An innovative approach to risk management in the banking sector that can change the ways things work

1. Introducing Risk Accounting
A methodology developed and promoted by
Financial InterGroup

2. To try something new or to repeat failure?
That is the question!
• The banking industry worldwide is torn apart by regulatory
attempts meant to stop the current crisis and prevent the
occurrence of a new one
• The previous Basel Capital Accords (I and II) have been considered
by academic researchers as falling short of their intended purpose.
Basel III is not expected to be different.
• As banks in the advanced markets have invested heavily in
implementing the provisions of Basel I and II, recognizing the failure
of their endeavors became difficult.
• Regulators and banks alike are facing huge challenges because the
financial crisis brought a new dimension to an already complex
problem.
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3. Challenges faced by banks
• Having to deal with poorly formulated regulations, little
support from the supervisory bodies and more and more
stringent capital requirements
• Compliance requirements inconsistence between the markets
that banks are operating in
• Centrally developed compliance policies don’t always apply in
all markets in the same way
– Policies are difficult to replicate in different markets
– Policies may not fit the market’s regulations
• Legislators introducing new and complicated legislation too
quickly in an attempt to prevent or limit the effects of banking
actions and activities that they don’t understand giving rise to
“the law of unintended consequences”
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4. What doesn’t work
• Disconnect between the operational management practices
and the risk reporting practices
– Taking repetitive snapshots of isolated pockets of risk exposure
without being able to:
• correlate them,
• identify the elements that influence them and
• monitor their evolution over time
• Isolated treatment of risk exposure – by business line, by
product etc.
• Subjective risk assessment instead of consistent, direct
measurement practices
• Adopting technology that promises to be the solution but
cannot deliver the promised results
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5. Opportunities for banks in emerging markets
• Avoid the mistakes made by larger banks in more advanced
markets
• Establish a compliance framework that would ensure
consistent results across the business lines, geographies,
products etc. as well as unprecedented transparency and
flexibility for a more cost effective compliance effort
• Avoid having to needlessly invest in technology without a clear
view of the desired outcomes
• Decrease and simplify the workload required for the
compliance assurance activities
• Become the innovation center of the world’s banking industry
and a role model for other commercial banks worldwide
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6. Risk Accounting
• A next generation accounting system that is designed to account for
transactions on a risk-weighted basis.
• The rationale on which the risk accounting methodology is
constructed involves the combination of operational metrics with
risk metrics.
– These are presented in tables populated with risk factors and associated risk-
weights that relate to notional transaction values, the inherent risk
characteristics of different products and the risk mitigation effectiveness of
related systems and processes.
– The applicable risk weights are extracted from the tables and tagged onto the
transactions which are then processed to produce quantitative and
qualitative risk metrics using a new unitized valuation metric called a ‘Risk
Unit’.
– Risk Units can be mapped and aggregated into cross-enterprise risk reports
and dashboards by product, organization, risk type and geography.
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7. Brief History
• The methodology was pioneered by Mr. Peter Hughes and his
team during his time with JP Morgan Chase
• The need for such a methodology was derived from the lack of
reliable risk information for use in monitoring risks and risk
related management decisions
• Years of research and experiments resulted in an operational
risk measurement system and a new risk measurement unit
• Over 2,500 cases provided the basis for research and early
experiments were successfully conducted within JP Morgan
Chase Bank
• The methodology was further refined and its scope enlarged
in the last 8 years when it also gained significant academic
recognition from leading universities
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8. Implementation Steps
• Pilot projects
– Applying best practice templates in live operating environments
– Ideally, conducting 2 pilot projects in 2 different business lines or
departments should provide comparative sets of results that would
prove the effectiveness of the methodology
– The pilots would also help calibrate the measurement parameters of
the methodology relative to the market
• Methodology introduction through a compliance framework
– Can be done through training or consulting assignments as well as
research projects in collaboration with regulatory authorities and
academic institutions etc.
– Support can be obtained from the Basel Committee once the pilot
projects produce meaningful results.
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9. Delivery options
• Research project – in a collaboration with the central
bank, the Banking Institute and possibly other academic
institutions
• Consulting assignment – within the bank
• Training assignment – for the bank’s personnel
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10. Conclusion & Next Steps
• Considering risk accounting as a compliance option is a
challenging choice but:
– It has already been proven to work within the academic world
and by pilot projects in various real world contexts. It can also be
tested at a smaller scale at fairly low cost
– The timing is perfect because the regulatory agencies worldwide
are actively looking for alternative solutions to Basel II that have
been proven in live operating environments
• Therefore, while the risk of failure is minimal, all that
remains is the desire to make a difference…
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