue across the region – constraining growth in mortgage lending and adding to damper on HPI • To cap it all – increased capital ratios and liquidity buffers Banks cannot grow their way to happiness but must leverage their existing balance sheet – as well as reduce costs

3. Our client’s challenge: Top of mind Risk and Regulatory Compliance business issues What’s keeping executives up at night? • Ensuring regulatory compliance • Managing through regulatory change • Managing regulatory exams, audits and requests (e.g. FFIEC) • Reducing cost for policy and control management • Adherence to policy and procedures • Lower AML and Fraud false positives, analyst efficiency • Reducing risk exposure • Ensuring regulatory compliance • Reducing control testing and internal audit burden • Reporting on risk exposure against business objectives and IT KRIs • Preparing for internal and external audits and RCSAs • Business continuity risk • Vendor Risk • Employee Fraud and Security Monitoring • Risk adjusted forecasting and risk-based resource allocation • Better financial risk management (e.g. market, credit, liquidity, stress testing) • Regulatory requirements • Financial reporting (e.g. SOX, IFRS, FSA) • Fulfilling compliance obligations (e.g. BSA / AML, SEC, FINRA, FSA, BaFin) • Aligning risk exposure with business objectives • Risk management across market, credit, operational domains • Ensuring adequate regulatory and economic capital and liquidity • Quantifying risk exposure • Avoiding unexpected loss • Establishing risk appetite • Risk culture and policy CRO CFO CIO / CISO CCO

4. Market forces are driving increased focus on enterprise risk management and compliance capabilities • Where is capital used? • Where is the bank profitable • Where do we create Value? • How can we do better? • What could happen next? • How we comply with Regulation? Net Margin Pressures Accountability and Trust Transparency Requirements Capital and Liquidity Requirements Capital Allocation Changing Regulatory Requirements

5. At the heart of the system is the CPP (Core Prudential Programme) The CPP is aimed at identifying and intervening earlier to head off emerging “big picture” or “life threatening” matters before they can crystallise in any of the largest and most systemic retail and commercial banking groups in the UK (“A* banks”). CPP is designed to be more granular in its focus than current Close & Continuous (C&C) model and Arrow work, i.e. the FSA will look more deeply into the underlying businesses and asset portfolios based on: Additional in-depth reviews for assessing the sustainability of business models and strategies; the effectiveness of governance, risk management and control; the capital robustness of firms under stressed conditions; and the adequacy of firms’ liquidity. Enhanced baseline monitoring of liquidity (largely in place already). Enhanced C&C monitoring for governance through a more structured review across the Board, Committees, executive management skills and MI, budgeting and risk appetite. It is a continuous process with findings collated formally once a year. CPP is designed for the top nine high-impact deposit taking groups, . CPP Modules Business model module In-depth assessment of a firm’s business model to understand its risk appetite better and challenge its sustainability using a proposed new conceptual model and supervisory toolkit to identify material vulnerabilities. Governance module Informed by the knowledge gained across CPP, a continuous process of assessment through an enhanced C&C programme together with a more in-depth case study, which will apply a structured methodology to drive an annual formal assessment ahead of the next scheduled Arrow. Risk management and control module A more structured, in-depth review of a firm’s risk management and control effectiveness to assist in identifying where conditions exist in which life-threatening issues may occur. Capital module A structured integrated framework to stress test the capital robustness of the firms, using consistent central case and stressed case scenario prescribed and applied by both firms and the FSA. Liquidity module An enhanced rolling programme of in-depth liquidity reviews to complement the proposals under the Liquidity Programme for enhanced baseline supervision and C&C monitoring Lets spend some time on the regulation of the industry – which has grown more challenging and more onerous but has yet to prove its not merely shutting the stable door…. The new CPP is designed to be a comprehensive review of the firms business model and to identify key weaknesses that could compromise its viability under stress situations

6. 2 Customer Value Proposition 3 Profit and Funding Model Incorporate information about peers and the marketplace to challenge or validate risky elements in the business model Map the firm’s model against an FSA standard (per sub-sector) to identify issues, dependencies or links that may challenge a firm’s sustainability Overlay macroeconomic trends and data to challenge the robustness of the model and input assumptions underlying a firms strategy Business Model Sustainability Assessment Framework Establish whether the firm has a credible and sustainable customer proposition in material areas of operation which will ensure that it can continue to develop its business and attract customers Assess the track record of management to deliver the strategy and the strength of its franchises to underpin the delivery of its proposed strategy Business Model Sustainability Assessment Framework Element specific challenge Assess the business mix of the firm along product, customer and geographical lines to establish whether it is potentially under or over diversified, and/or placing undue reliance on a vulnerable area of activity Peer group and market analysis for themes, outliers and herds Business Model Value chain analysis 1 8 Assess whether the firm’s strategy raises potential risk, which is not sustainable in line with the risk appetite of the FSA 4 Business mix Macroeconomic analysis Business Strategy and underlying assumptions Returns and risk appetite Franchise and management strength 5 Operating Model Elements Incentives, KPI, metrics and targets 6 Review the firm’s incentives, metrics, KPIs and targets used to steer and measure its strategic, operational and competitive position Challenge the firm’s key resources including funding sources and drivers of profitability across all business and regions at a product level and company level and explore vulnerabilities 7 Key processes and infrastructure Understand whether the firm has a sound fundamental operating architecture which can sustain the current and future business Assessment Approaches Challenge each of the 8 Elements both quantitatively and qualitatively to determine if the business presents a viable, coherent story of a sustainable business Overall assessment of the acceptability of the risk/reward balance inherent within the strategy and business model

7. Governance and Risk management & control framework In reviewing governance of a firm FSA will be assessing whether appropriate structures and processes are in place to enable the firm’s Board and Executive to interface effectively such that there is an appropriately agreed strategy, a clear appreciation of the related risk appetite such that the Executive is able to operationalise strategy with that risk appetite subject to effective oversight and challenge by the Board. These structures and processes must be supported by appropriate management information to enable decision making and monitoring, and operated by the right people incentivised in the right way and within an appropriate culture. They should also be subject to independent challenge by the risk and internal audit functions. In reviewing Risk Management and Control for the purposes the FSA will be assessing the way the Executive implements strategy within the agreed risk appetite and implements effective risk management and operational controls to assure this risk appetite is not exceeded. Governance module Establish goals & objectives Assess risks and performance against strategy and risk appetite Risk management & controls module Key enablers Assurance over risk management Develop strategies to manage risks within appetite Effective Boards, Committees & Structures Management information and data Incentivisation, people and culture Monitoring & enhancing risk control processes Design & Implement risk control processes

8. So Having reviewed the regulatory framework and the history what are the main responses that we are seeing? • Focus on improving profitability sustainably by looking at cost across the board • Unit labour costs • Efficiency savings (BPM) • Legacy IT simplification and spend reduction • Focus on RoE and RoRWA to drive share price – this is good for the taxpayer! • Balance sheet optimisation • Closer engagement with the customer to re-build trust • Here data and analytics are key • Increased spend in the risk space • 50% of consulting spend is in this area • Stress testing and compliance • Infrastructure renewal – payments in particular although core banking remains an issue that is not addressed it must be eventually • Cost of compliance – how do we make it cheaper?

9. How Optimisation helps resolve the complex problems Optimization helps businesses make complex decisions and trade-offs about limited resources Discover previously unknown options or approaches Automatically evaluate millions of choices Automate and streamline decisions Compliance with business policies and regulations Free up planners and operations managers so that they can leverage their expertise across a wider set of challenges Explore more scenarios and alternatives Understand trade-offs and sensitivities to various changes Gain insights into input data View results in new ways